Many people in the EU think EU countries should be able to carry on with state spending at ever higher levels. They also seem to go along with a political class which by and large stands behind banks whatever balance sheet horrors they throw up, probably because the banks also lend lots of money to the governments. There has been no serious and widespread political move to apply more normal approaches to the near bankruptcy of some banks – requiring them to sell assets, cut costs, close down and write off poorly performing areas. All this could be done whilst still ensuring depositors were protected and a system collapse was avoided.
As a result we now have a combined banking and state debt crisis in several countries. The size of the banking problems guaranteed or supported by the state weakens the state. The size of the state’s borrowing and debt undermines the value of the state bonds the banks own. The two can move from propping each other up to threatening the solvency of each other.
So the argument is over who should pick up the bills for the excess spending and the losses? There are various candidates put forward:
1. Shareholders – after all they took the dividends in the good times, own the banks and have committed risk capital.Unfortunately now taxpayers own a lot of the shares in the weaker banks. Many shareholders have rightly lost out from poor banking.
2. Bondholders. So far junior bondholders have taken a hit in the weaker banks, but senior debt holders have not. Some say all bondholders should suffer losses in banks that need to restructure and write off losses. Others say to do so would make it much more difficult to refinance these banks. The EU seems to think bondholders after 2013 should be at risk but not current senior bondholders.
3. Depositors and other counter parties. There has been general agreement they should not lose money, other than in Iceland.
4. Taxpayers. In many cases taxpayers have been made to take troubled assets off the banks or to underwrite bank activities.
1. Some say the answer is simply to raise more in tax revenue. The private sector should shoulder more of the burden and pay up for the large public sector. Thoughtful politicians propose this should be done through more taxation resulting from growth in economic activity. Other politicians identify sectors like banks and oil companies, or rich people that they think could contribute more. All EU countries with a debt problem are aiming for more tax revenue. though the worst cases are suffering from falling output or slow growth making this difficult to achieve.
2. Some say there should be cuts in spending. Most countries at risk claim to be cutting spending, though it is often cuts in real terms not cash terms. The pace is variable by country but on the whole is slow compared to the scale of the debt build up.
3. Some say they should borrow more. If a country gets into trouble the IMF and EU should ride to its rescue with larger loans on easier terms. Otherwise countries should simply carry on borrowing very large sums on the public markets. The problem with this approach is you can get into a debt trap, where more and more spending is absorbed on paying debt interest, and forcing even more borrowing.
4. Some say countries should simply print more money to pay the growing bills. The sophisticated way of doing this is for the relevant Central Banks to buy in state bonds, keeping the interest rate lower than would otherwise be the case, and creating the money to do so. Critics say this simply results in inflation and a worse crisis in due course.
What should be clear to the political establishments is these problems do not suddenly vanish. If banks do not write off, cut costs and seek to get back to a profitable and sustainable level of business, they will need more support. If the action is delayed or ducked, it will be that much longer before the relevant economy has strong banks capable of normal financing of growth.
Nor does a state budget suddenly swing into balance or surplus because it has been able to borrow more. A sensible government works out what is its sustainable revenue, what level of taxation it can impose without damaging economic performance too much. It then budgets to spend that much and not more.
When will EU governments get it? Do you prefer any of the other options? How do you avoid a work out? Surely European countries need work outs not bail outs.