About the plan for Greek debt, bank recapitalizations, bigger EFSF

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The next EU summit on October 23 is fast approaching and European elites are working on a multi-faceted plan to contain the crisis. The new plan for the Euro crisis has three facets: 1) Greek debt restructuring, 2) bank recapitalizations, 3) increase of the funding capacity and scope of the EFSF. Though the plan is not yet finalized as its exact form will be determined on the next summit, it still is possible to make some early assessments by taking into account the systemic nature of the crisis.

By systemic crisis, I mean a malady of the system, which in this case is the euro architecture itself that lacked the necessary stabilizing mechanisms to prevent the crisis from becoming so severe; and also the lack of a unified and well-regulated banking sector (see Full Analysis of the Euro Crisis). The fact that the crisis is systemic implies that it will only be solved with system-wide measures. This suggests that the upcoming plan must abandon the self-defeating dogma of perfectly separable national crises that has so far treated the matter on a country-by-country basis, with all the unpleasant negative effects such a false diagnosis could have. Europe’s elites are now called to solve the consequences of their own mistakes and they should have the courage do it. They must accept that their policies have so far been part of the problem and not a solution to it.

What we have been facing in the Euro area is a crisis that simultaneously evolves in three separate realms: (a) debt crisis, (b) banking crisis, (c) under-investment crisis. So far our leaders have only been looking at point a while completely neglecting (and denying) the other two. Fortunately the new plan seems to have incorporated point b, as there is a discussion on how to best recapitalize banks. In that sense we are witnessing some progress and we are seeing steps towards a partial system-wide strategy. What remains to be seen is if there will be any provisions to address the under-investment crisis, however I am not aware of anything substantial towards that direction, so it seems to me that point c will be omitted once again.

Within the above-mentioned context a coordinated effort to restructure Greek public debt in conjunction with a system-wide bank recapitalization is a very positive step forward, yet it is largely insufficient to arrest the crisis for one very simple reason: it fundamentally depends on contributions from already indebted and already endangered member-states, which suggests that market pressures will again intensify a few days/weeks after the natural optimism the next summit will initially bring.

Here is where the tricky part comes into play and it has a name: EFSF. It is of cardinal importance to understand that nothing can be done at no cost. An expansion of the EFSF to allow it to undertake the task of recapitalizing private banks while also being expected to buy sovereign debt is a venture that will increase the burdens of all states and the bigger the EFSF gets, the bigger the burden. This extra cost can fundamentally put into risk the credit rating of France which implies that the credit rating of the EFSF will fall into jeopardy, bringing down with it, the programmes in Ireland and Portugal and whatever other task it might be assigned to.

With many parameters still unknown it would be unwise to expand further on the subject. From what we have so far it seems that European leaders are finally realizing that the crisis is systemic and must be addressed systematically. Greek debt restructuring in concurrence with bank recapitalizations is definitely a sound option. However what remains to be solved is the cost of all this process that for now will fall on the public finances of member-states either via the EFSF or some other route. This is certainly not good as it will be the Achilles Heel of any effort to contain the crisis. If that thorny part of the ongoing bargaining is not solved then I am afraid the next summit can be led to a failure just like the previous one on July 21 that was not even worth the paper and ink needed to print the final decision.

Let us hope that our leaders will finally grasp the severity of the moments and stop kicking the can down the road.