Desperate Times In Euroland

Wolfgang Münchau’s latest Financial Times column on the Eurozone is very much worth your time. He calls the current plan to lever-up the European Financial Stability Fund a “desperate con.” He says it’s modeled on the collateralized debt obligations that destroyed the world financial system in the first place. He says it’s “the equivalent of putting explosives into a can, before kicking it down the road.” And yet he’s not even really opposed to doing it. “Do not get me wrong,” he writes “I am in favour of an enhanced EFSF.”

The problem with the levered EFSF idea is that like the CDOs of yore it’s an effort to use financial engineering to hide the ball and exploit regulatory loopholes. In particular, “[t]here exist only two categories of solutions to the crisis: a fiscal solution or a monetary one. Politics blocks the first, European law blocks the latter.” So they’re trying to fudge with a conjuring trick.


This is the problem U.S. policymakers are faced with. Europe’s problems are solvable, but not within the terms of what’s considered politically acceptable. So at the moment the posture of the Treasury Department and the Federal Reserve system are to project confidence that the Europeans will eventually work this out, and to consistently firmly and gently push them to do so. The problems, however, aren’t so much that it’s difficult to think of a solution that could work as it is that it’s difficult to think of a solution that’s legally, politically, and institutionally viable. It would be dangerous for the American government to do anything other than express confidence that European politicians will work things out, but it would be equally dangerous for the American government to actually assume they will. The large Franco-Belgian bank Dexia, already majority owned by the two governments as a result of a bailout 2–3 years ago, has been just put on downgrade watch by Moody’s, a sign of financial markets’ prudent concern that the underlying European issues won’t be resolved.