This is an excerpt from Building a Crisis Management Framework for the EU that we wrote for the Crisis Committee of the European Parliament and then presented at the European Commission. Much of the discussion in this paper remains highly relavent and provides a useful guidance to policy makers about what they need to do after stemming the panic in the markets so you would want to read it.
Despite the fact that the discussion of the euro area crisis has focused primarily on issues in the sovereign debt market, it is instructive to remember at the outset that this crisis is not primarily a sovereign crisis but one that originated in the private financial sector. As often happens in credit crises, private sector debt is taken on to public balance sheets which makes them fragile and can, as in this case, result in serious dislocations of the sovereign debt market.
Note: This is my response, in the Financial Times A-List, to George Soros\'s suggestion that the the EU guarantee its banks. Re-Define believes that the most sensible thing to do is to first reassure the world that sovereigns such as Italy and Spain are sound
George Soros is right in saying the discussion on recapitalisation of European banks is flawed. However, the best way to address the panic in the banking system is not through guaranteeing the banks, but through restoring full faith in the solvency of large Eurozone economies instead.
Weaknesses in the European banking system have been known for some time, so why the sudden panic?
European Union policymakers have let Greece’s unique fiscal problems colour their prescription for countries such as Spain and Ireland which had banking, not fiscal, crises. Growth has also suffered in other countries, as austerity measures became fashionable. This economic slowdown, weak stress tests and the EU’s inability to handle the relatively small problems of Greece, combined to also erode confidence in Spain and Italy.
Development actors have long argued for an overarching international mechanism that would resolve sovereign debt crises in a fair, transparent, and consistent manner. Such a mechanism would assist poor countries that often suffocate under unsustainable levels of (sometimes odious) debt, lacking the political power and legal rights to negotiate with their creditors in an impartial and efficient forum. It would make handling sovereign debt problems less messy, more predictable, and the burden sharing simpler and fairer. It would also provide incentives to curtail irresponsible lending policies on behalf of creditors.