by Don Alexander, MBA
Associate, RSD Solutions Inc.
The recent confrontation between Greece and EU officials provide a good lesson for risk managers. EU officials continue to minimize potential risks, fail to take realize their magnitude and communicate the problems, and take the necessary steps to remedy the situation. These are all symptoms of a failure of risk management.
Greek Prime Minister Papandreou made a stand, against the proposed Greek debt restructuring, and even though he was forced to backpedal, Wyplosz argues that he did the Eurozone a favor by providing it an opportunity to change course. The Greek government has largely been following the dictates of EU officials to not restructure their debt, but this might have been the least costly remedy if done in a timely manner.
The Greek revolt, even if short lived, is good news on the European crisis front – it might provoke the long-awaited policy turnaround that is necessary to end the Eurozone crisis. It may finally awaken Eurozone leaders to the futility of the path they’ve chosen. One way or another, a disorderly Greek default is in the cards with its attendant contagion for all of the rest of the PIIGS (Portugal, Ireland, Italy, and Spain) and maybe even France. The cost of a default could be much larger than delaying the inevitable Greek restructuring.
Dazed and Confused? Eurozone officials took the wrong path in early 2010, because they did not fundamentally understand the nature and depth of the problem. Perhaps, they did not want to deal with it and brazenly assumed things would revert back to normal. However, the seriousness of the surging debt and slow growth revealed all the flaws hidden in the euro’s first ten years. There is a cost for their negligence.
At that point a real solution is inevitable – one that requires Eurozone leaders and the ECB to play on the same side with credible rules for all. An ECB backstop for Eurozone bonds will be required, but this does not mean underwriting banks and sovereigns. The ECB guarantee should be set to protect the ECB and to force a debt restructuring for countries that face unbearably high interest rates.
Banks will have to be bailed out, possibly with EFSF resources, but in a way that minimizes moral hazard and maximizes taxpayer protection. That means wiping out shareholders and, if need be, unsecured bondholders. The cost of the bailout could reach into the hundreds of billions and does not include recapitalizing financial institutions. A long-term cost is the sustained period of sub-trend growth resulting from the overhang.
Can we learn anything for risk management?
For more on this follow the link: http://www.voxeu.org/index.php?q=node/7222
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