The banking sector is the weak spot of any restructuring plan involving sovereign default. Here, direct bank support through bank recapitalisation is a much more effective and cheaper solution than a full guarantee of sovereign debt.
The taxpayers could get bank equity in exchange for their money. If this crisis is like others, there is a chance that share values recover and taxpayers break even in the long run. The 2007-2009 crisis has shown that governments are indeed able to contain a banking crisis by resolute action like forced recapitalisation and temporary nationalisation of banks.
The better prepared we are for such an event the smaller will be the impact on the economy. Europe's governments have had plenty of time to prepare over the last year, so why was such a solution not even considered?
The reasons are political. Such a solution would have upset powerful vested banker interests, even though it would have imposed the costs on those most responsible for the massive credit misallocation.
A strong negotiating position of politicians confronts two important obstacles:
- First, the finance ministry and banking authority typically lack competence and information in order to prepare contingency plans for bank recapitalisation.
There is an acute skill shortage in the finance ministry and what talent there is meets a wall of secrecy put up by an uncooperative banking sector.
- Secondly, the strong lobbying power of the banking sector deters politicians from preparing in advance and taking risks in favour of the taxpayer.
Conflicts of interest between the politicians and the bankers are rampant.
After the disastrous risk-management performance of many bankers revealed in the 2007-2009 banking crisis, it is surprising that the same people still enjoy great influence in the policy process. The consequences are predictable.
- If you ask a frog to come up with a plan for draining a swamp, you are like to end up with a proposal for more flooding.
- Bankers were asked to come up with a plan for private-sector involvement under the leadership of Ackermann and the Institute for International Finance; what they came up with was a plan for more support.
We would never ask the tobacco industry to work out a new public health policy.
A further problem is the fragmentation of political power in Europe. This prevents the political authority from taking a strong negotiating position against the sovereign-debt creditors. In 1982, when the US faced a sovereign-debt crisis brought about by US banks’ lending to Latin American nations, US finance minister Baker rejected private-sector demands that the US taxpayer bail out of creditors. While this seems similar to the position of German Chancellor Merkel, her position is much weaker.
Lastly, the ECB played a very obstructive role in preventing any effective bail-in of private creditors. This strengthened the “hostage taking” of the political authorities. At times, ECB board members gave the impression of being themselves captured by the financial elite of their home country. The ECB severely damaged its own reputation by siding so strongly with creditors and bankers rather than defending Europe's taxpayers and citizens.
And the future?
If the recent Greek bailout foreshadows the future of Eurozone "economic governance", the real question is “how much of this governance can the euro survive?”
The political economy of these European bailouts is unlikely to improve before the next sovereign-debt crisis hits. This would require that politicians take on the powerful banking lobby by forcing much higher capital standards on Europe's undercapitalised banks. There is no sign of this happening. The real peril for the euro may come from a taxpayer revolt against a financial elite that has betrayed the interests of the majority of citizens.
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