by Don Alexander, MBA
Associate, RSD Solutions Inc.
Eurozone policymakers and politicians continue to ignore the growing risks to the euro and the failure to take appropriate action to address these risks. They continue to view recent developments as a temporary liquidity crisis instead of a solvency issue. They commit all the classic failures of risk management outlined by Rene Stulz in a recent article in the Journal of Corporate Finance (2008). A proposed outline on VOXEU identifies some of the methods how the Euro crisis can be addressed.
The Eurozone crisis has taken a turn for the worst. A group of German economists from the “German Council of Economic Experts” have proposed a temporary program to stabilize financial markets by creating two temporary entities: the European Redemption Pact and the European Redemption Fund.
This involves the creation of a joint debt vehicle with a finite maturity date. The objective is to ease temporary market dislocations and mandate the implementation of credible fiscal reforms for all Eurozone members. This program would combine two elements: accounting and solidarity. Accounting requires member countries to consolidate public debt and eventually reduce debt levels toward more sustainable levels. Solidarity requires assistance from stronger members to weaker partners, but encourages fiscal discipline.
The European Redemption Pact is based on a revised Growth & Stability Pact that combines joint and several liabilities and a strong commitment to push countries toward a 60% debt-to-GDP ratio. The point is to separate the accumulated debt of member countries into a part that is compatible with a 60% debt threshold and a part that exceeds this limit. Participants can refinance themselves through a joint European Redemption Fund (ERF) until the debt refinanced reaches the 60% debt threshold. Participants in the program would be jointly liable, but each country is required to service its own debt financed through the ERF.
The advantage of the program is its limited duration and the strong strings attached for participation (tax provisions, collateral & redemption guidance). Another advantage of the program is a market rate for weaker members and for stronger member’s avoidance of a potential messy default.
The classic failures of risk management include using the appropriate metrics, measuring known risks, accounting for all risks, failure to communicate and failure to monitor and manage. Can we learn something from events in Europe?
For more on the article A European Redemption Pact, please follow the link: http://www.voxeu.org/index.php?q=node/7253
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