06/13/2012 01:27 pm ET Updated Aug 13, 2012

Europe's States, Rich and Poor, Must Share Their Debts

BRUSSELS -- The cumulative efforts of the European Union, European Central Bank, and private lenders over the last two years in endeavoring to get on top of the eurozone's sovereign-debt crisis already amount to over one trillion euros, yet we are still no nearer solving the crisis than in December 2009, when Greece's dire straits first became apparent.

It is high time to examine structural solutions and help eurozone countries honor their debts rather than continue to lend them money at higher and higher rates of interest.

Greece, for one, simply cannot dig its way out of debt on its own. Even the most recently negotiated debt-reduction strategy, a condition for the 130-billion euro bailout, is only aimed at reducing Greece's debt to 120.5 percent of GDP by 2020. Some analysts suggest this effort could easily be derailed by an economic shock or prolonged recession -- or, of course, by a Greek exit or ejection from the eurozone.

If it is accepted that Greece should remain part of the eurozone -- because the alternative of a return to the drachma would be ten times worse (a view I share) -- then heads of government in the eurozone must accept the inevitable logic that in a single currency area there is a common economic strategy, a single system of governance and a common bond market.

These are the kinds of moves that Germany, in particular, has been stoutly resisting. And with every bailout, public opinion in northern Europe hardens and provides ammunition for anti-European parties. The recently-agreed Fiscal Compact Treaty, negotiated at the behest of German chancellor Angela Merkel, commits its 25 signatories to greater budgetary discipline in the future, but it will do nothing to bring down current debt levels nor assist growth prospects.

But Germany and other paymaster countries are ignoring a cheaper and more effective solution to ever increasing demands for tax-payer funded bailouts: a system of eurobonds where the bondholders themselves bear the risks (and the costs) instead of the taxpayers. Mutualizing part of sovereign debt would enable payments to be made at a more sustainable (reasonable) rate than is available on the market to countries in trouble and facing potential further downgrades by credit rating agencies, which only prolong their recovery.

A recent study by Natixis investment bank has shown that a system of Eurobonds could produce savings on the order of 13.4 billion euros per year for the eurozone as a whole. The main beneficiaries would be the countries currently paying the highest interest on their government borrowing. But even Germany would pay less. It could be based on an insurance-style model with a "no-claims bonus," whereby states that are good performers and do not need to make claims for insurance pay lower rates than poor performers. This would address the dilemma of moral hazard, ensuring that states would pay a real price for fiscal profligacy.

If a thoroughgoing system of eurobonds is only possible in the longer term, once all the elements of a common European fiscal policy are in place, then a more immediate solution is required to start making inroads on the debt mountain. A proposal from the German government's own Council of Economic Experts for a European Redemption Pact offers the most immediate solution. In it, 2.3 trillion euros would be available for the mutualization of national debt exceeding 60 percent of GDP for those countries not part of a bailout program. It would be a temporary facility (until debts have been brought back down to sustainable levels), thus meeting the concerns of the German constitutional court and the letter of the EU treaties, and it would marry the necessary discipline (repaying debts) with solidarity (sharing low interest rates). This would also act as a substantial firewall for the likes of Italy or Spain, for whom the current and permanent bailout funds combined (the European Financial Stability Facility and the European Stability Mechanism, with some 750 billion euros between them) would still be insufficient. Italy, for instance, owes just under two trillion euros and Spain some 700 billion euros.

Without such a debt redemption fund or similar system, which rewards the good performers while penalizing the bad, we will continue to have recourse to the ECB injecting hundreds of billions of euros into the banking system every two or three months and appeals to international financial institutions or foreign investors for further handouts. And the hope of an end to the debt crisis will remain an elusive dream.