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Author

Vidia S. Ramdeen, MPA, SSBB

3829 Gomer Street

Yorktown Heights, NY 10598

P: 914-409-7700

E: vramdeen@gmail.com

Biography

Vidia is an Emerging Hedge Fund Manager at Ricochet Alternative Asset Management where is

Founder & CEO. Ricochet manages the Quantico Fund, a multi-strategy global macro hedge

fund. Vidia holds a BA in economics from SUNY Albany and a Master of Public

Administration degree from Pace University where he studied under John Allan James, and is a

6σ Black Belt, a member of Pi Alpha Alpha & an AOM reviewer. NB: Vidia has driven cross

country 6 times, from NY, NY to San Diego, CA. The first trip, accomplished in just over 2 days

(Official Time: 2 days 4 hours 52 minutes.

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The Wolfson Economics Prize

“If member states leave the Economic Monetary Union, what is the best way for the economic

process to be managed to provide the soundest foundation for the future growth and prosperity

of the current membership?” – The Judges, Wolfson Economics Prize

Executive Summary

Potential instability arising within the European Monetary Union (EMU) with potential

contagion to the global banking system is a function of mishandling of the exit of the most debt

stressed members. Therefore, the process of disintegrating any current member of the EMU,

must be handled strategically and methodically as to ensure the ability for the market to adjust

the flow of new capital into the global economy. Given the circumstance, the purpose is to

provide a frank yet detailed proposal intended to prevent else mitigate contagion which will

unduly cause a free fall of the euro leading to further downgrading of outstanding sovereign

Eurozone debt held by global investors.

The act of exiting the Eurozone, understood to be, in part, a function of defaulting on a

percentage of the debt, therefore allowing the European Financial Stabilization Mechanism

(EFSM) or the (ESM) (Matthias, 2011) to pay the outstanding amount to creditors and issue new

bonds to be purchased by the nation that has exited the Eurozone. However, as to not produce

immediate debt onto the exiting government, the new sovereign debt will remain held by the

EFSM or ESM on a T-Account basis, such that the exiting Eurozone nation will reestablish

economic sovereignty to the point of driving currency valuation against the euro near parity. The

decision for reentry to the Eurozone and repatriation to the euro will then allow repatriated

Eurozone nation to commence repayment on the accounts payable side of the t-account regarding

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the amortization of the bond (accounts receivable end of the EFSM) repayment of the

outstanding sovereign debt.

The process of managing the repayment of outstanding sovereign debt and in meeting the

interest payable obligation is more readily coordinated via the restructure of the outstanding debt

with the consortium of creditors. There is always a level of risk when purchasing sovereign debt.

The risk is subject to which the restructure reflects the adjusted real value of the debt outstanding

as well as provides new debenture financial instruments at fair market value to raise new funds

and to provide a sort of ‘hedge’ by enabling the purchase of new debt created as a function of the

devaluation arising from restructuring outstanding debt. The holders of new debentures if

holders of the old debentures will receive back invested capital, which is the agreed upon x% of

the outstanding amount payable at maturity including interest plus the contract on the new

debentures payable at maturity.

The dynamic of restructuring, rather than forcing the hand of the market in the short-run,

theoretically will reduce the risk of default and rate of return as a function of shifting the time

constraint to the long run. The long-run economic outcome of debt payments is theoretically a

function of GDP growth/accrued and assumed debt, and therefore the process of reentry and

economic reintegration of the once removed Eurozone member(s) is a function of domestic

economic restructuring.

Additionally, the symbiotic and ostensible simultaneous economic velocity in the transfer

of balance of payments is a function of enabling the proper level of liquidity into the market in a

manner that controls for marginal increases in the rate of inflation. The introduction of

additional liquidity into the global market is a function of maintaining a transfer of debt and

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currency swaps between the primary market, consisting of the United States, Germany, Japan,

and England. The aforementioned exchange of economic velocity will theoretically take

advantage of the appreciation in currency valuation for these nations speaking to their broad

currency baskets to control for inflationary pressures globally and to facilitate the necessary

liquidity into the markets to enable the facilitation of the transfer of payments. The varying

interest rates of member Eurozone nations, emerging markets, and syndicate nations will be

actively managed to ensure that the 6 month LIBOR average remains stable.

As GDP growth in the emerging markets accelerates, loose monetary policy will allow

nations of the syndicate to purchase the debt of these emerging market members such as Brazil.

Such injection of capital flow from the syndicate nation and removal of Brazilian real from the

market may facilitate the shift in currency appreciation to the bailout/emergency funds,

established to prevent contagion.

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Introduction

The purpose is to provide a frank yet detailed proposal intended to prevent else mitigate

contagion which will unduly cause a free fall of the euro leading to further downgrading of

outstanding sovereign Eurozone debt held by global investors. Potential instability arising

within the European Monetary Union (EMU) with potential contagion to the global banking

system is a function of mishandling of the exit of the most debt stressed members. Therefore,

the process of disintegrating any current member of the EMU, must be handled strategically and

methodically as to ensure the ability for the market to adjust the flow of new capital into the

global economy.

The current structure of the EMU sovereign debt crisis is not as complex as one may

believe. As oxymoronic as the aforementioned statement may appear, the cumulative debt

structure of the obligations outstanding, as a function of debentures outstanding (accounts

payable), interest payable (i-rates, debt rating, inflation) and debentures held (accounts

receivable), interest earned/accrued (i-rates, debt rating, inflation).

The symbiotic and ostensible simultaneous economic velocity in the transfer of balance

of payments is a function of enabling the proper level of liquidity into the market in a manner

that controls for marginal increases in the rate of inflation. The introduction of additional

liquidity into the global market is a function of maintaining a transfer of debt and currency swaps

between the primary market, consisting of the United States, Germany, Japan, and England that

is designed to take advantage of the appreciation in currency valuation for these nations speaking

to their broad currency baskets to control for inflationary pressures globally and to facilitate the

necessary liquidity into the markets to enable the facilitation of the transfer of payments. The

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varying interest rates of member Eurozone nations, emerging markets, and syndicate nations will

be actively managed to ensure that the 6 month LIBOR average remains stable.

As GDP growth in the emerging markets accelerates, loose monetary policy will allow

nations of the syndicate to purchase the debt of these emerging market members such as Brazil.

Such injection of capital flow from the syndicate nation and removal of Brazilian real from the

market may facilitate the shift in currency appreciation to the bail-out funds that are designed to

prevent contagion.

The nexus that exists via the economic integration between the 27 Eurozone members

(Henry, 2012) and the ‘monetary syndicate’, that includes the primary debt and currency swaps

market consisting of the United States, Germany, Japan, and England is to be viewed

conceptually as an interrelated web with the secondary debt market consisting of Eurozone

members. Conceptually, the monetary syndicate undergoes positioning in the exterior of the web

and encloses the 27 Eurozone members (Henry, 2012).

The potential influence of China in the sovereign debt market via purchases by the

People’s Bank of China (PBoC) is considerable as China is capable of purchasing excess debt on

the market and can play a facilitator role by providing liquidity to the market, essentially acting

as a market maker. The monetary syndicate nations will operate as an intermediary debt and

currency exchange network capable of injecting liquidity into the market from any syndicate

based central bank into euro zone central and subsequent commercial banks. The Venn diagram

shown in Appendix I, on a basic level, shows the interrelationship between the monetary

syndicate and the 27-N Eurozone members.

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The act of exiting the Eurozone, understood to be, in part, a function of defaulting on a

percentage of the debt, therefore allowing the European Financial Stabilization Mechanism

(EFSM) or the (ESM) (Matthias, 2011) to pay the outstanding amount to creditors and issue new

bonds to be purchased by the nation that has exited the Eurozone. However, as to not produce

immediate debt onto the exiting government, the new sovereign debt will remain held by the

EFSM or ESM on a T-Account basis, such that the exiting Eurozone nation will reestablish

economic sovereignty to the point of driving currency valuation against the euro near parity. The

decision for reentry to the Eurozone and repatriation to the euro will then allow repatriated

Eurozone nation to commence repayment on the accounts payable side of the t-account regarding

the amortization of the bond (accounts receivable end of the EFSM) repayment of the

outstanding sovereign debt.

The process of managing the repayment of outstanding sovereign debt and in meeting the

interest payable obligation is more readily coordinated via the restructure of the outstanding debt

with the consortium of creditors. There is always a level of risk when purchasing sovereign debt

to which the restructure reflects the adjusted real value of the debt outstanding as well as

provides new debenture financial instruments at fair market value to raise new funds and to

provide a sort of ‘hedge’ by enabling the purchase of new debt created as a function of the

devaluation arising from restructuring outstanding debt. The holders of new debentures if

holders of the old debentures will receive back invested capital, which is the agreed upon x% of

the outstanding amount payable at maturity including interest plus the contract on the new

debentures payable at maturity.

The dynamic of restructuring, rather than forcing the hand of the market in the short-run,

theoretically will reduce the risk of default and rate of return as a function of shifting the time

8

constraint to the long run. The long-run economic outcome of debt payments is theoretically a

function of GDP growth/accrued and assumed debt, and therefore the process of reentry and

economic reintegration of the once removed Eurozone member(s) is a function of domestic

economic restructuring.

A review of the European Union system of governance will be conducted to determine

the policy necessary to facilitate the means necessary to coordinate an economic exit from the

Eurozone. The expectation is for the return to the legacy currency for the exited nation.

