Government debt must be restructured. Bank debts have to be converted into equity and, where banks are insolvent, written off.

The idea of exempting banks secured debt from the pecking order for repayment is extremely problematic as well.

So, if internal devaluation is to work, the value of debts, where they already represent a heavy burden, must be reduced. Government debt must be restructured.

Money market funds from the United States are returning, albeit cautiously, to resume funding of European bank debt.

To protect commercial banks from risking their own solvency (and the whole country s solvency besides) once again, Richard Robb suggested that a small tax on banks short term debts be imposed in order to deter banks from over borrowing.

Governments that guarantee bank liabilities, however, must then also demand that bankers exercise more prudence than they might on their own.

Given their large, battered holdings of peripheral eurozone countries sovereign debt, many of Europe s thinly capitalized banks would be insolvent if their assets were marked to market.

Banks have less debt relative to their equity levels than they had in 2007.

Following that, the restructured bank can be recapitalized by raising new debt and equity.

The most obvious means of recapitalizing China s banks would be to inject renminbi denominated government debt into the banking sector.

Initially a financial crisis, it morphed into a classic public debt crisis after governments stepped in to guarantee banks obligations.

And a stronger economy would help domestic banks by reducing potential bad debt and mortgage defaults.

But it does this by giving the banks newly conjured government IOUs not euros in return for dodgy debt.

But, as local government debt grows, Chinese banks have begun to regard real estate and local financing platforms as a major credit risk.

Should one of these banks run into trouble because of a sovereign debt default, the necessary rescue funds will be readily available.

In 2012, American prime money market funds, which buy bank and corporate debt, were worth nearly 1.5 trillion.

Bank bonds could also be reduced and converted into equity, which would both avert a government takeover of banks and prevent socialization of bank losses from causing a sovereign debt crisis.

French President Nicolas Sarkozy and France s central bank (a member of the ECB) were less timid they urged Italian and Spanish banks to buy their governments debt.

Be it because of a sovereign default or because of large losses accumulated under complacent accounting rules, the insolvency of a large bank (particularly a European bank) is far from a remote possibility.

And, as debt burdens become heavier, public spending must be cut further and taxes increased to service the government s debt and that of its wards, like the banks.

If financial markets view them as likely to follow through, the too big to fail boost may apply more to the big bank s short term debt than to any banks long term debt.

Eternal Debts

Debt write downs and guarantees will inevitably bloat Germany s government debt, as the authorities are forced to bail out German banks (and probably some neighboring countries banks).

Similarly, in guaranteeing the debt of Irish banks in September 2008, the Irish government did something that no responsible government should have contemplated.

Debt Without Drowning

CAMBRIDGE Now that the European Union and the International Monetary Fund have committed 67.5 billion to rescue Ireland s troubled banks, is the eurozone s debt crisis finally nearing a conclusion?

If European banks had enough capital, a reduction in the value of Greek and other debt would reduce shareholder equity and disappoint investors, but it would not cause a banking crisis.

The Fed and Treasury feared that the lesson being taught in the last half of 2007 and the first half of 2008 was that the US government guaranteed all the debt and transactions of every bank and bank like entity that was regarded as too big to fail.

Countries at the center used their central banks strong balance sheets to pump money into the system and to guarantee the liabilities of commercial banks, while governments engaged in deficit financing to stimulate the economy on an unprecedented scale.

To avoid such an internal sovereign debt crisis, China s Budget Law, adopted in 1994, forbade local governments from borrowing autonomously, either by issuing bonds to the public or by getting credits from banks.

In the wake of the global financial crisis, local governments borrowed heavily from banks to support China s massive stimulus program, amassing 10.7 trillion ( 1.7 trillion) worth of debt by 2011.

There is a credit crunch, as banks with insufficient capital do not want to lend to risky borrowers, while slow growth and high levels of household debt have also depressed credit demand.

In practice, the banks have consistently dragged their feet on mortgage restructuring and are laying off staff, rather than hiring people who could help them deal with an initiative of the required scale.

The government is running budget deficits of 10 of GDP, despite having cut public sector wages, and now plans further cuts to service failed banks debt.

Paris Club debt reschedulings

The definition of what banks should hold for liquidity purposes should have been broadened beyond public debt to include a wide range of private sector assets based on market size.

While the Syrian Arab Republic welcomed the Group of Eight's decision to cancel the debts of the poorest countries, it felt that the debts of all the less developed countries should be cancelled, and that the debts of the middle income countries should be substantially reduced.

Now, the largest banks are claiming significant increases in non performing property loans, while the glut of new industrial capacity implies that some firms may not have adequate profits to service their debts.

This created a perverse incentive for commercial banks to buy the weaker governments debt in order to earn what eventually became just a few basis points, as interest rate differentials converged to practically zero.

Mortgage debts, too, must be written down.

This is needed to prevent even more private debt being put on government balance sheets, causing a fiscal blowout.

Eastern Europe was the worst hit. Countries at the center used their central banks strong balance sheets to pump money into the system and to guarantee the liabilities of commercial banks, while governments engaged in deficit financing to stimulate the economy on an unprecedented scale.

In addition, regulators should require banks to issue an additional amount of capital say, 10 in the form of long term debt that is forced to convert into equity if the bank and the overall banking system get into financial difficulty.

Many Americans now have too much debt.

India has written off the debts of all the highly indebted poor countries.