Economics – by invitation [Economist.com], 6th June 2011
Attempts to postpone Greek default seem sensible
OPINIONS obviously differ as to whether Greece will and should default, but there must be a high risk that it will and it seems generally agreed that this threatens to produce a banking crisis in the euro-zone. The most important action that must be taken is to prevent one.
There are many ways in which this could be done, but nationalisation is not one of them, as this only works for countries which own their printing presses. Either the banks need to have adequate equity capital or their deposits have to be guaranteed by an undoubted borrower. There seems no one who can legally take on the latter role. Banks everywhere are woefully short of equity capital, and it seems that those in the euro-zone are among the worst in this respect. Regulations therefore need to be changed so that euro-zone banks have adequate capital, even if they were to write down massively their holdings of Greek debt and any knock-on reduction in the value of other assets.
But there is no point in introducing regulations that cannot be implemented. The European Commision needs therefore to sponsor the creation of a fund which could underwrite new issues of bank capital. I have no idea about the legal issues that this raises but, as the devil is driving, it is a “needs must” situation. If created, it may not be needed. If the regulations required that banks with insufficient capital pay dividends and salaries in shares, rather than cash, banks’ management would have the necessary incentive (currently lacking) to raise new equity from shareholders.
As this underwriting entity is not yet in place, attempts to postpone Greek default seem sensible. If, as seems sadly likely, no underwriting entity is created, nor any other way established for ensuring that we avoid a euro-zone banking crisis, we must hope that Greek default can be postponed (preferably to the “Greek calends”) or that the IMF, ECB and EC will be able to plead with hindsight that, despite their failure to prevent it, the banking crisis was only a little one.