Tuesday, December 13, 2011

A question about the Wolfson Economic Prize

A £250,000 Wolfson Economics Prize competition has now been announced for the best answer to the following question: If member states leave the European Economic and Monetary Union, what is the best way for the economic process to be managed to provide the soundest foundation for the future growth and prosperity of the current membership? 

And, what if one believes no member state should have to leave the eurozone, because even though the eurozone undoubtedly presents many challenges, this crisis was primarily the result of bad banking regulations, and not of the eurozone? 

Let me explain. The only way the current imbalances could have resulted in building up the humongous European sovereign debt burdens, carried primarily by banks, was that the regulators allowed the banks to hold these exposures against zero or very little equity. This caused the banks to be willing to lend too much, at artificially low interest rates. 

If that is the case, at this moment, when some of the European sovereigns are rated as “riskier”, and therefore banks are required to hold more capital when lending to these, the possibilities are either that these debtors will find it much harder to work themselves out of any excessive debt position, and or, that the remaining safe-sovereign-havens also end up dangerously overcrowded. 

It is bad enough that bankers lent the umbrella to the European sovereigns when the sun was shining and now they want it back when it rains, for the regulators to do exactly the same. 

What solutions do I envision?

Perhaps a general and substantial haircut on all outstanding European sovereign debt, Germany included, which would allow the stronger countries to help out more in getting the eurozone economy going… and, of course, a total reversal, over a period of time, of the current capital requirements for banks based on ex-ante perceived risk of default, and which will go down in history as the mother of all failed and truly stupid bank regulation Maginot lines.

I have now received an answer to my query, it is: “The question stands as framed

Unfortunately, it seems that the possibility of a solution that does not mean someone being expelled from the eurozone, is not acceptable.