HOW FRAGILE is Europe? Well, all it took to shake the continent’s financial system to its core was a snarky remark a couple of weeks ago by Italy’s prime minister. Silvio Berlusconi mused that his finance minister, Giulio Tremonti, is “not a team player.” Since Italy has accumulated debt to the tune of 120 percent of gross domestic product, and since financial markets trust Mr. Tremonti as a fiscal hawk, the markets interpreted that Italy’s finances were about to get even wobblier. Interest rates on Italian government bonds shot up — with Spain’s bonds not far behind.
The Italian scare is a watershed for the European Union and its decade-old experiment with a single currency. Suddenly, “contagion” from the debt crisis afflicting peripheral European countries such as Greece, Ireland and Portugal no longer seems theoretical. It’s one thing to bail out Greece. But there probably isn’t enough money in all of Europe to rescue a trillion-dollar economy such as Italy’s or Spain’s.
Yes, neither country is in imminent danger. And, yes, a “stress test” has just shown that Europe’s major banks could withstand a severe recession. But the market’s jitters about Italy and Spain show that the risks to both remain intolerably high. And the “stress tests” did not examine what would happen in the event of a Greek default.
It’s time for the continent’s leaders, Germany and France, to stop temporizing and acknowledge that the Greek debt, which is over 150 percent of GDP, must be restructured. The same goes, possibly, for Ireland and Portugal. It’s said that Germany and France may be about to do that, starting with a summit Thursday. But we’ve heard this before. The solutions reportedly under discussion — such as using the German-backed European Financial Stability Facility to finance a massive buyback of Greek debt, or extending the maturity of bonds already in private hands — might be too little, too late, even if rating agencies approve, which is not certain.
What’s needed is a European version of the Brady Plan, the debt swap engineered by the administration of George H.W. Bush. It permitted creditors to trade in their Latin American bonds at a discount, in return for fresh long-term paper backed by solid collateral. Banks took a “haircut” but avoided crippling write-downs. Best of all, Latin American countries could restart growth — which is something that Europe’s debtor nations desperately need as well. Once the fire in the periphery is doused, Italy, Spain and other major countries with heavy debts must enact pro-growth structural reforms.
Understandably, German and French leaders have tried to solve the problem so far at minimum cost to their banks and taxpayers — urging Greece and the rest to impose harsh austerity in return for loans. But the costs are too high for Greece, Ireland and Portugal to bear. They will have to be shared among creditors, debtors and solvent-country taxpayers (Germans, mostly). All concerned will have to absorb a sharp financial hit. Bettter that it should come in a controlled manner, if at all possible. German Chancellor Angela Merkel and French President Nicolas Sarkozy say they are committed to United Europe and its single currency. If they mean it, they will pay the price.