Elena Carletti : markets are very right this time worrying about the current crisis in the euro area

Far from being irrational, markets are very right this time worrying about the current crisis in the euro area.
History threatens to repeat. The first sovereign default recorded in the fourth century C. when 10 of the 13 municipalities in the Attic Greek Maritime Association reneged on loans in the Temple of Delos. Today, it seems increasingly likely that another sovereign default will take place in Greece in the coming years.
How should the euro area to prepare for such an event? The answer: quickly.
The recent proposal by France and Germany for non-sovereign stressed the importance of collective action clauses in debt contracts in the euro zone. These clauses, which make debt restructuring more quickly by forcing bondholders of minorities to accept the terms agreed by the majority of creditors, although substantially include, but are a distraction from what is likely to be the main issue, namely, financial stability.
Collective action clauses are designed to solve the holdouts, the bondholders in which some try to get a better solution is offered. These problems are exacerbated by the sovereign debt in early 1990.
Retrospective laws
Most emerging market sovereign debt was written in the United Kingdom or the law of New York. In the euro area, most are under domestic law. In Greece, 90 percent is subject to local laws. Therefore national governments can act retrospectively by passing a law that makes binding agreements if some bondholders accept the terms of the agreement.
It seems unlikely that the issues of financial stability can be solved so easily. Most banking regulation is the sovereign debt as risk free as there is no need to hold capital against them. After the 2007 crisis, regulators encouraged banks to have more public debt to make sure you have sufficient liquidity and can post as collateral for refinancing operations. The changes are clearly needed. But it may not be desirable to promote the diversification of sovereign debt in the euro area.
Diversification helps reduce risk, but it spreads more widely. In the case of Greece, where the nominal amount outstanding sovereign debt is relatively low, diversification is probably safer because a defect can be absorbed. However, for debt issued by the countries most heavily indebted, like Spain, is more dangerous. Spanish debt is not much around that, if widely held, the failure could bring down the entire banking system of the euro area.
Default Quick
Careful design of the regulation on the basis of the size of holdings in the financial system is necessary. This is just the beginning of the necessary institutional changes.
A sovereign default would have to be done very quickly, otherwise it would create huge flows of capital in the euro area countries perceived as weak to those who are as strong as Germany. It would be difficult to stop this kind of event in anticipation of a default, much less if the bankruptcy proceedings were to take a minimum of six months, as some legal experts have suggested for Greece. Questions concerning the priority of claims, deposit insurance and guarantees for holders of other bank debt, would have to be resolved.
There is an alternative to the cessation of payments in the euro area: A country can only leave the monetary union, temporarily. This would also have to be done quickly to prevent massive capital outflows. The government would have to rename overnight all contracts on a new currency, probably in a ratio of 1 to 1 with the original amounts in euros. There would still be an exchange rate determined by the market between the new currency and the euro.
Out of the euro
It would certainly be dirty details, but the advantage would be that the defaulting government to regain control of monetary policy and, potentially, be able to guarantee the banking system. It would be inflation, but this, along with the devaluation of local currency may help the country to grow exports. A few years after a sovereign nation has its budget deficit and public debt under control, he could reapply to join the euro.
The financial stability issues raised sovereign default in modern financial systems should be the focus of the formal discussion of the euro area. It is somewhat surprising that they have - at least formally - has not been. No easy way out. Time to break taboos.