ECB's Bini Smaghi: Crisis firepower must reflect risks

European Central Bank

Bini Smaghi said that while it was difficult to get political and public support for putting massive amounts of taxpayer money on the table to fight the crisis, having a sufficiently large arsenal was crucial.

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"It is important to realize that the size of the backstop has to be proportional to the systemic risk we may face," Bini Smaghi said in a speech, posted on the ECB's Internet site on Tuesday, but dated October 17.

"The best way to deal with contagion is to act quickly, with enormous firepower - the "bazooka" as Hank Paulson used to call it," he added.

European leaders will meet in Brussels on Wednesday to discuss increasing the effective capacity of the EFSF, the European rescue fund to tackle the ever-intensifying crisis.

Bini Smaghi warned against allowing countries restructure their debt easily, saying it would let them off the hook from honoring their signature and reward irresponsible behavior.

In Europe, stronger economic governance was needed, even if it required changing the Maastricht Treaty, Bini Smaghi said, and added that countries seeking assistance should yield some of their sovereignty to European authorities.

But even with new measures, one should not expect a quick turnaround in Greece -- worst hit by the debt crisis -- as an overhaul of its economy will take "several years," he said.


Bini Smaghi also said that while there was an inclination to punish banks for their past mistakes, it would be counterproductive.

"You don't teach the banking system a lesson by letting it collapse once in a while," he said, adding that banking system backstops had to be identified to show the markets that banks will survive even if the crisis takes a turn for the worse.

This means ensuring banks have sufficient capital, but at the same time not adding too high hurdles for them.

"We should avoid promoting solutions which end up producing the opposite result, in particular having a permanent excess of capital and entrenching the idea that euro area public bonds are unsafe assets," he said, but added that higher capital now could help stem the negative spiral between banks and public finances.

European authorities are expected to agree on a recapitalization drive to lift bank capital across Europe by up to 110 billion euros.

The plan is designed to protect EU banks from the fallout of a Greek default and ease their borrowing difficulties amid a creeping credit freeze.

(Reporting by Sakari Suoninen and Marc Jones; editing by Anna Willard)