Peterson Institute publications
The Peterson Institute for International Economics is a private, nonprofit, nonpartisan
research institution devoted to the study of international economic policy. More › ›
RSS News Feed Search

Op-ed

European Banking Needs a State-Led Triage Body

by Adam S. Posen, Peterson Institute for International Economics
and Nicolas Veron, Peterson Institute for International Economics

Op-ed in the Financial Times
July 2, 2009

© Financial Times


The Bank for International Settlements has just announced that national governments have done too little to clean up their banking problems, and it is right. The European Summit concluded that there can be no fiscal federalism to transfer funds between banking systems, were they to require recapitalization. That is reality. It seems difficult to craft a policy responding to the first while abiding by the second. Yet, all recent systemic banking crises in developed countries (including the US savings and loans, Sweden, and Japan in the 1990s) have only been solved when there was a government-led triage process, with state intervention to resolve the cases of insolvency.

Carrying out the needed Europe-wide bank restructuring without fiscal transfers between members is difficult, but not impossible. In A Solution for Europe's Banking Problem, we propose the creation of a "European Bank Treuhand," a fiduciary entity or trustee that would be created jointly by those countries where the main continental European banks are headquartered (the United Kingdom is a separate case, as most of its banks have only limited operations on the Continent). The Treuhand would have three tasks.

First, it would apply triage to all large or heavily cross-border banks, assess their balance sheets on a truly comparable basis (including stress-testing), publish what it found regarding specific banks simultaneously, and thus signal where capital is required and how much. A triage done by national authorities, even on the basis of commonly agreed methodologies, would remain ineffective given the enormous incentives to protect national bank champions, triggering a supervisory race to the bottom. That is the main reason for the nonresponse of European bank supervisors to date.

Second, it would serve as the catalyst for the intergovernmental negotiations to recapitalize and restructure those financial institutions that are insolvent. Cases such as Fortis in late 2008 have shown that ad hoc burden-sharing agreements are possible, but that they can unravel quickly when there is no trusted player to steer the process, which is what the Treuhand would do. In fact, because it would be dealing with all large or significantly cross-border institutions in continental Europe and releasing the results simultaneously—about 40 in number—there would be a strong incentive for national governments to pick up their share of the burden where they have minority interests, lest they be punished by markets and governments on their majority-owned cases.

None of the existing European Union–level institutions has the mandate and skills needed to achieve such a task, including the soon-to-be-created European Banking Authority, which will take years before acquiring the necessary heft. Importantly, like the US Resolution Trust Corporation or bodies in Sweden and Japan, this would be a temporary institution, to exist long enough to resolve the crisis.

Third, the Treuhand would manage those assets and institutions thus brought into public ownership on behalf of the owning national governments. This would provide the necessary neutrality and professionalism through barriers to politicization of bank operations. It would also deepen markets for pricing and liquid disposal of assets by extending beyond one country's remit. Additionally, having a nonnational trustee for publicly held banks and bank assets would reduce the risk of either institutions being held too long in the public sector or there being a race to the exits once one state decided to privatizes—both risks real and harmful in the absence of European coordination.

The Bank Treuhand would have no need for a unanimity requirement, as only some European countries would have to join to make it work. We think the critical mass would include Austria, Belgium, France, Germany, Italy, and the Netherlands, plus possibly Spain and Sweden.

The hope that a combination of green shoots and a steeper yield curve will cure European banks' current ills is dangerous, magical thinking. Waiting does not reduce the need for triage, but only increases the ultimate cost. Setting up a European Bank Treuhand is the way to unlock policy action, prevented by the competing incentives of national governments. Otherwise, it will be Europe that will risk the repeat of Japan's lost decade.


RELATED LINKS

Book: Responding to Financial Crisis: Lessons from Asia Then, the United States and Europe Now October 2013

Policy Brief 13-21: Lehman Died, Bagehot Lives: Why Did the Fed and Treasury Let a Major Wall Street Bank Fail? September 2013

Op-ed: Misconceptions About Fed's Bond Buying September 2, 2013

Op-ed: A Dose of Reality for the Dismal Science April 19, 2013

Op-ed: Five Myths about the Euro Crisis September 7, 2012

Working Paper 12-7: Lessons from Reforms in Central and Eastern Europe in the Wake of the Global Financial Crisis April 2012

Article: Why the Euro Will Survive: Completing the Continent's Half-Built House August 22, 2012

Policy Brief 12-18: The Coming Resolution of the European Crisis: An Update June 2012

Policy Brief 12-20: Why a Breakup of the Euro Area Must Be Avoided: Lessons from Previous Breakups August 2012

Book: Sustaining China's Economic Growth after the Global Financial Crisis January 2012

Testimony: A New Regime for Regulating Large, Complex Financial Institutions December 7, 2011

Working Paper 11-2: Too Big to Fail: The Transatlantic Debate January 2011

Policy Brief 10-24: The Central Banker's Case for Doing More October 2010

Policy Brief 10-3: Confronting Asset Bubbles, Too Big to Fail, and Beggar-thy-Neighbor Exchange Rate Policies February 2010

Article: The Dollar and the Deficits: How Washington Can Prevent the Next Crisis November 2009

Speech: Rescuing and Rebuilding the US Economy: A Progress Report July 17, 2009

Testimony: Needed: A Global Response to the Global Economic and Financial Crisis March 12, 2009

Testimony: A Proven Framework to End the US Banking Crisis Including Some Temporary Nationalizations February 26, 2009

Speech: Financial Regulation in the Wake of the Crisis June 8, 2009

Paper: World Recession and Recovery: A V or an L? April 7, 2009

Op-ed: Stopping a Global Meltdown November 12, 2008

Book: Banking on Basel: The Future of International Financial Regulation September 2008

Book: Bailouts or Bail-ins? Responding to Financial Crises in Emerging Economies August 2004