Sunday 11 July 2010 11:14 pm

If policymakers fail, let us turn to St Francis

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As an exercise in transparency Europe’s so-called stress tests have already failed. We were promised the methodology and all we got was the madness; a drip, drip, drip of information that has slowly driven the markets round the twist. When will policy makers learn that what investors really want is clarity? DON’T BE FOOLED BY RALLY Yes, the banking sector may have rallied over recent days. However politicians should not be fooled. This market reaction has nothing to do with optimism about the health of the financial system. Instead, it has been largely a result of short positions being closed as traders decided they couldn’t make an informed decision in such an opaque environment. It’s not as if the stakes aren’t high here. These tests go beyond the issue of the strength of the banks and go to the heart of the problems that Europe is currently facing. The tests are in truth not just a test of the banking sector but also of the credibility of Europe’s nation states. While MF Global might believe that the media is wrong to bemoan the “absence of a plan to recapitalise the [banking] sector”, Credit Suisse gets neatly to the point. Its analysts highlight that the process is in fact a test of the willingness of the official sector to provide capital to those firms that fail. MINISTERS COULD CALM MARKETS Hopefully this point will not be lost on Europe’s finance ministers as they gather in Brussels today. If they can make clear that they have the capacity to make good under funded banks then things might just calm down a little. If they fail in this simple task then the market will be right to continue to worry about sovereign risk. This raises the interesting issue of the EFSF (European Financial Stability Facility), which is primarily intended as a sovereign guarantee vehicle. There have been hints over the last few days that this could be used as a funding source for the financial sector. If this is true then this very much blurs the lines between bank bailouts and sovereign bailouts. Any country that uses the facility will be deemed to be unable to fund its failed banks out of national resources. This in turn will open fresh questions about the fragility of that particular country’s national finances. ST FRANCIS’S WORDS APPROPRIATE The worry has to be that if policy makers make a mess of these stress tests then they could achieve exactly the opposite effect that they were hoping for and drive Europe back in to chaos. Let us all pray that they get it right. The words of St Francis seem particularly appropriate: Where there is doubt, [let me bring] faith; Where there is despair, hope Where there is darkness, light Guy Johnson co-anchors European Closing Bell weekdays on CNBC. http://europe.cnbc.com

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