Eurozone crisis
Haircuts must be possible for all new bond issues, says report
By Sarah Collins | Friday 25 February 2011
Eurozone countries should immediately begin issuing short-term bonds that allow for creditor haircuts should a country become insolvent, a new report has said.
Issued by the seven-strong European Economic Advisory Group (EEAG) of international economists, the report recommends a three-step rescue mechanism, which would issue cash bailouts only to countries facing short-term liquidity problems. "Intergovernmental bailout systems in Europe risk opening up additional contagion channels through which the crisis of a single country could in the end endanger the euro system as such," the report says.
Driven by a need to eliminate the moral hazard it says is implicit in the EU's current rescue funds, the group recommends that the new system be accompanied by stricter budgetary surveillance, including the possibility of errant countries being forced out of the eurozone.
Sanctions for countries flouting EU deficit limits should apply immediately, once Eurostat has determined that spending has crossed the EU's 3% of GDP threshold. Sanctions for overspenders should include not only financial ones, but political ones, including the suspension of the country's vote in Council meetings.
The report also categorically rules out the pooling of debt into a common eurobond.
For solvent countries with short-term cash shortages, the EEAG says it should receive Community loans under the new European Stability Mechanism - the EU's permanent rescue fund, which is to be endorsed at a summit, on 24-25 March.
The borrowing government would be forced to offer up collateral - state agencies or land - to back up the loans, which would last for a two-year term.
Countries with a debt-to-GDP ratio of above 120% would be declared potentially insolvent - Greece's ratio is already 140% - and would have to begin renegotiating their debt with outstanding creditors, according to collective action clauses attached to new bond issues (legal agreements that allow for creditor haircuts).
During the renegotiation, the ESM would be able to extend one-year loans with a 5% interest premium.
If this fails to stabilise a country's debts, then mandatory haircuts of up to 50% must be imposed on all creditors, the group says. The ESM in this case would be able to intervene to guarantee a country's bonds only after the haircuts have been applied.
Eurozone countries are currently grappling with possible changes to the EU's current rescue fund (the European Financial Stability Facility), which is due to expire in 2013, and the outline of its successor (the European Stability Mechanism).
Divisions are still rife over whether to increase its lending capacity from a current €250 billion to its stated €440 billion, allow it to issue pre-emptive credit lines to countries in liquidity trouble, purchase bonds directly in secondary markets or lend money for countries to repurchase their own bonds.
(europolitics.info)
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