新年，同样的危机

The measures introduced by the European Central Bank last December, especially the Long Term Refinancing Operation (LTRO), have relieved the liquidity problems of European banks, but have not cured the financing disadvantage of the highly indebted member states. Since high-risk premiums on government bonds endanger the capital adequacy of banks, half a solution is not enough.

Indeed, that supposed solution leaves half the eurozone relegated to the status of Third World countries that have become highly indebted in a foreign currency. Instead of the International Monetary Fund, it is Germany that is acting as the taskmaster imposing tough fiscal discipline on them. This will generate both economic and political tensions that could destroy the European Union.

I have proposed a plan that would allow Italy and Spain to refinance their debt by issuing treasury bills at around 1%. I named it in memory of my friend Tomasso Padoa-Schioppa, who, as Italy’s central banker in the 1990’s, helped to stabilize that country’s finances. The plan is rather complicated, but it is legally and technically sound. I describe it in detail in my new book Financial Turmoil in Europe and the United States.

European authorities rejected my plan in favor of the LTRO. The difference between the two schemes is that mine would provide instant relief to Italy and Spain. By contrast, the LTRO allows Italian and Spanish banks to engage in a very profitable and practically riskless arbitrage, but has kept government bonds hovering on the edge of a precipice – although the last few days brought some relief.

My proposal is to use the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) to insure the European Central Bank against the solvency risk on any newly issued Italian or Spanish treasury bills that it may buy from commercial banks. This would allow the European Banking Authority to treat these various T-bills as the equivalent of cash, because they could be sold to the ECB at any time.

Banks would then find it advantageous to hold their surplus liquidity in the form of T-bills as long as these bills yielded more than bank deposits held at the ECB. Italy and Spain would then be able to refinance their debt at close to the ECB’s deposit rate, which is currently 1% on mandatory reserves and 25 basis points on excess-reserve accounts.

This would greatly improve the sustainability of these countries’ debt. Italy, for instance, would see its average borrowing cost decline from the current 4.3%. Confidence would gradually return, yields on outstanding bonds would decline, banks would no longer be penalized for owning Italian government bonds, and Italy would gradually regain access to the market at more reasonable interest rates.

One obvious objection to this strategy is that it would reduce the average maturity of Italian and Spanish debt. I believe that, on the contrary, this would be an advantage in the current exceptional circumstances, because it would keep the Italian and Spanish governments on a short leash; no country concerned could afford to lose the ECB facility.

In the case of Italy, the short leash would dissuade former Prime Minister Silvio Berlusconi from seeking to topple Mario Monti’s new government (which has only a fragile majority), because if Berlusconi precipitated an election, the electorate would punish him. This would help to reestablish political stability and accelerate Italy’s return to the market.

My proposal fulfills both the letter and the spirit of Article 123 of the Lisbon Treaty. The ECB’s task is to provide liquidity to banks, while the EFSF and ESM are designed to absorb solvency risk. The ECB would not be facilitating additional borrowing by member countries; it would merely allow them to refinance their debt at a lower cost.

Together, the ECB and the EFSF could do what the ECB cannot do on its own. This would provide temporary relief from a fatal flaw in the euro design’s until the member countries devise a more permanent solution.

The EFSF would have practically unlimited capacity to insure eurozone T-bills in this way, because no country could default as long as the scheme was in operation. Nor could a country abuse the privilege, lest it be automatically withdrawn, causing the country’s cost of borrowing to rise immediately.

For the first time in this crisis, the European authorities would undertake an operation for which they have more than sufficient resources. Coming as a positive surprise to the markets, it would reverse their mood. After all, markets do have moods; indeed, that is what the authorities have to learn in order to deal with financial crises.

Contrary to the current discourse, the long-term solution must provide a stimulus to get Europe out of a deflationary vicious circle – structural reform alone will not do it. The stimulus must come from the EU, because individual countries will be under strict fiscal discipline. It will have to be guaranteed jointly and severally – and that means eurobonds in one guise or another.