Soros: Europe Must Bailout Banks to Restore Confidence

(March 24, 2011) — Hedge fund guru George Soros has asserted that the European Financial Stability Facility (EFSF) must assume control of Europe’s banks because bailing out countries alone won’t solve Europe’s sovereign debt crisis.

In an article by Soros in the Social Europe Journal, he argued that the majority of peripheral sovereign debt should be converted into Eurobonds, which he says would create a more level playing field among different countries in terms of borrowing costs. “The risk premium on the borrowing costs of countries that abide by the rules will have to be removed, and this could be done by creating eurobonds,” he wrote. According to Soros, Europe will “suffer something worse than a lost decade” if it does not take control of banks.

Furthermore, Soros criticized Germany for failing to take responsibility for the debt crisis and for acting selfishly by bailing out countries to solely rescue its own financial system. “Germany has been bailing out the heavily indebted countries as a way of protecting its own banking system,” Soros wrote. “…Thus, because the arrangements imposed by Germany protect the banking system by treating outstanding sovereign debt as sacrosanct, debtor countries must bear the entire burden of adjustment.” Consequently, according to Soros, Germany has control over terms by which the eurozone handles the crisis and it is in Germany’s hands to prevent “two-speed” regional growth.

Investment consultants argue that in assessing the sovereign-debt crisis, one should look beyond Europe. “Sovereign risk is not just about Europe,” Cynthia Steer, managing director of investment strategy at Russell Investments, told aiCIO earlier this year. “It’s about differentiating between countries and trying to understand the unique circumstances of countries, and about how they’re evolving in the monetary trilemma,” she noted, describing the trilemma as the confluence of stable exchange rates, capital controls and freely-set interest rates. “One can get two out of three, but rarely three,” she added.

“It’s profound, it’s going to continue, and it’s going to impact everything we do,” she said, going on to note that “For the first time in my years as an institutional investor, portfolios are going to have to understand inflation and deflation and live with that within the framework simultaneously.” In order to do this, she explained, institutional investors need to examine their portfolios within different risk parameters, looking at their sensitivity to inflation and deflation.

David Ritter, Senior Vice President of LCG Associates, an Atlanta-based investment consulting firm, noted that the sovereign debt crisis and volatility have created an opportunity for skilled active fixed-income managers. “We’ve told our clients to review their current fixed-income allocations, recommending they become less focused on a benchmark,” he told aiCIO. “If you look at an overall diversified portfolio, fixed-income still tends to be less volatile than equities, so looking at unconstrained fixed-income strategies makes the most sense, giving managers the most ability to add value.”