Necessary euro bailout flies in face of capitalism
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Shanghai Daily, December 12, 2011
If any solution to the European crisis proposed over the next few days is to restore confidence to the sovereign-bond markets, it will have to be both economically viable and politically palatable to rescuers and rescued alike. This means paying attention not just to the plan's technical details, but also to appearances.
There is growing consensus about any solution's key elements.
First, Italy and Spain will have to come up with credible medium-term plans that will not just restore their fiscal health, but also improve their ability to grow their way out of trouble.
Second, some vehicle has to stand ready to fund borrowing by Italy, Spain, and any other potentially distressed countries over the next year or two. But there is an important caveat, which has largely been ignored in public discussions: if this funding is senior to private debt (as IMF funding typically is), it will be harder for these countries to regain access to markets.
Private markets need to be convinced both that there is a low probability of default, and that there is some additional loss-bearing capacity in the new funding.
This may seem unfair. Why should the taxpayer accept a loss when they are bailing out the private sector by providing new funding?
The simplest solution is to treat official funding no differently from private debt - best achieved if official lenders buy sovereign bonds as they are issued (possibly at a predetermined yield) and agree to be treated on par with private creditors in a restructuring.
The bottom line is that official funding must be accompanied by loss-bearing capacity. If the funding is channeled through the IMF, and is to be treated on par with private debt, the Fund will need a guarantee from the EFSF or strong eurozone countries that it will be indemnified in any restructuring.
Once the first two elements of the plan are in place, there should be little need for the third - bond purchases by the ECB in the secondary market in order to narrow interest-rate spreads and provide further confidence.
But there is one more element that is needed to assure markets that the solution is politically viable. Citizens across Europe, whether in rescued countries or rescuing countries, will be paying for years to clean up a mess for which they were not responsible.
Not all banks voluntarily loaded up on distressed government bonds - some were pressured by supervisors, others by governments - but many have made unwise bets. If they are seen as profiting unduly from the rescue, even as they return to their bad old ways of paying for non-performance, they will undermine political support for the rescue - and perhaps even for capitalism.
So a final element of the package ought to be a monitored pledge by eurozone banks that they will not unload bonds as the official sector steps in; that they will raise capital over time instead of continuing to deleverage (if this hurts bank equity holders, they should think of this as burden sharing); and that they will be circumspect about banker bonuses until economies start growing strongly again. Cries that this is not capitalism should be met with a firm retort: "Nor are bailouts!"
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