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Coco for Europe

BERKELEY – After a year and half of delay and denial, Greece is about to restructure its debts.

This, by itself, will not be enough to draw a line under the eurozone’s crisis. Greece will also have to downsize its public sector, reform tax administration, and take other steps to modernize its economy. Its European partners will have to build a firewall around Spain and Italy to prevent their debt markets and economies from being destabilized. Banks incurring balance-sheet damage will have to be recapitalized. The flaws in eurozone governance will have to be fixed.

The indispensible first step, however, is a deep write-down of Greek debt – to less than half its face value. The burden on the Greek taxpayer will be lightened, which is a prerequisite for reducing wages, pensions, and other costs, and thus is essential to the strategy of “internal devaluation” needed to restore Greek competitiveness. Forcing bondholders to accept a “haircut” on what they will be paid also promises to discourage reckless lending to eurozone sovereigns in the future.

Bringing us to the question of why it took policy makers a year and a half to get to this point.  The answer is that there are strong incentives to delay. The Greek government, for which restructuring is an admission of failure, continues to hope that good news will magically turn up. Likewise, French banks holding Greek bonds cling to whatever thin reed of optimism they can and lobby furiously against restructuring. European policymakers, for their part, worry that a sovereign-debt restructuring will damage the financial system and be a black mark for their monetary union.