Should not EU cut its grand bargain with all its over-indebted sovereigns before any Brexit vs. Remain voting took place?

David Folkerts-Landau, the chief economist at Deutsche Bank writes, “An Italian debt crisis poses an existential risk to the eurozone. The current game of chicken is irresponsible. It also ignores the dangers inherent in any financial crisis, the costs of which would dwarf those of having the ESM step in”, “Europe must cut a grand bargain with Italy” November13.

Of course Italy cannot be expected to pay €2.450 billion, meaning over €40.000 per citizen, denominated in a currency that is de facto not Italy’s real domestic (printable) currency. Be sure Sir, Italy will not walk the plank, as Greece had to do.

But of course what Folkerts-Landau writes, “The option of a debt write-down with private sector involvement is also unfeasible”, is not possible either.

One way to solve Italy’s (and Europe’s) sovereign debt crisis as painless as possible could be by using a Brady bond/zero coupon mechanism as used creatively by the US in 1989 during the Latin American debt crisis. I mentioned the use of those bonds to FT in a letter of 2008, “"Après us, le déluge", as did William R. Rhodes in 2012 with “Time to end the Eurozone's ad hoc fixes”.

A complementary tool to help fix Italy’s (Europe’s) banks, as I wrote to FT in 2012, would be to do what Chile did during its mega bank crisis in 1982 namely: a. having central banks issue bonds in order to buy “risky” loans not allowing banks to pay dividends until those notes had been repurchased; b. forcing banks to hold more capital with central banks subscribing shares not wanted by the market with these shares resold over a determined number of years and c. generous financing plans to allow small investors to purchase equity of the banks.

Obviously, for Italy’s (and Europe’s) banks to be really helpful to the real Italian economy, it would be imperative to get rid of the credit risk weighted equity requirements for banks, those which erode the incentives for banks to give credit to those who most could do good by receiving it, like SMEs and entrepreneurs.

What is absolutely true though is that to solve Italy’s (Europe’s) problems, more zero risk weighted loans to the sovereigns, in order for government bureaucrats to allocate the resources derived from bank credit, will just not cut it… no matter how much haircut on Italy’s (or other European sovereign’s) debt you accept.

Europe would need to start the process of helping Italy (and Europe) by getting rid of all current high-shot regulators. Not only would they be too busy, as until now, covering up their mistakes, but also, as Einstein said, “We can't solve problems by using the same kind of thinking we used when we createdthem.”

Sir, I suspect all in FT would vote for a Remain if given a chance, but before doing so, would you not prefer EU authorities to clearly explain to you how they intend to fix the European sovereign debts overhang. That which if not fixed will crash the Euro and thereby most probably also crash the European Union? Sir, would it not look truly silly Remaining in something gone?

PS. It is clear that without the help of those wanting immensely more to save the European Union than to save some cushy jobs, the future of the EU very sadly looks very bleak.

@PerKurowski

Prudence is ok. But prudence on top of prudence is very dangerous too!

Sir, William Rhodes holds that “Without prudence as a value we are all at risk” August 8. Absolutely, that is only as long as we are prudent when being prudent. Let me give you the mother of examples about what I mean.

Bankers already looked at credit risks when deciding interest rates, amounts of exposure and other terms of their financial assets. And they did so in a quite risk adverse way; if we remember Mark Twain’s saying “A banker lends you the umbrella when the sun shines and wants it back when it looks like it is going to rain”.

But then came the regulators and, in the name of their prudence, set also the capital requirements for banks based on the same perceived credit risks… something which suddenly allowed banks to earn much higher risk-adjusted returns on equity when lending to “The Infallible” than when lending to “The Risky”… and which of course resulted in distorting the allocation of bank credit in the real economy.

And so if we begin loading prudence on top of prudence, especially on top of the same prudence, that is when we enter into that Roosevelt territory of having nothing to fear as much as fear itself.

These nanny regulators from Basel, who basically force bankers to eat broccoli when they eat spinach and reward them with ice cream when eating chocolate cake, have now turned our economies into obese monsters, with none of the muscles provided by credits to the risky medium and small businesses entrepreneurs and start ups.

William Rhodes, worse than regulatory uncertainties is the current regulatory certainty.

Sir, William Rhodes writes that "many other countries are challenged by the weakness of bank lending to productive, employment-generating investments. The banks are in large measure constrained by regulatory uncertainties." "Major central banks must co-ordinate policy", February 4.

Wrong! Banks, when lending to productive, employment-generating investments are in large measure constrained by regulatory certainties... those that order banks to have much more capital against such “risky” lending than against lending to the less productive “absolutely safe”… those which thereby allow banks to earn much higher risk adjusted returns on equity when lending to something safe-not-productive than when lending to something risky-productive

Throwing Basel II, III, out of the window, is the best way to free us from the too risky risk-adverse bank nannies.

Sir, William Rhodes makes many valuable and correct suggestions in “The time has come to end the eurozone´s ad hoc fixes” November 27. 

The most important is when he reminds us about the need to “reformulate the balance of regulation in favour of enabling the banks to lend more to small and midsized enterprises, which are the prime job creators in most economies” and suggests this can only be the result of a banking union that “can separate banks from sovereigns”. 

But, in my opinion this is too an important and urgent goal so as to have to wait for a banking union. It could be much faster attained by simply throwing Basel II and III out of the window and getting us some new bank regulators; some who understand and give importance to the function of banks in allocating economic resources in an efficient way. 

Banks, like those William Rhodes worked in, used to give the loans or make the investments in whatever produced them the highest risk and transaction cost adjusted return on their equity. 

Unfortunately though, the current generation of bankers, start out doing the same, but they now have to adjust it for the different capital requirements based on perceived risks regulators impose. 

And that simply means that most bank credit will go to “The Infallible”, with low capital requirements, and that “The Risky”, like those small and midsized enterprises Rhodes fondly speaks of, are because of higher capital requirements, effectively locked out from access to bank credit on competitive terms.