Should the guys at the European Central Bank have to sit through a screening of “Too Big to Fail”?
It might remind them that a lesson of 2008 meltdown is that you can’t extend and pretend your way out of the abyss, even if you’re brandishing a bazooka. If Europe’s central bankers accept this fact, they aren’t showing it.
Take the ECB’s decision this month to oppose a restructuring of Greek debt. By now everyone who isn’t employed in a policymaking role acknowledges that Greece’s finances are unsustainable and getting worse. Even some politicians are coming around.
As Ireland’s post-bailout death spiral makes clear, austerity alone simply is not going to do the trick. Balancing a budget that is as out of whack as Greece’s “has been known to cause riots if done in a single year,” warns Paolo Manasse, an economics professor at the University of Bologna.
Yet officials at the ECB insist the alternative — inflicting losses on bondholders who until recently were all too happy to foot the bills for the big, fat Greek consumption party — is still too damaging to even contemplate. Taking a book out of the Tim Geithner playbook, ECB board member Juergen Stark last week called a possible restructuring a “catastrophe” because it would do bad things to the banks.
Meanwhile the real catastrophe plays out before our eyes. Every day that goes by without a restructuring that forces investors to share European taxpayers’ pain, the ultimate cleanup tab rises. You only have to survey the mess that is the U.S. housing market — or the wreck that once was the Irish economy — to see how that movie ends.
“You cannot really afford to keep buying time, because it is so expensive,” says Daniel Gros, who runs the Center for European Policy Studies think tank in Brussels. “Paying out 100% to existing bondholders is just too big a burden to bear in this situation.”
Devising a workable restructuring isn’t simply a matter of throwing a switch, but it’s not impossible either. Gros has been calling for months for policymakers to cook up a rational restructuring program. The market fully expects the holders of bonds issued by Greece, Ireland and Portugal to recoup far less than 100 cents on the euro when repayment time comes. Why not hold investors to that view?
Here is where politics start to intervene. The ECB holds hundreds of billions of euros of exposure to the weaker economies, and thinly capitalized European banks hold billions more. Like the Fed before it, the ECB is sensitive in part because it has staked so much on a muddle-through view that is implausible without costly subsidies to the banks’ creditors. And even if the ECB concedes it has to take the hit sooner or later, the decision is not its alone to make.
“This is Jean-Claude Trichet’s frustration,” says Gros, referring to the ECB chief (pictured above). “He knows Berlin will not go for a restructuring, so preparations are not taking place.”
If anything that is an understatement. This week the spreads widened on bonds issued by countries previously resistant to the euro plague, Spain and Italy. This implies the problem is spreading, even as the Greeks get ready to take another round of checks.
“It is hard to acknowledge if you are Trichet that a country can fail,” says Gros. “But the longer this goes on, the greater the chance you find yourself stumbling into something like the weekends Paulson became famous for.”
If the ECB has been weak, European leaders look little better. They are so cowed by the threat of debt market contagion that some admit they are willing to baldly lie just to smooth the waters for a day or two. Euro area President Jean-Claude Juncker said last month he is willing to mislead the public if the price in terms of market stability is right.
Considering that Greece’s problems started in earnest when it came to light it had lied about its debt and deficit numbers, this is quite an ironic position for European officialdom to take.
“When it becomes serious, you have to lie,” Juncker said. Either that, or you have to get serious. No prizes for guessing which course Europe will choose.
