January 11, 2012
Throughout the European debt soap opera, Europe’s leaders have expressed their willingness to “do whatever it takes” to restore stability and save the euro. This column argues that, too often, policymakers have in fact been “doing whatever it takes” to serve the banks.
After initial denials, Europe’s leaders have started to acknowledge that IMF Chief Christine Lagarde was right. Through their statements and decisions, policymakers are showing their agreement with her assessment in August 2011 at the Federal Reserve’s Jackson Hole symposium that there was an urgent need for recapitalisation of Europe’s banks (Lagarde 2011).
This recognition of reality is the good news. The bad news is the EU’s bank recapitalisation is being handled in a way that will make a recovery from the Europe’s debt crisis more problematic than it needs to be. There are five concerns:
- Incentives for deleveraging;
- Absence of firm guidelines on dividends and executive compensation;
- Omissions of a recession scenario and of an unweighted leverage ratio from the stress tests;
- Inequitable burden-sharing during debt restructuring; and
- Insufficient measures to permit an escape from the adverse feedback loop between sovereign debt and bank debt.