European banks hold much of this debt. The IMF estimated that European bank exposure to Eurozone peripheral members is 80 percent of their capital. Thus, any debt reduction or default without simultaneous cash infusions to banks would be devastating. To make matters worse, Europe’s economic growth has stalled as the Eurozone is not promoting growth. The ECB has raised rates rather than lowered them and member nations are simultaneously cutting spending and increasing taxes - policies that stunt growth and paradoxically increase deficits.
For the Eurozone to survive long-term, Europe needs a massive restructuring of its debt and recapitalization of its banks. A bold restructuring and recapitalization plan would consist of the following, each of which would need to be consummated at the same time:
• The debt of the member nations would be reduced to manageable levels through pay downs and voluntary write-downs by banks.
• “Eurobonds,” which would be akin to U.S. treasury bonds, would be issued by the Eurozone.
• The funds received by the Eurozone would be used to pay down debt and recapitalize the European banks.
• The “investment” in the European banks would be in return for preferred stock, which would be issued to those Eurozone members that experienced an increase in borrowing costs as a result of the creation and issuance of eurobonds.
Is this type of restructuring plan or any other debt restructuring plan realistic? Four huge obstacles stand in the way.
First, the numbers involved in a comprehensive restructuring of Eurozone debt are huge. Any debt reduction and bank recapitalization plan will require massive amounts of funds, a significant portion of which will be provided or implicitly guaranteed by strong Eurozone members like Germany (which has seen its economic growth stall).
Second, the creation of a “eurobond,” which could allow the Eurozone to raise the funds needed to implement a comprehensive restructuring, will increase rates for stronger members of the Eurozone, while reducing rates for weaker members. Increased rates will mean higher interest payments for the likes of Germany and France, which will negatively impact their already tepid economic growth. A recent emnid poll demonstrates that 76 percent of Germans are against the creation of a eurobond.
Third, a Eurozone fiscal integration with a “real economic government” must be established. The Eurozone members have already relinquished a certain amount of their sovereignty by agreeing to a single currency - the euro - and to rely on the ECB for monetary policy. To achieve a fiscal integration, Eurozone members need to relinquish more sovereignty as it relates to fiscal issues. In many ways, however, this places the democracy of member nations at risk.
Fourth, the politics of this situation may be too overwhelming. For instance, Germany will need to convince its voters to foot the bill for nations like Greece and Portugal. Greece and Portugal will need to convince their voters to give up their sovereignty to centralize economic power. These are huge political issues and, indeed, may be too big. As a result, it is fair to question whether the Eurozone will survive.
Piecemeal proposals and in-between policies risk not just the Eurozone but could cause a new banking crisis. The Eurozone and the ECB need to act with haste and take bold steps to fix the debt crisis before it’s too late.
Jonathan Henes is a restructuring partner at Kirkland & Ellis, LLP. He has led some of the most complex restructurings in the United States and abroad in a variety of industries, including media, chemicals, energy, manufacturing, real estate, retail and telecommunications.