In my June 2011 article “Is it Time to Rethink Sovereign Debt” I described how, “…in our globalised economy, no country is an island. Every nation has internal debt (owed to lenders within a country- often that countries citizens or banks) and external debt (owed to foreign lenders- often other countries, or large international financial institutions) and the numbers are staggering. According to figures published in the CIA world fact-book, the USA has external debts alone of USD 14 trillion (around USD 45,097 per person), the European Union has external debts USD13.7 trillion (around USD 27,864 per person) To put these figures in context, the value of the entire US economy is $14.2 trillion and the value of the entire European Union economy is $16.2 trillion. These relationships are not clear-cut. Many international banks, which are systemically important in their own countries will hold huge tranches of ‘risk free’ government debt, which are then leveraged against other investments here and abroad…“
The European debt crisis has been the most visible of the continent’s many elephants in many rooms. The visibility of this elephant has been made more astonishing by the seeming lack of political will to arrive at a decisive and timely solution to what can only be described as potentially Europe’s most economically significant threat since the great depression. On December 21st Bloomberg reported that European banks ‘devoured’ the ECB’s offer of almost half a trillion Euros of fresh cheap capital (primarily to refinance maturing debt). Bloomberg added that , “….politicians, including French President Nicolas Sarkozy, are also pushing the banks to use the cash, which is borrowed at a current interest rate of 1 percent, to purchase higher-yielding southern European sovereign debt, thereby forcing down borrowing costs in the region.“ There is no doubt that the ECB’s latest intervention has averted a frighteningly serious domino of defaults- but their logic has been described as many as giving cash to the child of a serious drug addict, hoping the child will wean the parent off drugs by buying them more…
It’s Time for the Bank of Recovery
If (rather than being political actors) the Euro-Zone was a group of companies, operating within a reasonably mature financial market- there would be a clear-cut solution for this problem. A structured vehicle would be created to get risk off the group balance sheet, allowing for restructuring and creditor agreements- while enabling the healthy parts of the group to regain financial strength without being crippled with debt burdens. Aside from political will, there is nothing to stop the Euro Zone economies from adopting a similar principle.
In this model:
- A supra-national ‘bank’ is created (perhaps managed by the IMF). This bank is capitalised by the ECB (in exchange for equity) together with any other participants (such as investment banks, hedge-funds, international sovereign actors) who wish to invest in the structure (also in exchange for equity)Here’s where the political will comes in…
- Sovereign creditors (be they banks or- indeed- sovereign actors) sell the riskiest elements of their debt into the Bank of Recovery – taking fair market value (which may be somewhat less than they were hoping) in new-cash against the remaining term of the debt. In this sense, we would understand riskiest debt to be the debt of the PIIGS nations- and those on the periphery experiencing the greatest increase in lending spreads, or the greatest economic burdens. This would immediately significantly cleanse the balance sheets of participants holding these instruments (reducing counterparty risk, perceived market risk, and so on). On the ground, this could give a significant and relatively immediate boost to lending and market participation within the underlying economies.
- The Bank of Recovery now becomes the primary creditor of this risky debt and (through co-ordinated political action) converts this debt into very long term instruments (50,60yrs+) paying dramatically reduced coupons. A cash balance within the Bank of Recovery would also allow a proportion of this debt to be written down completely where (for example, in the case of Greece) there is little hope of structured repayment. From here-on-in… the Bank of Recovery becomes the manager of this aggregate of debt, periodically issuing dividends to equity holders (who can also use their equity in this restructured vehicle as collateral elsewhere in the market).
- The Bank of Recovery would also include a supra-national oversight committee who (independent of the European Parliament and European Central Bank) would be tasked with ensuring their debtors (the sovereigns) comply with the terms of restructure (for example, compliance with measures, ratios and so forth). By way of assuring compliance, the Bank of Recovery itself could be responsible for issuing the credit ratings and other guarantees of countries it becomes a creditor to.
This model may seem oversimplified, but every year- the world of corporate finance creates structures just like this for complex cross-border multi-billion dollar organisations… to help them survive, and protect the interests of stakeholders.
The economic tools to create a solution like this at a continental level do exist, but for policy-makers to use them, it means some significant changes in attitude:
- When politicians refer to ‘our nation’s best interest‘ they must realise our economy is globalised.. this means that their nation’s best interest is inextricably linked to the best interest of their neighbours- and nations further afield. This means making decisions which may be politically unpopular in the short term, but which will carry huge benefits to society.
- Policy-makers will have to do the two things which, more than anything, they avoid at all costs. Firstly Accept responsibility and be secondly… be honest… This means that all political parties must accept that it is their collective policies over the last quarter century of development which have got us here. These policies may have seemed right at the time, but- in the face of globalisation- have had a rather unexpected emergent outcome. As for being honest, this means an open discussion of just how big this problem really is – with a call-to-action for all participants in the economy to really come together and innovate our way out of this.
- Policy-makers must also realise that the world has changed astonishingly since the treaties and accords were written that installed them. You cannot govern a 21st century globalised business with the management style of an 18th century trading firm. In the same way, the modes (and rationale) of governance must be brought up-to-speed with the nature of the citizens they are responsible for.
The inconvenient-truth of this situation is that however many observers and commentators espouse rhetoric about solutions for this crisis, without buy-in from the individuals who are responsible for our economy? those words are in vain.
“Knowing is not enough; we must apply. Willing is not enough; we must do.” Johann Wolfgang von Goethe