The euro zone debt crisis has been playing second fiddle to the US-led rise in global bond yields over the last month. Tax reform led to a sharp rise in US yields and other markets followed, but the ongoing crisis in Europe could again be dominating investor attention, according to Citi Chief Economist Willem Buiter.
“Now that the Irish government has reached an agreement with the EU/IMF on a financial support package and associated conditionality, the market’s attention will turn to Portugal, whose sovereign, at current levels of interest rates and growth rates, we judge to be less dramatically, but quietly insolvent,” Buiter wrote in a research note Friday.
“We consider it likely that Portugal, too, will need to access the EFSF/EFSM soon.” Buiter said.
Buiter said the current size of the liquidity facilities in place within the European Union is sufficient to deal with another speculative attack or as he puts it “even fund Spain completely for three years”
3 Tough Measures to Solve the Crisis
If the euro zone is truly to put the debt crisis behind it, three very painful measures are going to be needed, Buiter said.
The first would be very painful for European politicians, particularly German Chancellor Angela Merkel. The EU would need a much larger liquidity support facility of at least €2 trillion ($2.6 billion).
“Concerns about the liquidity of fragile euro-area banking systems and about the impact of sovereign default on the solvency of banks have led euro area policymakers to delay the day of reckoning for the sovereigns in the hope of muddling through without another round of bank bail-outs," Buiter said.
“If sufficient liquidity support can be put in place by the EU ... to fund all sovereigns at risk of losing access to market funding, if the liquidity and capital fragilities in the euro area banking sector can be resolved, if an EU-wide special resolution regime for banks were put in place, and if a mechanism for the orderly resolution of sovereign default can be created by the expiry date of the EFSF and the Greek facility in mid-2013, then sovereign debt restructurings, including haircuts, would become very likely around the time a new, permanent financial support facility, the European Stability Mechanism, is introduced.”
The second solution, in Buiter’s view, is for a “restructuring of the unsecured debt of and recapitalisation of the systemically important ones among them.”
“The sovereign debt crisis in the euro area periphery is closely tied up with a suppressed banking crisis throughout the euro area — core and periphery” Buiter said.
Any default within the euro zone would turn attention to the banks, many of which he believes have been allowed to exist in a vegetative, zombie-like state.
“Unless the resolution of these banks can be coordinated in an orderly manner with the restructuring of the debt of the insolvent euro area periphery sovereigns, Europe could be faced with a disorderly, indeed chaotic, period of sequential sovereign and bank default”.
Buiter’s third mechanism is to allow sovereign debt defaults.
“Burden sharing in the correction of an unsustainable fiscal position should see creditors share the burden, as well as tax payers and the beneficiaries of government spending programs,” he said.
If policy makers where to listen to Buiter, Portugal asking for assistance from the EFSF/EFSM could be least of investors problems.