[P2P-F] must read on euro bailouts

Fri May 6 11:53:22 CEST 2011

see http://www.ft.com/cms/s/0/ee728cb6-773e-11e0-aed6-00144feabdc0.html

Europe is running a giant Ponzi scheme

By Mario Blejer

Published: May 5 2011 22:47 | Last updated: May 5 2011 22:47

One of the pillars upon which the euro was established was the principle of
“no bail-out”. When the sovereign debt crisis hit the
eurozone<http://www.ft.com/indepth/euro-in-crisis>this principle was
ditched. As Greece, Ireland and Portugal were unable to
service their unsustainable levels of debt, a mechanism was instituted to
supply them with the financing necessary to service their obligations. This
financing was provided, supposedly, in exchange for their implementing
measures that would make their, now higher, debt burdens sustainable in the
future. Yet the mode adopted to resolve the debt problems of countries in
peripheral Europe is, apparently, to increase their level of debt. A case in
point is the €78bn ($116bn) loan to
Portugal<http://www.ft.com/cms/s/0/b8e251a8-75c7-11e0-82c6-00144feabdc0.html>.
It is equivalent to more than 47 per cent of its gross domestic product in
2010, possibly increasing Portugal’s public debt to about 120 per cent of
GDP.

It could be claimed that this mechanism is helping the countries involved
since the official loans, although onerous, carry better conditions than the
ones that need to be serviced. But the countries’ debts will increase (as a
percentage of GDP the debts of Greece, Ireland, Portugal and Spain are
expected to be higher by the end of 2012 than at the start of the crisis).
The share of debt owed to the official sector will also increase (in
addition to the bond purchases by the European Central
Bank<http://www.ft.com/cms/s/0/3ee5e0e6-75b2-11e0-80d5-00144feabdc0,s01=1.html>,
which reportedly owns 17 per cent of these countries’ bonds with a much
higher percentage held as collateral).
EDITOR’S CHOICE
ECB holds fire on interest
rates<http://www.ft.com/cms/s/0/e550a554-76f9-11e0-be6e-00144feabdc0.html>-
May-05
Lex: European Central Bank
<http://www.ft.com/cms/s/3/935d6bda-7729-11e0-be6e-00144feabdc0.html> -
May-05
MPC keeps interest rates on
hold<http://www.ft.com/cms/s/0/4449b4c8-76fb-11e0-be6e-00144feabdc0.html>-
May-05
Lisbon reforms to focus on jobs and
deficit<http://www.ft.com/cms/s/0/b7d79688-773e-11e0-aed6-00144feabdc0.html>-
May-05
Portugal’s €12bn bank fund
questioned<http://www.ft.com/cms/s/0/ad7c6ee8-773e-11e0-aed6-00144feabdc0.html>-
May-05
Global Insight: Clouds darken ECB
meeting<http://www.ft.com/cms/s/0/ba665b52-766a-11e0-b05b-00144feabdc0.html>-
May-04

Is this ongoing piling of debt an indication of imminent defaults? Probably,
but not necessarily. An immediate default could result in major market
commotion, given the high exposure of European banks to peripheral debt.
Therefore, European governments are finding it more convenient to postpone
the day of reckoning and continue throwing money into the peripheral
countries, rather than face domestic financial disruption. Consequently, as
long as European and international money (through the International Monetary
Fund’s generous financing) is available, the game could go on.

It is based on the fiction that this is just a temporary liquidity problem
and that the official financing helps the countries involved to make the
reforms that will allow them to return to the voluntary market in normal
conditions. In other words, the narrative is that the recipient countries
could and would outgrow their debt. To “prove” this scenario is feasible
several debt sustainability exercises are being dreamt up. But the fact is
that this situation is only sustainable as long as additional amounts of
money are available to continue the pretence.

Here is where this situation resembles a pyramid or a Ponzi
scheme<http://www.ft.com/cms/s/0/83307ab2-e382-11df-8ad3-00144feabdc0,s01=1.html>.
Some of the original bondholders are being paid with the official loans that
also finance the remaining primary deficits. When it turns out that
countries cannot meet the austerity and structural conditions imposed on
them, and therefore cannot return to the voluntary market, these loans will
eventually be rolled over and enhanced by eurozone members and international
organisations. This is Greece, not Chad: does anyone imagine the IMF will
stop disbursing loans if performance criteria are not met? Moreover, this
“public sector Ponzi scheme” is more flexible than a private one. In a
private scheme, the pyramid collapses when you cannot find enough new
investors willing to hand over their money so old investors can be paid. But
in a public scheme such as this, the Ponzi scheme could, in theory, go on
for ever. As long as it is financed with public money, the peripheral
countries’ debt could continue to grow without a hypothetical limit.

But could it, really? The constraint is not financial, but political. We are
starting to observe public opposition to financing this Ponzi scheme in its
current form, but it could still have quite a way to go. It is apparent
that, if not forced sooner by politics, the inevitable default will only be
allowed to take place when the vast part of the European distressed debt is
transferred from the private to the official sector. As in a pyramid scheme,
it will be the last holder of the “asset” that takes the full loss. In this
case, it will be the taxpayer that foots the bill, rather than the original
bondholders that made the wrong investment decisions.

Is this good or bad? It all depends on how one assesses the value of the
time gained. Would a bank crisis now be more damaging to the European
economy than a future debt write-off? Or, alternatively, is recognising
reality and accepting a debt restructuring now preferable to increasing the
burden on future taxpayers? At the end, it is a political decision, but it
would be refreshing if things are called by their name. Euphemisms may be
useful in the short run, but one finally recognises a Ponzi scheme when it
persists.

*The writer was governor of Argentina’s central bank and director of the
Centre for Central Banking Studies at the Bank of England. Samuel Brittan is
away*

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