Politicians will hate this, but according to Nomura economist Richard Koo it’s too late to save Europe unless they’re willing to go nuclear.
By that he means: Big time guarantees across the entire financial system to ensure that everyone survives. Lots of taxpayer money with few strings attached.
Any half measure, such as asking banks to try raising money fr6m the private sector could be a disaster.
Government needs to ease atmosphere of mutual mistrust by guaranteeing banks’ liabilities
There is little time left in the eurozone: policy missteps thus far have already created an atmosphere of mutual mistrust among banks.
Mr. Volcker prevented this from happening in the Latin American crisis by quickly making it clear that all banks shared a common fate. This gave the authorities ample time to deal with the problems. In the current crisis, however, the time for creating such a bond between the banks is long past.
One thing the authorities can and should do to alleviate this mistrust is to fully guarantee all deposits (liabilities) at financial institutions. The Japanese government used this simple but highly effective tool to prevent a worsening of the financial crisis in 1997.
Similarly, the US government’s announcement soon after Lehman Brothers collapsed in 2008 that it would guarantee liabilities of financial institutions went a long way towards calming frayed nerves. Roger Altman, who served as Deputy Secretary of the Treasury under the Clinton administration, said that aid for the banks, including the “show money” of these guarantees, amounted to some $13trn (Roger Altman, “America’s blueprint for saving Europe’s banks,” Financial Times, 11 October 2011).
This is the part politicians will hate:
Capital should be injected immediately and with as few strings as possible
The proposal of using taxpayer money to recapitalize European banks is already on the table. If the plan is to be meaningful, the accompanying principal reductions must be large enough to enable the distressed nations to resume growing.
Some have proposed increasing the haircut for Greek bondholders to 50% from the original figure of 21%. If they really intend to implement this bold proposal, the authorities should simultaneously announce a large capital injection into the banks. Unless the two measures are presented as a package, attention will focus solely on losses at the banks, exacerbating the atmosphere of mutual mistrust within the financial sector.
The authorities should also declare that they are prepared to inject capital with few or no strings attached. And the capital must be relatively cheap, since the ultimate goal of this exercise is to prevent a credit crunch.
With so little time available, the authorities need to prepare a capital injection that can be implemented together with the principal reductions without waiting for banks to raise their own capital.
Finally, he offers these 4 specific suggestions:
(1) Provide a full guarantee for financial institution liabilities as Japan did in 1997 and the US did in 2008.
(2) Prepare a capital injection scheme to prevent principal write-downs and the resulting losses from draining bank capital and sparking a credit crunch.
(3) Make it easier for the banks to accept the capital by attaching as few strings as possible, and keep the cost low enough that banks will not need to cut back on lending.
(4) Because so little time is available, the government capital injections should be presented as a funding source of first, not last, resort.