Sunday, 14 July 2013

Let's not waste a crisis!

This article was pubished in The Malta Independent on Sunday - 14 07 2013

There is one absolute certainty about how the EU works. It is 99 per cent talk, talk and yet more talk, and the real decisions that take the remaining one per cent are only taken when an impending crisis forces politicians’ hands to abandon their comfort talk zone and do what needs to be done to avoid being overwhelmed. A second near certainty is that when decisions are forced on EU politicians, quite often these are temporary measures that are just enough to tame the crisis without doing what really needs to be done to address the problem at its core.

It is in this context that I judge the Prime Minister’s action this week to raise the irregular immigration problem to crisis levels also in the context of Pope Francis’ visit to Lampedusa and the visit to Malta of EU President Van Rompuy. The only way to raise the issue to crisis level is by threatening to behave irrationally to mirror the irrationality of EU northern nations by allowing the full burden of the immigration problem to be shouldered by the southern border states.

Often the threat is more effective than the execution. And it is fair to presume that the Prime Minister used the threat knowing that once Europe is awakened from its slumber to smell the coffee, execution will not be necessary.

Malta is a generous nation. Our heart bleeds for the tragedies of each and every immigrant that is forced to seek refuge. But charity begins at home and we cannot sit idly carrying a disproportionate burden whilst the northern members pursue their talk-talk games about a human crisis unfolding on our shores.

If anyone wants further proof of the games that EU politicians play, one needs only observe what is happening in the limping measures being taken to resolve the euro crisis. The eurozone economy has contracted for six consecutive quarters. This week, the IMF revised its 2013 forecast down again: it expects the eurozone to shrink by 0.6 per cent this year. The outlook in the core eurozone economies has worsened but the brunt of the pain is being borne by the peripheral economies.

Greece is in its sixth straight year of recession; Spain’s unemployment rate stands at almost 27 per cent; Italy’s credit rating was downgraded this week. Years of joblessness, economic hardship and edicts from creditor countries are straining the political fabric in Portugal and Greece.

The bail-outs of Greece, Portugal, Ireland and Cyprus have saved these countries from economic death but rendered them permanent occupants of the sick bay with little prospect of a permanent resolution as austerity measures continue to crush their growth prospects.

Meanwhile, the euro area is holding endless meetings on how to avoid a future banking crisis. A new architecture is being put in place for having some sort of banking union, with a single regulator for the largest banks, a single resolution mechanism for dealing with banks that hit the rocks without burdening the taxpayers, and eventually a common deposit insurance scheme.
This is all well and good but it will lead nowhere because we are designing the roof without taking care of the foundations. It is necessary to make preparations for such re-designed banking architecture but, first and foremost, before preventing a crisis tomorrow we must resolve the crisis of today. We must clean up the banks to ensure that solid foundations are prepared for tomorrow’s re-designed architecture.

Banks are central to Europe’s prospects. The fear, especially in peripheral economies, is a repeat of Japan’s experience in the 1990s, when “zombie” banks staggered along for years, neither healthy enough to lend to firms nor weak enough to collapse. Without such effective credit channels, the problem economies will remain mired in eternal recession verging on deflation. Without effective transmission mechanism, the ECB monetary policy becomes sterilised.

The eurozone will not work without a banking union, but a banking union requires a bank clean up first, including the sanitation of German regional banks. Germany hints that it might consider taking on such mutual obligations in the future, but not now. The problem is that now is when the banks are half dead. Waiting for zombies to come back to life is a fool’s game.

There are many danger signs in Europe. The average price-to-book ratio for European banks remains below one, suggesting that investors think lenders are worth more dead than alive. In America, where banks were recapitalised quickly, the ratio exceeds one. Italy’s two big lenders, UniCredit and IntesaSanpaolo, have ratios of 0.34 and 0.42 respectively. Investors think such banks are worth only a fraction of the value they show on their books!

Why? Because the amount of shaky loans keeps climbing: worryingly, there are more non-performing loans in the Italian banking system than there is core capital. Lots of peripheral banks have been loading up on their own shaky governments’ bonds. Mortgages account for even more bank assets and house prices keep falling – at the fastest rate on record in Spain in the first quarter.
Loans to non-financial firms contracted in May by 4.1 per cent in Italy, five per cent in Portugal and 9.7 per cent in Spain. Banks in strong countries are lending less across borders. Lenders in weak countries pay more to borrow than banks in strong ones. This divergence ripples through to customers: the difference in the cost of borrowing between German and Spanish firms rose from a mere six basis points in the summer of 2011 to 149 basis points earlier this year. So much for the ECB low interest policy!

As long as Europe’s banks are not strong enough to lend, its economy will struggle to grow. The ECB will undertake an “asset-quality review” before it takes up the role of eurozone banking supervisor next year. Banks that fall short must be recapitalised – by raising fresh equity from private investors, by bailing in creditors and, in some cases, by bringing in public money.

But this would re-establish the pernicious link between weak banks and weak governments. Countries whose governments have been bailed out, and others like Spain and Italy that are undergoing deep restructuring to avoid having to request a bailout, are in no position to recapitalise their banks. Private equity has little appetite for bank risk.

It is high time Europe’s politicians give the ECB the green light to monetise the ESM so that this rescue fund will have all the necessary funds, without relying on approval from 18 national parliaments, to recapitalise zombie banks and bring them back to life through the only medicine that works: fresh capital. Exposing banks as under-capitalised without having a ready solution to recapitalise them is a sure way to create a crisis of confidence that could spread like wild fire.

The EU’s talk-talk politicians know that nothing will work before sick banks are cleaned up and recapitalised. Yet, as we saw this week, the EU continues to make grand plans for the future but only takes baby steps to resolve the problems of today. Greece was given another morsel of €2 billion from the pledged rescue funds, even though it is clear to one and all that Greece is getting nowhere and these funds will never be repaid. The important thing is that Greece does not blow up again before the German elections in September.

Only a crisis will force the EU into real action. Prime Minister Muscat did well to raise the irregular immigration problem to crisis level. The challenge is how not to waste this crisis.

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