In December 2011, the Adam Smith Institute asked one of its Senior Fellows, Miles Saltiel, to form a team to compete for the £250,000 Wolfson Prize for an essay on the best course for the Eurozone if members decide to drop out. He assembled a crew of City professionals and economists. They pored through the law-books, worked up the sums and took the counsel of an international group of seasoned veterans. They concluded that the legal situation is so ambiguous that drop-outs will have strong negotiating hands. The sums are plain scary:
- Bank contagion of €740bn , swamping even German bank capital;
- Policy cost of €1tn, including reform, monetary and fiscal easing; and
- Haircuts for selected creditor classes of 100%, if the ECB sticks to its guns by insisting on its status as an “official creditor”.
Most alarming is the institutional mismatch: the ECB should be taking the lead but is hampered by its own statutes; not even Germany is in a position to ride to the rescue. And the need to minimise turmoil means that any secession will come as a surprise.
- This is no excuse to for policy-makers to bury their heads in the sand. They need to brace themselves and be ready to tweak the international mechanisms to meet the specifics of dropping out from the Eurozone.
- The occasion of secession should be handled calmly all round, with the seceding state making provisional agreements with its neighbours and others to minimise spill-over.
- Restructuring needs the skills of the IMF, who in turn need local leadership. If the ECB can’t step up, European states and others should create “Resolution Funds”, possibly one for each seceding country, to finance reform and supervise restructuring.
- The EU needs to take an adult approach to restructuring. Fines make no sense and treaties have no force. Once realistic plans are agreed, the EU should co-operate with drop-outs while they stick to their promises, but hold out the threat of reduced decision-making rights if they stray. So too must the regulators act with maturity, restraining pro-cyclical burdens on financial organisations including central banks.
- The eventual settlement should be embodied as a treaty, to iron out the complexities and regularise the dislocation of secession.
Click here to see the essay, setting out the analysis and proposals in full. It is offered as a contribution to the debate between contestants for the Wolfson Prize, which we see as playing a positive part in adding to public understanding and the formation of professional opinion.