Posted Tuesday, Dec. 6, 2011, at 8:59 AM
Photo by Julien M. Hekimian/Getty Images
The headline elements of the new Franco-German Eurozone plan are, naturally, getting the bulk of the attention. But I'd like to draw attention to two subtler points that I'm not hearing as much about. One is that the new fiscal noose provisions can be suspended by Qualified Majority Voting in the Council of Europe. QMV is the EU's complicated version of a supermajority, and it essentially means that as long as the larger countries display solidarity these rules won't actually be enforced against Germany, France, or other big countries. That actually seems like an economically sensible arrangement to me, but if I were Irish or Portugese I wouldn't be too thrilled with it and Irish voters have a nasty habit of voting "no" on EU treaty referenda as it is.
The other is that they appear to be guaranteeing that never again will bondholders be asked to take losses if a country can't pay its bills. I understand why they wrote this provision in. Logically speaking, the fact that Greece was insolvent shouldn't have created a liquidity problem for Italy. But in the real world, the fact that owners of Greek bonds were made to eat a 50% haircut was the proximate cause of the Italian liquidity crisis. But it seems like a deeply problematic idea. For starters, as Felix Salmon argues it seems weird for the very same German politicians who are opposed to cosigning new "Eurobonds" with their southern partners to now be issuing an unconditional EU guarantee of all the debt of all the member states. Even here in the United States where we most certainly do have a hefty pool of central government debt, there's no unlimited federal guarantee of the debt of subordinate government units.
It seems to me that when you combine the new fiscal policy rules with the bailout guarantee, what you've really done is created very strong incentives to try to hide the ball. Europe will be completely giving up on the concept of markets disciplining the fiscal policy of national governments and relying entirely on a bureaucratic and legal process to do so. But again if you look at American states and municipalities, almost all of which have formal legal requirements to run balanced budgets, you'll find that there's still a broad array of trickier and contingent liability gimmicks that can be used to generate substantial leverage. But there are market issues alongside the legal ones. Illinois has engaged in a lot of budgetary shenanigans over the years which is reflected in its borrowing costs. Municipal bankruptcies are rare, but they definitely happen and bond buyers are aware that they happen.