How to Resolve the Euro Crisis

NEW YORK – A comprehensive solution of the euro crisis must have three major components: reform and recapitalization of the banking system, a eurobond regime, and an exit mechanism.

First, the banking system. The European Union’s Maastricht Treaty was designed to deal only with imbalances in the public sector; but, as it happened, the excesses in the banking sector were far worse. The euro’s introduction led to housing booms in countries like Spain and Ireland. Eurozone banks became among the world’s most over-leveraged – and the worst-affected by the crash of 2008. They remain badly in need of protection from the threat of insolvency.

The first step was taken recently when the European Financial Stability Facility was authorized to rescue banks as well as governments. This needs to be followed by other steps. The equity capital of banks urgently needs to be substantially increased. And if a European agency is to guarantee banks’ solvency, that agency must also oversee them.