Whether the intergovernmental agreement for the creation of a fiscal union decided at the Dec. 8-9, 2011 EU summit will succeed is uncertain. Nonetheless the Eurozone leaders? decision to exclude bondholders from accepting partial losses (haircuts) on all possible future bailout programs was a major improvement in the search for a permanent solution to the European crisis. The decision amounted to an explicit admission that the Private Sector Involvement Plan (PSI), so insistently promoted by Germany and imposed only on Greece, turned out to be a great failure. This should not be a surprise to anyone. PSI plans undermine investor confidence in countries that accept them. In addition, these plans are not very practicable; the very fact that the representatives of the Greek government and those of the bond holders are still in search of an agreement demonstrates the difficulty in implementing them.
Meanwhile, the Greek economy is continuously deteriorating and financial markets? confidence has dissipated as indicated by the 10-year Greek government bond yield, which exceeds an extraordinarily high rate of more than 35 percent. Furthermore the Greek PSI program, via contagion, had a negative impact on the rest of the Eurozone countries, particularly these countries with relatively high public deficits and debt to GDP ratios. These countries experienced rising interest rates of their sovereign debt as investors lost confidence. This is an important reason that the crisis worsened, and as long as the Greek PSI is not abandoned, it will continue to be a source of contagion in the Eurozone (?Time to jettison the plans to hit Greek creditors, ? Financial Times January 6 2012, Athanasios Orphanides.
We propose that the European sovereign debt crisis must be resolved by Europeans. The EU or the17 EU countries that share the Euro (the Eurozone) have the means to easily cope with the crisis. What they are lacking is the firm determination to safeguard the Economic and Monetary Union (EMU) and the Euro at any cost. Once the importance of unity is understood and the governments clearly communicate this commitment to the markets, the solution will be quickly attained. The stronger the commitment and determination is, the smaller the cost of the recovery from the crisis. This requires that each Eurozone?s member government speaks with one voice. If such commitment had been demonstrated from the beginning of the crisis billions, if not trillions, of Euros would have been saved because the crisis would never have spread so rapidly to evolve into the worst recession after the Great Depression.
With the newly introduced policy, the ECB may have already started a reversal of the crisis. Unlimited availability of liquidity to Eurozone banks will possibly induce banks to purchase Eurozone countries? sovereign debt. Such a move will raise bond prices and reduce bond yields, thus making easier the refinancing of Eurozone countries? public debt. As a result, countries that have been practically cut off from the private capital markets because of the prohibitively high interest rates can be prevented from bankruptcy.
An alternative monetary policy is for the ECB to provide insurance guaranteeing Eurozone member countries? sovereign bonds. Such a policy could be an efficient way to restore stability through substantial reductions in government bond yields for solvent countries (?The Eurozone needs a post-Lehman style firewall,? John Paulson, Financial Times December 15, 2011). Eurozone countries such as Ireland, Italy, Portugal, and Spain will eagerly agree to pay a small fee to the ECB to insure their debt. As a result, they will be able to borrow in the market at low rates, maintain sustainable public debt to GDP ratios, and remain solvent. Consequently, the ECB will not have to lend to Eurozone countries, which is prohibited by the ?no bailout? clause of the EU treaties and will also increase its income.
Greece can benefit from the ECB?s bond guarantee program. However, it must reduce its debt to GDP ratio to a sustainable level prior to receiving sovereign debt guarantee insurance. Only solvent Eurozone countries should receive such service because they do not jeopardize the credibility of the ECB. Greek debt reduction should not be implemented through a PSI program as this is tantamount to bankruptcy, which will be detrimental, and stigmatize the country.
Alternatively, the ECB can engage in a one-time purchase of a portion of the Greek debt and thus reduce its debt-to-GDP ratio through a loan agreement with the ECB. This portion of the debt would be close to 100 -120 billion Euros, an amount almost equal to the haircut presently negotiated with the representatives of the reluctant bond owners. This amount is also approximately equal to the increase in the Greek debt since the country started negotiating the first rescue program with the Troika. Upon recovering from the recession Greece will agree to gradually begin repaying its loan to the ECB. The two solutions presented here with exception the purchase of 100-120 billion worth of Euros of Greek bonds do not violate the EU treaties. Granted, it is difficult for Greece to avoid the presently negotiated PSI plan as a large amount of 14.5 billion Euros of its debt expires in March 2012, Greece still must not accept the PSI program as a long-term solution to its economic problems. Even if the PSI plan is signed and executed it will be to Greece?s long-term benefit to pay back all losses imposed on the private bond owners in order to regain its credibility.
A restructuring of the Greek debt to be repaid during a much longer period at lower interest rates can make it affordable for Greece to meet its public debt obligations; thus, it will be a preferable and viable solution. This program could be adopted and implemented by the EU and the ECB without having to be complemented by a PSI plan.
If, however, the crisis continues and takes a turn for the worse, EU country leaders must take quick action. They must convene in a summit and announce their decision which must be backed by immediate real action proving that for first time in the last 19 months are serious to save the EMU the Euro and the EU. In this way the vision for a united Europe and the uninterrupted hard work for a period of over 60 years of so many practitioners of European integration will not be wasted. EU member-state leaders must temporarily delegate authority (perhaps for a year) to the ECB, the EU Commission, and the two European Courts to do whatever it takes to save the EMU and the Euro. The duration of this delegated authority to EU institutions should be long enough to be able to amend the existing treaties or to draft, approve, and ratify a new treaty.
The mere announcement of such a decision should be sufficient to calm the markets but if necessary, action will also follow. Initially the ECB will pursue the programs discussed above providing more liquidity to banks and insurance to government bonds. It can also buy national bonds and extend loans to the European Financial Stability Facility (EFSF); thus, the ECB will enhance the ESFS?s ability to carry out bailout programs of any Eurozone country regardless of the amount involved. Announcements of such strong commitments will certainly reduce the sovereign bond interest rates and will make the implementation of these programs unnecessary. This is one certain way that the discipline of economics could have been very useful. By providing advice to policy makers, economists would have helped save enormous amounts of resources by only affecting expectations and calming down markets.
In the meantime the EU leaders must seek a long- term solution to the sovereign European Debt Crisis. Amending the EU treaties or drafting a new treaty is the only way to protect the EU, the Eurozone, and the Euro from future crises. This will be a long-term democratic process that involves all EU countries? constituents, governments, and EU institutions. The amended or new treaty will create a fiscal union which will transfer all fiscal powers to the EU Commission, the European Court of Justice and the European Court of Auditors. This way the fiscal authority will move away from the member states, thus they can no longer violate the fiscal rules. The treaty must provide for the introduction of a Eurobond. Furthermore, the ECB should be given a dual mandate for both price stability and economic growth. The political path to creating supra-national institutions that take fiscal policy out of the hands of member-state governments will certainly be steep; it will most likely generate opposition from radical right (left)-wing political parties and Eurosceptics. Denationalizing the process of fiscal policy making and the specific policy instruments prescribed above will make it possible for the EU to apply effective stabilization policies. Under this new regime no EU country will ever be asked or dictated to follow only austerity measures that impoverish its citizens, lead to anarchy, and cause economic calamity.
* George Zestos is professor of economics and Jean Monnet Chair of European Integration and Tatiana Rizova is an assistant professor at Christopher Newport University in Virginia USA.