Thank God for José Luis Rodríguez Zapatero, the Spanish prime minister. For the first time in the three years since the outbreak of the financial crisis, a European leader has done something intelligent and surprising. Spain’s unilateral decision to publish the stress tests of its banks has bounced the European Union – at a summit in Brussels last Thursday – into following a Spanish lead, and to accept an uncharacteristic degree of transparency.
Does this mean that we are about to get on top of this wretched crisis? Well, so far, the EU has agreed to publish the stress tests of only 25 banks. They are not the main problem banks in the eurozone. There is a good chance that governments will extend those tests to other banks. But it is no reason to get too excited.
The fundamental problem is that governments are still fighting the wrong crisis. Global investors have recognised a fundamental truth, that this is not a sovereign debt crisis at heart, as Germany and the European Central Bank keep on telling us, but a banking crisis and a crisis of policy co-ordination failures.
Since the banks are guaranteed by their respective governments, most private debt is ultimately public debt. The European Central Bank and the newly created European Financial Stability Facility – the €440bn ($545bn, £368bn) special purpose vehicle to stabilise the European bond markets – will absorb billions of euros of junk debt which, on default, would trigger a massive redistribution of income from northern Europe to southern Europe. So far, this crisis has cost European taxpayers nothing. But that would change if, or when, some of the Greek debt gets restructured. That will not happen for three years. But, by then, most of that Greek debt would wind up in the hands of the EFSF and the ECB. A default at that point would confront the EU with a binary decision: either to go for fiscal union, or to break up. The investors do not know which way the EU will jump. Nobody does.
One conceivable strategy for getting out of this mess is to remove the lingering doubts about the banking sector. Except for Greece, the sovereign debt situation is under control everywhere. The problem is not the actual government debt, but the contingent debt, most of which is located in the banking sector. If there is more transparency about the banking sector, the situation would be eased.
If the publication of the stress tests would lead to a process of bank recapitalisation, we would be well on the way. But I do not see it. Germany’s bad bank scheme is so incredibly unattractive that hardly any banks have taken it up. Yet, the German government is in no position to force the banking sector to accept new capital. The Landesbanken – probably the biggest financial toxic waste dumps on earth – are controlled by the state governments.
The situation is not much better in Spain, where the Bank of Spain is already pushing hard for a consolidation of the cajas, the local savings banks. We will no doubt get a lot more bad news from the Spanish banking sector, as Spain goes through the adjustment. Having been sceptical about Mr Zapatero’s willingness to do what needs to be done, I am a touch more optimistic now. His recently decreed labour market reforms are a step in the right direction, but probably insufficient.
Elsewhere in the eurozone, there are several other trouble spots. France also has its share of poorly capitalised banks, and so do Austria and Belgium.
Uncertainty will persist, until we have a reliable estimate of the remaining toxic waste in bank balance sheets, and some resolution trajectory. The only information that was ever leaked in Germany was a worst-case estimate by the banking regulator a year ago of a total write-down volume of €800bn, about a third of Germany’s annual gross domestic product. I have no idea what the number would be today.
To resolve this crisis, we need to know those numbers and a lot more. Most importantly, the EU must set up a workable system of economic policy co-ordination, including a strategy to deal with resurgent internal imbalances. On that point, we are actually regressing.
The decision to publish the stress tests masked an otherwise disappointing European summit. After months of debate, all the European Council had to show was another stability pact and another Lisbon agenda – a now defunct growth initiative. One of the lessons of the early stability pact – from 1999 until 2003 – was that sanctions do not work, because they cannot be applied in the real world. The revised stability pact, agreed in 2005, moved away from an emphasis on sanctions to incentives. The idea was sound, but ultimately failed because of insufficient policy co-ordination. The decision to revert to the original sanctions-based approach is silly. If sanctions do not work, then surely, lots of sanctions are not going to work either. As for the Lisbon agenda, it is now called Agenda 2020, and it is just as hopeless.
What has become clear in the last few months is that Herman Van Rompuy, the president of the European Council, is not providing sufficient leadership to move the process forward. Without a plausible end game in sight, I would expect investors to continue to place bets on the eurozone’s demise.