It would be possible for the ECB to underwrite all the existing and future debt of the Eurozone sovereigns, without moral hazard, but Greece should leave, says Piere Lagrange, manager of GLG’s European Long Short Fund…

The underwriting MUST be conditional on the country achieving budget deficit and debt targets, within a time horizon of (say) five years. In fact, periods could be framed for each country in accordance with its ability to meet targets; a bit like a debt rescheduling process, based on what people can realistically repay. Lessons from war damage payment and Weimar: give targets which are tight enough to limit moral hazard, but realistic enough that they can be achieved. 

Additionally, the ECB could consider guaranteeing new short-term debt issued by the sovereigns unconditionally, with the existing debt remaining conditional upon meeting the deficit criteria. Sovereigns should be asked to pay for the guarantee through (e.g.) a 50 basis points per annum fee. This would create an arms-length transaction, and would be much affordable than the amounts that the sovereigns will continue to pay if we persist in ploughing the current furrow! This inspiration comes from the astute thinking which saw Italian banks pay 80 basis points for sovereign guarantee earlier this year.

If the ECB, backed by the governments, announces something similar to the proposals outlined above, I believe the markets will massively correct the current negative stance. Investors will price in what they perceive to be the probability of countries achieving their debt and deficit targets within the five-year protection period provided by the ECB.

This system should be applied to those countries that have strong prospects of returning to solvency, given the time. Greece has probably gone too far, and is unlikely to qualify, so here is another thought; instead of providing futile support to keep Greece inside the Euro, we should keep that money to help them outside the euro, with a flight path to potentially regain access in five years.  A Marshall (Merkel) plan for Greece? While I have total sympathy for trying to preserve the European construction and limit the humanitarian disaster unfolding within it, I have yet to see anyone making a realistic case as to how Greece can possibly remain within the Eurozone, without the moral hazard of writing off their whole debt.