A German plan for revamping the euro-area proposes an automatic mechanism for sovereign debt-restructuring. This mechanism, designed by Berlin’s Ministry of Finance, is designed to prevent any form of risk-sharing between euro-area countries and to confine the costs of fiscal and financial instability primarily within the more fragile countries. From the perspective of debt defaults, the plan could enforce more discipline, but it also risks dramatizing any future episode of financial instability.
The 18 countries sharing the euro are still struggling to recover from seven years of financial troubles that have jeopardized the very survival of the common currency. Since 2010, a slew of different proposals have been put forward for improving either the centralization of the area’s economic governance or, alternatively, for decentralizing the risks and limiting the amount of risk-sharing. The German government seems to have lost faith in any form of centralized governance, and it would rather try to shield German taxpayers from sharing the potential costs of a sovereign debt crisis in other countries.
The plan is described in a letter sent at the end of November by the Ministry of Finance to the heads of the Finance and Budget Committee of the German Parliament. The unpublished missive prescribes an automatic mechanism for restructuring the public debt of any country requesting financial assistance. Once a country asks for help through the European Stability Mechanism (the ad hoc fund established in 2012), for whichever reason, sovereign bond maturities will automatically be lengthened, reducing the market value of those bonds and causing severe losses for all bondholders.