Merkozy decrees: no more losses
James Saft is a Reuters columnist. The opinions expressed are his own.
Call it the Merkozy Plan – there shall be no more losses.
German Chancellor Angela Merkel and French President Nicolas Sarkozy unveiled on Monday yet another final plan to save the euro, this time calling for new treaty provisions to ensure members maintain fiscal discipline as well as an all-too-predictable move to hold monthly meetings of EU heads, seemingly an attempt to revive Europe by providing business for its caterers.
Perhaps most importantly, the two agreed to scrap a previous agreement to make private sector creditors share in the losses in all future bailouts. Bondholders still face a 50 percent write-down on their holdings of Greek debt, but that’s it, from here on out it’s all going to come out of the hide of taxpayers.
Of course there is the (slim) possibility that future bailouts will include burden sharing by banks and others who hold European government bonds, but given how poorly it was received this time it is best not to hold your breath. The policy U-turn is wise, reckless and deeply depressing all at the same time.
Wise because there is a direct line of causation between the imposed Greek writedown and the subsequent massive sell-off in Italian bonds. Investors are capable of imagining the future, and in the future they saw no guarantee for toxic Italian bonds (as well as others).
“It was a terrible mistake,” European Central Bank Governing Council member Athanasios Orphanides said on Monday. “By forcing the impairment of any state bond we have triggered concern internationally of all state bonds in the euro zone and that’s one of the key reasons we have a problem,” the Cypriot central banker said.
Those sales of bonds by frightened creditors threatened to make failure by Italy a self-fulfilling phenomenon, as the higher the interest rate went the less solvent Italy became. With the rot spreading into Belgian and French bond markets and with some German bonds trading at levels that only make sense if investors expect to be re-denominated in new deutschmarks, a change in policy is inevitable.
Once abroad though, this idea of private sector participation in bond losses, which is of course basic to a market-based system, is tough to extinguish. If the International Monetary Fund becomes the vehicle for funding the bailout it will want to be the senior creditor. It would be as difficult for Barack Obama to explain to his taxpayers why they are spending money to make investors whole as it will be for Angela Merkel to tell hers.
Perhaps the ECB will be willing to fund a bailout while remaining on par with investors, but then again, perhaps it will want to be recapitalized in advance too.
SOMEONE HAS TO PAY
The move is reckless because in pinning all of the costs of the bailout on the public purse, which is the only possible source of funding now, Sarkozy and Merkel have managed only to underline exactly how vulnerable Europe‘s finances are.
Standard & Poor’s will warn all 17 euro zone nations they risk a downgrade in the next three months, according to reports. This makes perfect sense, as a move to absolve private sector creditors from their share in losses only increases the burden on those better-rated countries which will now bear more of the losses, something that ultimately may harm those weaker countries they backstop.
It is also reckless because the U-turn only further institutionalizes the tacit policy that banks will not be made to absorb the consequences of their actions. While it is good that Europe is taking steps to force countries not to borrow excessively, the banking system they have created and backstop will find other reckless loans to make. A bond market without losses is nonsense. The next crisis starts here.
Finally, this is deeply depressing because we are faced with two likely alternatives; a cataclysmic fracturing of the euro or insufficiently democratic policy-making. Given German, Austrian and Finnish distaste at the prospect of bailouts – of investors and countries – it seems unlikely that the proposed treaty changes will be put to a popular vote everywhere. Given that the new treaty changes imply a real loss of sovereignty for those who go along, this is quite a bit short of the sort of thing that ought to happen in a full, participatory democracy.
Then again, having hitched the euro’s fortunes to this particular engine, a “no” vote on the proposals could easily bring on a disorderly disintegration of the euro zone, which would be a very bad outcome.
It’s hard to be in favor of bailing out feckless investors, even harder to countenance major changes in government without sufficient public participation. It’s harder, perhaps, at this point to devise an alternative.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)