Eurozone regulatory responses – or, How the policymakers are steering us into another depression

Well, all my hopes were in vain. The decision of the policymakers is obviously to destroy lending on the European market and consequently any hope of a recovery any time soon.

The European leaders decided in the early morning hours on Thursday to let private investors (mostly EU banks) to take a 50% cut in theface value of their bond holdings – something that would reduce the Greek debt to 120% of GDP by the end of 2020, combined with a 130bn more for bailout of Greece by the EU and the IMF.

What a strategy!

This is how I would sum it up: let’s destroy the banking system and freeze lending in Europe again (and possibly endanger every other strong economy in the World) in order to keep Greece on life support just a bit longer, and offer them a huge relief – they will decrease their debt to only 120% of GDP by 2020 (!?), more than any eurozone economy (and any world economy besides Japan) has at the moment.

Maybe they should have all rather had a good night sleep instead. 

Let’s take a closer look at their response to the crisis.

First of all is the Greek ‘rescue’ plan. It’s hard to see how this plan can actually help Greece stabilize. Keeping the status quo is not going to make investors ready to invest into the Greece economy. Pushing more money into an insolvent country and keeping it on ‘life support’ will make its economy more and more vulnerable and dependent on foreign aid. The policymakers are turning Greece into a long term problem for Europe. This will have negative implications on all fronts – it will ruin confidence around Greece for a long time, disabling it to achieve any growth whatsoever, it will create massive social instability in the country, and it will give further rise to euro-scepticism around the continent. The country’s future seems to be a lock-down in debt, social turmoil and inability to create growth. Greece at this point doesn’t only need a debt restructuring, it needs a restructuring of its entire economy, starting from the labour market, public sector, industrial policy and so on. This is what the policymakers should have focused on, instead they choose to short-fix Greece until 2020. According to all of this, I fail to see how Greece will be able to grow at all until 2020.

The second great idea was to impose a 50% loss on banks holding Greek debt. Apparently it was the banks’ fault to invest into ‘safe’ assets such as the peripheral sovereign debt and MBSs, while being instructed to do so under Basel standards. Buying AAA rated securities with low yields isn’t quite a quest for profits. It is more likely a sound investment since every bank has a responsibility against its depositors and strives on keeping a good reputation for itself; otherwise, all its depositors will switch to another bank. This is something that the Wall Street “99%” protesters and all alike don’t understand. Investing into MBSs and Greek debt at the beginning of the decade looked like a decent investment, since the securities were heavily backed up by governments. Blaming the banks of making risky investments and forcing them to undertake huge losses on the same investments they were encouraged to buy by the regulators, is absurd. I can see the policymakers blaming the banks again in 2 years from now, when we’ll still be in a recession, that they refused to suffer bigger losses on Greek debt and this is why the situation got worse. I wouldn’t be surprised to stumble upon such an opinion.

The outcome of such a contractionary policy will be just that – a huge contraction of lending as the Euro banks will most likely shrink their balance sheets causing a lack of support for the real economy. I have pointed out earlier in the blog that 80% of Europe’s companies depend on bank loans to run their business (compared to only 30% of American companies). The recovery is obviously postponed by the policymakers, and I can’t think of a good reason why this is so.