Geithner to Europe: Day Late, Euro Short

Treasury Secretary Timothy Geithner said Europe is trying to move forcibly to fix its debt crisis, reports Dow Jones Newswires, the sister company to FOX Business.

"I think they are moving--they are certainly trying to signal more commitment--to put more force behind their efforts to try to deal with the financial crisis they are facing," Geithner said after touting President Barack Obamas jobs bill at a United Parcel Service (UPS) package-handling facility.

But the problem wont be solved by creating more liquidity to buy bad bonds or recapitalize banks.

The problem is moribund, state-run economies. Talk now of blowing out the European Unions rescue fund to quadruple the size of its original $600 billion means Germany and France will have to do more to back up an even bigger fund.

And that, as I warned you two months ago, means France and Germany could put at risk their sovereign debt's Triple-A ratings. Germany backs 27% of the present $600 billion EU rescue fund, France 20%, Italy 18% and Spain 12%.

Meanwhile, Greece is backstopping just 2.8%, Portugal 2.5% and Ireland 1.6%.

Member countries of the euro zone backstop the fund, which lends euros to member countries. EU officials are now talking about increasing the size of the fund via borrowings in the debt markets in conjunction with the European Central Bank.The ECB is fast becoming Europe's bad bank.

David Beers, head of S&P's sovereign rating group, told Reuters these options could have "potential credit implications in different ways," including for leading euro zone countries, such as France and Germany.

But the problem is this. Greece has about 12 million people with about $300 billion in debt, and as economist Nouriel Roubini says its problem is a chronic lack of competitiveness. Anywhere from 70% to 80% of Greeces private-sector companies are owned by the Greek government, state-owned enterprises staffed with political cronies exacting their own payback from getting officials elected. Unions run dozens of companies too. All of this means any bailout of Greece will founder if its economy is not restructured from the ground up. A 2-trillion-euro rescue fund would likely let leaders just delay making structural changes. The only way to that would be to kick Greece out of the European Union, and let it devalue its way out of its own homegrown crisis, as Argentina did during the late 90s. Argentina was shut out of the debt markets until it got its act together. As Greece effectively is now, with yields spiking higher to 28% on its bonds. Stabilizing Europe and thus ending the market volatility here will rest on an emerging plan with three pillars. First, European leaders may increase the size of the Euro zone rescue fund to 2 trillion euros, or roughly four times the current size, via even more borrowings. That fund would backstop the European Central Bank, which could use the funds to recapitalize banks or buy distressed bonds from Germany or Italy.

Next, Greece could see a 50% writedown of its sovereign debt.

On paper, the plan sounds solid, but it wont be simple. For one thing, European leaders disagree strongly on the details. German officials are balking at letting Germany backstop even more debt for an even bigger EU rescue fund, as officials there say using leverage violates EU treaties launching the Euro zone.

And ECB officials also are squeamish about buying sovereign debt. China has been talked about as an investor, but if the ECB wont buy Euro bonds, why should China?

Next, a 50% debt haircut falls short of the 80% many observers think Greece needs.

Of course, theres a bright side: the European rescue plan doesnt tap the U.S. in a big way. Even so, that could easily happen againthe Federal Reserve lent European banks more than $600 billion during the financial crisis of 2008.

Overall, the Euro zone banks need to raise a big $1.7 trillion to $2.3 trillion of funds in the next three years to help with debt rollovers.

Goldman Sachs estimates Europes 38 biggest banks might need anywhere from $41 billion to as much as $126 billion in extra capital to cope with Greek, Irish, Portugese government bonds and losses on Italian and Spanish government debt.

Question: Can the ECB print and buy several trillion euros worth of bonds without unleashing inflation? Can the ECB shut down insolvent banks anywhere in the Euro zone, which are hotly contentious political decisions because the EU has no Federal Deposit Insurance Corp.?