What Comes Next in Europe
After Friday’s mega rally, I look forward to some subdued trading this week.
This usually occurs when a holiday falls on a Wednesday. Traders can’t decide whether to take the long weekend up front or at the end.
So many take the whole week off.
Just as well, we could use some down time.
Today, as we digest what happened in Europe, the obvious question arises. What comes next?
For starters, the heads of state coming out of the Council of Europe meeting last week pledged to have the new structure by July 9, even though the new stabilization mechanism will take longer to phase in.
For the first time, there will be a greater accountability (and control) over continent-wide commercial banking and access to some underwriting of debt coverage. It also means that national banking systems will need to relinquish some oversight to the European Central Bank (ECB).
For months, a number of people (myself included) have insisted that the solution to the European mess requires greater financial integration. The shortcoming seemed rather straightforward.
The EU had ushered in a more centralized monetary system (single currency and all that) but had no centralized fiscal system to parallel it. Simply put, that required adherence to currency rules without any ability to coordinate the credit and fiduciary end of the spectrum.
Well what came out of the Council in the early hours of Friday will not solve the debt problem in Spain, Italy, Portugal, or Greece. There is no magic short-term fix. But it might just provide the underpinnings for a credit system that may begin to operate.
The banks are the problem right now.
They are short on liquidity, have insufficient reserves, and operate in a constricted interbank lending environment. Simply injecting new capital into the system will not address the problem.
Some banks need to fail.
But until the Council moved on Friday, no structure was in place to allow failures to occur without massive waves of panic. The Germans were correct that bailouts would not fix the problem.
Setting up a system of floated bonds would simply have required that taxpayer money in healthier nations – Germany, France, the Netherlands, Austria, the Scandinavian countries – would simply have been drained to address financial inabilities (or refusals) in weaker EU sisters.
We all seem to have relatives like that. You know, the ones who cannot get their financial act in order but know who to call when the rent comes due.
That was the shortcoming blown large in Europe.
So what has changed?
New Lines of Credit Emerge
The new stabilization system to replace the current bailout program will have access to more money. It will, however, now have a price. Banks needing assistance will be handing over some of their control to receive a check.
And that handover will now include the stabilization entity (under the supervision of the ECB) taking equity positions in the ailing commercial houses.
For some over here, this smacks of the 2009 U.S. stimulus program . But I want you to keep one very interesting observation in mind. Aside from all the problems perceived in the American approach, the taking of equity positions in bailout recipients turned out not to be one of them.
The U.S. taxpayer has been paid back with interest.
Now that does not guarantee the same thing will happen in Europe. There some banks will close. The key there is to limit the contagion when that happens, and, to make this possible, a cross-border structure needs to be in place.
Until Friday morning, no agreement existed to set one up. That was the important decision made in Brussels.
The phrase “creative destruction” has always irked me. An economic system certainly needs uncompetitive enterprises to be replaced by those better able to adapt. But the human pain is always the down side in this process.
Let’s face it. It will not be just banks that will close. The changing nature of the financial currents will also sacrifice companies in one country or sector of the EU in favor of others.
Now Europe is used to this and set up an entire system of support to make those transitions less painful. One of the main concerns moving forward is how much of that system will survive the changes coming.
On one extreme is the Greek model, where a huge percentage of the population is on permanent life support paid for by the government. On the other is Wisconsin – when things get tough, just limit workers’ rights and balance the budget on the middle class.
Seems Europe has a greater responsibility than just pulling itself out of the swamp it created. We need somebody to start playing Goldilocks and find a manageable way that is somewhere in the middle.