Whether the nation is Greece, Italy, Portugal, France, Belgium, or any other Eurozone member

nation, the idea is to return to the legacy currency, restructure the domestic economy and budget

to create jobs and educate the workforce in order to create and fill domestic jobs that directly

contribute to year over year marginal growth in GDP.

As a function of structuring new debt, the issuing syndicate nations with the higher

debt/GDP ratio will have an easy money policy subject to maxima range constraints of the

following: (10 basis points + inflation) and minima = 0. The idea is to encourage investment

into private markets as a function of rising GDP as funded by easy liquidity. The anticipated

nominal zero interest rate for bank deposits and holders of treasury bonds will provide a negative

real interest rate after adjusting for inflation. Any monetary syndicate nation with a lower

debt/GDP ratio may fluctuate from tightening to loosening credit as is best directed by global

macro-economic forces.

The introductory analysis begs the question of what the immediate impact of the

aforementioned would be. Holders of fixed rate mortgages in the U.S. will be subject to less

income in real dollars subject to the rise in prices for consumer basket goods. This increase does

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erode the value of the higher fixed interest rate by deflating the real rate of return on the

underlying collateral instrument held by the bank to ensure payment of the amortized mortgage

debt obligation. Given the extent of the sovereign debt crisis, the externality for the U.S. market,

is not severe to the point of reconsidering the underlying monetary economic policy.

The major externality in the global market is deflationary and inflationary pressure as

well as instability given declining levels of real GDP growth subject to real decline in the rate of

return of aggregate productivity, a function of the employment rate, underemployment rate, and

the net contribution to GDP after expenses, expressed as a rate (%) of the underlying ratio. The

rate of real productivity from the exited Eurozone nations is a contributing factor in the ability

for the bail-out fund to not require further assistance via quantitative easing from members of the

syndicate nations.

To illustrate, here is an example of quantitative easing to demonstrate the process from

which a monetary syndicate member nation is a function of its underlying currency pair, and in

this case, it is the USD/JPY currency basket. In this case, the pairing has experienced downside

volatility from parity to which the JPY/USD valuation, which has experience upside volatility

from parity, can enable quantitative easing initiated by the Bank of Japan to provide liquidity to

the market. Purchasing of US treasury bonds by the Bank of Japan allows for the European

Central Bank (ECB) and the Deutsche Bundesbank (German Federal Bank) to engage in further

quantitative easing by purchasing debt issued by the Bank of Japan. The combination of the

ECB and the Deutsche Bundesbank can replace more yen in the market with less Deutsche

Marks and Euros, which will effectively control the inflationary effects of quantitative easing.

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Of importance is to note the expected return in GDP of the underlying contingency

economic plan that supports the appreciation of the legacy currency relative to the global basket

of currencies. The appreciation of the legacy currency will render a new valuation against each

currency as represented by the balance of outstanding debt in euros held by each creditor

(foreign banks and investors holding the sovereign debt of the exited Eurozone member). The

valuation of the legacy currency is a function of the assumed restructured debt amount as

rendered from the converted currency (euro) in exchange for the legacy currency as adjusted for

euros.

The Maastricht Treaty (Nugent, pg. 363, 2006) is the facilitator the European Union (EU)

to which the governing laws as overseen by the European Council and promulgated by the

European Court of Justice (ECJ). Therefore, the Eurozone members are not only economically

integrated by also politically integrated as well. For example, the Third Pillar of the Maastricht

Treaty (Nugent, pg. 368, 2006) enables the “Provisions on Cooperation in the Fields of Justice

and Home Affairs (JHA).” (Nugent. pg. 368, 2006) The Maastricht Treaty since its inception

has been amended and labeled the Amsterdam, Nice, and Lisbon treaties, collectively referred to

as the Treaties of the European Union (Nugent, 2006). Without specific regard to the changes

made over the years, the impact politically and structurally to the exited Eurozone nation is to

include the provisions outlined under the Treaties of the European Union.

The length of time for any exited Eurozone member to reintegrate into the Eurozone may

be a function of years. Over this time, the cost of maintaining Eurozone services as a function of

the treatise provisions will burden the administrative system operations of the exited nation to

which cost of maintenance is prohibitive to growth. Exited Eurozone nations must reestablish

internal political and government administration operations, which do not seek to restrict

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economic velocity of trade and currency exchange, and do not restrict personal movement of

Eurozone and exited Eurozone members.

Once removed from the Eurozone, industry growth within the domestic economy of the

exited nation will link to multinational comparative advantage relationships that are a function of

manufacturing and intellectual property creation from the exited Eurozone nation. Although the

purpose of this paper is not to detail the macroeconomic activity of the exited Eurozone nation,

for future consideration for reentry, the importance herein is to acknowledge that all efforts

undertaken is to be seen as methods to eventually strengthen the Eurozone. Strengthening as a

function of facilitating reentry of all exited nations once domestic economic GDP is robust to

which the legacy currency is appreciating whilst preventing hyperinflation and year over year

GDP growth is marginally positive.

Conceivably, the exited sovereign member nation economy will be growing at the same

rate as while a member of the EZ, the opportunity to rebuild and restructure the economy is

present and critical to meeting the expectation of investors regarding meeting interest rate

payments on serviceable debt and repayment of debt principle. The devaluation of currency will

seek to establish the national economy as a net exporter to which trade partners are either net

importing nations, or nations that have currency valuations above or at parity. The ability for the

exited EZ member nation to establish trade partnerships with EZ nations enables the exited EZ

member to become a manufacturing hub for EZ nations to the point of advancing global trade.

For example, if Greece does indeed exit the Eurozone, Greece is able to retool the

economy to become a net exporter of durable goods manufacturing such as baby diapers,

formula, and other goods in demand by wealthier nations, including cutting-edge electronics

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such as televisions, etc. Ideally, Greece’s objective is to become a supply-chain economy, which

is, become an economy that is strategic to the supply chain development of major existing

corporations and emerging companies with guaranteed contracts. Considering the low nominal

value of Greek currency, the selling of manufactured goods from Greece to the EZ will enable

Greek banks to hold euro deposits in exchange for the drachma.

Trading in and out of the EU as a function of purchasing Greek manufactured goods will

avail a global supply of market competitive consumer durable and non-durable goods. The value

of the euro renders goods from legacy currency nations to be relatively inexpensive to the euro

currency basket. Trade from the EZ to wholesalers or direct to retailers in a country with an

exchange rate competitive to the euro will yield the comparative advantage of being able to

import consumer durables at a price either lower or at least competitive to the internal

manufacturing cost.

Additionally, such consumer non-durable and some durable goods produced perhaps

more competitive than what the trade nation GDP contribution as an exporter of identical goods.

Such a strategy will work in a market to which there are little to no substitutable goods or to

which there is an elastic demand curve for substitutes relative to the availability of a lower priced

substitute. Additionally, examining the complementary goods market in trade partner nations

will reveal consumer goods arbitrage opportunities to manufacture complementary goods, such

as ketchup to a nation with high hot dog consumption, Ceteris Paribus. The ESM has the power

to provide direct capital investment into the exited sovereign nation. The capital injection is

necessary to procure manufacturing plant, property, and equipment necessary to add value over

debt to the domestic economy.

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Literature Review

The amount of recent literature to include scholarly and non-scholarly works covering the

Eurozone crisis in aggregate is copious. The central theme, interpreted as the consensus

evaluation of the outstanding literature renders the use of austerity measures without rectifying

the underlying dysfunction, whilst seeking a plan to mitigate the risk of a free falling euro and

actively seeking to avoid the downgrading of sovereign debt. Inclusively, the aforementioned do

remain a function of the probability of contagion of one or more highly indebted nations upon

the release of a single member of the Eurozone in default.

Of primary importance to the literature review is the understanding of EU law and the

constraints placed by the Maastricht Treaty on the Eurozone members with regard to receiving

any form of bailout funding as well as on leaving the formally integrated Eurozone, a function of

EU membership. The relinquishing of the euro is only one aspect of the process in removal from

the EZ. The political process and organizational dynamic of belonging to the EU involves

administrative offices and national services that facilitate cross-border travel and commerce

between EZ members. An exit from the EZ will restrict the movement of EZ and non-EZ

members from the exited EZ member nation as well as hinder trade and commerce, and

obfuscate the immigration and visa administrative procedures once handled by the EU.

Additionally, the objective of the Literature Review is to provide a background into the

content of the crisis as well as the direct content as stated by individuals in and around the

Eurozone crisis. The latter essentially is to provide quoted word-for-word detail that does not

alter the semantics or syntax regarding the insight behind the selected chosen words. Therefore,

there is little paraphrasing and in-text citation, rather, there is direct quotation given the

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importance of specificity. The importance of understanding the precise thoughts of political and

financial leaders as well as business economists and business journalists is critical to the

complexity of the scope in argument over the actions necessary to resolve the Eurozone

sovereign debt crisis.

The European Debt Crisis and European Union Law (Matthias, 2011), provides the most

critical points to consider in discussion of European Law under the auspice of the current

Eurozone Sovereign Debt Crisis. Specifically, Matthias’ argument does consider at length the

effect on the EU with regard to the debt crisis and the loss of member nations. Matthias provides

a very detailed synopsis of the crisis from the purview of EU law as well as the purview of the

potential disintegration of the Eurozone.

