Practical analysis for investment professionals
10 November 2011

European Sovereign Debt Crisis: Littany of Unresolved Issues Looms Large

Posted In: Economics
A Greek woman holds a flag in front of the Greek parliament during a protest in Athens, Greece.

Here is a list — comprehensive but most certainly not complete — of unresolved issues in the European sovereign debt crisis:

1.  Does it make sense for a member-state to leave the European Union and/or the eurozone?

There has been much discussion about forcing Greece and other nations to exit the EU and/or the eurozone, but does this make good economic and political sense?

2.  How can the eurozone countries force a member-state to leave?

It is still unknown what mechanism in the Maastricht Treaty would allow for a member to be expelled from the eurozone or the European Union.

3.  How can the entire eurozone improve its finances?

Currently there does not seem to be discussion of how to get the 13 of 17 eurozone members that are in violation of the Maastricht Treaty’s “convergence criteria” back on track to be in accord with the criteria.

4.  What unique investment opportunity does the EFSF provide?

As currently structured, the European Financial Stability Facility (EFSF) does not offer any unique investment potential. This is because the EFSF has been retooled and leveraged to provide additional firewall power. Yet this retooling has not created an investment opportunity that investors could not independently create themselves using European sovereign debt and derivatives that are available in the open market. Previously, the EFSF was a AAA-rated credit with lots of potential liquidity — and was thus a unique investment vehicle.

5.  What happens if a large contributor to the EFSF is downgraded?

If one of the large contributor nations to the EFSF has its sovereign debt rating downgraded, this action would likely result in a downgrade event for the EFSF, too. This effectively limits the size of the EFSF.

6.  How will the EU and the eurozone lower the high correlation between their sovereign debt and their banking institutions?

A vicious circle exists because of the high correlation between European sovereigns and their nations’ banking institutions. If the sovereigns weaken, the balance sheets of the banks are weakened, and that in turn weakens the sovereigns that are back stopping the banks’ debts.

7.  How can Europe unite its monetary and fiscal policy?

Monetary policy is coordinated by the European Central Bank (ECB), but fiscal union does not yet exist in the European Union or the eurozone. Without fiscal coordination, economic policy coordination is nearly impossible, notwithstanding the bedrock free-trade zone that is in place.

8.  How can European policymakers increase the economic competitiveness of the EU vis-à-vis the rest of the world?

EU member states and eurozone members are not keeping pace with other, more dynamic economies. How will Europe’s global competitiveness be improved?

9.  How can Europe increase economic competitiveness within the EU itself?

Southern members of the EU and the eurozone seem to be at a capital disadvantage in comparison to the larger, better financed norther member-states. How will this issue be resolved? Can it be resolved?

10.  How can the European Central Bank be asked to serve as a “lender of last resort” and still be in compliance with its charter?

Many commentators are calling for the European Central Bank to serve as the lender of last resort in the eurozone. However, if it were to serve this function, the Frankfurt-based institution would be in violation of its own charter, which explicitly states that the bank’s singular focus should be price stability.

11.  How should European policymakers cope with banking institutions that are “too big to save?”

In some of the European Union’s member states, banks have balance sheets that are larger than the gross domestic product (GDP) of their home countries. These banks are not only “too big to fail,” they are also “too big to save.” How will this problem be rectified?

 

About the Author(s)
Jason Voss, CFA

Jason Voss, CFA, tirelessly focuses on improving the ability of investors to better serve end clients. He is the author of the Foreword Reviews Business Book of the Year Finalist, The Intuitive Investor and the CEO of Active Investment Management (AIM) Consulting. Previously, he was a portfolio manager at Davis Selected Advisers, L.P., where he co-managed the Davis Appreciation and Income Fund to noteworthy returns. Voss holds a BA in economics and an MBA in finance and accounting from the University of Colorado.

Ethics Statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all systems of ethics distill to this simple statement. If you believe I have deviated from this standard, I would love to hear from you: jason@jasonapollovoss.com

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