Wolfgang Munchau, who writes for the Financial Times and the blog EuroIntelligence, argues that the fact that EU member nations managed to survive their first series of bank failures does not mean it can afford to take the risk of defaulting to continued improvisation. Munchau comes out squarely in favor of a coordinated, funded rescue program.
From the Financial Times:
This has been a week of self-congratulation in Europe. We have saved a handful of banks. We have, in effect, started to cut interest rates. We even had a summit of European leaders that produced warm words of solidarity. It looks as though the Europeans have reached substantive agreement that no systemically important bank should ever be allowed to fail….The rescue of Fortis and Dexia last week, two large, but not too large, cross-border European banks, should be seen as a sign that our emergency procedures are working. Look, they say, we met quickly and decided what needed to be decided. It was fast and unbureaucratic. We do not need a European rescue fund, let alone any new institutional set-up to deal with this, they say. We can do it ourselves.
I agree that the few ad hoc rescues have worked. But do not fool yourself. They worked because they were the first wave of rescues and because they involved banks such as Fortis – of just the right size, based in just the right small- to medium-sized country where political leaders are sufficiently rational not to hold each other to ransom as midnight approaches on Sunday.
But what if this had been a bank with a name of a large European country, or an acronym that refers to a large European city, banks that are simultaneously too big to fail and too big to save? I shudder to think what would happen when Silvio Berlusconi, Angela Merkel, Lech Kaczynski and the next Austrian leader have to meet to discuss the future of a large cross-border European bank.
What worked for banking rescues numbers one to five may not work for rescues number six to 50 – the estimated number of systemically important banks in Europe. And that number does not include some banks we have already rescued, which politicians judged to be important for their domestic banking system, like Germany’s IKB Bank, but with no European relevance whatsoever. We have been squandering money.
Nor does it include the likes of Hypo Real Estate, which is not even a bank at all,….
The Europeans are of course right in their overall ambition not to allow systemically important banks to fail. They are also right in their scepticism about their ability to distinguish between illiquidity and insolvency during an emergency. But I fear we are still well short of a strategy. We might be lucky, and scrape through what could well become the most dangerous month of the crisis so far. If, for example, the credit default swap market were to blow up in the next couple of weeks – a non-trivial probability – we have no plan.
Nicolas Sarkozy, the French president, was therefore right when he appeared to back a €300bn rescue fund. Regular readers of this column will probably recall my somewhat constrained enthusiasm for his economic policies. But this had the makings of a good plan. He ended up distancing himself from it, when it became clear that Angela Merkel, the German chancellor, would not support it. But he was right and she was wrong. Of course, a European plan should not have been a copy of the bail-out that was finally adopted by Congress on Friday. The US plan failed to address the problem of an undercapitalised banking sector. That issue is even more important in Europe where many banks have an extremely weak capital base, with leverage ratios of 50 or more.
Europe does therefore not need any bail-out plan, but a plan that specifically addresses the capitalisation problem. Concretely, three things are needed: the first and most important is money. A sum of €300bn will not cover the EU in a worst-case scenario, but it is a sensible number to start with; secondly, you need a semi-permanent crisis committee empowered to take decisions; and finally you need a strategy to apply symmetrically and based on clear rules about when to recapitalise, and when not.
If you pursue a strategy of taking purely national decisions, you run the risk that at least one government will hit its own financial ceiling before this crisis is over, or that decisions have negative spillovers on the banking systems of other countries. Moreover, you end up with a beggar-thy-neighbour regulatory race, as we saw last week when Ireland and Greece unilaterally issued blanket guarantees for large parts of their banking sector. Last night, Germany was preparing a full deposit guarantee for its own banking system. Last but not least is the risk of violent political setback against a process that lacks transparency.
For Europe, this is more than just a banking crisis. Unlike in the US, it could develop into a monetary regime crisis. A systemic banking crisis is one of those few conceivable shocks with the potential to destroy Europe’s monetary union. The enthusiasm for creating a single currency was unfortunately never matched by an equal enthusiasm to provide the correspondingly effective institutions to handle financial crises. Most of the time, it does not matter. But it matters now. For that reason alone, the case for a European rescue plan is overwhelming.
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It is reasonable to think that Bernanke/Paulson would likely be trying to create an effective coordinated global response of large size in order to arrest the mushrooming spread of contagion. A Plaza/Louvre/Basel-esque kind of Accord. The IMF meets at the end of this week: (IMFC: Saturday, October 11, 2008; DC: Sunday, October 12, 2008 ) What are the most likely scenarios that would be deployed? Separately, what would the most effective effort include? From Bernanke’s work one would think an aggressive over-response is likely, if such a response can be sold politically.
