If Euroland wants to avoid a bleak new year, they need to take some more action to see off future crises. They need a banks strategy and a growth strategy.
Fixing the banks requires looking again at all the weak banks. The Regulators need to work with them in private, and require them to improve their solvency as quickly as possible . Some have enough reserve already. Some will achieve it this year through profits and retained earnings. Those that cannot need to sell assets, write off bad and doubtful debts, raise new capital or some combination of the three to be in better shape. If a bank is scarcely solvent it needs to be harried to reconstruct itself before it jeopardises the whole system. Shareholders and junior bondholders should take the pain. Profitable parts of the busineses should be saved or sold, and bad businesses put into work out or administration.
The EU as a whole also needs to promote more vigorous private sector led growth. It could start by cutting its own budget sharply, to allow lower taxes or less public borrowing in each member state. It should follow up by substantial deregulation, making it easier to set up a new business in the EU and cheaper to undertake business in the EU.
Member states in Euroland need to take action to rein in their own budget deficits, as some are and all are required to do. This will be easier if output and tax revenues start to pick up more rapidly.
The European Central Bank needs to stand behind all major banks in the Euro area and provide as much liquidity as they need. During the restructuring period it would not be helpful to seek premature repayment of the special facilities made available. Money supply is very restricted in the Euro area. The Bank needs to help rebuild confidence so it starts to expand a bit more.
Working towards a solution for the banking crisis needs to go hand in hand with curbing state deficits. The Regulators have made the banks hold large quantities of government debt as their prime assets, claiming this is “risk free”. The Bank of England and other Central Banks have made commercial banks buy more government bonds to hold as extra liquidity, getting them to pay high prices by historical standards, and setting them up for major losses should bond rates rise. At a time when Germany can still borrow for ten years at 3.1% Greece has to pay 11.9%, Ireland 8.5%, Portugal 6.4% and Spain 5.5%. If other countries join the danger list, or if there is further deterioration in these countries credit rating, it will simply weaken European banks more.