We need a mechanism for sovereign debt crisis resolution

In the future I will be writing a weekly column for the Danish business daily Børsen. The first column appears in today’s edition of the newspaper (you can read the article in Danish here). International news outlets and newspapers interested a syndication deal on my new weekly column are welcome to contact me (lacsen@gmail.com).

On this occasion I here share the English translation of the article:

We need a mechanism for sovereign debt crisis resolution

Recently nearly all the news flow in the financial media has been about the risk of a Greek sovereign default. But Greece is not the only country, which is currently in serious risk of a default. The same is the case for Ukraine, Venezuela and Puerto Rico. Thus, if we are unlucky, we might get 3-4 sovereign defaults within the next 1-2 months.

It is quite obvious that a possible Greek or Ukrainian sovereign default is something that contributes to the uncertainty surrounding especially the European economy and it is clear that this is contributing to increasing volatility in global financial markets.

The main source of uncertainty in relation to sovereign default is uncertainty about when it happens and what creditors that will be affected.

If we compare a sovereign default with a company or a bank going bankrupt, then it is the case that we in most developed economies in the world have relatively clear rules on how a possible bankruptcy should be handled in legal terms.

It is usually the case that a company in financial trouble under certain conditions can go into receivership, while trying to see if the company can be rescued. And if this rescue attempt fails then there will be quite clear rules about what creditors are first in line when the estate is made up.

Such mechanisms mostly ensure that an orderly and controlled restructuring or liquidation of the company can take place and at the same time ensure the greatest possible transparency about who will bear any losses.

Unfortunately we don’t have similar rules and mechanisms when it comes to sovereign defaults. As a result even a minor risk of a possible sovereign default creates unnecessary volatility in the global financial markets.

This, however, need not be the case and one may wonder why we in the EU hardly have discussed the possibility of organizing a mechanism within the EU, or at least within the euro area, which can ensure a more transparent and proper handling of threatening sovereign defaults.

In 2010, the four economists – including the former chief economist of the World Bank Anne Krueger – put forward a concrete proposal for “A European mechanism for sovereign debt crisis resolution”. The plan for example included a proposal for a special European court to oversee the process of debt negotiations and debt restructuring. Such a court and clear rules on debt restructuring would greatly help to make the handling of the sovereign debt crises much less politicized than it is today.

Unfortunately, the proposal has not received much attention among European decision-maker, and one can only fantasize about how much easier the handling of the Greek debt crisis would have been if we had such rules and mechanism for orderly debt restructuring in place in recent years.

Companies go bankrupt. And so does governments. We therefore urgently need to set up institutions and mechanisms to handle sovereign defaults.

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