Varoufakis Proposal for Eurozone Sovereign Debt

Econintersect:  Former Greek finance minister Yanis Varoufakis has proposed a debt restructuring process for over-indebted Eurozone countries that does not involve writing down debt or bailing out insolvent countries.  It is based on an idea proposed by  Varoufakis with Stuart Holland and James K. Galbraith (link below).

Varoufakis presents his proposal in an article at Project Syndicate (A New Approach to Eurozone Sovereign Debt) and draws on a July 2013 article by Varoufakis, Holland and Galbraith: A Modest Proposal for Resolving the Eurozone Crisis, Version 4.0.

Varoufakis very clearly describes the difficult policy constraints imposed by the structure of the Eurozone and the frequent violations of the strict letter of those constraints by members of the EU-18 using “creative ways to amend the rules“. For this discussion alone the article is very useful.

What Varoufakis suggests (Econintersect interpretation) is a form of conversion of sovereign debt that exceeds the 60% of GDP limit imposed by the Maastricht Treaty to what we will call ‘semi-perpetual’ bonds owned by the ECB. They are not truly perpetual because countries liable for such bonds would be required to make periodic payments of interest and principle. But the amount of principle payment could be adjusted as necessary (again an Econintersect assumption) to assure default would never occur in time of fiscal stress.

Here is Varoufakis in his own words:

In brief, the ECB could announce tomorrow morning that, henceforth, it will undertake a debt-conversion program for any member state that wishes to participate. The ECB will service (as opposed to purchase) a portion of every maturing government bond corresponding to the percentage of the member state’s public debt that is allowed by the Maastricht rules. Thus, in the case of member states with debt-to-GDP ratios of, say, 120% and 90%, the ECB would service, respectively, 50% and 66.7% of every maturing government bond.

To fund these redemptions on behalf of some member states, the ECB would issue bonds in its own name, guaranteed solely by the ECB, but repaid, in full, by the member state. Upon the issue of such an ECB bond, the ECB would simultaneously open a debit account for the member state on whose behalf it issued the bond.

The member state would then be legally obliged to make deposits into that account to cover the ECB bonds’ coupons and principal. Moreover, the member state’s liability to the ECB would enjoy super-seniority status and be insured by the European Stability Mechanism against the risk of a hard default.

Such a debt-conversion program would offer five benefits. For starters, unlike the ECB’s current quantitative easing, it would involve no debt monetization. Thus, it would run no risk of inflating asset price bubbles.

Second, the program would cause a large drop in the eurozone’s aggregate interest payments. The Maastricht-compliant part of its members’ sovereign debt would be restructured with longer maturities (equal to the maturity of the ECB bonds) and at the ultra-low interest rates that only the ECB can fetch in international capital markets.

Third, Germany’s long-term interest rates would be unaffected, because Germany would neither be guaranteeing the debt-conversion scheme nor backing the ECB’s bond issues.

Fourth, the spirit of the Maastricht rule on public debt would be reinforced, and moral hazard would be reduced. After all, the program would boost significantly the interest-rate spread between Maastricht-compliant debt and the debt that remains in the member states’ hands (which they previously were not permitted to accumulate).

Finally, GDP-indexed bonds and other tools for dealing sensibly with unsustainable debt could be applied exclusively to member states’ debt not covered by the program and in line with international best practices for sovereign-debt management.

Varoufakis points out that a federal solution (i.e. the United States of Europe) would also address the current problem but acknowledges the lack of support for that in Europe, particularly after the extreme distress of the last five years. He offers the alternative discussed here as a way to “help to heal Europe’s wounds and clear the ground for the debate that the European Union needs about the kind of political union that Europeans deserve“.

John Lounsbury