Europe: What Is To Be Done: Halt the Crisis: The ECB should announce that it will become Lender of Last Resort for all Eurozone Countries. If I were running the show I would lead this off with a particular show of force. A short term bond issue for which there is heavy short interest I would have the ECB buy into specifically and dramatically to drag bond yields to 1.25%, in an effort to cause the shorts to miss their margin calls and take heavy losses on the issue.
This is not because I have anything against shorts, think they are acting irresponsibly or even initiating some type of implicit attack. Instead, its because I don’t need to waste the rest of the afternoon or god-forbid the better part of a week with markets wondering whether or not I am serious. It will become abundantly clear within the first 10 mins of trading that I am quite serious and prices need to adjust, lest there be more losses of this type.
Replace Individual Sovereign Debt with Eurobonds…. Independent Issues of Sovereign Debt are Banned…. Sliding Scale on New Issues…. Issue Holds For Violation of EC Rules: A violation of European Commission rules can result in a increase in the penalty rate for new issues or a hold on the funding on new issues…. The Single List is Replaced By Eurobonds…. Super-Sovereignty for Eurosystem Banks….
Right now, the EC is attempting to use “market discipline” to impose reforms on peripheral countries. As I pointed out from the beginning this is a dangerous game. It only works if you are actually willing to drive the bond markets over a cliff and if you are actually willing to do this and the markets believe you then you go over the cliff automatically…. [F]or this to fail all you need is incompetence, not intransigence, on the part of your counterparties. This is the problem with doomsday devices or credible commitments to be irrational, generally.
To solve this the EC should just abandon attempts at market discipline – which are unserious or in any case should not be used by serious people – and replace that with administrative discipline…. This is the power it really wants. It wants the power to say that Greek retirees will not get their pension checks unless Greece shapes up. It does not want the power to say Greek bondholders will not get paid. You see where that leads…