"Open Letter to European Leaders on Europe’s Banking Crisis"

A call to action on Europe's banking crisis:

Open Letter to European leaders on Europe’s banking crisis: A call to action, by Alberto Alesina, Richard Baldwin, Tito Boeri, Willem Buiter, Francesco Giavazzi, Daniel Gros, Stefano Micossi, Guido Tabellini, Charles Wyplosz, Klaus F. Zimmermann: Europe is in the midst of a once-in-a-lifetime crisis. Every European knows what happened when financial markets seized up in the dark years of the 1930s. It is not an exaggeration to say that it could happen again if governments fail to act. We are not predicting that it will happen, but it is critical to know that this is what is at stake.

Trust among financial institutions is disappearing and there are risks that fear will spread more widely. Turmoil in financial markets must be stopped before it causes major damage to the real economy. The savings of hundreds of millions of Europeans are directly threatened. If the turmoil produces credit market paralysis, jobs and businesses will be destroyed on a massive scale. A further weakening of the real economy would put more loans at risk and create a vicious cycle of falling asset prices, deteriorating ability to repay loans, and diminishing credit flows.

Actions by US policymakers are welcome, but they are not sufficient. Decisive policy action is required in Europe as well.

Policy spillovers: European-level actions to supplement and coordinate national actions

The US authorities learned last week that saving one bank at a time won’t work; a systemic crisis demands a systemic response.

In Europe, saving one bank at a time means either a rescue effort mounted by one nation, despite important spillovers to neighbouring countries, or last-minute improvised coordination and agreement about fiscal burden sharing. The national responses and ad-hoc cooperative efforts to date have been useful. Yet interdependence among European banks is too deep and too wide-spread for national responses or case-by-case coordination to be enough. Each national policy intervention and each cooperative intervention by a small number of countries can have unpredictable implications for other European nations. It is critical that national authorities sit together and coordinate their responses, developing Europe-wide solutions where appropriate.

Now is the time to act while the situation still appears manageable. Last week’s events in the US demonstrate that financial crises do not evolve smoothly and predictably. One unexpected event can trigger a cascade of failures and panics that become increasingly difficult to control.

Solutions

Many solutions will be part of the answer. In the US, dealing with the immediate crisis requires restoring liquidity to money and credit markets, and creating the conditions for the resumption of the securitisation of prime mortgages and other illiquid but sufficiently homogeneous and transparent assets. In Europe, the key problem is high leverage among the internationally active large banks. Hence the EU contribution must be centred on a recapitalisation of the banking sector, through the injection of public equity or through mandatory debt-to-equity conversions. This has to be done at the EU level (e.g. through the EIB). The current approach of rescuing one institution after another with national funds will lead to a Balkanisation of the European banking sector. Agreeing a harmonised level for deposit insurance would also be important.

To prevent future crises of this nature, regulation of the European financial markets and institutions at the European level will also be required.

The problem is not a lack of understanding of how to stop financial crises. The problem is a lack of political will.

Unless European leaders immediately unite to address this crisis before it spirals out of control, they may find themselves fighting over how best to salvage the aftermath.

• Sign the letter (All economists are welcome; bona fides will be verified before posting names so there may be some delay)
• View current signatories by most recent signatory or sorted alphabetically by surname.

Comments

[Anonymous]

Every European knows what happened when financial markets seized up in the dark years of the 1930s. It is not an exaggeration to say that it could happen again if governments fail to act.

I dislike this statement.

says...

I live in Bulgaria which is situated in the Balkans and I don't like the expression "lead to a Balkanisation of the European banking sector". Here we do not have your problems.

I think that the greed that ruled the European banking sector lately was huge. The cure for it is the falling down of the most greedy ones.

If politics save them now with money from their electors this will ruin any discipline in the near future.

[Ranjit Mathoda]

Warren Buffett says European banks made the mistake of trusting geeks with computer models: http://mathoda.com/archives/433

[hari]

This is non-starter by FT libertarians!

ECB framework is not developed like US/Fed and will take a lot of time to be fully operational in trms of raising capital for EU banking institutions - currently responsibility of member states (not ECB).

However, I expect Ecofin/ECB to deal with their policy framework going forward after current (US) credit crunch
and subprime fraudulent marketing/pricing thruout EU banking sector. This will take time and eventually there will be a mechanism to deal with future banking liquidity emergencies and ECB will also have new statutues under Lisbon Treaty.