The structure of the Matthias argument compares EU law and parliamentary duty to the

actual political and economic actions taken to prevent a default of the most egregious of default

candidates. The decision to include much of the Matthias analysis and argument in the Literature

Review, rendered due to the specific context of EU law as well as the analysis to market

dynamics to include policy recommendations that do establish a framework on which stability in

the markets is very conceivable.

According to Matthias, 2011, “The analysis will reveal most disturbing risks for three

core issues of European Union law – nothing less than the integrity of European

constitutionalism, the future of democratic Government in the EU and the conservation of wealth

and stability (which are also legal values). This development has an impact on the future of

European Union law and its scholarship, as well.” (Matthias, 2011)

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Matthias, 2011, continues to describe the manipulation of government reporting

regarding the integrity of Greek debt to which the data had been “statistically manipulated”

(Matthias, 2011) in Q4 of 2009 to “conceal its true public debt and was practically bankrupt.”

(Matthias, 2011) The first bailout package (110 billion over 3 years) (Matthias, 2011) presented

as a loan to Greece involving “the euro area countries and the International Monetary Fund

(IMF).” (Matthias, 2011). Greece is therefore indebted to “the euro area Member States (euro

80 billion) and the IMF (euro 30 billion).” (Matthias, 2011)

The terms of the first bailout package included interest rate modifications that effectively

lowered “the interest rates by 1%, and extended maturity to 7.5 years. Up to September 2011,

euro 65 billion have been disbursed, euro 47.1 thereof by the euro area countries. The

implementation is surveyed by a “troika” legal expert team of the Commission, the European

Central Bank (ECB) and the IMF.” (Matthias, 2011) Therefore, should Greece exit the

Eurozone, the remaining percentage owed after the restructuring of the Eurozone debt of 80

billion as well as the IMF debt of 30 billion including, accrued interest will still be owed and

represented by the first generation of debt issuance.

Further analysis by Matthias, 2011 reveals, in opinion, a method to avoid contagion. “It

is important to note that the operation of the ESM will include private sector involvement. If it is

concluded, after a debt sustainability analysis in line with IMF practice, “that a macro-economic

adjustment programme can realistically restore the public debt to a sustainable pathi”, the main

private creditors are to be encouraged to maintain their exposures. If this is denied, negotiations

between the Member States concerned and the private creditors must be initiated following a

plan to be included in the macro-economic programme and led by the principles of

proportionality, transparency, fairness and cross-border co-ordination (to avoid the risk of

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contagion). The negotiations will be supported by standardized collective action clauses

(CAC’s) “consistent with the CACs that are common in New York and English law” for new

loans after 2013, the exact content of such clauses being meticulously described in the EMS

agreement.” (Matthias, 2011)

With regard to the question of whether EU law has been or will be breached given the

process of exiting the Eurozone or the process of servicing outstanding debt obligations by EZ

members, according to Matthias (2011), the breach occurred as a function of “rescuing activity.”

(Matthias, 2011) “From the beginning, the Member States’ rescuing activity has been under

close legal scrutiny by the European legal scholars, and rightly so. There are good reasons to

submit that this policy is in breach of important provisions of the TFEU (Article 136).”

(Matthias, 2011)

Further, according to Matthias, (2011), “To begin with, Article 125ii TFEU is rather

explicit: “The Union shall not be liable for or assume the commitments of central Governments

… of any Member State, … A Member State shall not be liable for or assume the commitments

of central Governments . . . of another Member State, …” In the present legal situation, a bailout

by the Union (first sentence) or by one or more Member States (second sentence) is forbiddeniii

.

As a result, the decision of the Eurogroup of 2 May 2010 concerning Greece, the establishment

of the EFSF, the extension of both in 2011 and the Eurogroup’s support for Ireland and Portugal

are in breach of European Union law.” (Matthias, 2011)

Additionally, Matthias (2011) does point to the reasoning behind the decision to support

austerity as flawed as in unconvincing enough to breach EU law. “None of the counter-

arguments brought forward against this reasoning is really convincing. The argument, that the

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wording “shall not be liable for or assume the commitments” was related to a duty of liability or

assumption of commitment, and that consequently a deliberate support was not contrary to

Article 125iv

TFEU was explicitly enshrined in the Treaty together with other articles – above all

Articles 123, 124 and 126 FEU –to force the Member States to take up loans solely under the

conditions of the financial markets and thus to consolidate their public spending for the benefit

of the stability of the common currency.v” (Matthias, 2011)

Even the prospect of deliberate help by some Member States would operate against this

target. In fact, other voices point at that ratio: a rule designed to stabilize the euro could not be

put into place against measures aiming at the same stabilization – such as the rescue packages for

the Member States in troublevi

. This argument appears, when the Eurogroup claims to act “to

safeguard financial stability in the euro area as a whole”, and it should not be easily dismissed.

However, it is not valid in all of the cases at hand. The Greek part of the European economy is

much too small and the options for the restructuring of debts are much too obvious – the

safeguarding of financial stability did not demand a breach of the lawvii

. But even if this was

denied for Greece, at least in the Irish and Portuguese case it becomes apparent that a shift of the

system from a strict “no-bailout” to mutual support cannot be achieved by the mere re-

interpretation of a core article of the Treaties or an “implicit modification”viii

, even if one

considers a discretionary margin in favour of the Member States’ Governments in matters of

economic emergency action.” (Matthias, 2011)

In a sense, one cannot exclusively hold Greece accountable for the Eurozone sovereign

debt crisis. The global economy has been slow to grow year over year GDP to the point of

mounting debt obligations and the servicing of said obligations. Although there has been

tremendous growth in the emerging and frontier markets, the growth experienced in these areas

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has spurred inflation, which is still a reflection of an economy seeking maturation. The decision

to enable Greece into the Eurozone rendered under the suspicion of impropriety as Greece,

expected to be an inferior economic contributor and somewhat of a ‘weak link’ to the monetary

operations of the Eurozone. The actuality is of a handful of nations in the Eurozone that are

potentially in danger of default, which is a default in euros, which will cause severe problems to

the value of the currency as well as the downgrading of debt, potentially by the three debt rating

agencies.

Further analysis from Matthias (2011) reveals the following. “In addition, the basis for

the ECB’s security markets programme is rather weak, as Article 123 TFEU explicitly prohibits

the purchase of debt instruments from “central Governments, regional, local or other public

authorities, other bodies governed by public law, or public undertakings of Member States”. Of

course, it must be added that the prohibition only applies if such instruments are “purchased

directly.” This very prohibition aims at avoiding the direct financing of States (or other public

entities) by the ECB to undertake some open market operations in the fine-tuning of its monetary

policy (Art. 18 ECB Statute), but not to circumvent the prohibition of financial support for

Member States. If for instance Italian State bonds are bought by the ECB, this is currently done

to keep them marketable and to keep interest rates at a lower level for Italy – and this is beyond

what the bank is empowered to do under Article 123 TFEU and Article 18 of its Statute.

Moreover, many of the bonds bought by the ECB are not “marketable instruments’ any more,

due to the weakness of the debtor (in this case of Greece)ix

.” (Matthias, 2011)

Matthias (2011) goes on to question the compatibility of the IMF with “its Treaty

powers” (Matthias, 2011) and the implications to “public international law” (Mathias, 2011).

“As far as the legal system of the EU is concerned, even if a view was taken that stresses the

19

counter-arguments against the illustrated position, it would still be most disturbing that a

complete shift in the EMU had been undertaken without setting aside the legal doubts. In its

judgment of 7 September 2011, the Bundesverfassungsgericht upholds the German legislation

implementing the Greek package and the EFSF. The Court concentrates on German

constitutional law and only marginally (but rather explicitly) underlines the stabilizing function

of Articles 123 and 125 TFEU together with a line of other articlesx. Earlier in 2010, the former

French minister of finance, Christine Lagarde, quite openly admitted the unimportance of the

Treaties for the policy options takenxi

. In a European Union based on constitutional foundations,

this is not a reassuring perspective.” (Matthias, 2011)

Clearly, what Matthias (2011) has described as stated by former French minister of

finance is to ostensibly stress the importance of the economic sovereignty of the euro as

paramount and supersedes the governance and oversight of the EU law. However, the Treaty

may inset an addendum to facilitate the ESM. According to Matthias (2011), “The new Article

136 TEU which will enable the creation of the ESM is intended to be inserted by a Treaty

amendment following a simplified revision procedure under Article 48xii

TEU due to the

profound changes in the EMU’s institutional structure. However, there is no increase of “the

competence conferred on the Union in the Treaties” – in which case the simplified procedure

would be excluded -, as the proposed section empowers the Member States, not the EU.

