While the causes of the eurozone crisis vary over the countries affected, and in some cases stem from private sector uncompetitiveness or indebtedness, the immediate problem the eurozone crisis presents is a sovereign debt crisis. In some countries like Greece, it was the government itself that had accumulated an excessive amount of debt, although to some extent this reflected a weakening of business activity caused by rising domestic input costs and the depressing impact of the global financial crisis on international trade, resulting in decreased tax revenue and increased welfare payments. In other countries like Ireland, the government had been fiscally prudent, but their private sector had borrowed excessively, and to forestall the turmoil of widespread default during the financial crisis, the government chose to either borrow to bail out the private sector or else effectively take over its debts by guaranteeing them. Naturally, any increase in the loan demand from a particular borrower tends to raise the interest rate that the borrower must pay to raise new loans and refinance existing loans as they mature, but debt crises typically also involve a vicious circle as the additional interest expenditure increases the danger that the borrower will at some point be unable or unwilling to keep servicing its debt, prompting an increase in the risk premium payable on that debt. A debt crisis also decreases the market value of any existing fixed interest rate loans made to the borrower concerned and hence increases the implied market yield on that debt, but, before this debt matures, this is a bigger problem for its holders than the borrower.
A standard benchmark interest rate for sovereign debt sustainability is provided by the expected nominal GDP growth rate of the economy – to the extent that the average interest rate paid on the stock of debt exceeds this level, the country must run a primary (ie not including the interest outlay itself) budget surplus just to hold the debt stock at a steady proportion of GDP. If the country fails to achieve a primary surplus this large, its debt burden (as a proportion of GDP) grows exponentially. Depending on a country's perceived maximum
Notwithstanding the so-called "no bailout" clause in Article 125 of the Consolidated Treaty on the Functioning of the European Union (TFEU), which stipulates that "the Union shall not be liable for or assume the commitments of...any member state", the more creditworthy eurozone countries are willing to help its more indebted members for various reasons. Ostensibly, the justification for such support may be that one eurozone sovereign default might trigger a cascade of defaults as alarmed investors shun other marginal countries' debt, potentially resulting in the
An obvious way for the creditworthy countries to help the indebted countries is to reduce their interest rate expense. The creditworthy countries could achieve this either by lending them money at
Assistance from EU governments and the IMF has so far taken the form of emergency lending to the indebted countries in the event that the market cost of loans to them is deemed prohibitively expensive. The first eurozone emergency loan package was a €45bn three year loan facility for Greece, comprising €30bn in bilateral loans from the (then) 16 eurozone member states and €15bn from the IMF (and therefore partly representing a further indirect loan from all 27 EU member states as well as the other members of the IMF), agreed on April 23rd 2010. Since this amount appeared to be insufficient and failed to stem the rise in Greek government bond yields, it was quickly enlarged to €110bn (split 80:30 between the eurozone countries and the IMF) on May 2nd even before it began to be drawn down by Greece on May 12th. A €750bn loan facility to cover subsequent eurozone emergency lending was introduced on May 9th 2010. This comprises a mixture of loan commitments of up to €250bn by the IMF, €60bn from the European Financial Stabilisation Mechanism (EFSM) and €440bn from the European Financial Stability Facility (EFSF). The EFSM is a loan facility, provided by the European Commission and therefore backed by all 27 EU member states, which borrows the money it disburses in the international capital market (which it is readily able to do as the EU is rated as a
The EFSF is to be replaced in 2013 by the European Stability Mechanism (ESM), another SPV. Although full details have yet to be agreed, it is planned that the ESM will lend up to €500bn and also differ from the EFSF in that (1) its loans to eurozone countries will formally rank above other unsecured loans in the creditor hierarchy and (2) that it will be backed by capital rather than guarantees. Most of this capital will, however, be callable; the difference between callable capital and guarantees being that eurozone countries would be required to pay additional capital into the ESM as the likelihood of loan defaults rises, rather than after a default has occurred.
