Europocalypse - Are The Days of The Eurozone Numbered?

: Nouriel Roubini It's the end of the Eurozone as we know it. Credit: Mauro Luna The fate of the eurozone is ominous. As the debt crisis in Greece continues to s pread and infect other eurozone nations such as Italy and Portugal, the euro-zon e appears to be teetering on the brink. This is its last stand, says Nouriel Rou bini, chairman of Roubini Global Economics and professor of economics at New Yor k University's Stern School of Business. According to Roubini, the status quo is no longer sustainable. Only a comprehensive strategy can rescue the eurozone now . NEW YORK The eurozone crisis is reaching its climax. Greece is insolvent. Portug al and Ireland have recently seen their bonds downgraded to junk status. Spain c ould still lose market access as political uncertainty adds to its fiscal and fi nancial woes. Financial pressure on Italy is now mounting. See the Slide Show >>> How The Greek Economy Fell From Grace in 13 Steps By 2012, Greek public debt will be above 160% of GDP and rising. Alternatives to a debt restructuring are fast disappearing. A full-blown official bailout of Gr eece s public sector (by the International Monetary Fund, the European Central Ban k, and the European Financial Stability Facility) would be the mother of all mor al-hazard plays: extremely expensive and politically near-impossible, owing to r esistance from core eurozone voters starting with the Germans. Related: Money Matters: Why Germany Wants to Keep the EU Together

Related: The European Union's Catalogue of Failures: George Soros Meanwhile, the current French proposal of a voluntary rollover by banks is flopp ing, as it would impose prohibitively high interest rates on the Greeks. Likewis e, debt buybacks would be a massive waste of official resources, as the residual value of the debt increases as it is bought, benefiting creditors far more than the sovereign debtor. So the only realistic and sensible solution is an orderly and market-oriented bu t coercive restructuring of the entire Greek public debt. But how can debt relie f be achieved for the sovereign without imposing massive losses on Greek banks a nd foreign banks holding Greek bonds? The answer is to emulate the response to sovereign-debt crises in Uruguay, Pakis tan, Ukraine, and many other emerging-market economies, where orderly exchange o f old debt for new debt had three features: an identical face value (so-called pa r bonds); a long maturity (20-30 years); and interest set well below the currentl y unsustainable market rates and close to or below the original coupon. Even if the face value of the Greek debt were not reduced, a maturity extension would still provide massive debt relief on a present-value basis to Greece as a euro of debt owed 30 years from now is worth much less today than the same euro owed a year from now. Moreover, a maturity extension resolves rollover risk for the coming decades. Europocalypse - Are The Days of The Eurozone Numbered?: Nouriel Roubini Page 2 of 2

The advantage of a par bond is that Greece s creditors banks, insurance companies, and pension funds would be able and allowed to continue valuing their Greek bon ds at 100 cents on the euro, thereby avoiding massive losses on their balance sh eets. That, in turn, would sharply contain the risk of financial contagion. See the Slide Show >>> How The Greek Economy Fell From Grace in 13 Steps Rating agencies would consider this debt exchange a credit event, but only for a v ery short period a matter of a few weeks. Consider Uruguay, whose rating was dow ngraded to selective default for two weeks while the exchange was occurring, and t hen was upgraded (though not to investment grade) when, thanks to the exchange s s uccess, its public debt became more sustainable. The ECB and creditor banks can live for two or three weeks with a temporary downgrade of Greece s debt. Moreover, there would be few holdouts that refuse to participate in the exchange . Previous experience suggests that most hold-to-maturity investors would accept a par bond, while most mark-to-market investors would accept a discount bond wi th a higher coupon (that is, a bond with a lower face value) an alternative that could be offered (and has been in the past) to such investors.

At the same time, the best way to contain financial contagion would be to implem ent a pan-European plan to recapitalize eurozone banks. This implies using offic ial resources like the EFSF not to backstop an insolvent Greece, but to recapita lize the country s banks and those in Ireland, Spain, Portugal, Italy, and even Ge rmany and Belgium that need more capital. In the meantime, the ECB must continue to provide unlimited resources to banks under liquidity stress. To reduce the risk of financial pressures on Italy and Spain, both countries nee d to press ahead with fiscal austerity and structural reforms. Moreover, their d ebt could be ring-fenced with a larger package of EFSF resources and/or with the issuance of Eurobonds a further step towards European fiscal integration. Finally, the eurozone needs policies to restart economic growth on its periphery . Without growth, any austerity and reform will deliver only social unrest and t he constant threat of a political backlash, without restoring debt sustainabilit y. To revive growth, the ECB needs to stop raising interest rates and reverse co urse. The eurozone should also pursue a policy partially via looser monetary pol icy that weakens the value of the euro significantly and restores the periphery s competitiveness. And Germany should delay its austerity plan, as the last thing that the eurozone needs is a massive fiscal drag. Related: Eurozone Divorce Imminent: Nouriel Roubini Related: A 2008-Scale European Financial Crisis This Year? : Niall Ferguson The eurozone s current muddle-through approach is an unstable disequilibrium: kick ing the can down the road, and throwing good money after bad, will not work. Eit her the eurozone moves toward a different equilibrium greater economic, fiscal, and political integration, with policies that restore growth and competitiveness , including orderly debt restructurings and a weaker euro or it will end up with disorderly defaults, banking crises, and eventually a break-up of the monetary union. The status quo is no longer sustainable. Only a comprehensive strategy can rescu e the eurozone now.