by Tito Boeri
The leaders of the eurozone finally agreed on a plan. It is a very ambitious rescue plan, as it should be, to stop the self-fulfilling prophecies that brought us to the brink of another Great Depression. But the plan should now be made acceptable also to European citizens.
In the next couple of weeks we shall see how effective these extreme measures are in reducing the spread between Euribor and the ECB refinancing rate. If they are successful, there will be no need to implement these measures. If they are not, public debts in the eurozone are bound to skyrocket. If they only partly succeed in reassuring markets, there will be sizeable outlays to the banking sector. The insurance on the interbank market is potentially very costly – before the crisis the overnight volumes in many Euro countries were of the order of 1-2 per cent of gross domestic product – while the bank recapitalization plans commit so far up to 20 per cent of the eurozone GDP and this share is bound to increase further as national plans are unveiled and countries are forced to raise capital to match the core tier one levels of UK banks (too bad that there was no cross-country co-ordination in this respect!).
Is public opinion in the EU ready to accept such potentially massive transfers of resources from the taxpayer to the banking sector? True, it is mainly gross debt that will increase. By selling assets later on, net public debts may actually go down when the crisis is over. It is also true that in saving the banking system we ultimately save our economies and million of jobs. Nonetheless, there is a non-negligible risk that plans committing large resources to bank rescues will find strong opposition in national parliaments. Read more
by Christopher Carroll
In the past decade or so, an economist asked to tell a horror story over toasted marshmallows at a cookout would not have conjured up empty McMansions haunted by sub-prime ghosts (though in retrospect that would have been a pretty good tale). Instead, among friends, if the mood was right, we might say to each other in a spooky voice “think what will happen if the baby-boomers all decide to cash in their stock investments at the same time!” Followed by nervous laughter and a quick change of subject.
At first blush, it seems that we were barking up the wrong tree. Today’s global conflagration originated in the market for sub-prime mortgage securities, which has little evident connection to boomer retirement investment decisions. It is easy to follow a direct chain of links from the sub-prime sparks that first flared in the spring of 2007 all the way through to last week’s stunning losses in stock markets around the world. Read more
By Viral V. Acharya
The G7 and Eurozone meetings have raised hopes of expedient recapitalization of several banking sectors with the use of public funds. Such recapitalization is rightly aimed at shoring up equity base of the highly leveraged banks whose capital is essentially eroded, and of better-capitalized banks whose equity base has suffered too due to a spillover from adverse news about the highly leveraged ones. In light of this much-needed response to the global financial crisis, it is important to remember that following the first round of recapitalizations, regulators should and will look for ways to “clean up” the system. To this end, well-capitalized banks and financial institutions need to be given incentives to acquire weak banks sooner rather than later. Read more
By Benn Steil
Given the unprecedented credit market turmoil and central bank interventions of recent days, the US government’s mammoth $700bn Troubled Asset Relief Program (TARP), approved with great haste and huge expectations just a few days prior, is already looking like a sideshow. If the Federal Reserve is to return to being a lender of last resort, rather than first resort, Treasury Secretary Henry Paulson needs immediately to get TARP front and center of the economic relief effort.
The reason TARP has failed to calm the markets is that it is still almost completely undefined. The universe of troubled assets that the Treasury could potentially buy is far too large for anyone to speculate as to its likely economic effects. It is therefore critical that Secretary Paulson significantly narrow the scope of the intervention in a way that is clearly and transparently connected with the two most urgent tasks: reviving the credit markets and preventing a spiraling freefall in the housing market. Here is how it should be done. Read more