[obey]

hari says "This is non-starter by FT libertarians!"

- The proposal is to use the EIB's balance sheet to recapitalize the banks. That does not require any involvement by the ECB, only perhaps a rejigging of the EIB mandate by the board of governors - i.e. the EU member states.

[anne]

"The current approach of rescuing one institution after another with national funds will lead to a Balkanisation of the European banking sector."

"I live in Bulgaria which is situated in the Balkans and I don't like the expression 'lead to a Balkanization of the European banking sector.' "

"Balkanization is a geopolitical term originally used to describe the process of fragmentation or division of a region or state into smaller regions...."

Thank you for explaining the objection, but I imagine the term Balkanization is always misleading and doubtful when used in historically fragmented western Europe.

[anne]

"Every European knows what happened when financial markets seized up in the dark years of the 1930s. It is not an exaggeration to say that it could happen again if governments fail to act."

"I dislike this statement."

Agreed completely, the statement as such is totalitarian or authoritarian in tenor, the statement is in effect no more than a personal threat by the letter writers.

[anne]

So, a few days difference in policy from that which is the right and true prescribed policy could just possibly set Europe politically in the 1930s. Is the no longer the slightest sense of what a heritage of democracy may be or what being offensive is?

[Andrew]

I dislike the statement, as well. Particularly considering that Europe better positioned to find an FDR or two, while the US...well, the US hasn't had such a great track record these last few years.

[Lafayette]

hari: However, I expect Ecofin/ECB to deal with their policy framework going forward after current (US) credit crunch and subprime fraudulent marketing/pricing thruout EU banking sector.

Not to mention that of the $700B, $250B is earmarked to repurchase European bought SIVs. At today's rate, that's more than 175B euros.

The European's are just as affected by the lack of credit confidence, but the actual holdings of the Toxic Waste are far less.

Still, without basic inter-bank trust, overnight banking credit freezes.

[hari]

Marquis - ECB problem is that policy mandate is still in development stage and the process will only become a bit more manifest and normative - compared to Fed - when Lisbon Treaty comes into force in 2010.

Meanwhile, imagine ECB cannot or law doesn't allow it to enter or intervene in member CBs policy constraints. Unlike Fed, which can create (literally!) credit facility out of thin air, as we saw in case of AIG, ECB cannot.

That's why Sarkosy is calling European G-7 Govs to summit to discuss the financial crisis: meaning what's EU policy?

[hari]

Obey - I don't think you understand the mandate of EIB. For example, when Sweden/Denmark decided to go ahead with the bridge across Oresund, EIB provided the bridging finance. It does that for almost all EU transnational transport projects.

FT Libertarians are not followers/supporters of EIB mandate. They're principally interested in injecting credit into EU banking sector - a la America - which will not happen, for your info. EU doesn't have the same level of toxic CDS in its banking balance sheets, although three or more are currently under rescue.

BTW I'm a Swede and retired from EU. I shld have told you on another threat when dealing with Carl Bildt's nationalization of banking sector, in 1992, crisis.

[hari]

Moreover, UK/Sweden/Denmark are outside Euro currency. There is one bank currently under rescue in Copenhagen. But the crisis in Lon/City is more serious, specially for FT journalists.

[BJ Feng]

From what I understand, European banks are much more highly leveraged than US banks in that their loan to deposit ratios are higher. They may or may not have as many toxic assets, I heard that a lot of the worst crap was sold to German institutions, who had no idea of what was going on in the real estate markets here, and relied solely on ratings.

That being said, the housing decline in Spain and Britain is even more severe than it is in the United States where the housing bubble was contained to select States such as California, Nevada, and Florida.

Plus, from what I've read, several European countries have draconian foreclosure laws that make it impossible for lenders to foreclose without waiting years. In the US, foreclosure takes less than a year, the market is allowed to correct and deadbeats can't squat on the lender's property for years.

If anything, I thought that Europeans would be more open to government intervention. I can't believe there would be any philosophical objections, I mean doesn't government bail out failing corporations all the time? This should be business as usual for Europe where they have a social contract to intervene for the sake of the common good. Look at Italy spending billions to help an airline that deserves to die. Why don't they just raise taxes on the rich? Are there any rich left?