Consequently, the doubts raised are at least far less serious compared with the other points made

herexiii

.” (Matthias, 2011)

However, Matthias does express concern regarding the facilitation of the ESM “as a new

structure for emergency action outside the EU’s own institutional framework.” (Matthias, 2011)

Additionally, according to Matthias (2011), “The ESM appears to be a regional copy of the IMF,

20

and it is totally “intergovernmental”; even more so, it is deliberately shaped as a tool for

international cooperation beyond the EU level. Of course, the Member States are free to found

new international organizations among themselves as a matter of principle, which may also

include the marginal involvement of the common institutions as long as there is no judicial body

of the new organizations among themselves as a matter of principle, which may also include the

marginal involvement of the common institutions as long as there is no judicial body of the new

organization competent to adjudicate in EU law mattersxiv

. Nonetheless, the erection of a new

international institution enhances the complexity of the design of European integration, and it

also sidesteps some crucial features of the EU’s institutional concept, which should strive for

more transparency and not for a complex plurality.” (Matthias, 2011)

Matthias (2011) continues to address the concerns of the EU citizens, which he describes

to be in regard to the “future of welfare and stability in the EU and, in this context, the question

whether the tools chosen by the political actors are viable. According to Article 3 TEU, the

Union promotes “the well-being of its peoples”. The economic side of this aim is further

developed in sections 3 and 4 of the same article, including the principle of price stability

(Article 3, 2nd

sentence TEU). The risk that the ESM might conflict with this principle is

obvious. The existing legal construction of the EMU following the Maastricht Treaty and the

Stability and Growth Pact (SGP-1997) is one of strict stability which does not allow for

emergency intervention because the prospect of such intervention would jeopardize the

incentives to perform a solid budgetary and financial policy in the Member States.” (Matthias,

2011)

Perhaps of the most important contribution Matthias has made to the Eurozone Sovereign

Debt Crisis is the following. According to Matthias (2011), “It is one of the most important

21

elements of the EMU that it contained two rules limiting public debt from the outset: the 3% -

limit for new debt and the 60%-limit for overall debt. In such a framework, a State debt that

cannot be discharged needs restructuring with all consequences for the State concerned, in

particular concerning future interest rates. Price stability is enhanced if a Member State must

always take into account the risk of debt restructuring. The EFSF and the EFSM are thus a clear

deviance from a legal concept.” (Matthias, 2011)

With regard to the ECJ intervention capability, Matthias (2011) states the ECJ “can only

intervene in the framework of Article 273 TFEU. Though the ESM is outside the institutional

framework of the EU, its core principles have to be respected because the mechanism functions –

via Article 1 36 TFEU – as an instrument to overcome the obstacles to establish a rescue

mechanism within the Treaties. Requirements of national constitutional law might be added, as

the German Bundesverfassungsgericht held that “mechanisms of considerable financial

importance which can lead to incalculable burdens on the budget” would be impossible without

mandatory approval by the German Bundestag.xv

” (Matthias, 2011)

The path to requisition as described by Matthias (2011), “Out of the four measures within

the reform package related to budgetary control, three concern the preventive limb, which first of

all is reformed by a directive implementing prudent fiscal policy-making as a new principle of

budgetary governance. Annual expenditure growth is oriented towards a “prudent medium-term

rate of growth of GDP.” “Revenue windfalls” are to be used for debt reduction, not for

excessive expenditure. Benchmarks are to be established by the Commission, and in case of

deviance from these benchmarks, the Commission may issue a warning or the Council may (if

the deviance is persistent and/or particularly serious) take corrective action under 121xvi

TFEU.88.” (Matthias, 2011)

22

The implications to EU law & EU economic governance (Matthias, 2011), according to

Matthias (2011), “The evaluation of European economic governance during the last eighteen

months does not concern legal details and jurisprudential niceties. It is no exaggeration that

some core principles of European Union law are at stake. Whether in the evaluation of

emergency reaction or in the field of economic governance, three most disturbing questions had

to be asked: about the integrity of European constitutionalism, about the future of democratic

institutions in Europe, and about the conservation of wealth and stability as legal values in EU

law.” (Matthias, 2011)

In support of the EU law and the euro, Matthias (2011) closes with the following.

“Doubts about the operability of a common currency in Europe are back in the discussion, and

some scholars even feel an inclination for scientific support of EU –critics or adversaries to the

EMU. But neither overdone or apology nor distinct rejection are helpful to serve as an overall

direction of European legal scholarship. What is needed the most is an orientation towards the

core principles of European Union Law. After all, the success of the EU in bringing forward

peace, common European values and the well-being of its peoples is to a large extent, if not

primarily, due to the concept of “integration through law”. Integration is on its way following

the Lisbon Treaty, the euro has been the common currency for more than ten years now, and all

this should not be jeopardized easily. It is the loss in public support caused by the developments

that is most disturbing.” (Matthias, 2011)

The next literature in review is “The Failure of the Euro” The Little Currency That

Couldn’t” (Feldstein, 2012). Feldstein’s argument is central to the discussion of whether the

euro should prevail as an integrating exchange unit for a politically and economically integrated

network. In the words of Feldstein (2012), “The euro should now be recognized as an

23

experiment that failed. This failure, which has come after just over a dozen years since the euro

was introduced, in 1999, was not an accident or the result of bureaucratic mismanagement but

rather the inevitable consequence of imposing a single currency on a very heterogeneous group

of countries.” (Feldstein, 2012)

The next segment of the Feldstein argument defines the euro as an experimental currency

doomed to fail. According to Feldstein (2012), “The adverse economic consequences of the euro

include the sovereign debt crises in several European countries, the fragile condition of major

European banks, high levels of unemployment across the Eurozone, and the large trade deficits

that now plague most Eurozone countries. The political goal of creating a harmonious Europe

has also failed. France and Germany have dictated painful austerity measures in Greece and

Italy as a condition of their financial help, and Paris and Berlin have clashed over the role of the

European Central Bank and over how the burden of financial assistance will be shared.”

(Feldstein, 2012)

Feldstein argues that a single currency must come with a “single fixed exchange rate

within the monetary union and the same exchange rate relative values. Economists explained

that the euro would therefore lead to greater fluctuations in output and employment, a much

slower adjustment to declines in aggregate demand, and persistent trade imbalances between

Europe and the rest of the world. Indeed, all these negative outcomes have occurred in recent

years.” (Feldstein, 2012)

The use of policy issued by the ECB designed to curb inflation, according to Feldstein

(2012), “caused interest rates to fall in countries such as Italy and Spain, where expectations of

high inflation had previously kept interest rates high. Households and governments in those

24

countries responded to the low interest rates by increasing their borrowing, with households

using the increased debt to finance a surge in home building and housing prices and government

using it to fund larger social programs. The result was rapidly rising ratios of public and private

debt to gdp in several countries, including Greece, Ireland, Italy, and Spain.” (Feldstein, 2012)

Feldstein argues the rising debt to GDP ratio in the aforementioned several countries

including Greece, Ireland, Italy, and Spain, is the harbinger that will cause the euro to ultimately

crash, rendering the outstanding debt to junk and lowering each respective sovereign debt rating

to junk status. Due to the provisions of the Maastricht Treaty, the debt issued by each Eurozone

member was viewed to be as guaranteed as the German Bund and therefore Greece and Italy

issued bonds with rates only a few basis points below that of the Bund long-term rates.

Feldstein continues to state the following. “But the plan to increase the banks’ capital has

not worked, because banks do not want to dilute the holdings of their current shareholders by

seeking either private or public capital, and so instead they have been raising their capital ratios

by reducing their lending, particularly to borrowers in other countries, causing a further

slowdown in European economic activity. Nor can the efsf borrow the additional funds, since

such a move is opposed by Germany, the largest potential guarantor of that debt. Moreover,

even a trillion euros would not give the efsf enough funds to provide effective guarantees to

potential buyers of Italian and Spanish debt if those countries might otherwise appear insolvent.”

(Feldstein, 2012)

Feldstein (2012) further states the supposed instability of the Eurozone as well as the lack

of a provision within the Maastricht Treaty (Feldstein, 2012) for a Eurozone member to return to

their legacy currency. According to Feldstein (2012), “The alternative is for Greece to leave the

25

Eurozone and return to its own currency. Although there is no provision in the Maastricht Treaty

for such a move, political leaders in Greece and other countries are no doubt considering that

possibility. Although Greece is benefiting from its membership in the Eurozone by receiving

transfers from other Eurozone countries, it is paying a very high price in terms of unemployment

and social unrest. Abandoning the euro now and creating a new drachma would permit a

devaluation and a default that might involve much less economic pain than the current course.”

(Feldstein, 2012)

Feldstein also considers Germany to be at great risk when evaluating the risk posed by

Greece and the potential contagion of Italy and Portugal to follow. According to Feldstein

(2012), “Germany is now prepared to pay to try to keep Greece from leaving the Eurozone

because it fears that a Greek defection could lead to a breakup of the entire monetary union,

eliminating the fixed exchange rate that now benefits German exports and the German economy

more generally. If Greece leaves and devalues, global capital markets might assume that Italy

will consider a similar strategy. The resulting rise in the interest rate on its debt might then drive

Italy to in fact do so. And if Italy reverts to a new lira and devalues it relative to other

currencies, the competitive pressure might force France to leave the Eurozone and devalue a new

franc. At that point, the emu would collapse.” (Feldstein, 2012)

The process of leaving the EZ, as described by Feldstein (2012), may trigger a contiguous

chain of events likely to destabilize the EU and cause a potential bank run on the exited EZ

nation, for instance, Greece.

