Wall Street Journal Europe
July 24, 2011
by Irwin Stelzer
Frau "nein" becomes Frau "ja," and the euro zone is saved. So we are told by the 17 Heads of State after a meeting that even the tough-minded analysts at Jefferies International concede "exceeded expectations."
Of course, past meetings helped set the expectations bar quite low. Still, let's not quibble: Because German Chancellor Angela Merkel and French President Nicolas Sarkozy decided that some progress had to be made lest Greece bring down Italy, Spain, and perhaps the euro, the Heads put their heads together and staved off—deferred would be a better word—a crisis that was about to burst on the euro zone, primarily because Ms. Merkel won her battle to have private-sector investors share the pain. The reaction of Ms. Merkel, not noted for her taste for irony, humor and displays of chutzpah, to U.S. President Barack Obama's call to remind her of the fragility of the world financial system and her fiscal responsibilities is not recorded.
The deal includes a new €109 billion bailout for Greece, contributed by member states, the International Monetary Fund, and a "voluntary" contribution by the private sector, demanded by Ms. Merkel. Through a variety of means private-sector creditors will share the cost of the bailout, putting Greece in "selective" or "restricted default," repaying some but not all of its loans in full and on time.
Greece is also to benefit from a variety of other measures, at least one of which—a two-percentage point reduction in the interest rate charged for bail-out funds—will also be made available to Portugal and Ireland. Extending the new, lower 3.5% rate to Ireland was a major concession by Mr. Sarkozy, who always wanted to withhold such a rate cut until Ireland raised its 12.5% corporation tax to the levels extracted by its euro-zone partners.
Oh, yes, and all euro-zone members promised to reduce their deficits and solemnly agreed to closer policing of their spending—after deleting the words "legally binding" from the earlier draft's description of the new national fiscal frameworks. Greek glee at the bailout was tempered by the Dutch and Finns' insistence that loans be secured by buildings and other state-owned assets. "It was very insulting," said Greek Prime Minister George Papandreou, who is having great difficulty delivering on past promises.
In order to allow the word "default" to be spoken in polite company, the deal had to include a way around the threat by Jean-Claude Trichet, head of the European Central Bank, to bankrupt the Greek banking system by refusing to accept as collateral any sovereign paper tainted by the default. Mr. Trichet wrung from the politicians an agreement to indemnify the ECB to the tune of €35 billion ($50.2 billion) for any losses it might suffer by allowing Greek sovereign bonds to be used as collateral by Greek banks.
Those who have long been aching to add fiscal to monetary union are pleased that the European Financial Stability Facility henceforth can finance the recapitalization of banks, and extend credit to countries bordering on but not yet in as poor a condition as countries in need of a bailout.
But the folks at Citigroup Financial Markets point out that expanding the ESFS' flexibility without providing it with more funds is the equivalent of giving it "new tools, but no more ammunition," something the bank's economists find "very disappointing." The €440 billion funding level of the ESFS, is in their view "a small number to support the European banking sector and the Spanish and Italian sovereign bond markets. Hence, the pressure on the Italian and Spanish bond markets is likely to stay high, suggesting adverse consequences for banks throughout Europe."
Even after the haircuts administered to private creditors, and the interest-rate reductions, Greece will remain burdened with a debt:GDP ratio of around an unsustainable 150%. Another write-down will surely be required ere long. Economists at Capital Economics Ltd. say that failure adequately to fund the ESFS makes them "doubt that the package alone will bring an end to recent contagion effects and prevent the debt crisis from continuing to deepen in coming months."
More important, there are aspects of this deal that will have profound but not easily visible consequences. Private investors must now recognize default risk when setting a price on the money they lend to euro-zone countries [U.S., take note]. And by what consultants at the Lindsey Group characterize as "formally collectivizing" much of the existing unsustainable debt and associated risk, the euro-zone policy makers have reduced each euro-zone members' incentive to fiscal prudence and economic reform.
Finally, the euro zone remains what it was before with one new feature. It is still a grouping with a huge north-south divide, with the southern tier stuck in the no-growth lane, unable to compete in a globalized economy. The Greek economy is shrinking at an annual rate of over 5%, and unemployment, now at 15%, is rising. And growth in the euro zone as a whole seems to have come to a screeching halt, which makes one wonder where the policy-making nous and money will come from to fund the "Marshall Plan" over which the Brussels eurocracy now plans to preside.
The new feature, the construction of additional architecture to facilitate the transfer of funds from north to south for as far ahead as anyone can see, increases the possibility that the southern laggards will prefer steady transfusions of money from their healthier northern neighbors to the hard work of strengthening themselves by changing their unhealthy work and fiscal habits. That's moral hazard writ large.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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