Over the past month, a new phrase has entered the vocabulary of the European debt crisis: "Euro-TARP." The phrase refers to speculation that European finance ministers may recapitalize the region's banks to restore confidence in the institutions just like the U.S. did in the throes of the 2008 financial crisis through its $700 billion Troubled Asset Relief Program, which involved purchasing toxic mortgage-backed securities and later equity from banks. Despite continuing bad economic news, a report yesterday in the Financial Times that European bankers are merely "examining" such an action led to a late-day rally in markets. Such anticipation has created a lot of chatter in financial circles that Euro-TARP is now the best only hope for the global economy to escape problems sparked by debt-saddled nations like Greece and Italy.
Why the idea is gaining steam: Some of the biggest banks in France, Germany and Belgium hold tens of billions of euros in sovereign bonds from Greece and Italy, and their shares are falling as concern mounts about a Greek default. In this climate, a number of institutions--including, most recently, the Franco-Belgian lender Dexia--are having trouble financing their day-to-day operations and staying profitable. The European Union has already established a $589 billion fund--the European Financial Stability Facility (EFSF)--that can be used to recapitalize banks in eurozone countries (it can also be tapped for sovereign bailouts). But The Netherlands, Malta, and Slovakia have yet to approve of expanding the bailout fund. And the clock is ticking.
What the markets are expecting: In late September, European officials floated a convoluted TARP-like scheme in which European banks would swap their sovereign debt for debt issued by an EFSF-funded "special purpose vehicle." Now, as the Financial Times notes, it's looking more likely that national regulators will "take the lead and recapitalise weak institutions on a bank by bank basis." A Morgan Stanley note this week suggests that a Euro-TARP could involve writing down Greek debt while recapitalizing banks in "core" European countries (Germany, France, Belgium etc.) to around eight percent of their top-notch "core Tier 1" capital and banks in "peripheral" European countries (Greece, Ireland, Portugal, etc.) to 12 percent of core Tier 1 capital. The BBC's Paul Mason, meanwhile, predicts that Euro-TARP will involve France, Germany, and Benelux refinancing their own banks while EFSF money goes toward Spanish and Italian institutions. As for the price tag of these measures, Antonio Borges of the International Monetary Fund said today that Europe needs anywhere from €100 billion to €200 billion to recapitalize its banks (JPMorgan and Morgan Stanley put that number at €150 billion and €140 billion, respectively).
Signs that the markets are right: European finance ministers are hinting that more aggressive measures are urgently needed to stabilize the region's banks. "Capital positions of European banks must be reinforced to provide additional safety margins and thus reduce uncertainty," Olli Rehn, European commissioner for economic affairs, tells the Financial Times. In a sign that these measures might be handled on a national level, Wolfgang Schäuble, Germany's finance minister, announced this week that his country may reactivate support mechanisms instituted in 2008 to recapitalize banks.
What happens if they're wrong: Some major market players--including JPMorgan--are now arguing that a Euro-TARP solution may be the only way out of the long-simmering European debt crisis. If banks aren't recapitalized to guarantee their survival regardless of a sovereign default, Europe's sovereign debt crisis could morph into a financial crisis. As U.S. News & World Report's Rick Newman writes, "a Greek default could be the European equivalent of the Lehman Brothers bankruptcy in 2008, which started a run on the whole U.S. financial system." But Euro-TARP could also backfire. "A TARP-like program would also require E.U. leaders to admit that European banks are not properly capitalized, which--without a viable plan--could send the market into freefall," Business Insider wrote in September.
While the catchphrase of the moment may be Euro-TARP, Newman points out that there's a reason Europe is having a harder time than the U.S. in implementing a TARP-like solution:
In Europe, it's far harder to devise a systemwide financial bailout, since there's no centralized fiscal authority comparable to the U.S. Congress or the Treasury Dept. So every bailout maneuver requires negotiations among 17 sets of politicians, each answerable to restive taxpayers and rival political parties in their home nations.
And we thought there was gridlock in the U.S.