The idea of debt consolidation through an extension of its maturity, proposed by Michele Fratianni on FIRSTonline of last October 24th (“It's time to consolidate public debt: here are the advantages of lengthening government bonds”) is very interesting. However, there are also some "dark" sides to highlight.
The first is to understand whether this solution (rescheduling) is really preferable to the clean and immediate "haircut" (repudiation). 55% of Italian debt is domestic and constitutes a large part of the banks' assets. Even if the regulator allowed credit institutions to leave securities in the holding period category of their balance sheets (at nominal value), the judgment of the market could not be avoided: the price of government bonds in the secondary market would collapse, consequently reducing the value of the assets and, therefore, of the bank's equity. Is the capitalization of the banks sufficient to absorb the shock or will investors begin to doubt their real solvency? Indeed, the lengthening of the debt maturity imposes an additional cost on liquidity since it forces those who need it to sell consolidated government bonds at lower prices than in the absence of a restructuring. This would further stress an already suffering credit market with repercussions on investments and growth opportunities. The effects would also be negative for individuals: to avoid the additional costs of liquidity, consumption could undergo a further reduction which would add to the drop in income generated by the crisis. The impact on growth could also be negative and, above all, lasting: when liquidity becomes "precious", it is riskier to invest in long-term projects even if these would be potentially more profitable and innovative because they are able to move the production paradigm forward creating development. In other words, the drastic solution of repudiating part of the debt could give the backlash necessary to get back on the path of growth while a less traumatic solution runs the risk of prolonging the agony, like the maturities, by postponing the recovery of economic growth in village. Given that the cost of both solutions will be high, everything depends on the size of the debt restructuring and repudiation and, perhaps even more so, on how quickly the country will be able to regain its credibility and reputation.
The second doubt concerns the effects of a debt restructuring which, although called consolidation, is in fact a default within a monetary union. In 1926, Fascist Italy could count on the lira and a central bank free to print money. Today, however, we are inside the Euro with a supranational central bank. The closest historical precedent dates back to 1841 when 8 of the then nascent United States of America and the free Territory of Florida defaulted: yields immediately rose to 12% to reach 30% the following year. Historians have estimated that the United States returned to issuing bonds on the market after a relatively short period, but had to sustain a spread of more than one percentage point over equivalent Canadian bonds throughout the rest of the century. There is therefore no real "historical forgetfulness" on the part of the markets: when the investor returns to buy new issues after a debt default, he satisfies his appetite for risk by turning a blind eye to the quantities but remains very vigilant with the more on price by asking for higher spreads on interest rates. The obvious parallel with the current situation poses the problem of the cost of financing future debt. What will happen after the consolidation period? If the "degree of forgetfulness" of the markets is not so low, there is a problem of the future costs, in the long run, both for the country that has restructured and for the other members of the monetary union. In XNUMXth-century America, these costs were affordable because the country was growing rapidly and was willing to accept tax increases in the name of more infrastructure and public services. In recent decades, Europe has grown at modest rates and its citizens are reluctant to raise taxes. One wonders whether, with the lengthening of the debt maturity, interest rates are not only financially sustainable, but also allow appreciable growth rates also, and above all, beyond the consolidation period.
The third doubt concerns rigor and reputation. Italy has too high a public debt because it spends a lot, receives relatively little and does both unequally. The severe interventions imposed by the financial markets, the pressures of the other member countries of the European Union, and the requests of the European Central Bank push to act quickly and with lasting solutions. Rigor is transformed into reputation and this into contractual power in the European context, consolidating the path towards political union, the tacit objective of the European Community. With a debt restructuring, the effects would be diametrically opposite: Germany would become increasingly skeptical of countries that restructure their debt and this could push it to leave the Euro for a monetary area limited only to virtuous countries. Many governments believed they could easily gain reputation without paying the price of rigor by joining the Euro: the debt crisis is the test on which the financial markets are evaluating the real intentions of the countries and, consequently, the stability of the single currency . A debt restructuring, therefore, would not only harm the country that undertakes it but also the entire European Union. The question is political: how many sacrifices are individual member countries willing to make for a united Europe? At a national level, the problem of reputation is even more evident. In 1926, Mussolini was credible because he was the leader of an authoritarian regime and wanted to pay off the debt accumulated during the First World War that others before him had not been able to deal with. As leader of a regime, his time horizon was long-term, while as a "new" political subject, he was an element of strong break with the past. Today, legislatures have a time horizon that often does not exceed 5 years of mandate and a restructuring he would go to ask the same governments hitherto unable to contain the debt to be rigorous for 5 or 10 years. Rather than strict policy, markets may suspect that consolidation is the first in a series of measures aimed at forcibly diluting the debt burden. In this scenario, the effects would be perverse.
In conclusion, lengthening the maturity is certainly a viable solution to reduce sovereign debt even if some doubts remain about the effective cost and, above all, the effect in the medium-long term. Much of the result depends on the size and modalities. Not having to count on any kind of cooperation between states is the main advantage of the proposal but it also constitutes its major "limit": faced with this threat, the most intransigent states could prefer an unwanted (but still more convenient) collaboration and therefore in fact avoiding the restructuring itself which from a real possibility would remain only a potential threat.
