Modernivory tower

The European sovereign debt crisis

Irwin Collier, member

International Advisory Board

Kyiv School of Economics

2

Financial Intermediary Balance Sheet

Kyiv School of Economics, 6 October 2011

Assets (you own) Liabilities (you owe)

OPM = other people's money,(claims on you such as deposits, short-term credits)

YSIG = your skin in the game(Equity, a.k.a. net worth)

3

Leverage ratio = OPM÷YSIG

Kyiv School of Economics, 6 October 2011

Assets (you own) Liabilities (you owe)

OPM = other people's money,(claims on you such as deposits, short-term credits)

YSIG = your skin in the game(Equity, a.k.a. net worth)

4

Financial Intermediary Balance Sheet

Kyiv School of Economics, 6 October 2011

Assets (you own) Liabilities (you owe)

OPM = other people's money,(claims on you such as deposits, short-term credits)

YSIG = your skin in the game(Equity, a.k.a. net worth)

CYA = cover your ass[ets](highly liquid reserves,required or prudential)

OPP = other people's promises(Assets working for you)

5

Financial Intermediary Vulnerability 1: “bank-runs”

Kyiv School of Economics, 6 October 2011

Assets (you own) Liabilities (you owe)

OPM = other people's money,[your depositors choose to leave suddenly en masse, or you become unable to roll-over debt]

YSIG = your skin in the game(Equity, a.k.a. net worth)

CYA = cover your ass[ets](highly liquid reserves,required or prudential)

OPP = other people's promises(Assets working for you)

6

Financial Intermediary Vulnerability 2:assets turn “toxic”

Kyiv School of Economics, 6 October 2011

Assets (you own) Liabilities (you owe)

OPM = other people's money,[your depositors choose to leave suddenly en masse, or you become unable to roll-over debt]

YSIG = your skin in the game(Equity, a.k.a. net worth)

CYA = cover your ass[ets](highly liquid reserves,required or prudential)

OPP = other people's promises[These promises are broken because asset price bubbles burst, fears of debtor defaults]

7Kyiv School of Economics, 6 October 2011

Source: Wall Street Journal data from 31 Dec 2010

8Kyiv School of Economics, 6 October 2011

Illiquidity vs Insolvency

Last-resort lending: become the source of “other people’s money” to increase “cover your own ass[ets]”

Bailing-out: recapitalizing by swapping the bad “other people’s promises” with liquid and safe assets to bolster “own skin in the game”

Swedish-solution: government takes over failed financial institutions, restructures to reprivatize.

9Kyiv School of Economics, 6 October 2011

Whither Euro? Breaking-up is hard to do.

Economic sustainability AND Political sustainability are required€ Imposed austerity policies to increase credibility of future repayment

can be rejected by the voters.€ Bail-outs can likewise be rejected by taxpayers in the countries

running export surpluses and/or owed the money€ One fiscal-monetary policy does not fit all, certainly not yet. The ECB

has a European-scope, but no such common fiscal authority.

Creation of the euro but especially expansion of the euro-zone let politics get ahead of economic integration. European financial markets completely interwined. Complete unwinding would be a disaster.

Hard to imagine any solution beyond a deal to forgive a big chunk of Greek foreign debts (with the difference split between remaining Euro member taxpayers and those holding Greek bonds taking losses) in exchange for Greece leaving the Euro, allowing adjustment to take place through devaluation of the Greek currency.