22 November 2011

Simon Nixon: Debt crisis is a symptom of wider failings

In his WSJ column, Nixon writes that after almost two years in which the focal point of the eurozone debt crisis has shifted from one European capital to another, it has finally arrived where it belongs: in the bloc's headquarters in Brussels.

The eurozone in its current form was destroyed at Deauville in October 2010 with the insistence that bondholders would be required to take losses as the price of future bailouts, and it was buried at Cannes this month with the surprise announcement that Greece was free to choose to leave the euro. The first introduced previously unexpected credit risk into the sovereign-bond market, the second introduced foreign-exchange risk. The result is that now the entire market with the exception of German government bonds contains extreme liquidity risk, as investors, banks and corporations try to cut their exposure.

Even now, many cling to the belief the ECB could make these problems disappear. Yet even if the bank were to change its mind on the legality of a commitment to underwrite government debts, it isn't clear this would solve the problem. The ECB can only buy bonds in the secondary markets; its intervention wouldn't necessarily guarantee Spain and Italy could maintain access to the bond markets.

Besides, the run on the sovereign-debt markets is only the most visible aspect of the crisis: the run on the banking system is equally damaging. Short-term dollar funding markets and senior unsecured bond markets have been closed since the summer; the interbank market is also closing down. Despite the ECB's active role as lender of last resort to banks, there is little it can do to prevent a powerful deleveraging that is making their debt challenge much harder and further eroding their competitiveness.

At best, the ECB can only buy time—but time for what? It has always been clear that any true solution to the eurozone's debt crisis must start with repairing its broken sovereign-bond market—something that can only now be achieved by the creation of eurozone bonds. The European Commission is due to announce proposals for creating common eurozone bonds Tuesday but an agreement on a way forward could take months, while delivering the necessary treaty changes to achieve the two most effective options could take years. Meanwhile, the real question remains what political price Germany will demand to put its balance sheet on the line.

Germany's greatest fear is moral hazard. How can it be sure countries will stick with reforms once market pressure is relaxed? Simply replacing elected politicians with technocrats can only be a short-term remedy since fiscal sovereignty will remain with national electorates. Both EC President José Manuel Barroso and European Council President Herman van Rompuy are preparing proposals to improve eurozone economic governance. But most of the ideas under discussion amount to tinkering with existing rules to improve scrutiny of national budgets, not the full-blown fiscal and political union needed to credibly underpin euro bonds.

Perhaps the intensity of the crisis will force dramatic political change in Brussels as it has in Member States. Perhaps governments will embrace radical transfers of sovereignty to avoid the cataclysm of a euro collapse. But the risk is that, as so often in the crisis, when the politicians do finally act, it may be too little, too late.

Full article

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