Markets Insight

November 26, 2012 1:47 pm

Time to end the eurozone’s ad hoc fixes

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Europe must learn from the 1990s US Brady plan and act swiftly

We are fast approaching the third anniversary of the news from Athens in December 2009 that triggered the eurozone crisis.

The Greek government at the time announced that it had grossly understated the scale of its budget deficit. The persistent crisis is sorely testing the nerves of financial markets.

Urgently needed are bold official actions to end the uncertainty and start to build confidence. The architecture should be an agreement on an integrated package of key policy measures accompanied by clear implementing timelines.

Europe’s authorities have consistently underestimated the contagion impact of their ad hoc approaches and failed to learn from past sovereign debt experiences.

For example, I saw a similar saga in Latin America in the 1980s. The failures year upon year to find effective debt crisis resolution led to a lost development decade for the region.

The corner was turned only when Nicholas Brady, then US Treasury Secretary, developed a growth-orientated, market-based approach in 1989 – first with Mexico and then with 17 other sovereigns. The European leaders have failed to learn from this experience at great cost.

At a minimum, an integrated eurozone package should be finalised very soon, with timelines for implementation announced for the next six to nine months. This package should be based on the following essential steps.

First, a banking union must be put in place to separate banks from sovereigns. This would reformulate the balance of regulation in favour of enabling banks to lend more to small and midsized enterprises, which are the prime job creators in most economies, while also enhancing the credibility of Europe’s regulators.

The latest arguments over how much authority the European Central Bank should have and its relationships to the European Banking Authority and national regulators are worrying.

Progress here should not be undermined by turf battles, or by debates about whether the ECB’s powers should be confined to only the biggest banks.

From Northern Rock to Lehman Brothers we saw how crises can be triggered by smaller financial institutions in our intensively interconnected financial system. I hope there will be agreement soon to establish a single supervisor that can work closely with national regulators in a unified system.

Second, we need to ensure that the European Stability Mechanism and other financial safety nets, including sovereign bond buying by the ECB, and involving resources from the International Monetary Fund, are strong enough and managed in ways that can provide funds to governments on a scale and at a speed that builds confidence.

For example, action here is essential to resolve Greece’s difficulties. The eurozone governments, the ECB and IMF can tinker with the interest rates and maturities on Greece’s debts, but given that the country’s debt-to-GDP ratio is approaching 200 per cent, the situation is unsustainable, and especially so if the creditors keep demanding more budget austerity, so shrinking the real economy still further.

Robust eurozone financial structures need to be in place that can assist countries to transition from current conditions, where their financial difficulties are mounting and their unemployment rates are exceptionally high, to a sustainable growth-orientated path. Further delay on establishing financial support mechanisms will add to difficulties.

Third, the sustainability of the euro will be in doubt as long as the 17 governments responsible for the eurozone fail to agree on a fiscal compact.

The zone’s fundamental weaknesses, so exposed by the crisis, owe much to overly great reliance on monetary policy. While this is well recognised, Europe’s governments have yet to agree on a starting date for an effective fiscal compact.

There will not be financial market confidence even with the above integrated package of policies unless there are firm implementation timelines. Scepticism about the ability of Europe’s authorities to act on their rhetoric is now so substantial that announcing a schedule for concrete actions is imperative.

And this is urgent, because market pressures have repeatedly shown that policy makers have always far less time to act than they tend to believe.

The integrated package of measures that is needed has to be understood as providing a fresh basis to create confidence.

The success of the “Brady plan” lay in the fact that sovereign authorities built on it to show their own citizens there was a course to be pursued to establish stability and secure real growth.

They were able to muster public support and commitment, which is crucial for the successful resolution of sovereign debt crises.

William R Rhodes is president and chief executive of William R. Rhodes Global Advisors and author of ‘Banker to the World: Leadership Lessons from the Front Lines of Global Finance’

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