Edited by Thorsten Beck - Vox

The Future of Banking
money after bad and will not do so unless they can extract serious political concessions.
One cannot imagine how much several hundred billions of euros are politically worth.
Assuming that, somehow, bank recapitalisation and debt defaults can be handled
simultaneously (more on that later), how to make defaults reasonably orderly? Last
July, the European Council set the parameters of an orderly Greek default. Hau (2011)
shows that this agreement, dubbed voluntary Private Sector Involvement (PSI), has
been masterminded by the banks and only aims at bailing out banks, not at significantly
reducing the Greek public debt. Conclusion 3 is that there is no such thing as a voluntary
PSI. Banks are not philanthropic institutions; they always fight any potential loss to the
last cent. If not, they would have bailed out Lehman Brothers without the US Treasury
guarantee that they were denied.
This brings us to Conclusion 4 – in order to avoid a massive financial and economic
convulsion, some guarantee must be offered regarding the size of sovereign defaults.
Crucially, the country-by-country approach officially followed is unworkable. The
current exclusive focus on Greece is wholly inadequate. Markets look at Greece as
a template. Whatever solution is applied to Greece will have to be applied to other
defaulting countries. Adopting an unrealistically short list of potential defaulters will
only raise market alarm and result in failure. Such a list is difficult to establish on
pure economic grounds (should Belgium and France be added to Italy and Spain?) and
politically explosive (governments cannot provoke a default by including a country in a
near-death list). The only feasible solution is to guarantee all public debts, thus avoiding
both stigma and lack of credibility. Finland, Estonia and Luxembourg would do the
Eurozone an historical service by requesting to be part of a debt guarantee scheme.
What kind of guarantee scheme is needed? An example is provided in Wyplosz (2011).
In a nutshell, all sovereign debts must be partially guaranteed (eg up to 60% of each
country’s GDP, or up to 50% of the nominal value). The scheme would backstop debt
prices by setting a floor on potential losses. It would lead to less panicky debt pricing
by the markets. In turn these market prices would serve as a guide to debt renegotiation
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