Europe's finance ministers are in Brussels, trying to convince Ireland to accept a bailout from the stabilization fund established in the wake of last spring's crisis in Greece. The conventional wisdom, repeated everywhere in Europe this week, is that this is necessary to “stabilize the markets” and prevent “contagion.”
But the euro zone's main problem is not “contagion.” It's solvency. Bailing out Ireland does not make it more likely that Portugal or Spain or even France will be more likely to pay their bills going forward. And bailing out Dublin's bondholders does nothing to improve the solvency of any other European capital. On the margin it could make their problems worse, since each would have to contribute to the cost of the bailout.
The vital question with respect to Ireland is whether in the long run Dublin's commitment to recapitalizing its banks will overwhelm the government's capacity to repay its debts as they come due. Getting a loan from Brussels does nothing to address that question. It will merely put off the asking of it until some future date when the moment arrives for Dublin to pay its debts to Brussels. Nor will it reveal anything about whether Lisbon's fiscal path is sustainable.
For the moment, Dublin does not need to tap the debt markets. The scary yields of 8% or more on its thinly traded 10-year government debt are prices in the secondary market; they don't reflect what Ireland is actually paying on its debt—for now.
The conventional wisdom, repeated everywhere in Europe this week, is that an Ireland bailout is necessary to stabilize the markets.
But those yields do reflect the depressed market value of Irish sovereign debt, which in turn could hit the balance sheets of European banks that hold that debt if they have to mark it to market. The proposed bailout, then, would seem to be intended for the benefit of Ireland's lenders—banks in Germany and elsewhere that hold that debt on their books.
Saving those creditors from taking any haircut is the definition of moral hazard, however quaint that phrase has become. And if Brussels isn't careful, it could find itself in a position analogous to Dublin's now.
Dublin finds itself in this mess because at the height of the panic in September 2008, the Irish government in its infinite wisdom guaranteed the debts of all Ireland's large banks—not just depositors, but senior and subordinated bondholders too. It seems the height of folly for the EU to extend a similar guarantee, even by implication, to the holders of all euro-zone sovereign debt.
In a sense, it did this last May when it set up the €750 billion stability fund after Greece's rescue. This was supposed to calm markets and keep them open to government borrowing. But as the behavior of Irish and Portuguese bonds attests, that didn't work, because it did nothing to address the overspending and lackluster growth at the heart of Europe's debt problem.
Ireland, at least, is taking the overspending problem seriously. It would be in much better shape if not for that open-ended guarantee to bank creditors. Repeating Ireland's mistake on a continental scale won't save the euro, and could harm it. This week, German Chancellor Angela Merkel said that “if the euro fails, then Europe fails.” But the euro is a currency union, not a debt union—at least it wasn't until last May.
Mrs. Merkel has it backwards. If the euro zone, in violation of the treaty that created it, effectively assumes the debts of all its members, it would do more damage to the credibility of the currency bloc than a haircut for its lenders. If Ireland, like Greece, cannot pay its debts, it needs to restructure them, and the sooner the better.
“The Wall Street Journal.” – Wednesday, November 17, 2010
