Europe's piece­meal fail­ure

As a re­sult, we saw Lehman Broth­ers go bank­rupt, Bear Stearns bought up in a fire sale and a ma­jor Bri­tish bank come within hours of col­lapse.

The Pak Banker - - Editorial5 - Espen Friberg

WHEN I look at events in Europe to­day, with Ire­land get­ting bailed out and talk of crises brew­ing else­where on the con­ti­nent, I am re­minded of the weeks lead­ing up to the bank­ing cri­sis in 2008. As the credit crunch be­gan and banks found it in­creas­ingly dif­fi­cult to get ac­cess to fund­ing, pol­icy mak­ers faced a choice: deal with the prob­lem in a piece­meal way, or ad­dress the root causes im­me­di­ately.

For too long many pol­icy mak­ers opted to fudge their ap­proach; they dealt with the prob­lem bank by bank and re­fused to rec­og­nize the sys­tem's fun­da­men­tal flaws.

As a re­sult, we saw Lehman Broth­ers go bank­rupt, Bear Stearns bought up in a fire sale and a ma­jor Bri­tish bank come within hours of col­lapse.

Dur­ing that sum­mer I re­al­ized that un­less we put a fire­wall in place to pre­vent the cri­sis from spread­ing, we would face a catas­tro­phe in the bank­ing sec­tor and the wider econ­omy. That's why I took the con­tro­ver­sial step of in­ject­ing bil­lions of pounds into the bank­ing sys­tem to sta­bi­lize it. By tack­ling the fun­da­men­tal prob­lem, the lack of cap­i­tal in banks, we stopped a melt­down. It was dras­tic ac­tion, but I have no doubt that it worked.

The same ap­proach is now ur­gently needed for Euro­pean economies. It is not enough for the euro zone na­tions to bail out each econ­omy as it falls into a cri­sis - they must ad­dress the root causes of the con­ti­nent's prob­lems.

This hasn't been the ap­proach so far. In May, Europe even­tu­ally faced up to the fact that it had to help Greece, which was find­ing it in­creas­ingly dif­fi­cult to bor­row to cover its debts. But the res­cue was far too long in com­ing, and the United States Trea­sury de­serves a great deal of credit for forc­ing the is­sue to a head.

Thanks to the bailout, the im­me­di­ate cri­sis was re­solved; we bought some time. But that time was not used to put in place a more fun­da­men­tal ap­proach that would deal with overly in­debted Euro­pean economies.

And so, a lit­tle over a week ago, we saw a new cri­sis: Ire­land had to ac­cept that its banks' debts were so large that it needed help. The Euro­pean Union and the In­ter­na­tional Mon­e­tary Fund stepped in with a bailout pack­age, and again the im­me­di­ate cri­sis was averted.

But did the Ir­ish bailout draw a line un­der the euro zone cri­sis? Far from it. Bond yields rose for Por­tu­gal, Spain and even Italy, a strong in­di­ca­tion that prob­lems re­main.

More than any­thing, the prob­lems in the euro zone have ex­posed the mon­e­tary union's ba­sic fault line. The euro zone shares a com­mon cur­rency, but the po­lit­i­cal and eco­nomic union that un­der­pins it has a limited abil­ity to re­solve dis­agree­ments among mem­ber states and to take de­ci­sive steps to re­solve dif­fi­cul­ties.

The re­sult is a po­lit­i­cal cri­sis along­side the eco­nomic one: com­men­ta­tors speak as if the only op­tions are com­plete po­lit­i­cal union or the breakup of the euro zone. But the first will not hap­pen, while the sec­ond would cre­ate many more painful and desta­bi­liz­ing prob­lems. In­stead, just as with the bank­ing cri­sis, Europe must con­struct a fire­wall to stop the cri­sis from spread­ing.

This will in­volve two sets of steps. First, ac­tion is needed now to pro­vide sta­bil­ity. To that end, the Euro­pean Cen­tral Bank needs to make a firm com­mit­ment to buy­ing govern­ment bonds from at-risk coun­tries. That's what it did dur­ing the Greek cri­sis, where its re­solve played a key role in re­turn­ing in­vestor con­fi­dence to the bond mar­ket. Since then, how­ever, it has sent out in­creas­ingly mixed sig­nals about whether it would do so in the fu­ture (al­though last week it did step up its bond pur­chases, to some ef­fect).

The Euro­pean Cen­tral Bank should be clear that it will con­tinue to in­ter­vene to sta­bi­lize mar­kets, and it needs to con­sider go­ing fur­ther. Dur­ing my time as chan­cel­lor of the Ex­che­quer I au­tho­rized the Bank of Eng­land to en­gage in quan­ti­ta­tive eas­ing by in­creas­ing the money sup­ply, a step that has been taken twice by the Fed­eral Re­serve as well.

De­spite the suc­cess of our ac­tions, how­ever, the Euro­pean Cen­tral Bank has re­fused to con­sider do­ing the same. It should think again. Quite sim­ply, Europe can­not af­ford to bump along the eco­nomic bot­tom for the next few years with slug­gish growth.

The euro zone states also need to deal with banks car­ry­ing un­sus­tain­able debt. Last sum­mer Europe car­ried out so-called stress tests on its banks to see which ones were at risk of col­lapse. But these tests were in­suf­fi­cient (as I noted at the time).

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