Managing Deep Debt Crises in the Euro Area: Towards a Feasible Regime
| DOI | http://doi.org/10.1111/1758-5899.12571 |
| Author | Jeromin Zettelmeyer |
| Date | 01 June 2018 |
| Published date | 01 June 2018 |
Managing Deep Debt Crises in the Euro Area:
Towards a Feasible Regime
Jeromin Zettelmeyer
Peterson Institute for International Economics, CEPR and CESIfo
Abstract
In spite of the inclusion of collective action clauses (‘euro-CACs’) in euro area sovereign bond contracts since 2013, the euro
area still does not have a credible debt restructuring framework because: (1) stability risks of debt restructurings remain high;
(2) euro-CACs make it easy for creditors to hold out for full repayment; (3) IMF lending policies have not prevented the bail-
out of countries with unsustainable debts. In reaction, some proposals have called for hard criteria requiring debt restructuring
as a condition for access to official crisis lending. This paper argues that this is the wrong approach, because hard criteria are
error-prone, may trigger crises in high-debt countries, and lack credibility when the economic costs of debt restructurings are
high. Instead, the key to a credible debt restructuring framework is to reduce these costs, by cutting the links between sover-
eigns and banks and putting safety nets in place that limit contagion.
Policy Implications
•Modify bank regulation to discourage euro area banks from holding concentrated exposures to individual euro area sover-
eigns.
•Create a European Deposit Insurance System.
•Amend the ESM treaty to: (1) allow pre-qualified countries easier access to ESM liquidity; (2) require member countries to
include enhanced, ‘one-limb’collective action clauses in their sovereign bond contracts; and (3) immunize ESM lending
from legal action by creditors.
•Formulate ESM lending policies that prevent bailouts of countries with unsustainable debts, along the lines of the IMF
exceptional access policy that requires a maturity extension of existing debts when debt sustainability is not assured.
For most advanced countries, 2010 was the year in which
the global financial crisis was overcome –with growth
resuming much more quickly than had been expected even
in late 2009.
1
For Europe, it was the year in which the global
financial crisis morphed into the euro area debt crisis. As
the crisis unfolded in Greece and spilled over to Ireland and
other ‘peripheral’European countries, 2010 brought three
main realizations. First, the financial architecture of the
Maastricht treaty, which assigned responsibility for stable
government finances to the Stability and Growth Pact (SGP),
had a gaping hole: poorly supervised financial systems and
cross-border flow, leading to excessive private debt accumu-
lation, which could turn into a government debt problem.
Second, the SGP had not even attained its narrow objective,
namely, to keep public debt low and manageable. It had not
prevented persistent fiscal deficits debts in several countries,
notably Greece, and provided insufficient incentives for
accumulating fiscal buffers in many others. Third, the euro
area lacked any instruments to deal with debt crises, per-
haps because such crises were never meant to happen.
Now that they were happening, these instruments needed
to be invented in a rush.
Over the next four years, euro area policy makers
reacted to these problems –sometimes imperfectly and
haphazardly, but react they did. The reaction involved
three elements: revamped rules and surveillance proce-
dures aimed at influencing economic policies of EU mem-
bers directly; new European institutions focused on both
crisis prevention and crisis management; and legal
changes aimed at extending private sector burden sharing
in a crisis and thereby strengthening market discipline.
With respect to crises related to private debt and external
imbalances, this led to the creation of the European Sys-
temic Risk Board (2010), the Macroeconomic Imbalance
Procedure (2011), the Single Supervisory Mechanism and
Single Resolution Mechanisms (2014–2015) and the EU
Bank Recovery and Resolution Directive (2014), which
forces some private creditors to share the losses of bank
resolution. With respect to sovereign debt crises, steps
included reforms of the SGP (2011), the creation of the
European Stability Mechanism (ESM, 2012), and beginning
in 2013, ‘collective action clauses’in euro area sovereign
bonds, which allow the restructuring of bond contracts
with the agreement of a qualified majority of bond hold-
ers. As in the case of the BRRD ‘bail-in’rules, these were
intended to provide the legal underpinnings for private
sector burden sharing, should this become necessary, and
thereby strengthen market discipline.
©2018 University of Durham and John Wiley & Sons, Ltd. Global Policy (2018) 9:Suppl.1 doi: 10.1111/1758-5899.12571
Global Policy Volume 9 . Supplement 1 . June 2018
70
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