Former Bundesbank chief Axel Weber said Europe needs to consider guaranteeing all Greece's outstanding debt because Athens's only viable alternative is a messy default that would be more costly and risk sparking broader financial turmoil.
Mr. Weber, in his first interview since leaving the Bundesbank and the governing council of the European Central Bank at the end of April, said Europe's response to the crisis so far addressed Greece's immediate funding needs without offering the country a credible, long-term resolution for paring its growing mountain of debt.
That uncertainty is fueling fears that Athens will be forced into a messy default and has destabilized markets.
"Ultimately, solving the Greek debt problem will have to deal with the outstanding, past amount of debt, and there are, unfortunately, only very limited options: Either a default or partial haircuts or a guarantee for the outstanding amount of Greek debt," Mr. Weber said. "Governments have to decide which option they want to go for, but the current piecemeal approach of repeated aid programs inevitably leads to the latter solution."
Even after his resignation, Mr. Weber, 54 years old, remains an influential, if controversial, figure in European economic circles. His comments on Greece will likely draw notice in Berlin and other capitals as leaders grapple with the latest flare-up of a crisis that has plagued the Continent for nearly two years.
Since announcing his departure, Mr. Weber has frequently been named as a potential successor to Deutsche Bank AG Chief Executive Josef Ackermann, whose contract expires in 2013. Mr. Weber didn't rule out going to work in the private sector, but said he had a contract to teach central banking at the University of Chicago until May of next year. He said he hadn't decided what to do after that, but added that he wouldn't pursue another policy-making position.
Issuing guarantees could help persuade Greece's creditors to exchange the debt they currently hold for new bonds with longer maturities, effectively giving Athens more time to pay back its loans. Europe's banks, which hold much of Greece's debt, are resisting rolling over their Greek bonds unless they receive incentives, such as guarantees that that the debt will be repaid. Germany and other European countries have so far resisted making guarantees, arguing that it is in banks' best interest to participate voluntarily.
Yet Europe's leaders also are concerned about sparking a broader market panic, and have consistently rejected suggestions that Athens reduce its debt burden by forcing investors to accept less than they are owed, a so-called haircut—or worse, default on its obligations altogether.
Europe's prescription for Greece to overcome its debt problems involves a program of severe public-spending cuts, privatization of state-owned assets and a "voluntary" agreement by creditors to give Athens more time to meet its obligations.
Many investors and economists maintain that Greece's debt load, at €350 billion ($496.6 billion), or 155% of its forecast economic output this year, is simply too large for Europe's current strategy to work. Mr. Weber's comments add a prominent voice to that chorus, reflecting growing frustration in Europe over a failure to address what many consider the root causes of the crisis.
"At some point you've got to cut your losses and restart the system," Mr. Weber said, drawing parallels between the guarantee approach for Greek debt and the steps Germany and other countries took during the financial crisis to backstop troubled banks.
"The Greek problem is not a short-term problem and...it was not caused by the common currency," Mr. Weber said. "Instead it's a deep-rooted, fiscal and structural problem that probably needs more a 30-year time horizon to solve rather than a three- to five-year horizon. The measures Europe needs to adopt to resolve this issue are much more profound than just short-term liquidity funds."
Critics argue that debt guarantees would backfire by setting incentives for countries to overspend, a threat often referred to as "moral hazard."To avoid that, Mr. Weber said Greece and other euro-zone countries that receive bailouts should be compelled to sharpen clauses in future bond contracts stipulating that investors will automatically bear losses if a country needs a bailout. Most countries have dismissed such proposals amid concerns that acknowledging the possibility of a default would cause their borrowing costs to rise.
"What ought to be reinvigorated are the incentives that, in the future, countries have to face the responsibility for their own debt that they issue in the market," Mr. Weber said. "But to get to that point we'll have to deal with the legacy of outstanding debt."
Resistance to debt guarantees has been particularly strong in Germany and other countries in the euro-zone's northern tier, where popular pushback against the rescues of Greece and other periphery countries is strongest. Yet over the past year, the private sector has receded as Greece's main creditor as European governments extended loans to Greece so it could meet its obligations. With Europe's taxpayers holding the bulk of Greece's debt, public resistance to guarantees could soften.
Mr. Weber, who had been widely considered a leading contender to become the next head of the European Central Bank until his surprise resignation in February, clashed with his ECB colleagues over their decision last year to help stem the crisis by purchasing the government debt of Greece and other countries. He argued then that the move threatened both the central bank's independence from politics and its reputation as steward of the region's common currency.
In the interview, he described the dispute as a "watershed" moment that prompted his decision to step down several months later. He warned that the ECB was again overstepping its mandate by participating in negotiations alongside the European Commission and the International Monetary Fund with Greece and other countries over their austerity programs. Mr. Weber says the ECB should limit its role to monetary policy and not become involved in fiscal policy, which he argues injects it too deeply into the political process.
Ex-German Central Banker: 'Limited Options' on Greece
Former Bundesbank President Axel Weber sat down with Matthew Karnitschnig of The Wall Street Journal and Nina Koeppen of Dow Jones Newswires in Frankfurt last week to discuss the next steps for Greece, the role of the private sector and his controversial opposition to the European Central Bank's purchases of government bonds. The following is an edited transcript of his remarks.
The Wall Street Journal: A year after Greece's original bailout, Athens is poised to receive additional international aid. How do you perceive efforts so far to deal with the debt crisis on the euro zone's periphery?
Axel Weber: Many issues we faced about a year ago haven't really improved. My impression is that some of the issues are substantially worse than they were perceived to be a year ago.
WSJ: You opposed the ECB's controversial decision in May 2010 to purchase government bonds. What would have happened if the ECB had followed your path? Wouldn't the markets have imploded?
