Back to the Drawing Board for EU Rescue Plan

Sources: Financial Times- Europe’s Banking Crisis Needs a Common Solution, Sarkozy Recoils from EU-wide €300bn Bail-out, Europe Facing Tougher Time Than U.S., Europe Split on Bank Rescue Fund

The past two weeks have demonstrated that the $700 billion bailout by the U.S. government will not be enough to thwart financial crisis in Europe. The EU has also learned by U.S. example that rescuing one bank at a time does not avoid a widespread systemic meltdown, especially because the financial systems of the EU member nations are so strongly intertwined. While Europe does not have an underlying mortgage crisis, its main problem is the dangerously high leveraging characteristic of nearly all European banking giants. The key difference between the U.S. and European rescue approaches is that the EU aims to help bail out banks from bankruptcy, while the U.S. will buy toxic mortgage assets and retain them until their value is restored to provide market liquidity.

On Wednesday, Sarkozy hosted a summit where he presented a plan to create a joint funding pool, to which each of 27 member states would supply an apportioned amount of up to 3% of its GDP. A frustrated Sarkozy quickly disassociated himself from the plan after critics such as Germany and the UK opposed it. European Central Bank President Jean-Claude Trichet agreed with critics, saying that Europe’s lack of a federal budget make it ill-suited to support a united €300 billion bailout. Spain, Belgium and the EU finance ministers, who were not invited to the summit, warn that Sarkozy does not have the authority to make a joint decision on a rescue plan. The EU now finds itself back in the divided and uncooperative position where it started.

Also today, ten leading economists released a report proposing the following solutions to decelerate the crisis: 1) injecting capital/public equity into EU banks; 2) instating government-backed mortgage guarantees; 3) creating a "bad" bank to hold the toxic assets of failed banks; and 4) accepting common standards for bank deposit insurance. This last proposal, especially, comes in the wake of Ireland’s controversial decision to guarantee the debts and deposits of its six largest lenders, thereby drawing investors and funds out of British and Scottish banks where such a policy has not yet been established. Reports were just released that Greece is pondering a similarly problematic guarantee.

Discussion Questions:
1. Do you think the EU states should come together for a joint solution or manage the crisis separately?
2. If a rescue fund is created, how should contributions to the fund be decided? GDP as France has suggested? The amount of money needed to bail out a country’s banks? A country’s banks’ impact on other EU banks?
3. In what order should the money be allocated? Should countries in the worst shape or countries needing the smallest amount to stabilize be allocated funds first?