Saturday, July 02, 2011

Distinguished Professors...

...of The Recapitulator's Alma Mater state formally what I have said here for years.

So what to do? Prepare for the worst. Europe needs to expunge the rot from its banks so that the inevitable write-downs do not imperil its financial system. Sovereign debt and sovereign exposure must face large capital buffers. Sovereign debt must be marked to market. Banks must run serious stress tests to find implicit sovereign exposure. Banks with inadequate capital must raise it, find buyers, or reorganize. If that means bailouts of "systemically important" banks, then governments must do so, face their taxpayers, and make their regulators explain how they let this happen.

Sovereign defaults often follow financial crises. But with a more proactive policy, any European sovereign defaults need not create a second financial crisis.

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