European Sovereign Debt - Can't We All Just 'Net' Along?

It is seemingly clearer and clearer that with the current structure and membership, the Euro does not work. The market seems to be driving the change in the direction of membership changes (via restructurings and temporary devaluations - e.g. GRE CDS and WI Drachma) while the euro-zone-'management' seem prone to structural changes (i.e. EFSF umbrella, Euro-bonds, and fiscal union). While the cost of either approach is likely extremely high, some research from early Summer by ESCP Europe suggests a non-trivial approach that reduces aggregate debt for the European sovereign complex by almost 64% is possible. The solution:- bi- & tri-lateral netting, and free-trading.

Clearly, there will be winners and losers in this 'free exchange', and the game-theoretical bargaining process of 17 self-indulgent, self-interested career politicians is unlikely to resolve in an optimal direction. However, if nothing else, it is evident just how Gordian-knot-like any resolution is likely to be.

Europe's Web of Debt (as it stood in May 2011)

After three rounds of 'bargaining' including bilateral netting, trilateral netting, and then free-trading (in order to manage different maturities), the complexity reduces dramatically - leaving it very evident where the debt really lies.

The main results were as follows:

The EU countries in the study can reduce their total debt by 64% through cross cancellation of interlinked debt;

Six countries – Ireland, Italy, Spain, Britain, France and Germany – can write off more than 50% of their outstanding debt;

Three countries - Ireland, Italy, and Germany – can reduce their obligations such that they owe more than €1bn to only 2 other countries.

Additionally:

Around 50% of Portugal’s debt is owed to Spain;

Ireland and Italy can write off all of their debt to other PIIGS countries, and Ireland can reduce its debt from almost 130% of GDP to under 20% of GDP;

Greece can reduce their debt by 20%, with 60% owed to France and 30% to Germany;

Britain has the highest absolute amount of debt before and after the write off (owed mostly to Spain and Germany) but can reduce their debt to GDP ratio by 34 percentage points;

France can virtually eliminate its debt (by 99.76%) – reducing it to just 0.06% of GDP;

The authors summarize their findings thus:

This exercise does not solve the problem of the EU debt crisis, and raises more questions that it answers in terms of data reliability. However the revelation about how interlinked debt might net out (possibly even to zero) is a policy option. And indeed if this exercise leaves some countries with a large remainder it points to where the real problems are. Either way, it sheds light on the issue and uncovers information.

The fact that so much debt is interlinked presents a real opportunity to solve the problem. The web of interlinked debt is too thick to be dusted away by classroom games, however policymakers should attempt to replicate this study, and they may find that instead of spinning further webs they might get out a duster to clean things up.

The bottom line for us that while breaking up the Euro will be extremely expensive and potentially dramatically destabilizing from more than a simple market-perspective (as monetary-union disruptions have historically tended to end in civil hostility), this study provides a simple way to see how a fiscally-joined and central Treasury-based system 'could' come out stronger. However, the path to that 'potential' strength will be littered with the bodies of financial and non-financial equity holders, senior- & sub-debtholders, CDS traders, and FX jockeys thanks to risk-free rate re-adjustments, subordination, ringfencings, forced recapitalizations, and implicit austerity.

Comments

[GoldmanSux]

Spot on.

[SPADOC4]

This is a gross over-simplification of the debt. I'd have to say this article was meant for the boneheads in Lame Stream Media, such as USAToday, Time, or CNBS.

How is the different types of debt reconciled? Does the toxic mortgages in Country A retirement portfolio that yields 4% and owned by thousands of individuals through a mutual fund "net net out" the same as general revenue bonds in Country B sold at 6% (or whatever yield you chose) sold to individuals in Countries A, B, C, D?

And what about businesses with assets/debts in multiple countries sold to a completely different set or smaller subset of countries?

Just HOW is the debt numbers calculated?

[kahunabear]

Where is the blog post entitled, "Europeans reject Geitner and Bernanke's ponzi schemes, currently being played in US markets, to save Europe"?

It seems like a big deal that they know our way of levering up monetary policy is a BIG JOKE. Geitner is a tax cheat and sleazy snake oil salesman.

[Mr Lennon Hendrix]

So when the Brit'ish need cash they will cash out their UST holdigs.  So that is who will dump the US first.  Interesting.

[FeralSerf]

No problemo. The Fed stands ready with all the necessary Ben Franklins to buy as many USTs as the Brits want to sell.

Ben Franks?, I hear you cry! But we wanted Swiss Franks! No problemo! The SNB and the ECB are happy to provide as many as you need. You should have plenty to do that room you wanted wallpapered.

Now, where's that Austrian paperhanger when you need him?

[HitTheFan]

Why does ZH persist in refusing to recognise that the Euro currency is neither linked to, backed by, or dependant on any one country, or any of the member countries/

It is the world's first true 'free' currency, and it also has the largest gold reserves backing it IN THE WORLD.

I am beginning to wonder if ZH is stuck in its ways and thinking.

Please ZH and others, take the time to trawl the archives at FOFOA's blog. The Euro is the next global reserve currency, irrespective of how many PIIGS go bust.

[prophet]

G-20. BINGO.  Another glimpse into the composition of The Great Intervention.  

[Peter K]

French Book = Free Money ;) Takes flat book trading to an entirely new level.

Takeaway question: Who will pay the 'Les Rosbeefs?

Answer: Ben, of course :)

[Youri Carma]

Youri Carma: “0 – FORCE MAJEURE! – Call Void All Bankster Bogus Derivative Debts! Because paying off these trough fraud induced debts have become a technical and practical impossibility.”

Webster Griffin Tarpley: “So, cut those debts and whipe out all the derivatives. That’s gotto be the key demand!”

Why don’t you create a debtors club