Europe's Debt Crisis

Martin Feldstein argues that Greece must (a) default and (b) take a leave of absence from the euro. Neither will be easy to arrange, but it is difficult to say what the second course even means.

The design of the debt restructuring that everybody thinks is coming will be important. Angelo Baglioni argues for a "leveraged buyback". This would involve Greece buying back its debt using money borrowed from European Financial Stability Facility--with the crucial proviso that this loan would be senior to Greece's existing bonds. This would keep Greek bonds cheap as it bought them back, thus transferring more wealth from  creditors and letting Greece lower its debt burden more effectively. Baglioni says a buyback done this way would mitigate the knock-on effects of a conventional default (partial repayment or stretching out of maturities) through global financial markets. Looks right to me.

Jeffrey Frankel's blog has a couple of good posts on learning from the Europe's mistakes over Greece: where the ECB went wrong, and what to do about it next time.


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