30 May 2013

The Euro Crisis Can Be Solved

The only solution to the Euro crisis is more Europe, for example* Joschka Fischer said:
The price of the monetary union’s survival, and thus that of the European project, is more community: a banking union, fiscal union, and political union.
 There is not the political will for more Europe, and the longer the crisis goes on the more support for Europe evaporates:
Support for European economic integration is down over last year in five of the eight European Union countries surveyed by the Pew Research Center in 2013.
The only conclusion is that the long grind of austerity in the periphery will continue , or the Eurozone will fall apart.

The pessimism is congealed in this post by James Haley . There are two paths, he says, banking union or grinding internal devaluation. When I read it I thought, no there are other paths. The point of this post is to illustrate one.

The key to fixing the Eurozone crisis lie in repairing its broken banking sector. European banks have yet to recognise the losses on their dubious loans. European countries have not the funds to bail out their banks nor nor to pick up the tab for closing them down. Ireland tried and found itself in a sovereign debt trap.

On the whole, the Eurozone can afford to bailout or close down insolvent banks. That is why banking union is seen as a solution. There is enough room to raise the funds to pay for a programme to resolve and recapitalise Europe's banks.

Here is my proposal. Instead of new permanent institutions we could look to a one-off solution. The institutions for assessing the needs of banks for fresh capital or for closing down insolvent banks already exist. Bank stress tests have been conducted. They can be done again, but this time for real. The ESM has the power to invest directly in banks rather than forcing their home country to take on the debt.

The remaining problem is that this exercise will be costly. The solution is a one-off bond issue jointly guaranteed by all Eurozone countries. The EU already raises funds this way, but on a much smaller scale to support for example the European Investment Bank. Making the exercise a one-off can be used to create incentives for banks to come clean on their problems.

Let me anticipate two objections. One, why would Germany go along with this plan? Two, if it is done once it can be done again.

Germany has been reluctant to see Eurobonds, mainly because of moral hazard. This is different because it would be for a specific purpose, not directly funding individual governments but solving a Europe wide problem. Germany's own banks would benefit, both from recapitalisation and by removing the risks of default by some of their borrowers.

On the second objection. It would be necessary to follow up by making financial supervision more national. This would mean rolling back the single market for this sector so that banks which want to offer services in another Eurozone country would need to create a subsidiary which was separately capitalised and under the supervision of the host country.

*Joschka Fischer is not alone. Yesterday I picked up El Pais in a cafe and found Javier Solana, Felipe Gonzalez and Jacques Delors making the same point.

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