Charles Wyplosz: End of game? Don’t bet on it
25 July 2012
Ultimately, eurozone leaders will come around to the only way forward – the ECB underwriting both banks and sovereigns while additional controls on bad banking and bad fiscal governance are put in place.
Simple truth: Crisis rolls on until the ECB acts decisively
The simple truth has been known all along. The crisis will not end until the ECB acts as lender in last resort. It can do it on the cheap by either partially guaranteeing all eurozone public debts or by setting a cap on their interest rates. This will bring the speculative phase of the crisis to a temporary end, leaving room for the other required steps.
The ECB has started to move in that direction at the end of 2011 with its LTROs, but it did so via banks, in effect deepening the vicious loop between governments and banks. This is why the effect was short-lived.
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The first next step is already on the official agenda. Once debts are partially protected, their prices will settle and banks should acknowledge losses on their holdings. This will push a number of banks into bankruptcy. Inevitably, they will have to be restructured, and this will involve hundreds of billions of euros. Smart bank restructuring does not involve losses to be borne by the taxpayers but it requires liquidity injections.
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The ECB will have to act as lender to last resort for banks. The ECB has open that door too when it has called for a banking union. Its reasoning is absolutely correct on this.
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Injecting cash into banks amounts to throwing good money after bad unless the banks are properly restructured. That in turn calls for a single European supervisor with full bank resolution authority.
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National governments still balk at the prospect of giving up national authority. Authority which was used to protect their national champions with disastrous consequences (Ireland and Spain are two now-obvious cases in point and many national closets hide large skeletons).
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The second next step is to acknowledge that many public debts must be restructured. As noted above, commercial banks will have to take losses but more losses will have to be borne by the ECB and the EFSF, which have absorbed hundreds of billion worth of public debts. Private bondholders too will be hurt for having purchased what they saw as safe assets. This is a step that all governments want to avoid, which is understandable but futile. The more they wait, the deeper will be the haircuts and the larger the eventual losses. Prompt corrective action is a basic way to deal with this kind of situation.
When all else fails, policymakers will do the right thing
Over the last few months, these ideas have started to be taken on board, but partially and hesitantly. Coherence, however, is of the essence, as has been illustrated by the LTROs. At this juncture, the risk is that the banking union – a strong but ambiguous terminology – will not be carried to its logical conclusion. More money will be provided to Spain and Italy, but not enough and with counterproductive conditions.
The result is that the ECB will sit on the fence, acting whenever a climax is reached because its ultimate mission is to preserve the euro’s existence, but still short of acting as a fully-fledged lender in last resort for both banks and governments. After all, the ECB can rescue the eurozone, but it cannot repair it – only governments can do that.
To make things worse, governments will not accept to envisage public debt restructuring, leaving the root cause of the crisis untreated. There will be many more small steps in the right direction but certainly not the grand strategic plan that is sorely needed.
The really good news is that, at long last, the euro has started to depreciate. Since there is no room left for an expansionary monetary policy and since most governments cannot use fiscal policy in a countercyclical way – just letting the automatic multipliers act remains a dream – the only possible boost to stop economic recession from spreading is a rise in exports. A weak euro is in Europe’s interest.
© VoxEU.org
