Investors are hoping for a “big bazooka” to solve the debt crisis, says Ian Campbell on Breakingviews. Policymakers have promised a comprehensive plan. Expected to be unveiled this Sunday, it should cut Greece’s debt to sustainable levels, recapitalise banks, and greatly boost the firepower of the zone’s rescue fund, the European Financial Stability Facility (EFSF). But Europe’s “track record on taking decisive action is far from encouraging” – and there are plenty of potential difficulties clouding the outlook.
In July, bondholders agreed to a 21% haircut on Greek debt. With the Greek economy in free-fall and its debt-to-GDP ratio on course for 190% of GDP, there is now talk of a 60% haircut. But lenders are reluctant to take further losses on Greek debt.
A Greek haircut could trigger contagion. As economic analyst Capital Economics points out, “investors would presumably worry… that other troubled governments… would try to obtain similarly large” haircuts, implying higher bond yields and possible defaults, causing further losses for banks and other bondholders. Ireland, for instance, “has made incredible strides…and so may be justifiably outraged should Greece be allowed to default”, says Fxpro.com.
So recapitalising the banks to withstand further peripheral losses is crucial. Policymakers are reputedly planning to re-run recent stress tests and impose stricter minimum capital levels. But with markets hostile, banks may decide to reach the new targets by shrinking their balance sheets and lending less. This could worsen the credit squeeze and cause a recession. If governments step in, the €200bn or so likely to be needed would “push public debts towards the danger line”, says Ambrose Evans-Pritchard in The Daily Telegraph.
Boosting the EFSF’s firepower beyond €440bn is also easier said than done. Levering it up to €2trn implies more strain on core countries’ finances. A reminder of that arrived this week with credit ratings agency Moody’s warning that the stability of France’s AAA rating was at risk. So a stronger EFSF could simply cause more problems. Given all this, says Paul Taylor in The New York Times, don’t expect “the latest ‘comprehensive strategy’” to be “the one that does the trick”.