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Wednesday, September 29, 2010

Is there a case for a Chapter 9-style insolvency procedure for the eurozone?

An interesting letter in yesterday's FT by Annerose Tashiro of law firm Schultze & Braun in Frankfurt, argued that the eurozone should consider adapting a restructuring plan akin to the US bankruptcy code - the so-called Chapter 9 - which enables American municipalities and cities to default. She argued,

Looking into the framework that Chapter 9 provides, such a municipality would not be under the threat of any sort of liquidation or dissolution. There would also be no estate in the traditional sense and no assets – so no one is suggesting that the Greek school system should be sold off to pay its debts.
Interesting thought. German Finance Minister Wolfgang Schauble has consistently argued for the introduction of some sort of orderly insolvency procedure to deal with a sovereign default within the eurozone, fearing for Greece's in a first instance.

Such a mechanism would have several appealing aspects from a German - and economic - point of view:

- Crucially, it would transfer risks from taxpayers to creditors (where the risks belong). At the moment, German taxpayers are potentially liable for some €120 billion - a crazy amount by all standards. In total, roughly €29 billion has already been dished out to Greece as part of the first rescue package, with Germany being liable for a substantial part of that sum. The rest of the bailout package is theoretical at the moment.

However, should Greece continue to tap the bailout funds, and other countries - such as Ireland, Portugal or, heaven forbid, Spain - follow suit, these bailout fantasy sums would no longer be theory but will become an absolutely massive liability on the Bundesfinanzeministerium's books.

A chaotic default following taxpayer-backed loans would combine the worst of all worlds, and would be a disastrous blow to both the euro and the European Project as a whole. Even if the risk of a eurozone country defaulting was tiny (and it isn't), you can see why German politicians don't want to take this gamble.

- And close to German hearts, an insolvency procedure could encourage fiscal discipline. As a leader in the FT argued last week, "In a union so clearly unable to control the fiscal habits of its member states, the threat of default would be a powerful check on excessive borrowing and irresponsible lending."

- It could allow for Germany to sneak in other changes to eurozone governance, including temporary suspensions of voting rights for countries breaking soon to be toughened up EU budget rules.

Whether a Chapter 9-style mechanism or something else, any concrete proposal for an orderly default procedure is bound to come up against massive political challenges. The elephant in the room is Treaty change. Germany seems inclined to push for changes at the level of all 27 member states, which would require all EU countries to agree. Alternatively, the eurozone could establish such mechanism outside the EU Treaties, which, incidentally, would circumvent Britain.

An insolvency procedure would involve a clear transfer of powers from member states to the EU, as national laws must be brought in line with whatever is established at the European level.

BUT, instead of taxpayers footing the bill for the poor decisions of governments and companies they cannot vote out of office, such an arrangment would mean that ultimate liability will rest with those who actually made the mistakes.

If an insolvency procedure means no more taxpayer funded or ECB-led bailouts of governments - which have no basis in the rule of law in the first place - the net effect would actually be a fairer and more democratic eurozone.

* UPDATE: A leader in today's Handelsblatt makes a convincing case for an insolvency procedure. "Only when investors know their risks, prices can fulfill their role in the market place", it argues, noting that "neither banks nor countries should be 'too big too fail'. It calls for an insolvency procedure to be ready in a couple of years time, as "Greece might default after all".

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