The Corner

It’s Still The Politics

Writing in the Financial Times yesterday, Roger Altman warns (correctly) that both the U.S. and Europe are on the edge of recession. He points the finger . . .

It is the debilitating sovereign debt crisis in Europe that is pushing both regions back towards the brink. It is causing credit conditions to tighten again for sovereign credits, weaker borrowers and small and mid-sized business. It also is suppressing consumer and business confidence and the export outlook.

The never-ending nature of this crisis was avoidable. At every opportunity Europe’s leaders have delayed, taken the tiniest steps possible and generally averted their eyes to the elephants in the room.  Yes, everyone knows that the country-by-country politics are difficult, starting with Germany.  But the risk of another Lehman-like market collapse and subsequent economic contraction is huge. Faced with this, European leaders must confront the politics. Instead, their grudging incrementalism is deepening the risks. Implicitly, this was the message behind Treasury Secretary Geithner’s presence in Poland last week.

Ah yes, the politics. To understand why the politics are such a problem, take a look at what Mr. Altman suggests:

A single currency representing 17 separate nations inevitably requires a unified balance sheet behind it and, following that, a form of fiscal union.  The time for denying the latter is over. The European financial stability facility must be enlarged exponentially so that it can stand behind nations such as Italy or Spain. In addition, the mandate of the European Central Bank must be expanded. Just like the Federal Reserve, it should be responsible for maintaining a sound banking system and stable capital markets. This requires a permanent capacity to finance banks directly, just as a group of central banks did last week. It also requires the flexibility to buy and sell sovereign debt securities in secondary markets. These reforms must be accompanied by tighter, eurozone-wide bank regulation and supervision. It also requires IMF-like conditionality to accompany direct EFSF loans to member nations. Finally, the ECB should ease monetary policy now as there is no visible inflation risk.

In a way, and in the short term, he’s right. The notion of a “stand-alone” single currency was always an idiocy. Giving it the sort of proto-federal backing suggested by Mr. Altman makes better sense, even if the longer-term economic consequences of such an evolution would be malign (it would doom the periphery to stagnation and the center to a tremendous fiscal burden), and the political results disastrous. The problem, however, is that there is limited evidence that the taxpayers who would have to fund such an arrangement are prepared to support it, particularly in Germany. And it’s hard to blame them. German voters never wanted the euro, and were never given the chance by their political class  to say no. Adding injury to injury, the promises that were made to them about their new currency have been shown to be false.

That something needs to be done if the current crisis is to be contained, however, is beyond question. A key element needs to be the co-ordinated recapitalization of those of the large core-Eurozone banks that are dangerously exposed to the periphery. That is something that can be done, and should be done, at the national level. And it should be done now. The Swedish experience in the early 1990s (the country went through a deep banking crisis at that time) might suggest a few pointers.

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