According to Feldstein (2012), “Even though Germany is prepared to subsidize Greece

and other countries to sustain the euro, Greece and others might nevertheless decide to leave the

26

monetary union if the conditions imposed by Germany are deemed too painful. Here is how that

might work: although Greece cannot create the euros it needs to pay civil servants and make

transfer payments, the Greek government could start creating new drachmas and declare that all

contracts under Greek law, including salaries and shop prices, are payable in that currency;

similarly, all bank deposits and bank loans would be payable in these new drachmas instead of

euros. The value of the new drachma would fall relative to the euro, automatically reducing real

wages and increasing Greek competitiveness without requiring Greece to go through a long and

painful period of high unemployment. Instead, the lower value of the Greek currency would

stimulate exports and a shift from imports to domestic goods and services. This would boost

Greek gdp growth and unemployment.” (Feldstein, 2012)

Political risks remain with regard to the exited EZ nation, for instance Greece, with

regard to the forced exit from the EU considering no provision exists under the Maastricht Treaty

detailing the manner in which a Eurozone member is to discharge from the Union. According to

Feldstein (2012), “Another serious problem for Greece in making the transition to the new

drachma would be the political risk of being forced out of the EU. Since the Maastricht Treaty

provides no way for a member of the Eurozone to leave, there is the risk that the other Eurozone

members would punish Greece by requiring it to leave the EU as well, causing Greece to lose the

benefits that the EU offers of free trade and labor mobility. They might do so to discourage Italy

and others from pursuing a similar exit strategy. But not all EU members would necessarily seek

such a punishment, especially since ten of the 27 EU member countries do not use the euro and

Greece’s situation is clearly more desperate than that of Italy or Spain.” (Feldstein, 2012)

Given the level of Debt/GDP x > 100% which equates to negative net GDP growth for

Greece, the notion of a restructure is intuitive. Additionally, the restructuring will allow Greece

27

to reduce its involvement in the EZ and facilitate a move out. According to Feldstein (2012),

“The primary practical problem with leaving the Eurozone would be that some Greek businesses

and individuals have borrowed in euros from banks outside Greece. Since those loans are not

covered by Greek law, the Greek government cannot change these debt obligations from euros to

new drachmas. The decline in the new drachma relative to the euro would make it much more

expensive for Greek debtors to repay those loans. Widespread bankruptcies of Greek individuals

and businesses could result, with secondary effects on the Greek banks that those individuals and

businesses have borrowed from.” (Feldstein, 2012)

Recent developments from the EZ have indicated a debt write-down of a percentage on

the dollar outstanding as agreed upon by the debt holders seeking restitution. According to

Feldstein, (2012), “But as the experience of Argentina after it ended its link to the dollar in 2002

showed, domestic Greek debtors might end up paying only a fraction of those euro debts. For

Greece, the option to leave the monetary union may therefore be very tempting. Greece’s

departure need not tempt Italy, Spain, or others to leave. For them, the cost of leaving could

exceed that of adjusting their economies while remaining inside the Eurozone. Unlike Greece,

they can avoid insolvency by adjusting their budget and trade deficits without radical changes in

policy.” (Feldstein, 2012)

Within the framework of the argument put forth by Feldstein, Greece’s economic outlook

within the Eurozone is as bleak as the Debt/GDP ratio. The ability to pay back the outstanding

debt in aggregate is impossible and represents the fault of all involved, including the investors, as

the necessary due diligence was not performed to render Greece’s financial instability and the

misrepresentations on the balance sheet. Although the impropriety, initiated by Greece, the

28

investors obligingly accepted the risk of Greek sovereign debt should have foreseen the risk of

default should the global economic conditions unravel a sort of downside tail-risk.

Feldstein (2012) has included a synopsis of the mitigation plans discussed by the German

Chancellor and the Eurozone officials. The three-plan approach, which is essentially a Plan A,

Plan B, and Plan C, implemented to prevent contagion and enable the security and growth of the

EU after the exit of a member EZ nation. According to Feldstein (2012), “Commercial banks

should increase their capital ratios and that the size of the European Financial Stability Facility

(efsf), which had been created in May 2010 to finance government borrowing by Greece and

other Eurozone countries, should be expanded from 400 billion euros to more than a trillion

euros. This latter move was meant to provide insurance guarantees that would allow Italy and

potentially Spain to access capital markets at a reasonable interest rates.” (Feldstein, 2012)

Plan A, mentioned above, seeks to recapitalize the banks. However, this is identical to

the English adage of ‘throwing good money after bad money’. The following paragraph,

according to Feldstein (2012), details why recapitalization did not work. “The plan to increase

the banks’ capital has not worked, because banks do not want to dilute the holdings of their

current shareholders by seeking either private or public capital, and so instead they have been

raising their capital ratios by reducing their lending, particularly to borrowers in other countries,

causing a further slowdown in European economic activity. Nor can the efsf borrow the

additional funds, since such a move is opposed by Germany, the largest potential guarantor of

that debt. Moreover, even a trillion euros would not give the efsf enough funds to provide

effective guarantees to potential buyers of Italian and Spanish debt if those countries might

otherwise appear insolvent.” (Feldstein, 2012)

29

The second strategy (advocated by France) (Feldstein, 2012) and third strategy, according

to Feldstein (2012), are suggested to be quantitative easing by the ECB and a move to a “fiscal

union” (Feldstein, 2012). The following paragraph details Plan B with regard to the Eurozone

exit. According to Feldstein (2012), “The ecb to buy the bonds of Italy, Spain, and other

countries with high debt to keep their interest rates low. The ecb has already been doing this to a

limited extend, but not enough to stop Greek ad Italian rates from reaching unsustainable levels.

Asking the ecb to expand this policy would directly contradict the “no bailout” terms of the

Maastricht Treaty. Germany opposes such a move because of its inflationary potential and the

risk of losses on those bonds. (Two German members of the ecb’s executive board have

resigned over this issue.) (Feldstein, 2012)

The third strategy, according to Feldstein (2012), “is favored by those figures, such as

(German Chancellor Angela) Merkel, who want to use the current crisis to advance the

development of a political union. They call for a fiscal union in which those countries with

budget surpluses would transfer funds each year to the countries running budget deficits and

trade deficits. In exchange for these transfers, the European Commission would have the

authority to review national budgets and force countries to adopt policies that would reduce their

fiscal deficits, increase their growth, and raise their international competitiveness.” (Feldstein,

2012)

Feldstein (2012) also believes the EZ will continue without losing any current member

nations. “Looking ahead, the Eurozone is likely to continue with almost all its current members.

The challenge now will be to change the economic behavior of those countries. Formal

constitutionally mandated balanced-budget rules of the type recently adopted by Germany, Italy,

and Spain would, if actually implemented, put each country’s national debt on a path to a

30

sustainable level. New policies must avoid current account deficits in the future by limiting the

volume of national imports to amounts that can be financed with export earnings and direct

foreign investment. Such measures should make it possible to sustain the euro without future

crises and without the fiscal transfers that are now creating tensions within Europe.” (Feldstein,

2012)

The Editorial Comment (2011) of the Common Market Law Review provides a detailed

synopsis of the process regarding the most logical of the possible debt restructurings. According

to Editorial Comment (2011), “Firstly, concerning the private Greek debt restructuring, the

officially released Euro Summit statement merely states that Greece, private investors and all

parties concerned are invited to develop a voluntary bond exchange with a nominal discount of

50 percent on notional Greek debt held by private investors. There is thus no real banking deal

yet. In the early hours of 27 October, the Euro leaders only reached an agreement on a 50

percent haircut with the Institute of International Finance (IIF), the lobby group representing the

banking sector. The Euro leaders had placed the IIF between a rock and a hard place: if the

banks did not agree to accept a substantial debt restructuring, the political leaders would no

longer remain opposed to a disorderly Greek default.” (Editorial Comment, 2011)

The stipulations regarding a default strategy for the largest debtor, according to the

Editorial Comment (2011) “will only stand if at least 90 percent of the individual banks

voluntarily accept then. It is not certain yet that this will actually happen. Only in this scenario

could the activation of Credit Default Swaps (CDS contracts) be avoided, which would saddle

certain insurance companies with billion dollar claims. In addition, it must also not be

overlooked that the deal only concerns debt restructuring imposed on the private sector. This

represents about half of the total Greek debt. The rest of the debt remains in the public hands.

31

Thanks to this deal, if it ever materializes, and in combination with planned structural reforms of

the economy, Greece could possibly aim for a government debt GDP ratio of 120 percent by

2020, which is still double the maximum amount permitted under the terms of the SGP. Greece

is thus handed a lifeline, nothing else. In any event, austerity will be the order of the day for

many years to come in Greece.” (Editorial Comment, 2011)

The bailout or emergency fund is also critical to the argument put forth by the Editorial

Comment (2011) as the fund is the measure by the Euro-17 to maximize efforts to ensure

protection against contagion. According to the Editorial Comment (2011), “In other words, the

Euro-17 countries did not deposit any further own resources in the fund. Rather, they preferred

to explore two other options to leverage the resources of the EFSF: 1) providing credit

enhancement to new government debt, thereby reducing the funding cost. The option to

purchase this risk insurance would be offered to private investors. 2) Maximizing the funding

arrangements of the EFSF with a combination of resources from private and public financial

institutions and investors from emerging markets such as China or Brazil via the use of Special

Purpose Vehicles. The Euro Summit Statement indicates that the EFSF can use both these

options simultaneously, and that the leverage effect of each option could be up to four or five.

Taking into account that there currently still is some 200–250 billion euros in the coffers from

the EFSF, this could possibly result in a firewall of 1000 billion euros.” (Editorial Comment,

2011)

Since an escape clause is not included in the Maastricht Treaty the recommended course

of action as stated by Editorial Comment (2011) is to amend the Treaty. According to the

Editorial Comment (2011), “For all the commotion about the 50 percent write-off of private

Greek debt and the virtual 1000 billion euro in the EFSF, it cannot conceal the reality that – a

32

number of measures of secondary importance notwithstanding – no concrete decisions have been

taken with regard to the governance structure of the Eurozone. There are essentially two options

available to put this right: either we revise the Treaty, or we stay within the existing Treaty

frameworkxvii

. The former option has the unmistakable advantage that the birth defect of the

Euro can be rectified once and for all, namely the fact that monetary policy became a Union

competence, whereas economic policy essentially remained a national competencexviii

.”

