European Union Likely to Avoid Economic Disaster But Still Needs Fiscal Reform
STANFORD GRADUATE SCHOOL OF BUSINESS — The steps being taken to solve Europe’s sovereign debt crisis are likely putting an end to speculation that the European Union could come apart, says finance Professor Darrell Duffie of the Graduate School of Business. But current negotiations among Europe’s finance and political leaders are not likely to go all the way toward solving the union’s long-term fiscal problems.
At a Feb. 8 campus discussion of the debt crisis, Duffie and two other experts on international finance also chastised European banks for not doing more to shore up their capital. The others were Kenneth E. Scott, the Ralph M. Parsons Professor of Law and Business, Emeritus; and Patrick Brown, a lawyer with Sullivan & Cromwell LLP in Los Angeles.
Duffie, the Dean Witter Distinguished Professor of Finance, said the European Union is “muddling through” and likely will avoid a disaster for now, but there will be intermittent small crises over the next 5 to 15 years as the EU comes to grips with the fact it has a common currency but doesn’t have a central finance authority.
“The crisis is structurally imbedded in the fabric of Europe because of the inconsistency of a commitment to a monetary union without a fiscal union,” Duffie said, as part of a panel discussion at the Stanford Law School. The International Law Society, the Women of Stanford Law, and the Rock Center for Corporate Governance, which is a joint program of the business and law schools, sponsored the event .
Many economists blame the current debt crisis on the monetary union of some European Union members in 1999. They ceded national monetary and economic sovereignty without forming a fiscal union, not unlike the United States once was under the Articles of Confederation, Scott said. Europe’s political leaders consider control over fiscal policy central to each nation’s national sovereignty, but there have been proposals to create a “fiscal union” across the eurozone, notably from German Chancellor Angela Merkel who called for EU treaty changes in December.
Finance ministers across the eurozone have approved a three-year €750 billion rescue package called the European Financial Stability Facility and have agreed on other measures designed to prevent the default on the debt of member countries such as Greece, Ireland, and Portugal.
Duffie said the austerity reforms and cooperation from countries in trouble, such as Greece, will avoid a collapse of the EU or the euro currency system. “It is very unlikely the core of the eurozone will encourage the peripheral countries to leave the euro,” he said. “By and large it will stay intact indefinitely … muddling through, no disaster, which is much better than the alternative.”
Duffie said there was also a chance that European economies would grow sufficiently in the short term to offset the worst hardships created by the sovereign debt overload. If that happens, he added, European leaders will be less likely to undertake the reforms that would prevent another debt crisis in another 20 years or so.
He also stressed that banks in Europe are not doing enough to recapitalize by issuing shares or selling off valuable assets. Banks hold substantial holdings of bonds from countries such as Greece. “Clearly the European banks are undercapitalized. The fact that they haven’t failed doesn’t mean that they aren’t under extreme stress,” he said.
Brown, a lawyer who works with companies on mergers and acquisitions and other international financing packages, said he wondered why the European banks aren’t taking more immediate steps to recapitalize. “It’s a dangerous mentality to see how far you can kick the can down the road.”
He also noted that some of the banks may sell off U.S. assets, which could mean opportunities for buyers here.
Scott echoed the sentiment that banks may need to be pressured into raising more capital. “Additional write-downs would be appropriate,” he said.
Brown said the European crisis has definitely had an impact on U.S. businesses. The uncertainty about bailouts “stymied some efforts by companies in the U.S. to raise money in the public markets” in fall 2011.