Two dire predictions heading into 2012

Two dire predictions heading into 2012— a Greek exit from the eurozone and a collapse of the euro currency—have been avoided.  Last week, European Union (EU) leaders gave Greece about $65 billion in long-delayed bailout funds, which should ease that country’s liquidity crisis.  Perhaps more importantly, after four months of intense negotiation, EU finance ministers reached an agreement to create a single banking regulator to oversee the largest and riskiest banks in the 17-country currency bloc.  The new regulator will be tasked with creating a resolution fund to clean up troubled banks.  It will also establish a deposit fund (like the FDIC) to prevent bank runs.  While markets barely moved on the news, we view this as major progress towards resolving the EU’s three-year-old debt crisis.  Had this single entity been created prior to 2009, the crippling debt crisis might have been avoided.  This paves the way towards severing the debilitating link between troubled banks and struggling governments, which has devastated confidence in the common currency.

However, the eurozone is not out of the woods yet.  The common regulator won’t be in place until March 2014 at the earliest, and there are pending issues that need to be ironed out—not an easy task given the continent’s complex multilateral politics.  For instance, it’s unclear how much it will cost to set up the resolution fund and who will be on the hook for the tab.  Germany, for example, is opposed to paying for failed banks in Spain.  Furthermore, the political landscape may look different in 2013.  Italy’s Silvio Berlusconi has returned and announced he will run for the Italian premiership, potentially reversing the country’s austerity measures implemented by Mario Monti.  And it’s hard to see that anything meaningful will happen before the German election, which is scheduled for September.  Putting numbers around the resolution fund and deposit funds (they will be big) won’t sit well with German voters.  Nonetheless, we view establishment of a common regulator as an important step towards stimulating cross-border lending, and boosting trust and confidence across the eurozone.  That would go a long way towards helping improve US exports to the bloc, which have been sluggish for the past few years.



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