Edited by Thorsten Beck - Vox

VOX Research-based policy analysis and commentary from leading economists
Figure 1. Ten-year bond spreads over German bonds (basis points)
Conclusion 1 is that current policy preoccupation with widening the role of the EFSF
and enlarging its resources is bound to disappoint and trigger yet another round of
market panic. Unofficial estimates of how much more capital the banks included in the
European stress test need to restore market confidence (ie aligning their Tier 1 capital
to banks currently considered safe) range from $400 to $1000 billion. Even if the EFSF
can lend a total to $440 billion, with some €100 billion already earmarked for Ireland
and Portugal, this is not enough to deal just with the banking crisis.
The current plan is for banks to seek fresh capital from the markets, with EFSF resources
as a backstop. Conclusion 2 is that this plan will not work. Markets are worrying about
the impact of contagious government defaults on banks. They will not buy into banks
that are about to suffer undefined losses. Somehow, a price tag, even highly approximate,
must be tacked on sovereign defaults for investors to start thinking about acquiring bank
shares. They need to know which governments will default and in what proportion.
Since this will not be announced ex ante, market-based bank recapitalisation is merely
wishful thinking. Much the same applies to the much-talked-about support from China,
Brazil, and other friends of Europe. They well understand that they stand to throw good
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