Stefano Micossi, Director General of Assonime and member of the CEPS Board of Directors, observes in a new EuropEos Commentary that there is something surreal to the unfolding financial crisis of the eurozone, as the leaders grudgingly do what is needed to prevent disaster just minutes before it’s too late, and then in the next minute revert to the same behaviour that had brought them against the wall in the first place. He cites rising sovereign spreads within the area as the visible result of this strategy: they signal investors’ expectation that the future can only bring more of the same, a series of ever-larger sovereign debt crises, under Damocles’ sword that at some stage Germany, the paymaster of last resort, will close its purse and let Armageddon start

Micossi, Stefano

Archive of European Integration

 C o m m e n t a r y    Stefano Micossi is Director General of Assonime and a member of the CEPS Board of Directors. The views expressed are those of the author writing in a personal capacity and do not represent those of EuropEos or CEPS. Contributors to this series of Commentaries are members of EuropEos, a multidisciplinary group of jurists, economists, political scientists and journalists set up in 2002 with the aim of creating an ongoing forum for the discussion of European policy and institutional issues. It has published two books and numerous commentaries and essays on the negotiations leading to the Lisbon Treaty. Successful collaboration between its members and CEPS has led to this dedicated series of EuropEos Commentaries. For more information on EuropEos, please visit: http://www.europeos.it/EuropeosWEB  Available for free downloading from the CEPS website (http://www.ceps.eu) © CEPS 2010 The eurozone in bad need of a psychiatrist Stefano Micossi No. 6 / 9 December 2010 here is something surreal to the unfolding financial crisis of the eurozone, as the leaders grudgingly do what is needed to prevent disaster just minutes before it’s too late, and then in the next minute revert to the same behaviour that had brought them against the wall in the first place. Rising sovereign spreads within the area are the visible result of this brilliant strategy: they signal investors’ expectation that the future can only bring more of the same, a series of ever-larger sovereign debt crises, under Damocles’ sword that at some stage Germany, the paymaster of last resort, will close its purse and let Armageddon start. It is surreal, first of all, because public finances in the eurozone have suffered large deteriorations but do not appear unmanageable, under present polices, and indeed in many ways are better than those of the United States, the United Kingdom and Japan.1  True, Greece and Ireland are now confronted with harsh adjustment programmes that raise questions of political sustainability. Punitive interest rates on EU loans to soothe German public opinion have not helped. The Irish government’s decision to make good the losses of the banking system has added by one stroke about one-third to its debt-to-GDP ratio; perhaps the incoming government will reconsider, under pressure from outraged taxpayers, thus lessening future debt burdens. But for the time being both countries seem to be soldiering on with their bitter medicine, and they have now secured sufficient finance to manage their public debt in an orderly fashion until 2013. Portugal has suffered a large deterioration in competitiveness and current external payments, but its government deficit and debt, relative to GDP, are no greater than France’s, and IMF estimates indicate that a primary surplus in the order of 2% of GDP would stabilise its debt/GDP ratio. Spain has a debt-to-GDP ratio below 70% which would stabilise with a primary surplus of 1.5% of GDP, and is already taking strong measures to close its budgetary gap. Italy has a large debt but a smaller deficit, seemingly under control.  All in all, required budgetary corrections are large but not unprecedented – and the economic recovery now seems more buoyant than anticipated. Even if debt restructuring may at some stage become necessary in one of these countries due to slippages in ongoing adjustment programmes, this may not necessarily entail large losses for creditors.2 If this analysis is correct, financial markets are overreacting, and the most likely culprit is unsettling signals from policy-makers. Comparison with the situation in the US, UK and Japan is illuminating. T C o m m e n t a r y  Like the eurozone, those countries issue debt in their own currency – currently in much larger amounts relative to GDP – but unlike in the eurozone, there is no question that their debt rollover may encounter difficulty, or that the availability of dollars, pounds or yens for their redemption may be rationed by the central bank. Within the eurozone, disagreements between national leaders make such an event conceivable and even possible. Last week, the announcement by the ECB that it was resuming its purchases of sovereign debt was sufficient to stabilise deeply unsettled markets.   This is where the eurozone may be more in need of a psychiatrist than a financial guru. Our paramount problem is to reassure unsettled financial markets that sufficient finance will be available to manage the sovereign debts of all eurozone members: if we succeed, the money will actually not be used. But our eurozone leaders keep talking about bailouts and defaults, and ride on domestic fears that taxpayers will shoulder the debts incurred by others. After each intervention, their visible disagreement on what to do next invites the next crisis: like mountain climbers suffering from vertigo, they seem irresistibly attracted to a precipice brought ever closer by their uncertain steps. Let’s be quite clear: along this path at the end of the road either all of our sovereign debts become German public debt, or the euro will disintegrate into many separate currencies, with horrendous economic dislocations.    It is high time for our leaders to reassure investors that all sovereign debts within the eurozone will be rolled over in an orderly manner, which is quite the contrary to the weird obsession to write in the Union Treaty that they will lose their money. Moral hazard – fear that profligate governments will then be led to engage in even more profligate behaviour – can be countered by appropriately tough conditions in EU loans.  Thus, not only should the European Financial Stabilisation Facility (EFSF) be made permanent, but its resource ceiling should be increased upfront by a multiple – rather than ominously hinting that it may need an increase if another country runs into trouble. The recent EcoFin Council failed to recognise this simple truth. Perhaps wiser conclusions can be hoped for when the European Council meets next week.    Moreover, the EFSF’s remit should be broadened to include purchasing sovereign bonds when their markets come under strain, if need be with liquidity support from the ECB. This is a better alternative than letting the ECB purchase the bonds, since the ECB would not become directly exposed to the member states in need of financial support and fears of monetisation would not arise.   Its remit should also include injecting capital into ailing banks of countries under its assistance – with intervention rules making clear that equity holders and creditors will fully bear their losses. A credible commitment that banks, rather than taxpayers, will pay for mistaken lending is the best way to combat moral hazard within the financial system.                                                       1 Cottarelli, Forni, Gottschalk and Mauro, Default in today’s advanced economies: unnecessary, undesirable and unlikely, IMF, September 2010. 2 On this, see Daniel Gros, “All together now? Arguments for a big-bang solution to eurozone problems”, CEPS Commentary, 6 December 2010. While I disagree with its big-bang proposal, the note contains suggestion for managing debt restructuring that would minimize financial market disruptions.       

