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«BRU EGE L BLU E PR I N T 1 0 A European mechanism for sovereign debt crisis resolution: a proposal BY FRANÇOIS GIANVITI, ANNE O. KRUEGER, JEAN ...»

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A European mechanism

for sovereign debt

crisis resolution:

a proposal




A European mechanism for

sovereign debt crisis resolution:

a proposal





Volume X A European mechanism for sovereign debt crisis resolution: a proposal François Gianviti, Anne O Krueger, Jean Pisani-Ferry, André Sapir and Jürgen von Hagen © Bruegel 2010. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted in the original language without explicit permission provided that the source is acknowledged. The Bruegel Blueprint Series is published under the editorial responsibility of Jean Pisani-Ferry, Director of Bruegel. Opinions expressed in this publication are those of the author(s) alone.

Editor: Andrew Fielding Production: Stephen Gardner


33, rue de la Charité, Box 4 1210 Brussels, Belgium www.bruegel.org ISBN: 978-9-078910-18-3 Contents About the authors.............................................................iv Foreword......................................................................vi Executive summary............................................................1

1. Introduction...............................................................3

2. Why the euro area needs a sovereign-debt default mechanism...............6

3. Past attempts to create a sovereign-debt restructuring mechanism.........12

4. A European mechanism for sovereign-debt restructuring...................21

5. Conclusion...............................................................35 References...................................................................36 About the authors François Gianviti is a professor of law and Honorary Dean of the Faculty of Law and Political Science at the University of Paris XII. He was Director of the Legal Department of the International Monetary Fund from 1986, and General Counsel from 1987 until his retirement from the IMF at the end of 2004. He is a judge on the Regulatory Tribunal of the Qatar Financial Centre and a consultant to the IMF and the Organisation for Economic Cooperation and Development. He is also a member of the International Monetary Law Committee of the International Law Association.

Anne O. Krueger is Professor of International Economics at Johns Hopkins University, School of Advanced International Studies and a Senior Fellow of the Stanford Center for International Development and Professor Emeritus at Stanford University. She was First Deputy Managing Director of the International Monetary Fund from 2001 to 2006, and Chief Economist at the World Bank from 1982 to 1986. She is past President and Distinguished Fellow of the American Economic Association and a member of the National Academy of Sciences. She has published extensively on international trade, the Bretton Woods institutions, and economic development, including works on India, South Korea, and Turkey.

Jean Pisani-Ferry is the Director of Bruegel and Professor of Economics at the Université Paris-Dauphine. He was previously Executive President of the French prime minister’s Council of Economic Analysis (2001-02), Senior Economic Adviser to the French Minister of Finance (1997-2000), Director of CEPII, the French institute for international economics (1992-97) and Economic Advisor to the European Commission (1989-92). His current research focus is economic policy in Europe. He writes regular columns for Le Monde, Handelsblatt and the Chinese magazine Caixin.

André Sapir is a Senior Fellow at Bruegel and Professor of Economics at the Université Libre de Bruxelles (ULB), where he teaches international trade and European integration at the Solvay Brussels School of Economics and Management and at the Institute of European Studies. From 2005-09, he was a member of the Economic Advisory Group to European Commission President José Manuel Barroso. Previously,


he worked for 12 years for the European Commission, first serving as Economic Adviser to the Director-General for Economic and Financial Affairs, then as Economic Adviser to President Romano Prodi. He has published extensively on European integration, international trade and globalisation.

Jürgen von Hagen is Professor of Economics at the University of Bonn and a NonResident Fellow at Bruegel. He previously taught at Indiana University and the University of Mannheim. He is a Research Fellow of CEPR and a member of the Academic Advisory Board to the Federal Minister of Economics and Technology in Germany. He has served as a consultant to the IMF, World Bank, European Commission, ECB, Federal Reserve Board, and numerous governments in Europe and elsewhere.


The euro area lived for more than ten years with a ‘no bail-out clause’ that was supposed to be one of its fundamental pillars but the precise implications of which were left unclear. Some expected that a member state unable to finance itself in the market would suffer an ugly default; some expected that member state to call on the IMF for assistance; and some thought that an EU solution of some sort would be found, without knowing exactly what.

As French XVIIth-century churchman and occasional conspirator Cardinal de Retz used to say, ‘one leaves the realm of ambiguity at one’s peril’. The Greek crisis of spring 2010 indeed epitomised the cost of having remained in, and being forced to exit from, ambiguity. Disagreements about the desirable solution and uncertainty about the interpretation of the treaty resulted in a series of unclear compromises, none of which was sufficient to calm markets. In the end a temporary solution was found with the creation of the European Financial Stability Facility which, if needed, will be able to provide, jointly with the IMF, conditional financial assistance.

Problems remain, however. Many, mostly in Germany, are unhappy about what they see as a departure from the no bail-out principle, and this is why the EFSF was only allowed a temporary life-span. Also, there is still disagreement about principles and procedures for the resolution of debt crises.

