Merkel and Sarkozy Seek to Batten Down the Hatches before the Big Storm

German Chancellor Merkel and French President Sarkozy agreed Sunday (9 October) to recapitalise and therefore shore up European banks to the tune of €200bn to storm-proof them in case of another major shock to the financial system (if need be…). Is this a good or a bad move?

Well, its both.

Good

  • European leaders are starting to think seriously about tackling the solvency and liquidity crises in major European banks (‘encouraged’ by last weeks collapse of the Franco-Belgian lender Dexia)
  • A united Franco-German effort is a show of strength and calm amid the crisis atmosphere
  • Tackling the ‘bank’ problem should, in theory, stop the bleeding quicker should a major negative financial event occur on the scale of the collapse of Lehman Brothers in September 2008.
  • Overall, shoring up the banks should stabilise investor confidence (to what extent is unknown) and therefore quell some volatility in the markets

Bad

  • The most urgent problem is Greece and the potential of a Greek sovereign debt default. Helping out the European banks first is a bit like helping out the forecast victims of a unknown disaster before it has even happened. The ‘bank’ problem is, at best, only part of the constantly worsening picture.
  • €200bn is a tiny amount considering the trillions on European bank balance sheets. Dexia, for example, had  €520bn worth of assets – worth more than the entire Greek banking system.
  •  This action is more of a signal to banks to get their houses in order through raising private funds (as Merkel wants). Sarkozy, for his part, prefers to help banks via the €440bn EFSF which was set up to help the PIGs (countries) – not banks.
  • This action reveals the sham that are the ‘Stress Tests’ on banks in recent times. Dexia had passed them 3 months ago and is now defunct. Surely banks who apply for part of the €200bn fund are admitting they cant fund themselves otherwise and their investors would panic.
  • The Franco-German actions do not seek to address the core issue – the uncertainty cycle. Arguably, squabbling over trying to identify and solve the most urgent problem is not bringing Europe any closer to addressing the cycle, which is like a beating heart feeding these crises. Remember the following Economist inspired diagram from a previous PIIGSty post

The Bottom Line

FIRST its important to say that the duo have insisted a comprehensive solution to the Euro debt crisis will be delivered at the end of October. However, the stress placed on signalling bulking up Euro banks first and foremost seems to presuppose that a Greek default or a Greek exit (or expulsion) from the eurozone (however unlikely that is and it is extremely unlikely if not impossible as PIIGSty has illustrated before) is at least plausible in the very short term. This measure is likely to be viewed by commentators and investors alike as ‘preparing’ the banks for a doomsday scenario rather than achieve any intended altruistic goal of ‘tackling’ the problem in Northern European banks.

Merkel and Sarkozy seem to now be admitting that either (a) The Greek national debt (at 160-170% of GDP) is just too high to be controlled by patchwork bailouts and so Greece can’t be saved (politically poisonous at home and economically not a feasible long term option) or (b) that the cost of saving Greece is so exorbitant that the cheaper option is to bulk up bank assets.

As announced today (with more details by late October), the Franco-German alliance seems set to opt for the more feasible option because banks are well known, respected national institutions, employing native workers and holding native bank accounts. The urgency to help them can be understood by the electorates. Bailing out Greece, effectively a third time, is a bridge too far.

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