Originally published in the Financial Times
To a visitor from across the pond, the commotion in Europe over how to address its fiscal problems (or are they economic problems?) feels reminiscent of the disarray in America as its financial crisis unfolded a few years ago.
Words such as “restructuring”, “moral hazard” and “default” are sprinkled into conversations, often with little precision as to their meaning, let alone their consequences. Policy suggestions of every degree of plausibility spew forth with vigour. Nearly every meeting of national leaders closes with a disquieting mélange of firm talk and a sense that, like the US in the early days, Europe is playing catch up – not so much confronting its challenges as hoping they will melt away.
The eurozone does appear to have adapted pieces of the American experience to its own problems. For one thing, the €440bn stabilisation fund seems to share some chromosomes with America’s $700bn troubled asset relief programme, which ultimately played a critical role in turning the tide in the US. Also, European policymakers emit every indication of viewing Greece as that continent’s equivalent of Lehman Brothers, whose failure provoked the market panic that nearly felled the financial system. Just as many in the US see Lehman as too big to have let fail, European leaders suggest that the collapse of Ireland or Greece would unleash similarly destructive forces.
At the same time, European Pooh-Bahs show few signs of having processed another important lesson from the US: the need to distinguish between illiquidity and insolvency. In late 2008, the leading US banks buckled under liquidity problems that could be solved by temporary infusions of bail-out money. On the other hand, General Motors and Chrysler were insolvent; their liabilities vastly exceeded assets; only bankruptcy could redress that imbalance.
By every indication, European leaders cling to the illiquidity thesis even though many international economists, such as Kenneth Rogoff of Harvard University, believe the peripheral countries more resemble the carmakers. The European Union summit opening today is unlikely to change that impression, with the only concrete outcomes mooted to be marginal, such as ratifying extensions of loan maturities and small interest rate reductions for Greece.
So, Europe’s alphabet soup of rescue programmes does nothing to address suffocating debt levels. While the happy talk about harmonising tax policies, retirement ages and pay rules (not before 2013, at best!) may offer hope of improving the euro’s longer-term prospects of survival, it will not make an insolvent country solvent any more than alchemy can turn copper into gold.
Not all Europeans deny, of course, the need for debt “restructuring” in peripheral countries. Many EU experts would embrace it, at least for Greece and Ireland, albeit often without appearing to understand that it would probably mutate quickly into the uglier notion of “default.”
That is because if “restructuring” encompasses a significant reduction in principal owed – as the tougher minded are certain it does – default quickly moves centre stage as a result of the inability of even an overwhelming percentage of bondholders to compel the recalcitrant to reduce the principal amount of their paper. And default is what Germany’s Angela Merkel, France’s Nicolas Sarkozy and their colleagues insist cannot happen because of the Lehman experience.
The euro-confusion is not lost on US policymakers. In congressional testimony, before a stop in Berlin to proffer advice, Treasury secretary Tim Geithner was careful to stick to diplo-speak but his message was clear: Europe’s issues are “enormously difficult, incredibly tough things to fix”.
If some countries are insolvent and if European leaders are unwilling to risk the chance of a post-Lehman meltdown, that leaves subsidies from wealthy countries to their struggling neighbours as the most viable path forward. Here again, America offers an interesting comparison. Unlike with EU members, the fiscal troubles of US states are cushioned by Washington, often almost invisibly.
For example, while unemployment insurance programmes are run by the states, the federal government pays half the cost of extended benefits, funnelling money to states hard-hit by joblessness and generally struggling to balance their budgets. European sharing programmes, such as the common agricultural policy, are far more modest and not designed as automatic stabilisers.
However, particularly within strong countries such as Germany, the phrase – transfer payments – is akin to a four-letter word, with public opinion lined up in opposition. Prudence suggests scratching that efficacious approach from a list of plausible outcomes.
So the noose tightens. European leaders need to take a more stringent look at the problems of weaker members, instead of seeking refuge in half-baked ideas such as a eurobond backed jointly by member states, a concept that could bring participants in the common currency closer but would be utterly useless in addressing solvency problems.
Europe should absorb a last lesson from the American experience: The longer the day of reckoning is postponed, the greater the pain involved in fixing the problem.