According to Foster, the economic crisis that is experienced in Europe is not an accident. It is completely an outcome of the basic policy mistakes that started being committed a long time ago and since then; they have been intensified in the course of time. It is believed that there are two main mistakes that have brought about the economic crisis.
The first mistake is the adoption of a single currency, a move that was taken in the recent times, with no economic policy infrastructure in place that is vital for offering it protection (Foster, para 3). “Without arguing the wisdom of the Euro one way or the other, the fact is that if it were purely a matter of economic policy, the Euro could have succeeded as envisioned” (Foster, para. 3).
But prerequisites existed which were related to “harmonization of labor policy, commercial policy, environmental policy and so forth, and in the absence of these it was imperative to harmonize fiscal policies” (Foster, Para 3).Progress was made by Europe to a significant level in particular areas but little was done in some other areas.
The other big mistake that was made was adopting a generous “social welfare state without attending to the pro-growth policies necessary to sustain such a state in light of an increasingly competitive global economy” (Foster, para 3).
Where there is no increasing global competition a “slow-growth big government economic model” is viable. In the presence of severe and increasing external pressures, the economic growth in Europe resulting from increasing productivity as well as improved economic competitiveness is not just of benefit but it is as well vital for the survival of a nation (Paulo 2).
The problems arising from the European crisis that are face by the financial regulators are going to be looked at and the possible measures to deal with these are also going to be presented.
Problems Faced by the Regulators Following the Crisis
In order to avoid ending the use of a single currency, the E.U must, at the present, set up a credible plan to deal with the future of the Eurozone. Only a proposal that considers the following four problems would be reliable and will convince markets to start again financing on a sustainable base. One of the problems, which are a painful realty, faced by the E.U is that some of the nations will not be in a position to pay back their debts and the default can not be avoided.
This is a realty that must be acknowledged by the E.U. The first country to do this is Greece. However, Greece’s default in isolation would be controlled with ease since the funds involved are modest. However, the moment Greece defaults, there is a likelihood that other nations would follow suit. “Even if a rescue of Greece, Ireland, and Portugal is affordable, there could be no realistic way of preventing Spain from taking the same course” (Giavazzi and Kashyap, para 2).
Another problem is that the banks in Europe are in danger since they possess significant amounts of the government debt. While the defaults get closer, the banking systems all over Europe could be exposed to an “epic run”, while those who deposit as well as institutions ceases to be the banks’ customers in order to avoid incurring losses. The financial system in Europe is a “bank-centered” system. “A run would cripple credit flows, plunging the Eurozone in to recession and creating a global financial crisis” (Giavazzi and Kashyap, para 3).
Another issue is that, a program which guarantees the debt of all the nations is now in danger. Even if the nations such as France, Germany and other nations had wishes of offering a ‘blanket guarantee’, “the amount of money that was involved, which was about three trillion Euros, would compromise these countries’ credit ratings….having Spain as well as Italy in play, a full guarantee isn’t an option” (Giavazzi and Kashyap, para 4).
In addition, whatever rescue measure that can be taken has to go hand in hand with the steps to bring back growth and this is for the reason that there is no chance of paying back debts in the absence of economic expansion. Apart from Ireland, countries such as Italy, Spain, Portugal and Greece face “chronic problems”.
For instance, the per capita GDP of Italy has gone down, lower than it was twelve years ago. In case these nations do not take measures that will enable them to grow again, “even a large haircut on the existing debt won’t prevent the problems from re-emerging in a decade”(Giavazzi and Kashyap, para 5).
The crisis in Europe came about because leaders in the region have not considered these constraints. This is the reason why several measures that have been taken within the last two years have not led to convincing the markets. It is quite unlucky that, in the face of these painful realities that have been presented above, no easy way out do exist. However, there is hope of getting out of these if some particular measures can be keenly taken.
Measures to be taken
One of the measures that have to be taken to deal with the European economic crisis is to put in place a strategy that focuses on strengthening banks to a level that they can bear up with a sovereign default. As pointed out by Giavazzi and Kashyap, the European powerful countries are supposed to “pool their money and expand the European Financial Stability Fund to the point where it can backstop the banks against all losses from potential defaults” (Giavazzi and Kashyap, para 9).
The scale has to be adequate in order for it to as well cover the ensuing losses which the banks experience following writing insurance against a government default on top of covering direct losses on the “government bond holdings” of the banks. The whole amount that will be needed will be more than one trillion Euros ((“Managing banks beyond the crisis” para 3).
There are three conditions that have to come with the “stability fund’s support” to the banks. One of the conditions is that each and every major bank is supposed to be offered an estimate of the actual additional amount of capital that it requires. After this, the banks are supposed to be offered a window, probably a half a year, and in the course of this the banks are expected to “raise capital from the private markets” (Giavazzi and Kashyap, para 10).
The second condition is that the “stability fund’s financial support” is supposed to be there for all the large or major banks and offered to those banks which are not in a position to raise sufficient capital from the market. The money would be invested as “preferred convertible shares” having a dividend rate that is higher. In case there is injection of capital by stability fund, there will be replacement of the management.
The result of having these conditions is the creation of a great incentive for the banks to look out for the private investors. Such a situation was at some point realized in the United Sates where, as pointed out by Giavazzi and Kashyap; “after the U.S stress tests, all the banks found private financing rather than drawing on the backstop offered by the government” (Giavazzi and Kashyap Para 10).
The last condition is that, in order for the banks to obtain the support, their governments (national) are supposed to come up with reliable plan for growth. The crucial elements of a plan like this would be steps taken to deregulate the commodity as well as service and labor markets. The national governments would have a half a year to carry out the enactment of legislation which corresponds to the time before the conversion of the stability fund’s money in to shares (“Managing banks beyond the crisis” para 5).
The European economic crisis arose from the mistakes that were made in the past and have persisted to the present time. This has created painful realities that are being faced by the financial regulators. It is not easy to get out of this crisis. However, there is hope of getting out of it if there is commitment among the regulators and by them taking the appropriate measures, the crisis can be handled successfully.
Foster, John. The European financial and economic crisis: origins, taxonomy, and implications for the U.S economy, 23 September 2011. Web. 23 October 2011.
Giavazzi, Francesco and Kashyap, Anil. How to contain the European debt crisis, 20 July 2011. Web. 23 October 2011. .
“Managing banks beyond the crisis: The new financial landscape”. atkearney.com. atkearney, 2011. Web. 23 October 2011.
Paulo, Sebastian. Europe and the global financial crisis, April 2011. Web. 23 October 2011.