The increasing political responsibility of Europe
By Freddy Van den Spiegel, Economic advisor BNP Paribas Fortis and Partner of the Vlerick Centre for Financial Services
The whole world is increasingly pointing to Europe as responsible for a huge financial mess, threatening the stability of the world economy. And Europe, one of the richest regions in the world, seems to be unable to get the political leadership and courage, needed to tackle its major weaknesses. What is most frustrating is that the analysis of the EU weaknesses is extremely simple, and the remedies are well understood.
First, Europe counts an impressive number of big global banks, once considered an element of economic strength, but since the start of the crisis in 2007, a continuous source of trouble. They remain extremely vulnerable and undercapitalised. They still have to digest the legacy of the crisis, and they have to comply with the new stringent regulatory framework, which requires far more equity capital, and long term funding. The ECB is doing all it can by providing unlimited long term funding at only 1%. That helps for the liquidity problem, but not for the solvency problem. Most of these banks, incapable of attracting new shareholders, have decided to deleverage their balance sheets. However, given the size of their balance sheets, massive deleveraging could create a worldwide credit crunch, as the IMF has warned. To avoid this, European banks have to be massively recapitalised by their governments. But unfortunately many European governments are already over-indebted, and any further budget deficits caused by rescuing banks, would lead to rating downgrades and increasing sovereign risk.
That brings us to the second European problem of the unsustainable economic and financial situation in an increasing number of Member States. Greece is of course the trigger and the most obvious example. It represents less than 2% of the EU economy, but the political chaos in Greece makes it an easy illustration of the political weaknesses and inconsistencies of the European construction. And behind Greece is already the shadow of Spain, a big economy representing more than 10% of the European GDP. While Spain is not comparable to Greece in political terms, it has its own structural problems and is struggling with one of the biggest crashes in its housing market ever seen, followed by a deep recession and an extremely high unemployment rate of close to 25%, and even 50% for the younger generation. It is a typical example of the devastating downward spiral of the combination of banking and economic problems. The crash in the housing markets leads to a recession that weakens the government finances. It also undermines the banks, which have to cope with spiralling bad debt. Rescuing the banks increases the stress on the government debt, which is leading to increasing sovereign risk and higher interest rates. As Spanish banks are big investors in local government debt, they have to cope with the downgrade of their sovereign. These losses further undermine the government finances, etc.
The third problem of Europe is that the apparent incapacity of Europe to tackle its major structural deficiencies is undermining confidence and growth. An increasing number of EU member states are back in recession. Recession, combined with the two previously mentioned problems is fatal. It increases the problems for banks as well as the problems of sovereign risk.
While the analysis is relatively simple and straightforward, the difficult part starts where politics have to find solutions to the problems.
Clearly, banks have to be recapitalised in order to stop the downward interconnection between banks and their governments. Recapitalising banks will not always be possible at the level of the Member state, when that country is already weak. A European mechanism for bank recapitalisations is needed. The existing EFSF and its successor, the ESM, which were created to bail out the Eurozone countries in trouble, dispose of 700 to 800 bn €, and could use these reserves to bail out troubled banks. There is still a political discussion going on if the funds should be allowed to do that, but there is increasing consensus that this should be possible.
Second, Europe has to make it clear how it will act when member states get in trouble. Any remaining doubt is an open invitation for speculation against weaker member states and against the Euro. Until now, Europe has already invested a lot of money to rescue Ireland, Portugal and Greece. But at each intervention, the politicians of the richer countries, especially Germany, could not refrain from expressing their reluctance to go further in that direction in the future. That kind of communication is extremely destructive as it immediately raises doubts about the next steps if a new problem arises. Clear signals that the European Union and the Euro are here to stay would be the issuing of Euro government bonds by one agency for all Member States. It would demonstrate the full fiscal solidarity among members and would automatically protect the weaker ones from default. Also in that respect, immense progress has been made, but once again, Germany remains convinced that it is only a solution for “later on”. At least the concept of Eurobonds is accepted. Of course, solidarity has its limits. For countries like Greece, who lack the willingness for fundamental structural changes, an exit out of the Euro zone should be possible. And also that issue is now openly debated and considered technically possible, even if it would come at a high cost for all.
Gradually European politicians are arriving at solutions that were already clearly identified 2 years ago. The cost of 2 years of hesitation is immense for Europe and for the world. The question is, if Europe can from now on really stop this masochistic drama. At least the arrival of new politicians, like the new French president, Hollande, create a possibility – but no guarantee - for change. Let us hope that the international pressure can help the European politicians to do what has to be done. Already now, Europe has lost its credibility as a major world political and economic power. That is already dramatic, but any further hesitation could become fatal for the union.