By Lior Alkalay
Senior Analyst, eToro
At the upcoming EU summit, among the many debates that are certain to take place will be the creation of the rules which would govern a newly formed fiscal union, as well as the establishment of a banking union. To that end, Herman Van Rompuy, the European Council president, had submitted yesterday a well-detailed draft proposal for the Eurozone’s future, which included among other things a proposal that would allow EU leaders to use the €500 billion in the rescue fund account to recapitalize Eurozone banks, a matter that is of some great contention to Germany’s Angela Merkel.
But, earlier today, Van Rompuy issued a version of the plan significantly revised from previous drafts, which now is notable for its lack of details and absence of an implementation timetable. It also notably lacks Van Rompuy’s original suggestion that the ESM could be used to directly recapitalize EU banks, a matter which is also of great concern for the Spanish government.
It was a sweet moment of relief when the Spanish government finally and officially requested help from the EU to recapitalize its failing banking sector. But as markets began to digest the ramifications of the bailout, which by some estimates might be as much as €100 billion, that relief dissipated. Understand that under the current system, the bailout for Spain’s banks must be channeled through the Spanish government – the already highly indebted Spanish government – which will increase their public debt load by an equal amount. That is problematic to say the least and the reason why Spain’s government has been advocating for the bailout loan to be funded directly to its banks through the European Stability Mechanism.
The myriad issues will likely be debated innumerable times over the coming week and weeks, but whether there is any consensus in the end could be a moot point. The importance of a banking union is not a matter of debate; it is an obvious and immediate need. But that banking union will include all of the EU's banks, including Spain’s massively undercapitalized ones.
The fact is, for Spain’s banking sector time is of the essence, and the inertia resonating from the EU’s leaders – the lack of consensus, of commitment, of determination, of resolve – are doing nothing but propelling Spain’s banks toward a Lehman Brothers like disaster. Recall if you will that the U.S. government was basically indifferent to Lehman’s plight and it was only with their collapse that politicians were actually compelled to do something positive that would prevent a similar occurrence.
The Eurozone’s leaders appear to be following in the footsteps of their U.S. brethren – talk, talk, talk and no action. Will it take the outright collapse of Spain’s banks to light a fire under them? Perhaps Spain’s banking sector is meant to be the sacrificial lamb needed to get a true European banking union.
While a collapse of Spain’s banking sector would clearly be a negative event in the short term, would it really be that much worse than what is happening now? Right now, uncertainty and fear are driving markets. But an outright collapse of the Spanish banking sector will result in a cleansing of sorts; risk would be aggressively removed from the system, the “bad” banks would be swallowed by the “good” ones, and those left standing will be given a chance to recover. In the long term, a “revitalized” European banking union will be good for growth and value.
With the threat of a Lehman-like collapse hanging like the sword of Damocles over their proverbial necks, that should be justification enough to prompt Eurozone banks to erase bad loans from their books, which will finally make for a clearer valuation. Moreover, under just such a scenario, the ECB’s actions would be even more effective, and long term value investors could conceivably buy more good stocks at cheaper prices.