(Editorial Comment, 2011)

The procedure with regard to Treaty change, described by the Editorial Comment (2011)

as a viable opportunity for sovereign government to obtain greater control over EU affairs as

negotiated and thereby amended in the Treatise. According to the Editorial Comment (2011),

“The procedure may prove to be a cumbersome once again: the UK, for instance may very well

seize the opportunity to renegotiate the British terms of EU membership and try to bring certain

competencies back home. All this means that the latter option, of trying to find a workable

solution on the basis of the existing Treaty framework, is the more likely one. Articles 121 and

126 TFEU provide little room for manoeuvre in this respect. The residual Article 352 TFEU

might also be considered, but Article 352 TFEU requires unanimity in the Council: and besides,

the EU Court of Justice has limited use of the Article 352 TFEU in practice.xix

. This arguably

leaves Article 136 TFEU as the best option for the Euro Member States to introduce any changes

to the Euro governance structure. But everything will hinge upon the willingness of the

European institutions to accommodate eventual changes under Article 136 TFEU.” (Editorial

Comment, 2011)

The next literature in review is “The European Debt Crisis and European Union Law”

Ruffert (2011). The Ruffert work is of particular importance as there is detailed reference to the

33

policy amendments necessary for the ESM to ensure the sanctity of the euro and retain each

member state. According to Ruffert (2011), “The Treaty amendment should be ratified as

quickly as possible to ensure that the new paragraph enters into force on 1 January 2013 already.

The ESM will follow the EFSF in June 2013; the EFSM will not be continued after that date.

The ESM is established according to the model of the IMF with an effective lending capacity of

500 billion euros (subject to renewal) to be used for financial assistance “on the basis of strict

policy conditionality under a macro-economic adjustment programme and a rigorous analysis of

public-debt sustainability.” It will be an institution of the Member States of the euro area that

gives other Member States the opportunity to participate “on an ad hoc basis.xx

” As a matter of

fact, the new ESM will be created by a Treaty between the euro area Member States “As a matter

of fact, the new ESM will be created by a Treaty between the euro area Member States “as an

intergovernmental organization under public international law” located in Luxembourg. Hence,

we are going to be faced with a public international legal SPV or a European mirror image of the

IMF – according to the perspective one takes. Member States joining the euro area will

automatically become a member of the ESM.” (Ruffert, 2011)

Ruffert (2011) describes the reorganization as the following. “The international

organization will be governed by the Ministers of Finance of the euro area. Member States

forming its Board of Governors – the Commissioner for Economic and Monetary Affairs and the

President of the ECB holding observer status. The Board will elect a “Chairperson” and decide

by qualified majority according to the Member States respective capital subscriptions (80%

being defined as the qualified majority) or by mutual agreement (unanimity without abstentions

preventing adoption) in the most important cases: the granting of financial assistance (including

terms and conditions), the fixing of the ESM lending capacity and changes in the menu of

34

instruments. Internal disputes are to be settled by the Board of Governors, subject to submission

to the ECJ under Article 273 TFEU.” (Ruffert, 2011)

Additionally, Ruffert (2011) details the capital structure of the ESM (Ruffert, 2011) such

that the debt rating is to be at or near AAA. According to Ruffert (2011), “The total capital will

amount to 700 billion euros, thus a substantial augmentation of the current capital of the EFSF

(440 billion). What is more, the ESM will be provided with a paid-in capital of 80 billion phased

in by the Member States in five equal annual instalments from 2013 to 2017 following the paid-

in capital key of the ECB (e.g. France: 20.3859%, Spain: 11.9037%, Germany: 27.1464%). The

contribution key is also relevant for qualified majority voting. To implement Article 136 TFEU

(after the envisaged amendment), the ESM can intervene by loans subject to strict conditionality

under a macro-economic adjustment programme.” (Ruffert, 2011)

The safety net provided by ESM, deemed as “stability support” (Ruffert, 2011), is

intended to prevent the need to enact Plan B which is quantitative easing. According to Ruffert

(2011), “The purchase of bonds of the Member State that is in severe financing problems. In this

cases, the ESM takes over what was initially implemented with the ECB’s security markets

programme and later transferred to the EFSF. It is important to note that the operation of the

ESM will include private sector involvement. If it is concluded, after a debt sustainability

analysis in line with IMF practice, “that a macro-economic adjustment programme can

realistically restore the public debt to a sustainable path,” the main private creditors are to be

encouraged to maintain their exposures. If this is denied, negotiations between the Member State

concerned and the private creditors must be initiated following a plan to be included in the

macro-economic programme and led by the principles of proportionality, transparency, fairness

and cross-border co-ordination (to avoid the risk of contagion). Finally, the emergency clause of

35

Article 122 TFEU deserves scrutinizing. This rule provides an exception allowing bailout

activity of the EU via financial assistance, “where a Member State is in difficulties or is seriously

threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond

its control …” (Ruffert, 2011)

Ruffert (2011) does outline a plan that is rather intuitive to any economist, central

planner, or strategic planner open to amending and reinterpreting the Maastricht Treaty to

facilitate the voluntary removal of a member nation in a manner that is beneficial to the survival

of the Euro and in a manner in which contagion is preventable. The prospect of appeasing

private creditors via the macroeconomic programme and facilitating bailout funding to the public

holders of the sovereign debt in a binary attempt to satisfy all claimants perhaps is the most

viable solution to enable the return the flow of the principle capital investment to primary

investors of the sovereign debt. Article 122 TFEU is the cause that does enable the use of public

debt within a pooled aggregate fund for emergency debt refinancing and debt maintenance of any

member state threatened with removal from the EZ due to financial hardship.

Discussion

To facilitate the exit of any sovereign member of the Eurozone, a number of questions,

present as bulleted points below, to evaluate the risk to contagion as well as establish a macro

view of the interrelated connections and to estimate probabilities for any particular event to occur

that will create excessive risk to the money and banking system. The questions asked, listed

below, are answered in the pages that follow.

The Optimum Monetary Reconfiguration

Implications for Sovereign Debt, Private Savings, and Domestic Mortgages

36

The Effects on the Stability of the Banking System

Approaches to Transition

The Institutions Implications

The optimum monetary configuration of any member nation seeking to leave the

Eurozone refers to the optimum configuration with regard to the return to the legacy currency.

The optimum configuration is indeed oxymoronic as optimum given the fiscal disorder of the

house in consideration is far from ‘optimum’ to which the currency valuation will be far

removed from the value of exchange enjoyed under the euro. However, the restructuring of debt

in euros held inside and outside of the Eurozone will provide the opportunity necessary for the

default economy and establish a viable global macroeconomic position to which future GDP

growth can facilitate the repayment of debt obligations as well as support the notion of returning

to the Eurozone as an active participant.

The optimum configuration is indeed an estimation of the legacy valuation given the

exposure to debt after the debt restructuring in euros, to which the haircut will reveal anywhere

from ½ to ¾ or more reduction in outstanding debt obligations. Such a reduction will not over

burden the drachma once reinstated, however, the question of interest rates, which is a function

of coupon payments and the yield-to-maturity- YTM on new debt issues is a function of interest

rate theory.

The market for sovereign bonds especially in the times of the ‘new normal’, that is, the

elevated rise in unemployment within the Eurozone to essentially give rise to a situation where

Germany is driving the prowess of the economic union. To which, Germany chancellors and

leaders were skeptical of joining the euro for reasons related to economic support of member

37

nations as a function in the valuation of not only the underlying exchange currency, but the

structure regarding the interest rate and relative risk in downside volatility of the bonds issued

and outstanding.

The problem with issuing new debt to the exited EZ nation with repayment in the legacy

currency is the interest rate cannot be too high as to overburden the debt maintenance process

whilst facilitating the necessary payments to repay the principle. Therefore, the optimal

monetary amount cannot be optimal as the valuation of debt and currency will not be a direct

reflection of the underlying economic situation faced by the exited nation and its legacy

currency. The reality of the situation is to understand the calculation to obtain the optimal

interest rate on the long-term debt issues, pegged to the legacy currency, will yield a junk bond

rating to which the optimal interest rate will yield two different interpretations.

The first interpretation is one with which the optimal minima favored by the issuing

government and the second interpretation is one with which the optimal maxima is favored by

the investor seeking return relative to risk. Therefore, comparatively speaking using the two

economy model of low debt rating risk exposure (U.S, Greece), if the optimal minima on new

Greek debt issues (drachma), whilst still retaining the junk bond status is arbitrarily 6.5% with

the 1 year LIBOR at 1.10%xxi

which is a linear climb from under 1.00% one year ago, and if the

U.S. 30 year fixed mortgage mean (3.87%xxii

) is above core inflation, then the US central bank

policy of enabling easy money and liquidity into the market, which does function to keep

nominal interest rates at or near zero percent does facilitate the notion of earning 6.5% on what

ostensibly is to be considered junk status bonds with very high risk of default. Upside volatility

measured as tail-risk exposure in this case, expected to be a function of payment of interest via

38

two variables to include interest payment as determined by the underlying structure of the debt

instrument as well as repayment of principle in full.

