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Four illegal ways to sort out the Euro finance crisis

And one of them is about to be used

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German mum could sign off on the southern kids' credit cards

Then we've the two methods of dealing with the immediate problems. Rather than looking at the long-term reasons about how this all happened – how did the periphery get so screwed, etc – look instead at what we're going to do about the mountain of debt and imminent bankruptcy right now.

The first is to simply create the Mother of all CDOs. A CDO, you will recall, is the piling up of loans into one great big bond, whacking a guarantee on it, and then flogging it off. It caused a few problems when American mortgages were treated this way, you might remember. However, we could take some or all of the Greek, Portuguese etc debt, stick it all together in one girt big bond, whack an EU guarantee on it (the real guarantee would be Germany) and then sell it off. The interest that Greece etc would have to pay would fall in just the same way that if your parents signed for your 16-year-old self's credit card, you would get a better interest rate, and if they have to pay less interest then they're not quite bust.

This is attractive as a solution, as long as Germany doesn't then become AIG Financial Products and go titsup itself, but it's also illegal the way everything is set up at the moment.

The final way would certainly work. Currently, you can buy, say, Greek bonds at 50 to 70 per cent off. So, why doesn't the European Central Bank do this? Or the EFSF (the special fund set up to try and deal with these matters)? They could buy the debt at this discount, cancel the bit that is the discount and hey presto, Greece's debt burden falls by 50 to 70 per cent. They're saved! The people who lose money here are the banks selling that debt at a discount and they don't care because they know they've already lost that money: that's why they're selling it at that discount.

Yes, you've guessed it, this too is illegal. The ECB etc can only buy new Greek debt. They're not allowed to go into the secondary market, they can only buy in the primary.

So, the four major ways we could solve this are all illegal. Not that that really worries the EU, rules and laws are for the little people. Which is why in the announcement today we get this:

  • 7. To improve the effectiveness of the EFSF and address contagion, we agree to increase the flexibility of the EFSF, allowing it to:
  • intervene on the basis of a precautionary programme, with adequate conditionality;
  • finance recapitalisation of financial institutions through loans to governments including in non-programme countries;
  • intervene in the secondary markets on the basis of an ECB analysis recognising the existence of exceptional circumstances and a unanimous decision of the EFSF Member States.

Let's change the rules so we can opt for solution 4.

It's not actually a bad solution, and if it had been done six months ago would almost certainly have worked. But will it work now? Phone your local sovereign bond trading desk and ask them.

The rest of the draft agreement that has been leaked is an attempt to make sure that nothing like this ever happens again. Might work, might not: for they've still not solved the basic underlying problem. The eurozone just isn't (and is unlikely to be for many decades to come) an optimal currency area and thus, if we look at economic reasoning rather than political, just shouldn't be trying to have a single currency. ®

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