In an op-ed published on the Financial Times website Friday on the eve of the announcement of the Spanish bailout, economist Nouriel Roubini and historian Niall Ferguson wrote that the current approach to bailouts in the eurozone, which at the moment appears to be the way things are playing out in Spain, makes matters way worse.Here are their thoughts:
The way out of this crisis seems clear. First, there needs to be a programme of direct recapitalisation – via preferred nonvoting shares – of eurozone banks, in the periphery and the core, by the European Financial Stability Facility and its successor, the European Stability Mechanism.
The current approach of recapitalising the banks by the sovereigns borrowing from domestic bond markets – and/or the EFSF – has been a disaster in Ireland and Greece: it has led to a surge of public debt and made the sovereign even more insolvent while making banks more risky as an increasing amount of the debt is in their hands.
Europe also needs to prevent a run on its banks:
Second, to avoid a run on eurozone banks – a certainty in the case of a Greek exit and likely in any case – an EU-wide system of deposit insurance needs to be created.
The other major item missing from Europe’s plan to clean up the euro mess, according to Roubini and Ferguson, is a change of stance from Germany and the core on moving closer to fiscal union in the form of eurobonds or some other mechanism.
On fiscal union, Roubini and Ferguson suggest that the European Redemption Fund might be the way to go at this point:
Finally, given the unsustainably high public debts and borrowing costs of certain member states, we see no alternative to some kind of debt mutualisation.
There are currently a number of different proposals for eurozone bonds. Among them, the German Council of Economic Advisers’ proposal for a European redemption fund is to be preferred – not because it is optimal but because it is the only one that can assuage German concerns about taking on too much credit risk.