The eurozone in bad need of a psychiatrist. EuropEos Commentary No. 6, 9 December 2010

 C o m m e n t a r y  
 
 Stefano Micossi is Director General of Assonime and a member of the CEPS Board of 
Directors. The views expressed are those of the author writing in a personal capacity 
and do not represent those of EuropEos or CEPS. 
Contributors to this series of Commentaries are members of EuropEos, a 
multidisciplinary group of jurists, economists, political scientists and journalists set up 
in 2002 with the aim of creating an ongoing forum for the discussion of European 
policy and institutional issues. It has published two books and numerous 
commentaries and essays on the negotiations leading to the Lisbon Treaty. Successful 
collaboration between its members and CEPS has led to this dedicated series of 
EuropEos Commentaries. For more information on EuropEos, please visit: 
http://www.europeos.it/EuropeosWEB  
Available for free downloading from the CEPS website (http://www.ceps.eu) 
© CEPS 2010 
The eurozone in bad need of a psychiatrist 
Stefano Micossi 
No. 6 / 9 December 2010 
here is something surreal to the unfolding financial crisis of the eurozone, as the leaders 
grudgingly do what is needed to prevent disaster just minutes before it’s too late, and then 
in the next minute revert to the same behaviour that had brought them against the wall in 
the first place. Rising sovereign spreads within the area are the visible result of this brilliant 
strategy: they signal investors’ expectation that the future can only bring more of the same, a series 
of ever-larger sovereign debt crises, under Damocles’ sword that at some stage Germany, the 
paymaster of last resort, will close its purse and let Armageddon start. 
It is surreal, first of all, because public finances in the eurozone have suffered large deteriorations 
but do not appear unmanageable, under present polices, and indeed in many ways are better than 
those of the United States, the United Kingdom and Japan.1  
True, Greece and Ireland are now confronted with harsh adjustment programmes that raise 
questions of political sustainability. Punitive interest rates on EU loans to soothe German public 
opinion have not helped. The Irish government’s decision to make good the losses of the banking 
system has added by one stroke about one-third to its debt-to-GDP ratio; perhaps the incoming 
government will reconsider, under pressure from outraged taxpayers, thus lessening future debt 
burdens. But for the time being both countries seem to be soldiering on with their bitter medicine, 
and they have now secured sufficient finance to manage their public debt in an orderly fashion 
until 2013. 
Portugal has suffered a large deterioration in competitiveness and current external payments, but 
its government deficit and debt, relative to GDP, are no greater than France’s, and IMF estimates 
indicate that a primary surplus in the order of 2% of GDP would stabilise its debt/GDP ratio. Spain 
has a debt-to-GDP ratio below 70% which would stabilise with a primary surplus of 1.5% of GDP, 
and is already taking strong measures to close its budgetary gap. Italy has a large debt but a smaller 
deficit, seemingly under control.  
All in all, required budgetary corrections are large but not unprecedented – and the economic 
recovery now seems more buoyant than anticipated. Even if debt restructuring may at some stage 
become necessary in one of these countries due to slippages in ongoing adjustment programmes, 
this may not necessarily entail large losses for creditors.2 
If this analysis is correct, financial markets are overreacting, and the most likely culprit is unsettling 
signals from policy-makers. Comparison with the situation in the US, UK and Japan is illuminating. 
T
 
