Approximately eleven months ago, I argued that a solution to the Eurozone debt crisis required a more long-term approach that took into consideration the unique origins of the crisis in each of its ‘victim’ states and the resultant need for a solution that addressed these distinct aspects of the Eurozone’s failings. Unfortunately, the same argument remains apt today, the reason for which is that Europe’s leaders are still trying to solve the debt crisis with a singular focus on austerity and budget discipline, despite the fact that this will not solve the problem of recapitalising Spanish and Irish banks, among other things. To be fair to those leaders, many of them now realise the approach undertaken so far will not ultimately work, as evidenced by European officials acknowledging the need to consider giving funds from the European Stability Mechanism (ESM) to troubled banks directly, rather than via sovereign bailouts. However, the increasingly lone Eurozone member with room for significant financial outlays is determined to pretend that enhanced budget discipline in future and a commitment to austerity now will somehow prevent Spain’s banks from going bust. I fail to see the correlation.
This is not to say that the roots of the Spanish debt crisis, in poorly regulated banks and a real-estate bubble rather than fiscal profligacy, is the sole obstacle to the success of austerity-based solutions to the Eurozone’s ills. One need only look to Greece and the dire state of affairs there to conclude that German Chancellor Angela Merkel’s old-fashioned cure for indebted sovereigns works about as well as other old-fashioned antidotes, such as leeching. The importance of understanding how misplaced this approach is given the roots of the debt crisis in Spain and Ireland, as opposed to Greece, lies in the fear of moral hazard currently gripping the German people. Specifically, Mrs. Merkel’s reticence about sanctioning bolder solutions to the Eurozone crisis, in the form of debt mutualisation and direct lending to troubled banks, for example, lies in the fear that as soon as she weakens her resolve on these points, her taxpayers will be footing the bill for everyone else’s debt party.
There is no doubt something to this fear, because assuming Greece is let off the hook for all the structural reforms that have been promised and not yet carried out, other Eurozone states in need of such painful medicine may see an easier, preferable way out of their own uncomfortable situations. However, such a perception would ignore several key points, notably the incredible austerity-induced suffering the Greeks have already endured and, related, the lack of progress to show for it given how costly this austerity has been for the Greek economy. This would also ignore the fact that French and German banks benefitted significantly from the Greek bailout, which precluded the need to write down 100% of the considerable quantity of Greek sovereign bonds they held, and allowed them time to shed those toxic assets, of which they still held a non-negligible amount when the latest EBA stress tests came out.
To return to the point at the centre of this discussion, justifying harsh treatment of Spain and Ireland along the lines of a fear of moral hazard is to read inaccurately the cause of the trouble in those countries. To summarise: other indebted Eurozone members are unlikely to view the Greek experience, culminating in what has transpired over the past three years since the bailouts began as a cost-free debt binge, even if the EU were to turn round tomorrow and cancel all conditions attached to past and future bailouts; it would be wrong to perceive the bailouts extended by creditor states thus far as benefitting solely the recipient states, rather than being very much in the self interest of the former states as well; the concern about moral hazard is overblown in the case of Ireland and Spain, states that behaved as fiscally responsibly as the top performers in the run-up to the financial crisis. This is particularly so when the risk of moral hazard is set against that of imploding Spanish banks and the need to bailout the fourth largest Eurozone economy, larger than Greece, Ireland and Portugal combined.
It is nearly a year since I raised this issue, and I am hardly the only one to have noticed it, yet little has changed in the interim, at least in terms of European leaders’ approach to the debt crisis. The circumstances of the crisis, on the other hand, have deteriorated significantly, such that Europe’s leaders do not have another year to waste on the same ill-fated plans to turn the rest of the Eurozone into Germany. Instead, they probably have about a month to realise that a better approach would be to recapitalise Spanish banks with the ESM funds, issue common Eurobonds to fund some growth-creating measures in Europe and turn Germans more nearly into Southern Europeans, so that the indebted periphery of the Eurozone might have an export market.