Monday, October 31, 2011

EFSF needs bigger bazooka to maximise its firepower

by Willem Buiter

Financial Times

October 31, 2011

The European Summit to save the euro has brought temporary and partial solutions to three immediate problems facing the EU. First, to restructure insolvent sovereigns (Greece, most likely Portugal, quite possibly Ireland). Second, to recapitalise the many European Union zombie banks. And third, to ring-fence those sovereigns that, although most likely solvent, are at risk of a market liquidity ambush.

The 50 per cent loss likely to be imposed on private creditors is not enough to restore Greece’s sovereign to solvency. I expect that, ultimately, both private and official creditors (including the European Central Bank, but probably excluding the International Monetary Fund) will have to write off most of their Greek sovereign exposure. Likely future restructuring of the Portuguese sovereign was not addressed, nor was the likely need for further funding concessions for Ireland.

Bank recapitalisation worth around €106bn is likely to provide between a third and a quarter of what will ultimately be required to bring about a fully functional EU banking system. Public resources also have to be found to guarantee new issuance of senior unsecured bank debt.

Without that, the ECB will be the dominant source of short-term and long-term bank funding. As regards ring-fencing Spain and Italy, nothing has been achieved except to gain some time to achieve a proper solution. Evidence of this is Italy’s 10-year borrowing cost, which, following the summit, exceeded 6 per cent – an unsustainable level.


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