Monday, October 15, 2012

Only big debt restructuring can save euro

by Willem Buiter

Financial Times

October 15, 2012

During the summer there were a number of developments justifying optimism about the euro’s survival chances. Since late September, however, the euro area’s political leaders have done all they can to dash these hopes.

Among the positives were the decision to enhance the European Stability Mechanism, the rescue fund for troubled nations, allowing the recapitalisation of banks directly without going through the sovereign; the German constitutional court’s approval of the ESM; the emergence of a pro-European majority from the Dutch elections; and the European Central Bank unveiling its big but conditional bazooka, outright monetary operations (OMT).

And then it all went pear-shaped. Germany insists that any direct bank recapitalisation by the ESM be covered by a sovereign guarantee. The distinction between the ESM lending to the sovereign with the sovereign recapitalising its banks – creating an on-balance sheet sovereign liability – and the ESM recapitalising the banks directly but with a guarantee from the sovereign – creating an off-balance sheet contingent sovereign liability – is one of appearance only. Markets will see right through it.

Germany and its allies want the supervisory role of the ECB restricted to a small number of large, mainly cross-border banks. Systemic problems can be created by clusters of domestic banks, as demonstrated by the Landesbanken and cajas. In addition, Germany and the other supporters of a minimalist supervisory role for the ECB want to delay the start of that role and thus also the start of direct bank recapitalisation by the ESM. Finally, the German, Dutch and Finnish finance ministers argue that there should be no mutualisation by the ESM of sovereign debt incurred in past bank recapitalisations, including Spain’s. In the case of Ireland, which incurred about €63bn of sovereign debt recapitalising its banks, this significantly increases risks of an Irish sovereign default.


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