segunda-feira, junho 20, 2011

Banks, Central Banks and Moral Hazard in the Eurozone Debt Crisis

As intermediaries between net exporters and net importers, banks are naturally in the front line of any Debt Crisis, be it households (subprime mortages), corporates (junk bonds) or sovereigns.

The difference this time, comparing the Eurozone  problems to earlier Latin American Debt crises for example, is that there has been no creditor stand-still. Thus the original commercial investors have used their political and market power to push their riskier exposures onto official creditors, to the ECB through bank refinancing and secondary market bond purchases and to Central Banks through the TARGET system, and thus to their respective taxpayers. These new ECB and Central Bank exposures to the net borrrowing countries are a direct reflection of the need to  finance the net exports of the net surplus countries and to repay existing debt.
This “nationalization” of the intra-Eurozone cross-border exposure has certainly increased the burden for European taxpayers but has yet to provide any real debt relief to the net borrowers in Greece and Portugal. There has been no real "burden sharing" between creditors and borrowers.
Since the Euro taxpayers are being asked to bear the costs of excessive lending, a better solution would be to use such taxpayer funds to provide interest rate subsidies to bridge the gap between the returns required by real cash investors and the interest rates that would be sustainable from the perspective of the borrowers, but only for truly long term direct exposure (20+ years).
Lowering the interest bill is an essential step in debt workout, together through the reprofiling of  the repayment schedules of  existing debt.  Debt  discounts  could also help to reduce the debt stock, at great reputation costs and loss of market access, but it would do little to reduce the new debt need.  Registered Credit Default Swap volumes are miniscule (only about 1% of external debt in the case of Greece, so CDS pricing is almost a curiosity. 

In addition, if is to survive, the Eurozone needs to develop new balance-of-payments adjustment instruments.   Argentina and Mexico tried, unsucessfully, to keep their exchange rates fixed, but none of these  countries are good examples for the current Eurozone problems, because they all devalued in the end. For someone with dollars, the shopping was great on Calle Florida after an exchange rate storm.
There seem to be no case studies yet of successful external adjustments within a Single Market or Single Currency context.  Thus, the IMF needs to reinvent the wheel on bailouts, or better yet, find a sextant, because we are sailing into uncharted policy territory. When dealing with intra-Eurozone balance-of-payments adjustments, the usual IMF prescriptions (devaluation, tariffs, interest rate increases, capital controls) must now stay in the drawer.
It must be evident to all that  small-country fiscal and incomes policies cannot be expected do ALL the heavy lifting needed for rebalancing the Eurozone.  
Another clear lesson thus far is that the Single Currency requires maintainging Current Account deficits/surpluses much lower, because it does away with most of the usual adjustment tools.

We also know that existing creditors, net exporters and their banks, will always use their considerable political and market power to  resist absorbing a "fair share" any of the sacrifices for their imprudent lending decisions.  The excessive sovereign debt levels are themselves a clear example of the failure of market discipline.  Fully protecting existing creditors from "sharing the sacrifice" in the name of "applying market-based solutions" would further contribute to  "moral hazards" of  new and untold proportions.

Mariana ABRANTES de Sousa 
PPP Lusofonia

See also
One-armed midgets can't guarantee Eurozone rebalancing 
Greece and Portugal reduce Current Account CAB deficits
There is no virgin debt, there's always bilateral responsability for trade deficits
Adjustment effort to focus on blance of payments
Soluções para a crise do sobre-endividamento 
DeGrauwe on Euro and Financial Crisis, 1998
Stockholm principles and best practices in public debt management 
Proposal for Debt Reduction without Default 

Gaming Maastricht:  Capping official budget deficits, which reflect internal imbalances, is proves worse than useless if current account external imbalances are allowed to balloon on the back of overly easy cross-border credit and hot money capital flows.