How the euro zone can save itself
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Hugo Dixon
Greece is likely to receive another short-term sticking plaster after the euro zone’s leaders stared into the abyss. But a repeat of the drama of recent days is all too possible. The region can, and must, protect itself against Athenian delinquency.
Euro zone finance ministers have postponed a final decision on extending 12 billion euros of emergency loans to Greece. But the country should get the next tranche of its EU/IMF bailout program in early July. Around the same time, the authorities should agree to a new package of perhaps 120 billion euros that sees Greece through until end 2014 –- with private-sector creditors helping by rolling over their debts in some yet-to-be-determined quasi-voluntary manner. Athens still has the capacity to mess things up if it can’t get its parliament to approve the new austerity program. But following Friday’s cabinet reshuffle, the government looks like it will at least survive a no-confidence vote on June 21.
Greece’s saviors have been willing to retreat from what were presented as red lines — such as Gemany’s insistence that private-sector creditors extend the maturity of their loans rather than roll over debts on a voluntary basis — because they were so scared of the spill-over effects of a disorderly Greek default. Policymakers were right to be worried, but only because they have wasted the last year by failing to build adequate firewalls to protect against such a contingency. It’s not just Ireland and Portugal which could have been dragged down by a Greek bankruptcy. These small countries, which have already agreed to their own bailout plans, are no longer the real issue. Spain and even Italy, whose credit rating was placed on review for a possible downgrade by Moody’s on June 17, are the potential nightmares.
The foot-dragging and lack of contingency planning is virtually criminal. But it is still not too late to prepare for the worst. Indeed, given the real possibility that Greece will fail to stick to its new austerity program, it would be the height of folly not to.
The big issue is to prevent a bank panic in the periphery of the euro zone. Wholesale markets have long been closed for Greek, Irish and Portuguese lenders. There has also been a flight of retail depositors in Greece and Ireland, but it has been more of a fast walk than a run. There haven’t been queues of depositors standing outside branches as with the UK’s Northern Rock in 2007. If it comes to that, all hell could break loose.
It is vital to take pre-emptive action. As with any potential banking crisis, the solution is to stuff weak institutions with capital and shore up their funding lines.
The United States and the United Kingdom recapitalized their banks in 2008 and 2009. The euro zone, by contrast, has largely twiddled its thumbs. Even this summer’s European bank stress tests, the results of which are due to be published next month, will be flawed because they do not contemplate the possibility of a sovereign default. But there’s nothing to stop regulators from telling banks that pass the tests despite being filled with risky assets that they still need more capital — and should raise it in double-quick time.
Greek banks are the first priority. They need about 14 billion euros to be comfortable, according to a Breakingviews calculation. If they can’t raise it themselves, which some won’t be able to, they should be bailed out. A special fund which was created for this purpose last year as part of the original EU/IMF bailout plan remains untouched. There’s no point delaying any longer.
Spanish banks are the second priority. The government says the banking system needs no more than 20 billion euros of extra capital. But some market participants think it could need 100 billion euros, because of the banks’ exposure to Spain’s dire property sector. If the government persists with numbers that the market thinks is unrealistic, the state itself could run into funding difficulties. Madrid should be told by its euro zone partners to get ahead of the curve on bank recapitalization immediately.
The European Central Bank’s role as lender of last resort to banks must also be reinforced. Despite softening its approach many times in recent years, the ECB still doesn’t provide an adequate medium-term program for banks with liquidity problems. The Frankfurt-based institution argues that this should be the job of governments because such funding could land it with losses.
While there is some merit in the ECB’s argument, this isn’t an excuse for inaction. The U.S. and British governments both persuaded their central banks to operate special lending schemes during the credit crunch by indemnifying them against potential losses. This is harder to achieve in the euro zone because there isn’t a single government and there’s endless squabbling about who should pick up the tab. But the European Financial Stability Facility, the region’s bailout fund, could be repurposed for this task. And if banks were properly recapitalized first, the ECB’s potential losses shouldn’t be that big anyway. European policymakers — perhaps led by Mario Draghi, who is expected to be the next ECB president — should crack heads together over the summer.
If such a medium-term lending scheme existed and the weak banks were stuffed with capital, the euro zone would be in a much stronger position when and if Athens next veers off course. There would be much less danger of an EU-wide bank panic. Greece’s saviors could then afford to play hardball with confidence. If they don’t do this, Europe could soon be witnessing a replay of the game of chicken seen in recent weeks – with even higher stakes. And sometimes games of chicken end in disaster.