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Europe Still Avoiding Only Solutions to Its Crisis

I think the new deadline for a resolution to the European financial crisis is Wednesday, though I’m not sure a single deadline has been hit so far, so best to consider that soft.

We know the basic outlines of the plan that many European leaders want to create. It includes a haircut for investors in Greek bonds, possibly as much at 60%; some recapitalization of European banks after they take this hit, but done in a way that doesn’t undermine France’s credit rating; and a leveraging of the EFSF, the European bailout fund, to make the fund big enough to stop any run on Italy and other euro sovereigns and stop any contagion.

There’s some argument over the mechanism for the leveraging, but basically the situation is that the sovereign governments don’t want to spend the money – or don’t have the money – to create a backstop at the level that’s needed without risking their own credit.  Similarly, the European Central Bank isn’t equipped or willing to print the money or to perform the function of a central back, lender of last resort, and thus stand behind the debts. So the idea is to conjure it.

As Wolfgang Munchau writes, this is insane (h/t Brad DeLong:

A leveraged EFSF is attractive to politicians for the same reason that subprime mortgages once appeared attractive to borrowers. Leverage can have different economic functions, but in these cases it simply disguises a lack of money. The idea is to turn the EFSF into a monoline insurer for sovereign bonds. It is worth recalling that the role of those monolines during the bubble was to insure toxic credit products. They ended up as a crisis amplifier….

The simple reason why there can be no technical quick fix is that the crisis is, at its heart, political. The triple A-rated countries have left no doubt that they are willing to support the system, but only up to a certain point. And we are well beyond that point now. If Germany continued to reject an increase in its own liabilities, debt monetisation through the European Central Bank and eurobonds, the crisis would logically end in a break-up. There is no way the member states of the eurozone’s periphery can sustainably service their private and public debts, and adjust their economies at the same time.

If the ECB is not willing to be the lender of last resort — and so far neither it nor Germany agree it should — there are two options for Europe – fiscal union or a breakup of the euro. The leveraged EFSF represents the Third Way, and it should do just about as well as Tony Blair’s administration.

This is really a terrible situation, as Paul Krugman laments today. A great continent is being shattered:

The story of postwar Europe is deeply inspiring. Out of the ruins of war, Europeans built a system of peace and democracy, constructing along the way societies that, while imperfect — what society isn’t? — are arguably the most decent in human history.

Yet that achievement is under threat because the European elite, in its arrogance, locked the Continent into a monetary system that recreated the rigidities of the gold standard, and — like the gold standard in the 1930s — has turned into a deadly trap.

In some cases, that trap has already been triggered. Greece is in a terrible state, and it’s a mixture of economic stupidity and simple malignancy. As the Financial Times revealed in this confidential analysis from the Troika – the EU, the IMF and the ECB – Greek debts are spiraling because its economy has been deliberately broken in two. The situation is dire:

The poor and middle classes are being asked to pick up the bill for the excesses of the rich and corrupt; those who have declared their taxes correctly continue to be taxed more than those who don’t; and in a country with one of the highest cost of living, wages are being cut and taxes being raised….

I live in chaos. Chaos is a Greek word and aptly describes life in this country. I have been a good citizen of this country and have worked hard in the 25 years that I have lived here. I work from 2pm to 10pm daily. I put in 40 teaching hours per week. If you add the lesson planning and marking it’s nearly 50 hours per week. I only see my husband for half an hour a day as he teaches in a state school in the morning but because his salary is so low he needs to supplement his income in the evenings. How many of our European colleagues work so many hours?…

I can’t get to work easily most days because public transport is usually on strike three days every week. The streets are piled high with rubbish…

I work with a local council in Crete. There is an increasing sense of the country having fallen apart. All temporary contracts have been arbitrarily cancelled so we can’t run any sports or arts programmes, even those which are profit-making. No one answers the phones in the central offices in Athens because of the sit-ins, so we can’t work our way round the red tape.

The country’s economy has been almost vaporized. And the rest of Europe could have that to look forward to if they keep ignoring the only solutions that will work.

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David Dayen

David Dayen