EU to ask banks to voluntarily declare bankruptcy

Via Spiegel, Germany has finally tipped its hand as to how it plans to resolve the continuing crisis on the European periphery. With Berlin’s blessing, the EU will soon help Greece buy-out its old debts at reduced cost:

At the moment, Greek state securities are being traded at a sizeable discount to their face value. A five-year bond, for example, is being traded at around 70 percent of its face value — sometimes a little more, sometimes a tad less. Under the plan, in order to improve its debt position, the Greek government would offer to buy back securities from its creditors at a premium over the current market price. The transaction would be backed by the EFSF.

Investors would now face a choice: If they were to accept the bonds, then they would have to book a considerable loss. At the same time, they would have certainty that the losses would not be even greater.

Give credit to the policymakers for getting the central idea right: mere austerity is no match for the massive sovereign debt owed by Greece and its fellow PIIGS. Unfortunately, though, the EU hasn’t dropped all its bad habits. This intervention, like its predecessors, seems destined to be a combination of too late, too weak, and too small.

The central problem is that the buy-out program is going to be entirely voluntary for the bond creditors, which raises the question of who, exactly, is going to participate in it. Bonds from Greece, Portugal and Ireland are held by hundreds of European banks, insurers and pension funds, few of which can afford to take the massive write-down on offer without being forced to declare bankruptcy (or seek bailouts) themselves. Getting the ledgers truly and sustainably straight across Europe will inevitably require a greater share of the pain being distributed to the institutions who were loaning all the cash in good times. But why would they abandon their leverage, and expose their massive vulnerability, without being forced to?

Indeed, the dirty secret of the whole EU financial crisis is that German banks are at the center of it, holding hundreds of billions of euros of questionable bonds. German policymakers have said little about that fact publicly, while, behind the scenes, they’ve used their influence to obscure it. They were abetted by the suspect stress tests applied to banks by the EU last year (these were the same stress tests that Irish banks managed to pass shortly before being nationalized).

But as Europe plans a new set of stress tests that it promises will be more stringent than the last, the day of true reckoning — and the beginning of Europe’s real healing — might not be too far off.