Europe Urgently Needs an Insolvency System for Heavily Indebted Euro Countries

Europe finally needs an insolvency system for heavily indebted euro countries. When it comes to mapping out the details of such a system, however, particular care shall be taken. It is essential to take precautions to ensure that banks are no longer allowed to lend without limits to single euro states. These are the central findings of a study conducted jointly by the ZEW – Leibniz Centre for European Economic Research, Mannheim, and the international research network EconPol Europe, which were presented during a jointly organised ZEW-Econpol Lunch Debate in Brussels today.

The starting point for the analysis of a Franco-German team of authors is the observation that politics tends to delay debt restructuring if levels of government debt become unsustainable. In the case of Greece, for example, it took far too long for private creditors to be involved in a debt haircut. In the future, a statutory insolvency system should provide remedy for euro countries. It must be kept in mind that a flawed system could provoke the risk of triggering a new chain reaction of state and bank failures.

In their study, Christophe Destais (CEPII Paris), Dr.  Frederik Eidam and Professor Friedrich Heinemann (both of ZEW Mannheim) show how such risks can be minimised. Accordingly, with the help of credit limits and specific capital requirements banks should finally be forced to hold fewer domestic bonds in their balance sheets. The activation of an insolvency system should not be triggered by rigid rules. Instead – according to the authors – it would be advisable for an independent institution to decide on this matter. One such institution could be the European Fiscal Board.

The researchers are concerned that if the European Commission was granted with too many rights, this could again lead to politically motivated procrastination in the procedure. Imposing new collective action clauses could additionally facilitate a smooth debt restructuring process.

Professor Friedrich Heinemann, head of the ZEW Research Department “Corporate Taxation and Public Finance”, draws the following conclusion: “An insolvency system for euro countries must no longer be a taboo. Without a credible solution in the case of excessive government debt that imposes losses on private creditors, taxpayers from other euro states would ultimately be forced to foot the bill in order to bail out such a country. The risks associated with the introduction of a debt restructuring mechanism are controllable. It is important that policymakers do not lose any more time and take the first steps towards reform. Otherwise, the eurozone will ultimately remain defenceless towards governments that pursue irresponsible fiscal policies and count on receiving transfers.”