An immodest proposal

Everybody is having a proposal to solve the eurozone crisis, so I can as well come up with one, for fear of being left out, with apologies to Yanis Varoufakis for the title.

Executive summary:

  • Do an Iceland.

In more details, this would entail a programme like:

  1. Organise panic: the eurozone governments would announce, on a Sunday, that they are thinking of defaulting in a major way. It could be, say, a major Italian default, or perhaps announcing every member state with debt above the Maastricht criteria will default by what it takes to take them back within (60% of GDP, etc). The announcement is just about discussions, no decision is actually taken, but it has to be a credible threat. The aim of the proposal is to take at least one major eurozone bank close to insolvency.
  2. The consequence of the previous point should be that on the Monday market opening prices for bank shares collapse, as fears of contagion from one bank insolvency to another spread. The eurozone banking sector is currently worth approximately 300 billion euros, this should take it down to below 100, hopefully lower.
  3. On Monday evening, or whenever the panic has suitably set in, nationalise the eurozone banking sector (either the top 20 that covers 95% of the sector, or all licensed banks if need be, the small players are a sideshow anyway), paying private shareholders the now collapsed market price for their shares, aka peanuts. At the end of the day, all eurozone banks are now technically subsidiaries of a eurozone-wide quango (the EFSF or the EIB could be repurposed to fill this function). This eliminates any problem on the interbank markets as it is effectively abolished: there’s only 1 bank, let’s call it the EuroBank, whose internal netting can be coordinated.
  4. Split the EuroBank into two: new banks operating deposits and other payment processing type functions, by slicing out the narrow banks out of the former universal banks. Put all the rest in a “bad bank”. All the banks’ assets and liabilities not necessary in the narrow banks are there, as well as much sovereign bonds as possible.
  5. We end up with a bad bank that has assets like the worst eurozone govies, and liabilities such as the former banks corporate bonds, among others. The eurozone govies are then revalued down by what it takes to take the eurozone debt down to sustainable levels. Eurozone member state debt not held by the bad EuroBank does not default. Then comes the good bit: the bad EuroBank is now insolvent and can default on its own liabilities like corporate bonds, ETNs, commercial paper, etc. If it can’t be done within the current legal framework, pass emergency bank insolvency legislation, which should be doable quickly at the member state level without EU treaty changes.
  6. Clean up: progressively sell remaining valuable assets of the bad banks, like investment banking, preferably to operators outside the eurozone, so that the next investment banking disaster is someone else’s problem. A proportion of the junk could be sold to the UK, for instance, using a carefully spin on the “jobs for the City” idea. Narrow banks are also later re-privatised, under new regulations preventing them from becoming universal again.

So, the core idea is that the eurozone does reduce debt by defaulting, but not by defaulting on its own bonds owned by the public (non-eurozone government entities), but by having nationalised eurozone banks default on their corporate bonds and other emissions. Basically, by nationalising its banks at a bargain basement price, the eurozone buys back its own debt at a tremendous discount and then defaults on secondary obligations that are not so intensely systemic, even if the process is likely to be quite agitated. Incidentally, CDS on sovereigns shouldn’t even be triggered; CDS on eurozone banks will, and that’s OK.

And at the same time the process can be used to wipe out and restructure a parasitic sector, by extracting back the useful functions and closing down or selling away the harmful ones.

It may be argued that the process, a massive private banks default, will cause seismic waves with non-eurozone operators who own enough eurozone bank debt to take them down. So be it. At worse, other countries just have to do the same process, and nationalise their own banking sectors. We can, in a couple of weeks, get rid of the dominant character of a toxic industry that has resisted reform for more than three years after it caused a major crisis at great public cost. What is not to like about this?

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