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FT Alphaville » Buiter’s €2,000bn solution for the Eurozone

Buiter’s €2,000bn solution for the Eurozone

Posted by Izabella Kaminska on Jan 07 13:16.

The latest (and as usual, substantial) note from Willem Buiter, chief economist at Citigroup, has landed in the FT Alphaville inbox.

The bulk of its 84 pages can be summarized in one line though: “no sovereign is really safe” and there are “likely to be several sovereign debt restructurings in the euro area in the next few years”.

Which, of course, is interesting — but not really all that helpful.

Still, Buiter wouldn’t be Buiter without pronouncing his own opinion on what needs to be done. And as usual, his thinking goes beyond the conventional.

Without further ado, we present Buiter’s three-pronged solution for the Eurozone mess. In summary:

EA requires i) a much larger liquidity support facility, ii)
restructuring of the unsecured debt of EU zombie banks and recapitalisation of the systemically important ones among them, iii) restructuring of the debt of insolvent EA sovereigns.

Digging a little deeper into his thoughts, we begin to see the controversy.

For a start, Buiter wants the size of the liquidity facilities providing financial support to vulnerable nations to be immediately increased to $2,000bn.

Right now the current facilities — including the EFSM, the EFSF, the Greek package and the ECB purchases under the SMP — amount to between €737bn and €787bn. As he notes, that might be enough to tide over Greece, Ireland, and Portugal until mid-2013. But it’s nowhere near enough to fund the potential requirements of a troubled Spanish economy — especially if private liabilities there end up being absorbed by the government. And it’s because the market knows this that the crisis continues.

Furthermore:

The existing facilities also fall well short of what would be needed to fund the countries like Italy, Belgium and France, should they be frozen out of the markets by self-fulfilling speculative attacks or flight of investors — and it certainly is not enough to deter such attacks.

The problem is that the members of the euro area and even the European Union as a whole cannot in practice come up with an immediate €1,000bn extra to fulfill such an elaborate liquidity plan. Neither, it seems, could the IMF, since its mandates disqualify them from pre-funding.

So that leaves on two possible sources of funds, says Buiter:

The first is non-EU sovereign wealth funds, or bilateral sovereign support from outside the EU. The second is the ECB. And given the first option is likely to be politically unattractive, that only leaves the ECB. In principle, the ECB could provide €1,000bn (or even the entire €2,000bn) directly to the countries that need them, by expanding the scope of its purchases of their sovereign debt.

But, in case you thought that meant some sort of mega eurozone QE, it doesn’t have to. As Buiter explains, there is no need for the monetary base to be increased for the ECB to dish out another €1,000bn:

The ECB could instead expand its non-monetary liabilities, including term deposits, or by issuing ECB bills or bonds. With the short-term interest rate in the EA at or near the effective lower bound, there is no material economic difference between outright purchases of government securities financed by increases in the monetary base (in practice excess reserves, that is, overnight deposits by eligible banks with the Eurosystem) and outright purchases financed by increasing the stock of one-week term deposits.

However, it appears to be important to the self-image of the ECB that it not be technically engaged in quantitative easing (QE), that is, the monetisation of public debt or deficits. That wish can be granted without diminishing the effectiveness of their intervention in any way, through semantic sterilisation rather than substantive sterilisation.

So the key could be semantic sterilisation. Another subtle asset switch. The ECB increasing the stock of one-week term deposits to fund its asset purchases, rather than banks’ excess reserves outright. The term-nature of the manoeuvre would (technically) stop it from being seen as outright monetisation.

And yet, the move could inject enough liquidity to allow for a successful ECB bond programme.

One could call it ‘Enhanced Credit Support’, says Buiter.

Alas, he concludes, it’s unlikely the ECB would go for it. It would still be seen as too fiscally emotive.

But there is one other way. The ECB could, he says, focus on EFSF purchases rather than individual sovereign bond purchases.

As Buiter explains:

Instead of direct, unconditional support to fiscally impaired sovereigns, the ECB could provide indirect support to a conditional facility, either by lending to the EFSF or by purchasing securities issued by the EFSF directly, or in the secondary markets.

The EFSF is a private entity (a limited liability company incorporated in Luxembourg). It could be turned into a bank, making it an eligible counterparty to the ECB’s operations. Any debt sold by the EFSF to the ECB, or any loans provided by the ECB to the EFSF, could then be guaranteed by the euro area member states. Granting the EFSF (or its successor, the ESM) seniority over all other sovereign creditors other than the IMF would further limit the exposure of the contributing sovereigns to possible ex-post burden sharing should a sovereign default occur after a member state has borrowed from the facility.

The ability of the EFSF or its successor facility to borrow from the markets on acceptable terms, and thus to minimise the demands it would have to make on the ECB, could be further enhanced by making the guarantees of the EA sovereigns for the debt issued by the facility joint and several rather than pro rata (according to their shares in the ECB’s paid-in capital). This would effectively turn the debt issued by the facility into Ebonds or its loans into E-loans.

The difference from other proposals to issue Ebonds (such as the one launched by Eurogroup Chairman Jean-Claude Juncker and Italian Finance Minister Giulio Tremonti on 5 December 2010) is that the issuance of E-bonds or E-loans by the EFSF or the ESM would be capped, that is subject to a strict upper limit, rather than open-ended, as under the Juncker-Tremonti proposal.

Of course, this would still require a major Treaty revision, and might even encourage moral hazard. Nevertheless, with the lack of any other workable alternatives on the table, this move looks increasingly unavoidable to Buiter. Furthermore, it’s certainly a more palatable option to something like eurozone dissolution.

The liquidity expansion alone, however,  is not enough to stifle the crisis, says Buiter. It’s essential other actions are also taken.  For example, in his opinion, the €2,000bn liquidity scheme must also be accompanied by another round of stress tests, much more rigourous than the last. Ideally the notion of burden-sharing should also be nipped in the bud completely. If not — as is seemingly likely — the move should be imposed as swiftly and comprehensively as possible. Ideally in a coordinated and synchronised manner.

Lastly, for all this to work, a new mechanism for the orderly resolution of sovereign debt defaults is also needed. Without it, the fear of what might happen in a default scenario will continue to haunt the market.

All in all, some big thoughts from the Citigroup man on Friday.

 

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