Step by Step Approach to Crisis Resolution

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSdsolutions.com

                                    

 

Politics is not the art of the possible.

It consists of choosing between

                                            The disastrous and the unpalatable 

                                                          (JKGalbraith)

Eurozone officials and politicians have adopted a mini step-by-step approach to crisis resolution.  This approach has back-fired as cost of crisis resolution has increased dramatically as the sovereign debt crisis is turning into a full blown banking crisis.  The European Central Bank (ECB) finally took a big step last week when they made nearly euro 500 billion in three-year low rate loans available to 500 banks across the region.  This comes ahead of a crucial time for policymakers as a large volume of sovereign and bank debt has to be refinanced in the first quarter of 2012.  The ECB has provided a near-term fix for the Eurozone crisis, but what has to be addressed longer-term?

 

Charles Goodhart & Dirk Schoenmaker in “The Political Endgame for the Euro Crisis” (VOXEU, Dec. 14^th) discuss some of these issues.  The euro crisis is deepening, as European leaders continue with their “too little too late” policy reforms.  Solving Eurozone problems requires a strong direction for fiscal and banking policy.  This in turn needs greater political integration through an elected president of the European Commission and a two-chamber parliament representing EU citizens and EU member states. 

 

The euro has a supranational monetary policy framework, while the fiscal side is still national or inter-governmental.  With political legitimacy, the President of the European Commission could: first, enforce budget discipline on participating members and restrict the impact of fiscal spending, and second oversee Eurozone banking supervision and resolution to foster banking system stability. 

 

One step is the establishment of a Eurozone Minister of Finance with power to enforce provisions of the Stability and Growth Pact on fiscal deficits.  A second step is a reform of the parliamentary side of the political union by establishing one chamber to address issues of the electorate and a second chamber to represent interests of the separate member countries.  This would allow a gradual transition of banking supervision and resolution from the national level toward a wider European scale.  The new Eurozone Finance Minister would need specific authority from the European Parliament to establish budgetary and banking powers and the European equivalent of the FDIC, SEC, etc. 

 

The resolution of the euro crisis needs both political reforms as well as a technocratic solution.  There are major issues that need to be addressed, but the min-step approach to financial crisis resolution or risk management has a cost – often a higher cost.

 

For more on this follow the link:

 www.voxeu.com/index.php?q=node/7420

 

 

The Underpricing of Risk – What Can We Learn?

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Jeffrey Frankel, in a recent Vox communiqué called “The ECB’s Three Mistakes in the Greek Crisis and How to Get Sovereign Debt Right in the Future”, reviews the failure of the European Central Bank (ECB) and policymakers to fully integrate Greece into the Euro and fulfill the necessary conditions for membership. .

 

The first mistake, by the ECB and the European Commission, was to allow Greece to join the Euro in 2000 when it failed to meet the economic criteria established by the Maastricht Treaty, particularly the 3% ceiling on the budget deficit expressed as a share of GDP.  The second failure by European authorities, was to monitor budget deficits and debt levels that exceeded limits established by the Stability and Growth Pact, resulting in Greek borrowing costs similar to that of Germany.  As a result, international investors grossly underestimated potential risks.   The third mistake was not to send Greece to the IMF earlier.  European policymakers looked at the events in Greece as a temporary liquidity crisis rather than outright insolvency.  The result is a higher cost for a bailout.

 

There are two major lessons learned by policymakers from the Greek experience.  The first is that when specific criteria are established, such as the Maastricht fiscal criteria and the No Bailout Clause (1991) and the Stability and Growth Pact (1997), someone has to take responsibility for monitoring and enforcing them. The second lesson is that European authorities are not equipped to impose policy conditionality in rescue loan packages; this is the IMF’s job. International politics is less likely to prevent the IMF from enforcing painful fiscal retrenchment and other difficult conditions. Europe is no different in this respect than Latin America or Asia.

 

The failure to price risk correctly is now resulting in European policymakers discussing the possibility of a “soft restructuring” of Greek debt.  The term soft restructuring is used as a euphemism for extending the maturity of outstanding debt.  European authorities are looking for further spending cuts and increased privatization by Greece.  However, the failure to do the large-scale debt restructuring, increasingly demanded by investors, will increase the ultimate costs.