The Eurozone’s Last Stand

NEW YORK – The eurozone crisis is reaching its climax. Greece is insolvent. Portugal and Ireland have recently seen their bonds downgraded to junk status. Spain could still lose market access as political uncertainty adds to its fiscal and financial woes. Financial pressure on Italy is now mounting.

By 2012, Greek public debt will be above 160% of GDP and rising. Alternatives to a debt restructuring are fast disappearing. A full-blown official bailout of Greece’s public sector (by the International Monetary Fund, the European Central Bank, and the European Financial Stability Facility) would be the mother of all moral-hazard plays: extremely expensive and politically near-impossible, owing to resistance from core eurozone voters – starting with the Germans.

Meanwhile, the current French proposal of a voluntary rollover by banks is flopping, as it would impose prohibitively high interest rates on the Greeks. Likewise, debt buybacks would be a massive waste of official resources, as the residual value of the debt increases as it is bought, benefiting creditors far more than the sovereign debtor.

So the only realistic and sensible solution is an orderly and market-oriented – but coercive – restructuring of the entire Greek public debt. But how can debt relief be achieved for the sovereign without imposing massive losses on Greek banks and foreign banks holding Greek bonds?