By Kermit Schoenholtz, Professor of Management Practice and Director of the Center for Global Economy and Business, Matthew Richardson, Charles E. Simon Professor of Applied Economics, Sidney Homer Director, Salomon Center for Research in Financial Institutions and Markets and Professor of Finance & Thomas Cooley, Paganelli-Bull Professor of Business and International Trade
In spite of Sunday’s victory of pro- bailout parties in the Greek election, the European Monetary Union remains in a battle for its survival. What began as a debt predicament is now compounded by a rapidly expanding banking crisis and growing political instability that threaten European integration.
Recent European backing to stem the run on Spanish banks was a welcome step away from the prevailing position that fiscal and banking problems aren’t candidates for coordinated action. Unfortunately, the details of the support for Spanish banks are vague, and were insufficient to calm the financial markets. Instead, the yield on Spanish 10-year government bonds has risen above 7 percent to a euro-era high.
There is a good reason -- vague solutions that don’t address the integrity of the entire European banking system won’t work. Restoring confidence will require a full-fledged euro-area banking union, including common mechanisms to backstop bank liabilities and to resolve or recapitalize failed lenders. A common set of rules as the European Commission recently proposed isn’t enough.
With bank runs already under way, the immediate requirement is a euro-area Troubled Asset Relief Program like that used in the U.S. to clean up the banks during the 2008 financial crisis. The existing European Financial Stability Facility and the anticipated European Stability Mechanism aren’t up to the challenge. Both mechanisms provide funding to recapitalize banks through their sovereigns -- reinforcing the links between the banks and their sovereigns in a vicious cycle of declining creditworthiness. It also is unclear that they will have sufficient resources to meet the growing challenge.
Read full article as published on Bloomberg View