The day may yet come when the eurozone finally agrees a comprehensive package to end the crisis, but this was not the day. What policymakers agreed at 4am Brussels time on Thursday came close to what they set out to do. They secured a “voluntary” deal with the banks, and they agreed the outer perimeters of a system to leverage the European financial stability facility. But none of this is going to end the crisis.
The deal with the Institute of International Finance is for a “voluntary” 50 per cent haircut on Greek debt on behalf of their member banks. This would amount to €100bn, and would be supplemented by a contribution from eurozone governments to the tune of €30bn. The goal is to achieve a ratio of Greek sovereign debt to gross domestic product of 120 per cent by 2020.
I do not believe this is going to work. First, the agreement with the IIF is not binding on the banks. The IIF has yet to deliver the voluntary participation. Many banks would be better off if the haircut was involuntary, given their offsetting positions in credit default swaps. The whole point of a CDS is to ensure creditors against an involuntary default. By agreeing a voluntary deal, the insurance will not kick in. In other words, there is a significant probability that we will end up with an involuntary agreement – which is precisely the outcome the eurozone governments, except perhaps a small group of northern countries, had sought to avoid.
My second reason for scepticism concerns the forecast of sustainable 120 per cent debt-to-GDP ratio. The European Union has been consistently wrong in its economic forecasts for Greece. They misjudged the impact of austerity on economic growth and public sector deficits. This misjudgement is the reason why the voluntary bank haircut of 21 per cent, agreed in July, has now grown to 50 per cent. What happens if the outlook were to deteriorate further? There is no sign yet of a turnaround.
Third, in the unlikely event that the banks come up with the money, and that Greece manages to hit a 120 per cent debt-to-GDP level in 2020, it is far from clear that Greece can return to the capital markets even then. I believe that Greece will require a much lower debt-to-GDP level, perhaps around 80 per cent, to achieve sustainability and access to market funding. Italy has a debt-to-GDP of 120 per cent now – this number may have served as a benchmark for policymakers. But Italy has a far more solid base of domestic savers than Greece, and this level is not sustainable for Italy either.
On the EFSF, the leaders reached political agreement to leverage it up to about €1,000bn. Herman van Rompuy, the president of the European Council, made a revealing comment following the meeting when he said that banks have been doing this forever. Why should governments not do so as well?
The reason is simple. Banks can only do this because central banks and governments act as ultimate guarantors of the financial system. There exists an implicit insurance of unlimited liability. In the case of the European financial stability facility the very opposite is the case: there is an explicit insurance of limited liability. Germany wants its exposure capped to a maximum of €210bn. I doubt that global investors will rush into the tranches of the special purpose vehicle through which the eurozone wants to leverage the EFSF. I struggle to see how this structure can lead to a significant and sustained fall in bond spreads.
Leveraging can work, but only if the eurozone were willing to provide an unlimited backstop. This would be either in the form of an explicit lender-of-last-resort guarantee by the European Central Bank, or through a eurobond – or ideally both.
Now that is something I would consider to be a comprehensive agreement. It may yet happen, but not for a long time. The crisis, meanwhile, continues.
The writer is an associate editor of the Financial Times and president of Eurointelligence.