The currency valuation is a function of relative notes outstanding in the market,

determined by calculating velocity exchange moving averages over a 6-month period. Often,

economists miscalculate the real rate of inflation due to not calculating the velocity exchange, a

function of the receipts from consumer basket goods purchases. Simply stated, should the six

month average of consumer basket goods purchases decrease, there is a decrease or a shift to the

left in real spending and therefore in economic velocity exchange. Should the economy indeed

prove to be in an expansionary business cycle growth phase, as measured as a quarter over

quarter growth in GDP, the expected result is net savings in the domestic economy. Even with

interest rates low, the outcome suggests a measure of inflation control to which the currency

value will appreciate, increasing the real return on the real interest rate due to the increase in the

real interest rate from the nominal interest rate.

The optimal currency valuation is hence, considered a market determinant to which the

initial calculation will only function as a rough estimate to which potential arbitrage

opportunities may exist prior to the market adjustment of the currency valuation. However, such

a situation provides a hedge for investors of the new debt issues as the underlying risk to interest

rates may utilize a hedging strategy in the currency swaps market or simply by taking positions

(straddles, etc.) in the currency options market. The notion of risk management and volatility

measure for parameter control is critical to ensuring that investors are protected using divergent

binary strategies that enable the removal of initial exposure to the risk of holding the new debt.

39

As each debt issue approaches its time constraint, which is the asymptote on the yield

curve, or the equivalent to the date of maturity, and if considering the underlying economics of

the domestic economy of the debtor nation does improve as a function of the increase in GDP,

then an investor holding the legacy debt issues may relinquish any currency hedge position or

allow any call option to expire, which is applicable should the investor hold call options for

protection against exposure to the downside risk on the bonds. The currency hedge is to protect

against downside risk exposure, expected to be subject to reduction, as the interpretation of the

improving underlying economy should infer an increase in the probability of principle

repayment.

To determine the ‘optimal’ monetary reconfiguration, one must consider the relative risk

of the debt outstanding as the determinant of the currency conversion rate necessary to convert

outstanding legacy debt valued in euro’s relative to the underlying legacy currency of the

creditor bank. Therefore, if Greece has 500 billion euros in debt held by France, the drachma

must be valued as a function of the franc relative to the underlying debt exposure after the debt

restructuring. Greece’s aggregate debt outstanding is to be tabulated and dissected into tranches,

which reflect the percentage owed to nation, represented by each underlying legacy currency.

The conversion rate used is a function of the underlying debt enumerated as a weighted bond

value that discounted further by 50% to reflect the haircut of the debt restructuring. As German

debt, considered as the most secure within the EZ, the valuation curve is a function of German as

risk-free or 100%.

Additionally, the conversion rate, Ceteris Paribus, must reflect the debt restructuring.

Therefore, a 50% haircut will result in halving of the conversion rate. Additionally, the as the

Greek Debt/GDP is over 100%, the currency will be discounted by 25%, which is essentially a

40

devaluation of the currency as if artificially inflated. The conversion table that depicts the

optimum monetary configuration is available in Appendix II.

The exit of any sovereign nation and approaches to the transition process from the

Eurozone has tricky implications to the current and future sovereign debt rating(s), investor

confidence in outstanding debt, and in the marketability of future debt issues. A Greek exit from

the Eurozone will enable investors to price in the maximum exposure to risk of Greece as well as

price out any risk from the Greek economy with regard to new sovereign debt issues from any

sovereign Eurozone member and from the ECB. Although highly unlikely due to vehement

opposition from the ECJ magistrate, parliamentary leaders, minister of finance, and the

interpretation of the Maastricht Treaty, if Germany were to leave the Eurozone, the implication

to sovereign debt is considerable. The exit is considerable as downside volatility as measured by

movement in the euro currency basket to which the real to nominal value of the debt undergoes a

divergent movement path. Additionally, downside risk is such that all outstanding debt must

now yield at least an acceptable rate of interest from sovereign debt as the investor seeks expects

higher return relative to higher risk on all outstanding debt issued from sovereign nations of the

EZ, including on all future issues, and of all current and future issues from the ECB.

Private savings the stability of the banking system are always in jeopardy as a function of

a bank run in the most afflicted (debt ridden) EZ member nations, if default is expected and

should legacy currency measures advance. The role and ability of the ESM here is critical. The

ESM may function as a parallel to the Federal Deposit Insurance Corporation of the U.S., such

that the ESM may guarantee the bank deposits of up to 10 times the amount of the median

national poverty income level. This ratio is akin to the U.S. ratio of FDIC protection of

$100,000 with a median national poverty income level of approximately $10,000. The

41

protection of bank deposits will prevent a devaluation of the currency by flooding the market

with euros, which also will destabilize the Greek banking sector, which seeks to precipitate a

banking contagion where economies in danger of default also experience a bank run.

Domestic mortgages as paid and valued in euros must be restructured and marked-to-

market under the new legacy currency. Therefore, a mortgage contract agreed and signed upon

under the original EZ terms with the underlying collateral market value in euros must be

discounted as function of 100% maximum housing value as a determinant of the valuation of the

drachma. Interest rates associated with the restructured and refinanced mortgages must be

supported with the equivalent of Mortgage Backed Securities issued by the ECB and backed by

the ESM. The restructured mortgage and the MBS are integrated for tranche risk measure and

return valuation, and sold to investors, which the underlying mortgage risk supporting the Greek

collateral obligation are mitigated with the relative interest payment and stability of the

ECB/ESM issued MBS.

If the mortgage owner does hold a mortgage in another EZ country, France for example,

and is subject to personal savings restructuring to the legacy currency, the negotiating bank must

then accept an agreement from the ESM that facilitates payment in euros. The ESM payment is

expected to cover the difference between debt owed on the mortgage in euros and the debt in the

legacy currency once the legacy currency goes into effect. For example, if the mortgage,

including interest, is valued at 700,000 euros, and if parity value for housing in the Greek market

equates a house valued at 700,000 euros (weighted 100%) to be 300,000 drachma (weighted

100%), then the difference in value will be paid by the ESM to ensure integrity in the banking

and housing market.

42

Implications to international contracts held by any nation subject to removal from the EZ

(Greece, Portugal, etc.) and priced in euros represent a divergent exposure to risk. The stability

of the euro relative to other currency baskets and as a measure of value will undermine the

integrity of the existing contract such that the legacy currency will effectively force a revaluation

and ostensibly a renegotiation of the underlying asset and collateral value as enforced by the

contract. To protect the stability of the banking system, each at-risk international contract must

be parlayed by hedging with currency swaps and credit default swaps.

There is not a direct way to ensure the safety of international contracts denominated in

euros unless the euros exchanged into Eurodollars and held in a Eurobank, to which downside

volatility of risk exposure to the euro is removed and placed essentially on the USD. The USD is

a liquid currency to which the underlying debt issued as a function of the USD purchasable by

the ECB and other central banks. The value of the international contracts expressed as euros are

exchangeable for Eurodollars, effectively removing the exposure to the euro and allowing the

contract to be revalued as a function of the legacy currency against the USD. Although these

measures ultimately are subject to negotiation and agreement, this method effectively mitigates

the exposure of a euro to legacy by switching to the Eurodollar/USD to legacy valuation.

If managed properly, effectively, and with an eye toward the prevention of contagion, the

exit of any EZ member nation and the net effect on the banking system will be a function of

variance in volatility. If a member with a copious debt outstanding does choose to exit the euro,

necessary measures are to protect the value of the euro as well as the outstanding debt that is

valued in euros. Eurodollars as well as currency swaps, credit default swaps, and the ESM

issued MBS will collectively enable a plan of protection that will protect the underlying asset

value of euro denominated assets held in the banking system as well as the value of the euro. As

43

USD is entered into the market, the debt issued should be purchased by Greece, as quantitative

easing to which the drachma is purchased by the ECB to release debt priced in euros and sold to

investors seeking a return in euros and willing to accept underlying exposure to, in this case, the

drachma.

The aforementioned strategy seeks to protect the underlying asset and currency within the

banking system via a multi-tiered, staggered and integrated release of quantitative easing using

the US dollar, the Japanese Yen, the German Deutsche Mark, the Great Britain Pound, and the

Euro (ECB). The release of each aforementioned currency into the economy and subsequent

removal from the economy performed using a round robin system of quantitative easing as a

function of controlling the supply of the legacy currency and protecting the inflationary pressure

and interest rate risk associated with new debt releases.

Approaches to Transition & Institutional Implications

The transition process includes the move from the euro to the legacy currency, as well as

the exit of the legacy nation from the Eurozone, and the transition from a quasi-independent

political entity to a completely independent political and economic entity. The legacy nation

must plan and control its own budget as a function of a ‘long-term’ strategic plan established to

set the legacy economy on track to rejoin the euro over x time. A strategic plan, strategic budget,

and capital investment must all be present to guide the transition prior to the exit. Indeed, if

employment rises in the weeks before the exit, the impact on the banking system, readily

mitigated, is better able to absorb volatility. Details on page 35 detail the broader mitigation

plan.

44

The investment into the legacy economy is a direct injection loan system from the ESM

to Greek banks that then lend in drachmas, the capital amount to private manufacturing for

capital necessary to create jobs and grow GDP. The lower the cost of production, the more

competitive price of the good and greater the contribution toward reinvestment into the domestic

economy and into savings. Process control and performance improvement as a function of the

reduction in process variance and increase in quality per unit are catalysts toward achieving a

lower cost of production.