[obey]

hari - Getting back a bit late to this. The EIB's mandate is actually quite open - helping to fund major private and public projects that are of interest for the EU. If you look at the people working there, the way in which they lead funding operations in the capital markets, their impressive reputation in regard to due diligence, they seem to me the best the EU can do to an efficient and timely government led recapitalization of the banks.
Obviously, to the extent that one thinks such recap-ing is the right thing to do, which you don't seem to...

[Lafayette]

hari: ECB problem is that policy mandate is still in development stage and the process will only become a bit more manifest and normative

Agreed, which is why interventionist France is trying to get a "common plan à la Paulson" going, when Britain and the Netherlands are reluctant to have any further state intervention whatsoever.

This cacophony arises, I think, because each country sees the problem differently. At any rate, Trichet sees this as uniquely an American problem, which the US has the duty and obligation to repair, since it is the perpetrator of the fraud.

I guess he figures that the Paulson Plan will work as designed, if it passes. Not a bad guess. But, as you say, his hands are tied. He is not and cannot be a Bernanke.

The question of "What Europe?" amuses some. A long time ago, when Kissinger was at State, he asked the question, "When I want to call Europe, I call who?". That is Europe's major problem that continues to plague its status on the international scene.

[Lafayette]

obey: The EIB's mandate is actually quite open - helping to fund

The EIB has a total budget of 165B euros, most of which is committed already to investment projects.

Don't you think that what it might be asked to do is well beyond its means? And, for further capitalization it would have to go hat in hand to its shareholders, the 27 nations of the EU.

Within which there is NO AGREEMENT whatsoever for any particular action or inaction as regards this subprime mess.

Finance is like an Army. It is as effective as one is able to project it. (Anecdote: As Stalin once said of the Pope, "He has how many divisions, this guy?")

[Lafayette]

BJF: They may or may not have as many toxic assets, I heard that a lot of the worst crap was sold to German institutions, who had no idea of what was going on in the real estate markets here, and relied solely on ratings.

These will (supposedly) be recuperated by the Paulson Plan, for which about $250B is earmarked for toxic waste sold fraudulently abroad.

We shall see.

[Lafayette]

BJF: They may or may not have as many toxic assets, I heard that a lot of the worst crap was sold to German institutions, who had no idea of what was going on in the real estate markets here, and relied solely on ratings.

These will (supposedly) be recuperated by the Paulson Plan, for which about $250B is earmarked for toxic waste sold fraudulently abroad.

We shall see.

[obey]

Lafayette: "The EIB has a total budget of 165B euros, most of which is committed already to investment projects."

I think your figure is their customer loan book. Their full balance sheet is somewhere north of 300 billion. But, yeah, still small for the task at hand. You could also add worries about the hit to their balance sheet they've presumably already taken due to the credit crunch - over a third of their assets are in 'credit institutions' of which I don't know the exact breakdown.

But reinforcing its equity position would involve pretty limited commitments from the EU members, and if the capital injection plan it could be mandated to coordinate (i) were well-aimed and (ii) involved private-sector participation (which is the EIB's usual modus operandi), it would only entail an expansion of its balance sheet on the order of 50-60 billion Euros. It seems feasible enough to me, and the most politically viable as well: all it requires is some broad pronouncement from the council of ministers, and then the details regarding disbursements left to their relatively autonomous loan-officers. Their due diligence procedures are quite solid and resistant to political pressure. But obviously, not perfect.

I gather from the rest of you that the other option of moving through the EIB, which I'm much less familiar with, would be a bureaucratic nightmare. So in an imperfect world...

[Lafayette]

Modern day bugaboo

obey: I think your figure is their customer loan book. Their full balance sheet is somewhere north of 300 billion.

I got my figure from the total shareholder allocations, found here So, you tell me.

I suspect that the 165B euro figure I mentioned is the total total. For any larger operation, the EIB would need the buy-in and funding of the shareholder states. And, given the present cacophony amongst them, such is not likely.

They are all hoping the Paulson Plan will work, largely because their own Treasuries are nearly broke. Europe is entering into a recession, likely, but it has been aggregately a small growth economy for more than a decade. Like France, once with large Treasury holdings (aka national savings), countries have been depleting resources to maintain what it believes is Social Justice. It is not just the downtrodden that should bear the brunt of dismal economic activity.

