To understand euro zone bailout plans, just think BBB.
Bonds, Banks, Bailout
- The Bonds: If you own Greek debt, then you would be asked to accept a 50% haircut. That means you will get new Greek bonds worth half the old ones. The catch? It’s voluntary. A bondholder could say, “No.”
- The Banks: If banks are going to accept a 50% decrease in the Greek bonds that they own, then the value of their assets plunges. To prevent a ripple of bank failures, 70 Greek and Spanish banks would get an injection of new funds. The catch? Contagion. What about the other PIIGs’ debt?
- The Bailout fund: The Bonds and the Banks part of the deal require lots of money. At least $750 billion more. Where to get the money? One major source is the EFSF (European Financial Stability Facility). The plan is to make the stability fund 4 times larger. The catch? Who will loan it the money? NPR’s Planet Money perfectly describes “the catch” in this podcast.
Our Bottom Line: How can the euro zone enforce central monetary power when fiscal authority is decentralized?
And finally, even if none of the plans materialize, we can still remember BBB.
The Economic Lesson
In 1787, functioning under the Articles of Confederation, we had thirteen states with individual currencies and governments and taxing authority. If a state wanted to borrow more than it could afford, no one could stop it. If a state did not want to collect its federal taxes, no one could make them. If they did not want to contribute to payments on the national debt (from the Revolutionary War) they did not have to. And yet, the actions of individual states affected everyone else. Believing we needed a stronger central government, Alexander Hamilton and others like him convened a constitutional convention during a very hot summer in Philadelphia. We wound up with our Constitution and a powerful central government.
An Economic Question: Is it valid to compare the euro zone to the United States in 1787?Read More