Europe Is All Better (As Of January 2013)

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Ooh look there's another Europe thing. In this thing, Europe, in the form of the almost-existing ESM,* will take equity (?) stakes in troubled Eurozone banks, rather than its previous plan of buying senior debt of troubled Eurozone sovereigns so those sovereigns can invest the proceeds in equity stakes of their troubled banks.

There has been a lot of talk about collectivizing some European government debt, with people proposing plans in which Europe as a whole would be responsible for the amount of each country's debt under X% of GDP, or over Y% of GDP, or other. You can think of this as sort of a more financialized, more palatable, and more targeted version of that: instead of collectivizing an arbitrary dollar amount of each country's sovereign debt, you collectivize the amount needed to bail out that country's insolvent banks. This favors peripheral countries (because they have most of the bad banks, or at least the bad banks whose badness expresses itself in the form of insolvency rather than criminality), yet also has a certain appeal to Euro-core financial bureaucrats because the collectivized debt is going to bankers like them rather than to over-vacationed Greek pensioners etc. And money being fungible it's not the worst outcome for the pensioners etc. either.

The other thing about this new Europe thing is that the EFSF/ESM can stabilize peripheral government debt in the market without imposing new austerity conditions and without taking seniority, though people have doubts about that because you can always flip yourself into seniority if you're the lender of last resort. And there are many other details to be worked out and I invite you to read about them from someone who knows something about them. But the new news is the bank capitalizing, and that seems promising; the syllogism is I guess (1) this is TARP and (2) TARP kind of worked, ergo (3) this will kind of work.

One big detail to be worked out is that the new money for banks is contingent on a Eurozone-wide banking regulator: once a banking regulator is in place that basically allows Germany** to regulate Spanish banks, then Germany will give Spanish banks money in the form of equity investments. Then the banks will have money, which they will like, and the Germans will have the inner peace that comes from knowing that they can tell Spanish banks what to do, which they will like (also this), so everyone will be happy. So far everyoneis.

European leaders have taken can-kicking to a level of artistry and sophistication never before seen, so it's no surprise that the banking bailout is contingent on setting up a new continent-wide banking regulator by January 2013: why not take credit now for something that you might do in six months? Still it's a bit weird. In the private world if Thing A wants money and Thing B wants some control over what Thing A gets up to, the approach that they take is that Things A & B sign a contract (called an "investment agreement" or "stock purchase agreement" or "merger agreement" or what have you) in which (1) Thing B gives Thing A the money that Thing A wants and (2) Thing A gives Thing B whatever governance and veto rights Thing B wants.

Why not do that here? Why not have ESM/Germany/whatever offer to give Spanish banks money in exchange for preferred stock that lets the ESM/Germany or its designate (the ECB, German banking regulators, Sheila Bair) tell those banks what to do? One answer is that Germany, the ESM, the ECB, etc. are not set up to tell Spanish banks what to do yet, and getting them set up to even know what to ask for would require the same level of politicking as getting the new regulatory system in place. This is perhaps true though my uninformed intuition is that it is easier politically and otherwise to set up a body to supervise banks in exchange for money (seriously, one sentence in the contract, "you will do whatever Sheila Bair tells you"; she's a disinterested third party, looking for something to do, and her stock seems to be on the rise) than it is to set up a Eurozone-wide banking regulator that as one guy says "amounts to states giving up their sovereignty."

Another answer is that there's a prophylactic element to doing it by regulation rather than contract: the goal is not to tell Spanish banks what to do after they get a bailout, but before they need one. This is obviously true in the longer term though much, much, much less obviously true in the shorter term in which to some approximation every Spanish (Irish, etc.) bank either already needs a bailout or is never going to get one.

I suspect the main answer is just a bureaucratic resistance - shared by US bureaucrats, who tried to make TARP governance-free, and UK bureaucrats, who are getting tied in knotsover their RBS and Lloyds ownership - to doing market-y things with their equity stakes in banks. That's probably a good thing in the long run - those bureaucrats are better set up to be regulators than owners - but it does seem to have the effect of making everything they propose into a very long-run effort.

Encouraging blather [EU]
Europe agrees deal for struggling banks [FT]
Euro Zone Sees Single Bank Supervisor [WSJ]
EU deal for Spain, Italy buoys markets but details sketchy [Reuters]

* Except modified to be able to do this thing, instead of the thing it was previously set up to do.

** Obviously this is wrong and it's the ECB that will regulate and the ESM that will give money (but the EFSF will give money until the ESM is online) etc. etc. etc. but let's talk like humans and pretend it's German money and Spanish banks.

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