Photo: david.nikonvscanon on flickr
The buzz all week is going to be about the upcoming European Summit, and today specifically everyone is talking about George Soros’s big plan to save Europe.The plan introduces a new alphabet soup of acronyms like EFA (European Fiscal Authority) and DRF (Debt Redemption Fund), and on top of everything else in Europe, Soros’s idea may not be totally clear, so let’s cut to the chase and explain what Soros has in mind…
Soros wants Europe (using the ECB and Germany as a backstop) to take the risk of a sovereign blowup completely off the table. Investors should not have to worry about Spain or Italy going belly up. In exchange for governments getting this guarantee, a scheme would be put in place to financially penalise governments that do not adequately reform.
Right now, bailouts in Europe have a major flaw: They’re deadly. Governments are loathe to ask to borrow money from the established bailout funds, because as soon as they do, they have to come under a program and introduce aggressive austerity (killing their economies) and possibly losing market access.
The flipside of guaranteed backstops (say, if the ECB were to just cap sovereign interest rates) is that governments would all face a free-rider moral hazard problem, whereby they could spend like crazy on their economies without having any risk at all.
So Soros wants to thread the needle. He wants to backstop the governments with a fund, and he wants penalties that are meaningful, but less than deadly (fines commensurate with the government’s unwillingness to reform).
This idea of an entity that could punish governments for not reforming at the proper pace is key in all kinds of ways. First of all, it might be just enough control for Germany to get on board… after all Germany has hinted that fiscal burden sharing could exist if people gave up fiscal sovereignty.
When I was in Athens, a hedge fund manager lamented that the whole crisis could have been stopped in the very early days if German leaders had just stood up and said “Greek debt is my debt.” Then he said that Germany, in the background, could have knocked a few heads to make sure Greek gets its act together.
The idea of Germany knocking Greek heads was always going to be difficult, but perhaps if there were a centralized, formalized scheme to punish governments, it might work.