Wall Street Journal Europe
October 10, 2011
by Irwin Stelzer
We all know the bad news.
Greece can't meet its deficit targets, making its financial saviors reluctant to continue bailing out an economy that is now shrinking at an annual rate of 5.5%. Portugal, too, will miss its deficit target.
The funders of the Greek bailout want to redo their deal that would have limited the losses of private-sector investors to perhaps 10%, rather than the more-than 50% by which Greek bonds have declined in market value. The only question is whether the Greek default, which might occur within the next few weeks, will be orderly or disorderly. Italian and Spanish sovereign debts have been downgraded, and Belgium might soon join them. Many banks are woefully undercapitalized. Even the German and French economies, no longer immune from contagion from the south, are slowing.
So "What is to be done?," as Lenin famously asked en route to his successful revolution. Those modern-day revolutionaries, German Chancellor Angela Merkel and French President Nicolas Sarkozy, have been asking themselves that question ever since it became clear that the first phase of Europe's revolution—the formation of the European Union and the euro zone—was about to fail embarrassingly. And they now know the answer. Which is the good news.
The Merkel-Sarkozy axis and lesser players know that they have to do something, probably before the early November meeting of the Group of 20 industrialized and developing economies.
"There is a sense of urgency among ministers," says Olli Rehn, European commissioner for economic and monetary affairs, to which Ms. Merkel adds, "We're under the pressure of time and I think we need to make a decision quickly." That the word "quickly" can now be heard in euroland is surely a plus.
Ms. Merkel was referring to her demand that every country set up backstops for troubled banks, which she is prepared to do for Germany's banks, which have a $106 billion exposure to shaky sovereign debt.
Most euro-zone politicians no longer deny that their banks need recapitalizing, to the tune of between €100 billion ($133.77 billion) and €200 billion according to the International Monetary Fund, and €300 billion according to less politically sensitive observers. Any illusions those euro-zone policy makers had as to the health of their banks were dispelled when Belgium and France had to fly to the rescue of Dexia, a bank that passed with flying colors the stress tests conducted only three months ago.
The European Banking Authority, Europe's banking regulator, was then barred by national authorities from writing down the value of sovereign debt in its stress tests. That was then, this is now. The EBA at long last is considering modeling the effect on Europe's banks of a large write-down of the sovereign debt of so-called periphery countries. And José Manuel Barroso, president of the European Commission, will present a euro zone-wide plan to the G-20 in a few weeks.
All that remains to be decided is whether national treasuries (Ms. Merkel) or the European Financial Stability Facility (Mr. Sarkozy's preference) will be the first line of defense against bank failures, after the banks have exhausted their ability to raise fresh capital by diluting the value of shares held by existing shareholders. An important implementation detail, to be sure, but a detail nevertheless.
On Sunday, Mr. Sarkozy emerged from a meeting with Ms. Merkel and seemed to agree that bank recapitalizations are needed, but so far hasn't conceded that BNP Paribas, Société Générale and Crédit Agricole need a capital infusion of more than €20 billion, as J.P. Morgan contends. Mr. Sarkozy appears to be sticking to his position that the EFSF rather than his government should be the bailee in an effort to preserve his country's triple-A bond rating, loss of which would doom any hope he has of being re-elected next year, when France will likely be in recession as austerity bites.
The next thing to be done is to admit that the EFSF bailout fund's €440 billion, minus €120 billion in loans already made to Ireland, Greece and Portugal, is inadequate to confront the crisis that now has moved on to Spain and Italy.
Ms. Merkel is trying to figure out how to tell her voters that they are now members of the transfer union—money moving permanently from Berlin to the south—that the founders of the euro promised would never be imposed on them.
As one who believes that "if the euro fails, Europe fails," a result most Germans dread for reasons of history, she will find the way, which is now obvious: reassure her voters by establishing some mechanism by which the euro zone—read, Germany—can control the spending and tax policies of countries receiving bailout aid, and push through fundamental structural reforms.
Economists might have an alternative to the "quantum leap [toward] deeper European integration" for which Europe's business leaders are calling, but historians know better which path Germany will choose.
Finally, the roles of the IMF and the European Central Bank in supporting the price of sovereign bonds and providing liquidity must be clarified and institutionalized.
The IMF has evinced a willingness to consider buying bonds of troubled countries so as to keep the interest rates these countries pay at sustainable levels, and to offer short-term credit lines to governments; the ECB has been buying sovereign debt and providing liquidity for Europe's banks.
Although these loans are no substitute for capital infusions, they provide useful stop-gaps.
These are the things everyone knows need to be done. With 17 separate national politics at play, getting it done won't be easy. A new flag, sporting the Nike "Swish" and the company's motto might help: "Just do it."
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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