Wall Street Journal
March 10, 2011
Hardly have the first consultation materials landed on the banks' desks, and the chorus of disapproval is already in full swing. But the European Banking Authority's new round of bank stress tests are really a political exercise, and as there isn't any single number, or set of numbers, that can capture the political risks involved in getting Europe out of its debt hole, it's no use expecting the stress tests to provide one.
On the most important issue, sovereign default risk, the newly-created regulator is in a no-win position. If it doesn't model for default, then it ignores an obvious and material risk. If it does, then it undermines the credibility of any other EU efforts to avoid one. Obviously, the usefulness of a test that cannot answer the question uppermost in everyone's mind is scant, but it is hardly the EBA's fault that it is having to start its tests before the crucial March 24/25 summit that will—one hopes—provide more comprehensive answers. Last year, both debtor and creditor nations appeared committed to avoiding a sovereign default.
Only the outcome of the March summit will tell us whether that commitment is still intact. If the creditor nations want markets to have any faith in the outcome of the stress tests, they need to be able to demonstrate that the euro zone's institutional arrangements are solid enough to prevent a default. That will almost certainly mean easing the terms of the existing agreements with Greece and Ireland.
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