Some eurozone leaders have responded to the European public debt crisis by asserting their absolute commitment to preventing a sovereign default. But this has never been the view of Wolfgang Schäuble. Rather than consigning sovereign defaults to history, Germany’s finance minister would like to make them both more orderly and more predictable.
There are now rumours that others in the German government are coming round to Mr Schäuble’s way of thinking. Berlin is said to be pondering the creation of a sovereign resolution authority to manage an orderly restructuring should a country be unable to repay its debts.
There are some things to like in this idea. The approach taken by the eurozone has been to extend public funds to tide over cash-strapped countries. This is fine so long as it extends no further than providing liquidity to ease a market panic. But it would not suffice were a country unable to pay back its debts. There is a need to plan for what comes next.
The German idea might preserve more value for all creditors. The problem with public creditors stepping into the shoes of private ones is that some private lenders extricate themselves while others are left behind. This can leave scraps for trapped creditors if default is only deferred and not avoided.
The snag with Germany’s idea is that it goes too far, suggesting harsh measures if a country proves unable to agree or stick to a restructuring plan. External individuals would be appointed by a supranational resolution authority to safeguard the debtor’s financial affairs, obliging it to surrender some sovereign powers during the workout.
It is hard to see how such a plan could be imposed, let alone enforced. It would place the debtor nation in a position of colonial submission. If ever agreed to, this would be politically explosive.
New rules are needed to underpin the eurozone in the post-crisis world. The stability and growth pact has failed. To avoid moral hazard, these rules must admit the possibility of sovereign default.
Any orderly restructuring would involve creditors taking haircuts. So would a disorderly default. However, it would strengthen market discipline if creditors knew both that they would face haircuts and how those might be negotiated. The Germans are right to push these ideas. A colonial-style workout, by contrast, would lack credibility. When sovereigns default, what is needed is a conference table not a torture chamber.
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