At the request of the German government the European Council of October 2010 agreed on the principle of a sovereign debt crisis resolution mechanism. But this decision has only opened a series of new and difficult financial, institutional and legal questions, none of which will be simple to solve.

It is true, the international community has accumulated experience with the resolution of sovereign-debt crises but it has never come close to an agreement on what some in the 1990s called a ‘bankruptcy court for sovereigns’ or a ‘chapter 11 for states’ (by analogy to the US corporate bankruptcy procedure). The EU therefore has set itself the goal to explore, and settle on, what is so far partially uncharted territory.


In order to contribute to this important discussion Bruegel assembled, in summer 2010, a group of authors with expertise and experience at global and European level.

I was very pleased that, together with Jürgen von Hagen, André Sapir and myself from the Bruegel team, François Gianviti and Anne Krueger agreed to take part in this work.

Both were very senior IMF officials in the early 2000s and at the core of the proposal and heated discussions on the creation of the so-called Sovereign Debt Crisis Resolution Mechanism (Anne was in fact its main proponent and François its main legal architect).

This Blueprint lays out a concrete proposal for the creation of a European crisis resolution mechanism that could be made available following agreement within the Union and ratification of the corresponding treaty changes. It does not address any of the short-term discussions on the situation within the euro area. Rather, the focus is on the principles and the main tenets of a permanent system which the authors think should be put in place to improve the working of European Monetary Union.

–  –  –

This Blueprint starts from five observations:

i) The rules-based framework for fiscal policy created by the EU’s Excessive Deficit Procedure and the Stability and Growth Pact was insufficient to prevent a debt crisis. Economic and Monetary Union did not have policy tools to manage and resolve the crisis.

ii) The absence of any rules guiding market expectations about how governments and the European Commission would respond to a debt crisis contributed to the volatility of financial markets.

iii) Europe’s early stabilisation of Greece and, later, the creation of the European Financial Stability Facility (EFSF) did succeed in calming the markets but these measures were essentially ad hoc and temporary.

iv) The euro area needs a formal mechanism for dealing with sovereign-debt crises in an effective and predictable way.

v) Such a public acknowledgement by EU governments that the default of a government on its debt is a real possibility in the euro area would serve to strengthen market discipline and help prevent further debt crises.

This Blueprint makes a proposal for the creation of a European Crisis Resolution

Mechanism (ECRM). The ECRM would consist of two pillars:

• A procedure to initiate and conduct negotiations between a sovereign debtor with unsustainable debt and its creditors leading to, and enforcing, an agreement on how to reduce the present value of the debtor’s future obligations in order to reestablish the sustainability of its public finances. A special court would be required to handle such cases. The Court of Justice of the European Union is the natural institution for this purpose and a special chamber could be created within it for that purpose.

• Rules for the provision of financial assistance to euro-area countries as part of resolving the crisis. Should a euro-area country be found insolvent, the provision


of financial aid should be conditional on the achievement of an agreement between the debtor and the creditors re-establishing solvency. The task of supplying financial assistance could be given to the EFSF provided that it is made permanent and an institution of the European Union. Lending by the permanent EFSF could also be provided, under appropriate conditions, to euro-area countries facing temporary liquidity problems, as currently provided for by the temporary EFSF.

The creation of the ECRM would probably need to be established by a treaty. The mechanism would, therefore, only apply to future debt issuance.

1. Introduction The sovereign debt crisis in the euro area during the spring of 2010 has revealed that the monetary and fiscal policy framework of the European Monetary Union (EMU) is still incomplete. Clearly, the rules-based framework for fiscal policy created by the Excessive Deficit Procedure and the Stability and Growth Pact was insufficient to prevent a debt crisis despite its emphasis on keeping public sector deficits low and strengthening forward-looking budgetary planning. Moreover, once the crisis occurred and financial markets were agitated by it, it became obvious that EMU did not have policy tools to manage and resolve the crisis. In the end, the European Union responded to the crisis first by agreeing on stabilisation for Greece and then by creating the European Financial Stability Facility (EFSF) that succeeded in calming the markets. However, these responses were developed in an ad-hoc manner and on a temporary basis only and do not provide an adequate basis for dealing with any possible future debt crises in the euro area.

Several proposals have been put forward for how to improve the euro area’s capacity to deal with problems of excessive public debts. In order to prevent sovereign crises, the European Commission (2010) has proposed a number of measures to strengthen the Excessive Deficit Procedure and the Stability and Growth Pact. These proposals focus mainly on making the rules of the current framework more effective and on strengthening their enforcement by introducing stiffer and more automatic penalties for violating these rules. The European Central Bank (ECB) has made proposals (2010) going in the same direction and, at the same time, has called for the creation of a crisis management fund for the euro area, which would come into play if the strengthening of the rules-based framework does not suffice to prevent future debt crises. According to the ECB’s proposal, such a fund should provide ‘last-resort financing’ at penalty rates to governments facing difficulties in accessing private credit markets.

It is, however, the German government that has most forcefully argued for the creation of an orderly default mechanism for euro-area member states, partly as a condition for making the EFSF permanent. Following a French-German agreement on 18


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