Financial Times, August 15,2011
A comprehensive solution to the euro crisis must have three major components: reform and recapitalization of the banking system; a eurobond regime;andanexitmechanism.
First, the banking system. The European Union’s Maastricht treaty was designed to deal only with imbalances in the public sector; but excesses in the banking sector have been far worse. The euro’s introduction led to housing booms in countries such as Spain and Ireland. Eurozone banks became among the world’s most over-leveraged,andtheyremaininneedofprotectionfromcounterpartyrisks.
The first step was taken by authorizing the European financial stability facility to rescue banks. Now banks’ equity capital levels need to be greatly increased. If an agency is to guarantee banks’ solvency, it must oversee them too. A powerful European banking agency could end the incestuous relationship between banks and regulators, while interfering muchlesswithnations’sovereigntythandictatingtheirfiscalpolicies.
Second, Europe needs eurobonds. The introduction of the euro was supposed to reinforce convergence; in fact it created divergences, with widely differing levels of indebtedness and competitiveness. If heavily indebted countries have to pay heavy risk premiums, their debt becomes unsustainable. That is now happening. The solution is obvious:deficit countries must beallowedtorefinancetheirdebtonthesametermsassurpluscountries.
This is best accomplished through eurobonds, which would be jointly guaranteed by all the member states. While the principle is clear, the details will require a lot of work. Which agency would be inchargeofissuing,andwhatruleswoulditfollow?