A Bank Rescue Plan for Europe: The Ultimate Price Tag?
We have been saying for some time that Europe needs to come up with a pan-European plan to rescue its banks if it truly wants to put its sovereign debt problems to rest. This is necessary for the simple reason that any haircut which achieves the goal of not overburdening Greece would require write-downs that could spell trouble for many core-country banks. Yet now that a bank rescue fund is in the cards, it is important it not get bogged down by the EU 17-member parliamentary approval process. Tuesday’s “no” vote from Slovakia on the July 21st ESFS expansion has highlighted the monkey wrench in the system. As Euro bulls are frequently saying the bears don’t understand that Europe is political; this is mean to reassure us that because of sheer political will, it is going to succeed.
However we see the situation slightly differently. The two main non economic challenges EU leaders face are political and institutional. Merkel and Sarkozy must maintain broad political support as the crisis drags on while they simultaneously work to improve a cumbersome system ill equipped to deal with a crisis in the first place. European leaders appear to be focused on maintaining political support and are only marginally aware that broader institutional change is needed if the EU is going to withstand this and potential future crises.
Thus, the political challenges to the Euro may actually be larger than the economic ones. There is a reason that most national governments organize around a leader buttressed by institutions that operates with checks and balances but that can also act in a crisis. Economically Europe could recover if the difficult policy choices were made and if there were suitable institutions in place to bridge the gap between crisis and growth. But the problem with the economic solutions is that they are all political one way or the other.
Take the July 21st decision to increase the EFSF. It was finally approved on Thursday October 13th by a second vote in the Slovak parliament. Meanwhile events have overtaken the enlargement of the program and now it is universally recognized that Christine Lagarde was correct when she suggested in August that Europe needed a plan to shore up the banks.
To this end Merkel and Sarkozy are working on a plan to recapitalize the banks. Yet when this will be mobilized and implemented is anyone’s guess. We know it will be unveiled on or around October 23rd. The original meeting of the European Union where the bank rescue plan was set to be unveiled was pushed back due to disagreements between France and Germany. See where we are going with this? We cannot even say for sure when Europe will unveil a bank rescue fund let alone ratify it in the 17 member parliaments. Would it take nearly three months to approve as well? What if there is a second or third Dexia during the 4th quarter?
In order to leapfrog the 17 member country approval process France is pushing for a mandate expansion of the European Financial Stability Facility (EFSF) which would swiftly and expediently get a fund established right away. To us this seems like a viable and sensible plan. Meanwhile there is talk that the German Finance Ministry is planning to revise a national German measure, the Special Fund for Financial Market Stabilization (SOFFIN) that was used in 2008-09 to shore up bank capital for German banks. Great for Germany but not terribly helpful for the EU as a whole.
Of course European leaders should consider a range of options. But the problem for Europe is that they must decide and they must implement solutions. Several suggestions put forth so far would have been very helpful economically such as Euro Bonds, but they met such political resistance that the idea has all but dropped from the available policy menu. Europe must answer the question, what is the ultimate price tag and are the core economies willing to bear the cost? If the answer is yes they must communicate this clearly and swiftly to the markets and their citizens, preferably along with a plan. Credible moral suasion would go a long way to resolving the funding crisis that most European banks now face. It would certainly go a long way to giving credence to the idea that Europe has the political will to overcome the crisis and fulfill the political and economic mandate its founders had in mind.
Graph: European Sovereign CDS as of October 13, 2011 (Source: Markit)
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