The second strategy, or Plan B, referenced by Feldstein (2012) is a controlled quantitative

easing plan and is similar to the proposal in this paper except that instead of the ECB acting as

sole enabler of the EZ debt, the ESM will have a more active role in mitigating risk and

introducing capital into the market as necessary. The buttressing of the ESM on the issuance of

debt by the ECB will allow emergency fund capital to work actively in favor of the ECB by

replacing the capital entered into the market as liquidity.

The institutional implications are subject to the Maastricht Treaty and the legal

parameters governing the sphere of influence outlined within the Treaty. Institutions with

financial and political implications include the following. The IMF, the ECJ, the JHA (Nugent,

pg. 368-9, 2006), the European Council (EC) (Nugent, pg. 371, 2012), the European Regional

Development Fund (ERDF) (et al), the European Social Fund (ESF) (et al), the European

Agricultural Guidance and Guarantee Fund (EAGGF) (et al), the Financial Instrument for

Fisheries Guidance (FIFG) (et al), and the Cohesion Fund (CF) (et al). The IMF lending activity

may be in violation of its Maastricht Treaty powers to which the EFSF has mimicked powers as

a function of Article 122 TFEU (Ruffert, 2011).

45

Appendix I

27-n member

euro zone

United States

Germany

Japan

England

46

Appendix II

Foreign 0.25% Conversion EuroOct, 10 yr

Amount Reduction Rate Amountbond yields, low is good

AustriaAustria

SchillingATS

Divided

by2.5418 = 1 EUR

2.92

BelgiumBelgian

FrancBEF

Divided

by4.805 = 1 EUR

4.2

GermanyDeutsche

MarkDEM

Divided

by0.977915 = 1 EUR

2

SpainSpanish

PesetaESP 125.30125

Divided

by100.241 = 1 EUR

5.26

FinlandFinnish

MarkkaFIM

Divided

by2.972865 = 1 EUR

2.51

FranceFrench

FrancFRF 4.0997313

Divided

by3.279785 = 1 EUR

2.99

GreeceGreek

DrachmaGRD 1210.1688

Divided

by968.135 = 1 EUR

18.04

IrelandIrish

PoundIEP 103.99125

Divided

by83.193 = 1 EUR

8.1

Italy Italian Lira ITL 212.96875Divided

by170.375 = 1 EUR

5.97

LuxemburgLuxembou

rg FrancLUF

Divided

by2.817 = 1 EUR

2.37

The

Netherlands

Dutch

GuilderNLG

Divided

by2.20371 = 1 EUR

2.46

PortugalPortuguese

EscudoPTE 327.81188

Divided

by262.2495 = 1 EUR

11.72

Country Currency x / 2

Original Source: http://uwo.ca/finance/travel/docs/euroconv.html

Original Source for the bond yields: http://www.guardian.co.uk/news/datablog/2011/nov/07/euro-

debt-crisis-data#data

The data in the table above has been modified from its original format to reflect a more approximate

and realistic analysis of the underlying legacy value

47

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i On private sector involvement see Conclusions of the European Council, cited supra note 3 1 , Annex

II, pp. 29 et seq. - with quotations in the text -, and Preamble no. (9) of the ESM Draft Treaty. ii But see the warning facts reported by Snyder, "EMU-integration and differentiation: Metaphor for

European Union", in Craig and De Burea (Eds.), The Evolution of EU Law, 2nd ed. (OUP, 2011), p.

713. iii Lenaerts and Van Nuffel, European Union Law, 3rd ed. (20 11), para 1 1 -037; Schorkopf,

"Gestaltung mit Recht", 136 AÖR (2011), 339; Hentschelmann, "Finanzhilfen im Lichte der No Bailout-Klausel - Eigenverantwortung und Solidarität in der Währungsunion", (20 11) EuR, 289 et seq. Cf. also Kube and Reimer, "Grenzen des Europäischen Stabilisierungsmechanismus", (2010) NJW, 1913, who argue that the EFSF was an illicit circumvention of the prohibition. iv On private sector involvement see Conclusions of the European Council, cited supra note 3 1 , Annex

II, pp. 29 et seq. - with quotations in the text -, and Preamble no. (9) of the ESM Draft Treaty. v Cf. Louis, op. cit. supra note 5, 977, who rightly says that this is the "'budgetary code' of the Union";

Hahn and Häde, Währungsrecht (2010), para 27/19 et seq.; Häde, "Die europäische Währungsunion in der internationalen Finanzkrise -An den Grenzen europäischer Solidarität?", (2010) EuR, 855 et seq.; Frenz and Ehlenz, "Der Euro ist gefährdet: Hilfsmöglichkeiten bei drohendem Staatsbankrott",

48

(2010) Europäisches Wirtschafts- und Steuerrecht, 61 et seq. Some authors, however, wisely predicted that the EMU contained, from its outset, a de facto obligation to rescue defaulting partners (Herdegen, "Price stability and budgetary restraints in the Economic and Monetary Union: The law as guardian of economic wisdom", 35 CML Rev. (1998), 22, and similarly Amtenbrink and De Haan, "Economic governance in the European Union: Fiscal policy discipline versus flexibility", 46 CML Rev.

(2003), 1093). This, of course, does not create a legal obligation or even power. vi This was the core argument of the German Federal Government in the proceedings before the

Bundesverfassungsgericht, developed by its representative: Häde, "Rechtsfragender EU-Rettungsschirme", (2011) Zeitschrift für Gesetzgebung, 6 et seq., id., in Calliess and Ruffert, op. cit. supra note 72, Art. 125 AEUY para 8. vii

Cf. Faßbender, "Der europäische 'Stabilisierungsmechanismus' im Lichte von Unionsrecht und

deutschem Verfassungsrecht", (2010) Neue Zeitschrift für Verwaltungsrecht, 801. viii

This is rightly rejected by Schröder, "Die Griechenlandhilfen im Falle ihrer Unionsrechtswidrigkeit",

(201 1) DÖV, 63 et seq. ix Withregardto the ECB' s competences cf. Seidel, "Editorial", (2010) EuZW, 521, and - with less

rigidity - Müller-Graff, "Die europäische Wirtschafts- und Währungsunion: Rechtliche Rahmendaten für

Reformen", in Bechtold, Jickeli and Rohe (Eds.), Recht, Ordnung und Wettbewerb, Festschrift zum 70. Geburtstag von Wernhard Möschel (2011), ? . 890. Häde, op. cit. supra note 44, 20 et seq., takes a different view, and so does obviously Louis, op. cit. supra note 5, 975. x This could trigger off an indirect control by this Court in the future.

xi "We violated all the rules because we wanted to close ranks and really rescue the euro -zone."

quoted from: <www.reuters.com/article/20 10/12/1 8/us-france-lagardeidUSTRE6BH0V020101218>

(last visited 4 Oct. 201 1). xii

Cf. <ec .europa.eu/economy_f inance/articles/eu_economic_situation/2 010-05-03statement-

commissioner-rehn-imf-on-greece_en.htm> (last visited 4 Oct. 2011). The original Communication is no longer online (!). xiii

Similarly Calliess, "Perspektiven des Euro zwischen Solidarität und Recht - Eine rechtliche Analyse

der Griechenlandhilfe und des Retlungsschirms", (2011) Zeitschrift für Europarechtliche Stuthen, 278. xiv

See for the latest case in the line Opinion 1/09 of 8 March 201 1 (Patents Court). xv

The quotation in English is drawn from the press release. There is a following decision on the

implementation in Germany which temporarily stops the operation of a particular parliamentary committee: decision of 27 Oct. 201 1, 2 BvE 8/11. xvi

Cf. Streinz, Ohler and Herrmann, Der Iter trag von Lissabon zur Reform der EU, 3 rd ed. (2010), p.

86, who talk about some "fine-tuning". Cf. also Stotz, "Neuerungen im Bereich der Wirtschafts- und Währungsunion", in Schwarze (Ed.), Der Verfassungsentwurf des Europäischen Konvents (Nomos, 2004), pp. 225 et seq. xvii

See also Piris, “Divide Europe, save the Union”, The FinancialTimes, 4 Nov. 2011; Van den Bogaert, Ich bin ein ¤uropäer – Een uitweg uit de monetaire crisis? (inaugural lecture, Leiden University, 2010), available at media.leidenuniv.nl/legacy/oratie-van-den-bogaert.pdf xviii

Louis, “The Economic and Monetary Union: Law and institutions”, 41 CML Rev. (2004), 1075; Smits, “Het Stabiliteits- en Groeipact Nagekeken”, 58 SEW (2004), 53. xix

Case C-295/90, Parliament v. Council [1992] ECR I-4193; Opinion 2/94, Accession of the Community to the European Human Rights Convention [1996] ECR I-1759 xx

The Draft was not published before the beginning of July 2011 (<consilium.europa.eu/media/1216793/esm%20Treaty%20en.pdf> (last visited 4 Oct. 2011)). The outline (“term sheet”) of the ESM is designed in the Conclusions of the European Council of 24/25 March 2011, Doc. EUCO 10/1/11 REV 1. Quotations are from the term shee xxi

http://www.bankrate.com/rates/interest-rates/libor.aspx xxii

http://www.bankrate.com/rates/interst-rates/libor.aspx