Mr. Weber: A lot of things that have happened in slow motion in markets over one year would have happened in just a few days. We would have had a few very, very bad days in May in the markets, but governments would have ultimately understood the depths of the problem and they would have faced their responsibilities. I am absolutely convinced about it.
WSJ: Do you worry that the crisis in Greece will spread?
Mr. Weber: Sovereign debt is the hottest issue, globally, in financial markets and it's not just focused on the euro zone. The heat is on in Europe, but it's also a problem in the United States and Japan.
It could turn, if mismanaged, into a profound financial stability risk.
WSJ: Many European policy makers continue to insist that Greece faces a liquidity crisis and that its crisis can be solved with short-term aid. Most economists believe the country is essentially insolvent. Who is right?
Mr. Weber: The longer a liquidity problem prevails the more it mutates into a solvency problem.
What is happening in the market now is a clear and unmistaken call for a full-fledged solution rather than a continuation of the piecemeal approach.
WSJ: What does that mean for Greece?
Mr. Weber: Ultimately, solving the Greek debt problem will have to deal with the outstanding, past amount of debt and there are, unfortunately, only very limited options: Either a default or partial haircuts or a guarantee for the outstanding amount of Greek debt. Governments have to decide which option they want to go for, but the current piecemeal approach of repeated aid programs inevitably leads to the latter solution.
At some point you've got to cut your losses and restart the system.
WSJ: What you're suggesting sounds like a pretty clear violation of the no-bailout clause anchored in the European Union treaty.
Mr. Weber: Simply saying that there will be no bailouts is not credible any longer. It needs to be institutionalized and a commitment mechanism to make the no-bailout clause credible needs to be designed.
What ought to be reinvigorated are the incentives that, in the future, countries have to face the responsibility for their own debt that they issue in the market. But to get to that point we'll have to deal with the legacy of outstanding debt.
WSJ: In other words, let bygones be bygones and start over with tougher rules. Why not just issue eurobonds then?
Mr. Weber: To simply issue joint and several liabilities in the form of a eurobond, in my view, would be plain wrong. Rather, think of a liability that is exclusively guaranteed by the issuing country and that automatically leads to a clearly structured private-sector involvement once sovereign debt support is asked for by a euro-zone country in distress.
WSJ: You're referring to future debt issuance. Why not stipulate private-sector involvement as a condition of the current bailout, as the German government has advocated?
Mr. Weber: I don't see a lot of Greek debt being held by what I would call private-sector participants. A large part of the Greek debt is either guaranteed under the European/IMF [International Monetary Fund] program or is being held by the central banks and other public entities, such as rescued banks that are now fully or partly owned by the governments.
If you really add up all the truly private engagement in Greece, you won't find very large numbers.
WSJ: You're implying the risk of contagion would outweigh the possible benefits in this case. Should the possibility of default be ruled out altogether then?
Mr. Weber: You should never in principle rule out a default. To rule out failure, under any circumstance, would set the wrong incentives. Success and failure are part of the market mechanism. There are potentially huge costs involved in a default, but ruling out default could be even more costly in the long run.
The only way to enable orderly private-sector involvement is to focus on the new debt issuance and to make private-sector involvement part of a contingent bond contract. We'll need to come to a system where sovereign debt is being priced again on the standalone ability of governments to repay their debt, and to facilitate this it has to be part of the bond contract terms.
WSJ: One of the reasons for the current flare-up of the Greek crisis is that Europe and the IMF were too optimistic in their forecast of when Athens could begin raising money in the capital markets again. What's a realistic time horizon for that to happen?
Mr. Weber: The assumption that Greece will be able to return to the markets in 2013 has long been untenable. The support measures will have to be stretched out much longer.
Some very long-term guaranteed debt issuance, such as 30 years, for part of the Greek debt could help Greece return to the market for the remaining debt over a more realistic shorter time horizon. Instead, rollover risks have increased by shortening the maturity of debt in recent years.
A more realistic assumption for Greece to return to the market is between three and seven years.
WSJ: Many Greeks feel that European and IMF demands for more austerity go too far. Why not relax these measures, especially if you think Europe needs to consider guaranteeing Greece's old debt anyway?
Mr. Weber: Falling behind on what has been agreed by Greece in terms of consolidation measures is not an acceptable option.
Too little has been done so far and there is always an option of doing more.
WSJ: Greeks are increasingly worried about the stability of their financial system. What can Athens do to forestall further capital flight?
Mr. Weber: Greek private-sector deposits in Greek banks have gone down substantially. This myopic reaction of the Greek private sector risks undermining the European public-sector stabilization measures for Greek banks.
Ultimately, there will be a debate about financial repression. Take what we had in Germany—the Zwangsanleihe [compulsory loans introduced after World War I to help make reparation payments]. If voluntary contributions don't add up, then the one tool that is still on the shelf is financial repression.
WSJ: Do you agree with the ECB's stance that it won't accept Greek debt as collateral under a default?
Mr. Weber: If collateral is downgraded, haircuts in repo operations have to increase. If collateral is in default, it is no longer collateral that a central bank can lend against.
Central banks should really not get into a situation where they lend against collateral that the market does not accept at all. Once collateral ceases to be accepted in the interbank repo market I think it's a bad idea to have central banks continue to accept such collateral because then all the poor collateral will migrate to central banks.
WSJ: The ECB has been a central player in Europe's effort to fight the crisis over the past year. Has the bank strayed too far from its original mandate to set monetary policy?
Mr. Weber: Being at the negotiating table is undermining the independence of the central bank, because it risks becoming part of political deals.
Central banks should not get involved too deeply in crisis management that is clearly a fiscal issue...Then the central banks lose their independence.
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