An unacceptable plan
It would be a crucial mistake for the euro if Europe accepts haircuts on Spain and Italy's debt
Europe would be committing an historical and probably lethal error for European economic unity if this weekend's summit were to accept the idea of a haircut on Spain and Italy's sovereign debt in calculating the recapitalization needs of the European banks. The European Banking Authority (EBA) is planning to calculate recapitalization requirements on the basis that Greece will fail to repay 60 percent of its debt, Ireland and Portugal 40 percent and Spain and Italy 20 percent. That is, it throws into question the ability of Spain and Italy, countries that have not required a bailout and most probably will not need one, to repay their sovereign debt. This is the umpteenth resurrection of the idea of two Europes, the first of which includes countries such as France, Germany and the Netherlands, and the second made up of peripheral countries: the Mediterranean plus Ireland and Portugal. All in the same wagon regardless of whether or not they meet their commitments on debt and the deficit. It's the old farce that while central Europe is on the job, the south is taking a siesta. The indignant response of the Spanish banks and Mariano Rajoy's call for a vigorous response by the Spanish government are more than justified.
The EBA's cack-handed approach starts by raising the Tier 1 core capital ratio for all the European banks to nine percent from seven percent when it is evident that not all lenders need fresh capital. An unjustified increase in capital requirements would bring about further restrictions on lending without achieving an improvement in the situation of the banks. A bad move during a credit drought. It would not be untoward to suggest that since there are French and German banks weighed down by their exposure to Greek debt, the EBA's strategy is to place the ills of some on the shoulders of all.
But where the error degenerates into tragic fatuity is in the proposal to cut the value of the sovereign debt of countries such as Italy and Spain. Nobody would come up with the idea of cutting the value of the debt of a company with a double A rating by 20 percent; nobody, except in a moment of temporary madness, would suggest that Spain and Italy are not going to pay back 20 percent of their debt. With this crude and economically hostile proposal, the EBA is claiming that the deficit- and debt-deduction commitments taken on by Spain serve no purpose, and that it would not matter if the Spanish government were to drop restrictions on the budget to balance its books that have cost so many jobs. The EBA is poking fun at the recommendations of European summits that postulated the need for fiscal stability as the only requisite conferring solvency on national debt.
The farce does not end there. Why 20 percent and not 10 or 30 percent? Who is calculating the loss and how are they doing it? Surely the European authorities will have realized that such a poorly conceived and toxic proposal is an open invitation to a deterioration in asset quality. It shows the way for speculators to get rich quick by short selling.
For all of the above, the recapitalization method suggested by the EBA should be thrown out by the summit. The Spanish government should reject any such plans and refuse to accept them if they happen to be approved, because they would mean the beginning of the end of the euro.