Sep

25

I'm skeptical of the eurobond idea because I don't think it addresses what to me is the underlying problem. The problem is not, for instance, "Greek debt". Rather, the issue is who owns the Greek debt, i.e., the banks. The problem is not whether the Greek government (or the Portugese or the Irish) is insolvent and should default — of course they are and should — but rather what the knock-on effects will be.

The Germans should put up a big chunk of money, and get others (France) to contribute what they can, and then do a Bernanke and announce a schedule by which they will purchase over time €X of PIIGS bonds from the eurobanks. They could drain the problem paper from the financial system, with some haircut for the bondholders, after which they could restructure that debt as they pleased, meanwhile putting some downward pressure on rates, but also allowing the market to continue to discipline profligate governments.

Germany gained the most from the €Mark, in one sense, so they are now in a position of paying off the problems created. I think the ECB sees US-style QE as poison, and that's why the ECB is not allowed to be the buyer of bad bonds (even though they have been, in fact, doing it under the radar to keep the banks from folding). So, put the money into the EFSF, buy the bonds back directly in the marketplace, and then restructure them as needed, while redesigning the "system". Moral hazard, for sure, because some players will think it's okay to lend to the PIIGS again because the bad bonds will be bought back -hence the need for some kind of haircut, enough of one to send the message that, "whenever we have to buy bonds back, the bondholders will take some kind of hit, so don't count of this as anything but a money-losing strategy". You've cleaned out the bulk of the Greek (or Portuguese, etc) balance sheet, and then they are left to the bond markets and must adjust their fiscal reality. And lenders know to be skeptical, but the eurobanks are on better footing. Then the Greeks get to decide whether they want to become more like the Germans, or whether they want to go "back to the drak".


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