Enthusiasts for closer European union are wont to see a crisis like the present eurozone crisis as an opportunity to advance solutions involving increased integration. An example is the proposal to extend the EFSF/ESM SPV to borrow on behalf of all eurozone countries as a centralised funding mechanism issuing "euro bonds" and
Another way of ensuring that a borrower is able to obtain funding at an acceptable interest rate is to buy up the borrower's existing debt in the secondary market to hold its market interest rate down so that the borrower can issue new debt at a similar yield in the primary market. In conjunction with the May 2010 IMF/EFSM/EFSF loan package, on May 10th the ECB announced the Securities Markets Programme (SMP) to buy government debt of those eurozone countries with escalating yields, although the ECB somewhat incredibly presented the SMP as a measure "to ensure depth and liquidity...and restore an appropriate monetary policy mechanism". The details of the SMP regarding which countries' debt to buy, how much and at what yield triggers, are left to the discretion of the ECB's Governing Council, but all purchases are funded by reducing collateralised (ie virtually
To relieve the ECB, it has been suggested that the EFSF could buy troubled eurozone government bonds, either from secondary market counterparties or from the ECB to allow it to reduce its exposure to risk. Alternatively, the EFSF could lend to the indebted countries to allow them to buy back their own debt. Since this debt trades well below par in the secondary market, such repurchases funded by new loans would certainly reduce the nominal value of a borrower's outstanding debt, and if the loan from the EFSF is at a concession to market yields, the borrower's interest rate expenditure would also be reduced.
At an informal summit on March 11th 2011, euro area heads of government concluded that the the EFSF and ESM could buy government debt in the primary market in exceptional circumstances. While this is effectively the same as direct lending to the borrower, if primary market intervention is done in conjunction with an issue partly sold or at least offered in the market, it can ensure that the interest rate charged bears some relation to market rates.
In general, these assistance operations are undertaken subject to various conditions imposed on the borrower which ought to make default less likely, but the problem remains that, once the capital has been committed either by being transferred or pledged as callable capital or by guarantee, it is at risk of loss. Direct lending only helps the borrower if the interest rate charged is less than the rate that the market would charge, and unless the lenders are prepared to incur some (expected) cost to themselves to help the borrower, lending at
To RebelEconomist, it seems that a debt subsidy payment scheme like that offered by his former employer could both insulate the creditworthy countries from default losses and give them more control over the assistance they are providing to the indebted countries. Instead of making occasional large capital commitments as loans are disbursed or buybacks are executed, the creditworthy countries would make a stream of relatively small transfer payments to compensate the indebted countries for whatever is deemed to be the excess interest expense on new borrowing from the market. According to the scheme's objectives and constraints, in each case the concessionary interest rate might, for example, be set at a level believed to make the indebted country's debt burden manageable or to match the benefactor countries' funding costs. Given this concessionary interest rate, and the average yield on bonds similar to those to be issued, the size of these subsidising payments can be estimated from sovereign borrowing forecasts. For example, if Portugal is expected to issue €20bn of debt in the next year, and its excess (eg over comparable German bunds) market yield is deemed to be 5%, a payment of €1bn is sufficient to subsidise Portugal's interest cost arising from next year's issuance down to German levels (although of course such payments would grow as long as yields remained at crisis levels). Subsidy payments could be readily adjusted according to the progress of the programme for a particular indebted country, including being suspended if that country stopped servicing its debt or failed to comply with the conditions attached to the scheme, or more optimistically, its economic performance improved so that assistance was no longer needed. Since the subsidy can be curtailed at any time, such a scheme is arguably more in line with the no-bailout clause in the TFEU, because it does not involve the EU or any member state "assuming the commitments" of another member state. This controllability should also make a subsidy payment scheme more acceptable to the benefactor countries' electorates than lending to the indebted countries. Finally, because the scheme would not involve taking over credit exposure from the debt market, indebted country bond yields would serve as a better guide to investors' expectations of default, and loans would not be made at all unless they seemed likely to be repaid.
A likely objection to a subsidy scheme might be that it involves actual fiscal transfers from the creditworthy to the indebted countries, whereas loan capital and guarantees provided via supranational institutions like the ECB and the EFSF do not, but this would be disingenuous – unless market yields really do overestimate the probability of credit losses, loan capital and guarantees can be expected to generate losses in excess of any acceptable interest rate premium charged on EFSF/ESM loans over its cost of funding. Unfortunately, however, unless such probabilistic losses seem likely to be realised within the terms of office of the politicians deciding how to tackle the eurozone crisis, they are likely to be ignored.