I'll not blame them for that. I blame them for not having acted soon enough to change that circumstance. Infrastructural obsolescence and an inbred unwillingness to change it are the modern day bugaboo of any advanced economy. People got too used to a comfortable lifestyle, adopting the hubris that it would last forever.

And their politicians were unwilling to tell them otherwise, spending money profligately whilst it was coming in, largely to get themselves reelected. National mentalities were ill prepared for the paradigm change that began in the mid-1990s.

That do-nothing mindset is beginning to change here in Europe as it must in the US.

[obey]

I clicked thru your link. That's the figure for subscribed capital, which is actually huge, its an equity position bigger than any private sector bank. However, as the page says, they have a statutory limit of 2.5 on their leverage, which crimps their balance sheet. In any case this means that, even without any further commitment from the member states, they can already expand their assets from the current 300 bn to almost 400 bn Euros, which should be enough if they start making capital injections before the banks' cash flow position erodes too much. In Europe there is still time.

[hari]

Marquis & Obey - On EIB mandate and current credit crunch.

First, you guys are right in suggesting EIB could open its open market funds to help monetary distress in member countries - q's which countries - Euro-17 or Euro-27???

In my time with EEC/EU I did a lot of work with project financing with EIB - which is not in Brussels - in Luxemburg.
In fact, there is no cash in Brussels. It's all with EIB in Lux. The auditors and their collegium is also in Lux. The EIB monetary base in Euro bonds has developed since Maastricht Treaty was approved and Euro came into replace national currencies more than a deade ago.

Mandate of EIB is strictly for financing approved infrastructure development on transnational basis, as a priority. If you recall 1987 entry of Spain/Portugal, lot of their structural deficits were financed by EIB.

What Sarkosy/Fillon are trying to enforce is to *open* EIB purse for what they consider legitimate policy inside EU under the current global financial pressure.

The Board of EIB is its final arbiter on all policy, and their members come from their CBs. In case, Germany reverses its policy to grant EIB the authority to *print* more Euros -which I don't believe it will do under current desperate circumstances - Sarkosy and Brown (not inside Euro) will not be able to push it thru.

The Euro currency realpolitik is what UK/Sweden/Denmark have to take into policy consideration - they can't have their cake and also eat it! German's will resist any such divergence of EIB funds to bailout banking sector in individual countries.

[obey]

Hari - "Mandate of EIB is strictly for financing approved infrastructure development on transnational basis, as a priority."

Just anecdotally from discussions with EIB loan officers, it does not seem that they feel particularly restricted to infrastructure projects national or transnational. I have no figures on this, though. I got the impression they were happy to get involved in funding pretty much anything where there is a plausible 'public good' argument with a decent risk profile. Not sure if that is a more recent development though.

"In case, Germany reverses its policy to grant EIB the authority to *print* more Euros -which I don't believe it will do under current desperate circumstances - Sarkosy and Brown (not inside Euro) will not be able to push it thru."

- I don't really see the political argument here. Expanding the EIB balance sheet does not involve 'printing' Euros, they fund their operations through bond issues in the credit market, for which demand ought to be very strong given their EU backstop. The 'current desperate circumstances' are precisely an argument In Favor Of such an expansion.

[obey]

Just took a look at the EIB site. Here is an example of the kind of funding they can provide to alleviate the credit crunch , even without actually taking the more politically problematic action of capital injection in banks:
http://www.eib.org/projects/press/2008/2008-087-eur-150-million-support-to-smes-in-greece-eib-joins-forces-with-piraeus-bank.htm

Sorry - don't know how to embed links...

[hari]

The underlying principle of European Investment Banks participation in member countries (SMEs) enterprises demands domestic collateral from originating member country - unless the project is approved at the political level of the Commission.

In other words, you can use any or all examples from their site, it won't change the way in which EIB decides how to utilize its funds or underwriting of securities.

[hari]

Figaro is discussing the return of Dominique de Villpein, ex-PM/FM of France under Chirac. Sarkosy actually chanrged him for accusing him in the Clearstream case in Luxemburg offshore banking account and whatnot. So, if Sarko is now seeking help from Villepein, it surely means France is not only in a recession but facing other serious policy constraints - under Kunchner (a not so knowledgeable FM).