C o m m e n t a r y  
Like the eurozone, those countries issue debt in their own currency – currently in much larger 
amounts relative to GDP – but unlike in the eurozone, there is no question that their debt rollover 
may encounter difficulty, or that the availability of dollars, pounds or yens for their redemption 
may be rationed by the central bank. Within the eurozone, disagreements between national leaders 
make such an event conceivable and even possible. Last week, the announcement by the ECB that it 
was resuming its purchases of sovereign debt was sufficient to stabilise deeply unsettled markets.   
This is where the eurozone may be more in need of a psychiatrist than a financial guru. Our 
paramount problem is to reassure unsettled financial markets that sufficient finance will be 
available to manage the sovereign debts of all eurozone members: if we succeed, the money will 
actually not be used. But our eurozone leaders keep talking about bailouts and defaults, and ride on 
domestic fears that taxpayers will shoulder the debts incurred by others. After each intervention, 
their visible disagreement on what to do next invites the next crisis: like mountain climbers 
suffering from vertigo, they seem irresistibly attracted to a precipice brought ever closer by their 
uncertain steps. 
Let’s be quite clear: along this path at the end of the road either all of our sovereign debts become 
German public debt, or the euro will disintegrate into many separate currencies, with horrendous 
economic dislocations.    
It is high time for our leaders to reassure investors that all sovereign debts within the eurozone will 
be rolled over in an orderly manner, which is quite the contrary to the weird obsession to write in 
the Union Treaty that they will lose their money. Moral hazard – fear that profligate governments 
will then be led to engage in even more profligate behaviour – can be countered by appropriately 
tough conditions in EU loans.  
Thus, not only should the European Financial Stabilisation Facility (EFSF) be made permanent, but 
its resource ceiling should be increased upfront by a multiple – rather than ominously hinting that 
it may need an increase if another country runs into trouble. The recent EcoFin Council failed to 
recognise this simple truth. Perhaps wiser conclusions can be hoped for when the European 
Council meets next week.    
Moreover, the EFSF’s remit should be broadened to include purchasing sovereign bonds when their 
markets come under strain, if need be with liquidity support from the ECB. This is a better 
alternative than letting the ECB purchase the bonds, since the ECB would not become directly 
exposed to the member states in need of financial support and fears of monetisation would not 
arise.   
Its remit should also include injecting capital into ailing banks of countries under its assistance – 
with intervention rules making clear that equity holders and creditors will fully bear their losses. A 
credible commitment that banks, rather than taxpayers, will pay for mistaken lending is the best 
way to combat moral hazard within the financial system. 
 
                                                     
1 Cottarelli, Forni, Gottschalk and Mauro, Default in today’s advanced economies: unnecessary, undesirable and 
unlikely, IMF, September 2010. 
2 On this, see Daniel Gros, “All together now? Arguments for a big-bang solution to eurozone problems”, CEPS 
Commentary, 6 December 2010. While I disagree with its big-bang proposal, the note contains suggestion for 
managing debt restructuring that would minimize financial market disruptions.       


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The eurozone in bad need of a psychiatrist. EuropEos Commentary No. 6, 9 December 2010

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