Time for euro zone to revisit debt default option
Now, cognisant of the high public debt burden assumed as a consequence, the Irish authorities are engaged in a debt-restructuring negotiation with the European Central Bank, offering to repay an obligation to the ECB over 40 years.
The flurry over the direct lending to banks by the European Stability Mechanism is also an argument about sharing the debt burden. The European Summit of June 29th opened up this tantalising possibility. The Irish authorities, supported by the IMF, saw an opportunity to place some of their burden on the collective shoulders of Europe. But was it a mirage?
The creditor nations now say the June 29th statement was unclear and, perhaps, “legacy” debt would not be assumed by the ESM.
The United States has federally funded deposit insurance for banks, a fiscal union, and a “no bailout” provision; bank rescues are centrally co-ordinated, and states have historically been allowed to default.
The ECB’s Outright Monetary Transactions – the bond-buying programme designed to lower interest rates for crisis-hit euro zone countries – may finesse the need for hard choices.
But if holding the taxpayers of the debtor nations liable remains the centrepiece of the debt-reduction strategy, growth will remain throttled and debt ratios will remain high. The ECB will be sucked further into burden-sharing.
It is time to revisit the default option. Stunningly little use has been made of bank resolution powers. There are well-known and orderly ways to bring banks’ creditors to the table and engineer debt-equity swaps. Similarly, there exist well-established techniques for sovereign debt reprofilings. The notion that markets would be “spooked” has no good basis. True, Lehman is still fresh in the memory. But the Greek debt-restructuring was well received. And resolution of the festering Latin-American debt crisis in the 1980s required a co-ordinated restructuring.
Procrastination is costly. The high debt ratios will perpetuate vulnerability, and episodic surprises will ignite new crises. In pursuing the elusive debt problem, European institutions will be undermined and uncertainty and slower growth will be imposed on the rest of the world.
The default option is economically efficient, it is fair, and it is politically sensible. It may be the only way to hold together an unsustainable structure that threatens to drive deeper divisions and set back the magnificent integration project on which Europe has embarked.
Ashoka Mody is Charles and Marie Robertson visiting professor of international economic policy at the Woodrow Wilson school, Princeton University. He was a deputy director in the IMF’s research department