I enjoyed this piece but, to nit-pick, he says, “If, for example, the credit default swap market were to blow up in the next couple of weeks – a non-trivial probability – we have no plan.”
I think he means that its a non-vanishing probability of this happening or that evaluating that probability is a non-trivial problem. A probability is just a number and therefore never trivial!
Using mathematical terms inappropriately (to “sound smart”?) compromises a writer’s credibility.
Yves,
Since you’ve moved on directly to Munchau’s piece, I’ll repost my response….
Yves,
There’s no point on agreeing or disagreeing on outcomes, because they have not happened yet, but Munchau is a perfect example of the British press setting the bar higher for the EU than for the locals. Leaving aside that euro bashing sells more papers in Britain than its opposite, there is a generally gross underestimation in the anglo press of the fundamental desire on the continent that the EU and its money succeed, although this is almost totally masked in normal times when squabbling over bullshit takes the fore.
Note that the impetus towards establishing an EMU bank stability fund is today coming from Berlusconi – the absolute most unlikely of sources imaginable. I’d been wondering what was behind his recent notable silence.
They will do what has to be done.
Some perspective, major Euro indices 30% off highs as in beginning 2002. Then dotcoms etc dropping like flies, loans going bad and credit shrinking.
Indices still had a long way to go then ……
The day is coming when theTreasury is going to figure out that survival will require direct injectiions of capital into the clogged arteries.
But bankers have hysterical wives
And its an election year
Do something!!!!
Anything!!!!
No… no… no… not that!!!!!
Re: Charles Butler.
I hardly read this as euro-bashing, but more as sound advice on how to act in the best European interst. Don’t forget that Münchau is a German economist hailing from Munich.
owe –
I disagree because he suggests that the outcome of continuing under the same system is the worst case possible. The exclusion of all other possible courses of action and possible results leaves this as the most likely, by default. The implication is clearly that the eurosystem categorically does not work – a theme which he has been smacking about for a very long time on the basis of a wide range of evidence, but has yet to prove conclusively. I know that he hails from Munich, but I’d instead give his job description as British journalist.
Please, please… give the politicians some credit….
Who will pay for this bail out? The EU budget is next to nothing. Will individual countries pony up by population or by GDP? In other words will every German taxpayer have to put in as much as his Greek counterpart? Or does the German pay more because his economy is more powerful than the Greeks? Can you see where this is going?
And who will administer this? Will countries get angry if they do not get as much money as they contribute? Let’s say a country as done a great job at regulating their banks. Do their citizens have to still pony up so the Belgians can save their banks? Doesn’t this create moral hazard? Shouldn’t the countries (if there are any) that did correctly regulate their banks be rewarded and not punished?
Where are the howls of horror at the EU becoming a “super state”?
I would certainly agree that general policy direction should be harmonized on the European level, but this already seems to be the case since banks are being bailed out by equity injections and not by blank checks. And one glaring deficiency is the lack of a proper deposit insurance regime. These rules should be set at the European level while being executed at the national level.
But there are just too many spineless Europeans that the moment the going gets tough look to their big brother America for all the answers. The only problem with this approach is that most of the problems (but not all) with European banks are directly related to Europeans not following their own traditional ways but instead being way too quick to jump into whatever new “innovations” are coming out of the States.
Given the political architecture of Europe, the best that can be hoped for is a continuation of the ad hoc solutions on a national level. Trying to do more than gernal policy direction on the European level will be too complicated and never work. On the other hand the EU leaders will take advantage of the current crisis to gain more power for the future.
When the tide goes out you learn who’s been swimming naked, according to the sage of Omaha.
All this panic to stop the tide makes us suspect a severe scarcity of swimsuits among active swimmers. Have a good day.
http://keepitcleaneconomics.blogspot.com/
What bothers me about all these semi-permanent “solutions” like TAF, TARP, etc, and the new broad powers of the Fed, is how are they going to be wound down once the things get better?
Are TAF and TARP going to become household names, as in “Hey, I heard the First Federal just got a juicy piece of TARP last quarter…” Isn’t getting rid of the clusterf*** of extreme measures going to be an impossible legislative and regulatory feat? Can anyone imaging taking back from the Fed its new powers to oversee the broad financial markets, not just banks?
“Concretely, three things are needed: the first and most important is money. A sum of EUR300bn will not cover the EU in a worst-case scenario, but it is a sensible number to start with […] If you pursue a strategy of taking purely national decisions, you run the risk that at least one government will hit its own financial ceiling before this crisis is over […]”
There is something odd about this argument. He seems to be saying that, in order to avoid a contingency that may not even come to pass, the EURO states must take an action that in all likelihood won’t be sufficient should that contingency actually occur.