THE EURO CRISIS

Notwithstanding politicians' understandable statements to the contrary, the most important thing to note about this week's "comprehensive package" to sort out the Euro crisis is that it is not a solution, merely yet another means of buying time. Personally, I do not think that this is a bad thing (see below). However, other commentators are demanding more red meat, so I can see why the plain paper package was wrapped up in bows and ribbons.

There are three elements to the plan, and all of them represent wishes rather than decisions. First, Greece's private sector creditors will accept a "voluntary" haircut (i.e. write-down) on their Greek bonds of 50%, rather than the 21% agreed as recently as July. The agreement has to be voluntary in order to avoid a ruling of default, which would trigger credit default swaps on Greek bonds and might well have nasty implications for the bonds of other Euro area countries. However, a default ruling might occur anyway (if someone's decision not to pay you back half of what they owe is not a default, then what is?) and some bondholders may not go along with it.

Secondly, European banks (both within and outside the Euro area) will have to increase their capital by around Euro106 billion, so that by June next year, they have a capital ratio - capital to assets - of 9%. The problem here is that there are two ways to increase a ratio. What Governments want is that the banks increase the numerator, by going out and raising fresh capital. But that may well be difficult in today's markets, not least because of point 1. The alternative is to shrink the denominator by liquidating assets. In simple terms, that means lending less, which is the last thing said Governments want.

Thirdly, the Euro440 billion European Financial Stability Facility, the means of helping Euro countries in difficulties, is to be beefed up. The problems here are twofold. First, most commentators say that it should go up to Euro2 trillion (we are now firmly in the world of trillions!), but the package only talks of Euro1 trillion. Secondly, this will not be done by Euro Governments' stumping up more resources, there is instead talk of "leveraging" the existing facility by treating it as a sort of insurance scheme. Apart from the difficult message that that gives ("isn't this the sort of smoke and mirrors operation that got us into the mess in the first place?"), nobody yet knows exactly how this will work. Officials are working round the clock in order to put together a framework in time for the G20 meeting in November.

So if this is not a comprehensive package but a wishlist, why do I nevertheless think that it is OK? The answer is that it buys time, which (as I have said before) is crucial in a financial crisis. Consider the position of a bank that has a mortgage to a householder, who (because they lose their job) suddenly can't service the payments. If the bank calls the mortgage, and sells the house, then it will incur a guaranteed loss today. Furthermore, that loss will never be made up, since the householder will incur a break-up of the family, sink into depression and never get a job again. Even worse, the sale of the house will drag down property values in the neighbourhood generally, possibly triggering other foreclosures, where the bank has a mortgage. Against that background, isn't it better for the bank to hang in there, accept the occasional payments that the householder makes, and hope that they find a job in due course when things look a bit better?

The householder in the Euro area is Greece, and the bank is the other Euro area Governments, in particular Germany. The strategy has been to keep Greece in its house (in the Euro), while it undertakes reforms (to make it more likely that it gets a job in the future) and waits until things get better. In that respect, the strategy has been successful. Greece has been going bust, and the Euro has been collapsing, since at least 2009; but it has not yet gone bust and the Euro has not yet collapsed. Sure, the Euro area has problems; but everyone has problems. Even China has problems.

In the meantime, the Euro area countries are slowly groping their way to the sorts of longer-term changes that will represent a real solution to the crisis, in particular some sort of fiscal transfer mechanism between Member States and the right of the European Central Bank to issue unlimited liquidity to Euro area Governments. Both happen at national level; but the first was stymied by Member States' unwillingness to give up control of fiscal policy when the Euro was established, and the latter by the ECB's own statutes. Moves to change this will inevitably be slow, partly because they require changes to the E.U.'s treaties, and everybody remembers the saga over the Lisbon Treaty; and partly because the changes will have a major impact on E.U. countries (notably the U.K.) that are outside the Euro area, deeply affected by its decisions, but unable to influence them. If anybody had called for these changes two years ago, then the answer would have been a flat no. Sometimes things have to get worse before people accept the means to make them better.

German Chancellor Angela Merkel, who is leading on this issue, is often criticised as a bit of a tortoise when compared to some of the political hares in the European forest. But we should remember that the tortoise won the race in the end. To mix my metaphors, I think that up to now, she has played her hand with some skill.

Walter Blotscher