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Adolfo Laurenti Is Deputy Chief Economist at Chicago-based financial services firm Mesirow Financial. Previously he was an associate economist at LaSalle Bank/ABNAmro.

H.L.: You’re just back from a conference in Switzerland on the European debt problems. What’s the current status?

A.L.: It is bad. But I think in the past week we have seen some promising signs of improvement. I think that three major issues are on the table.

No. 1 is that we need to be realistic about Greece. Greece cannot repay its debt. They will go into some form or another of default. The real question is what will be the haircut on the Greek debt. There were a lot of unreasonable expectations on that front for a long time. Now I see that most people seem to agree with a 50 percent haircut, and that’s realistic, and I’m glad to see that people have come to the realization that it cannot be better than that.

The haircut will be suffered mostly by the holders of Greek debt, French and German banks, which raises the issue of the need to recapitalize the French and German banking system. We are seeing those conversations in Europe becoming more substantial. It was almost a taboo to mention a new recapitalization of the banks in Europe, and now it is what is being discussed between Angela Merkel of Germany and Nicolas Sarcozy of France.

The discussion is now how to do the recapitalization. The French would like the European Union to contribute out of the European Financial Stabilization Fund, while the Germans prefer each country to pay for their own banks first.

I think there are still details to be worked out, but the good news is that this issue is being addressed.

The third point is that there needs to be a firewall to be around Spain and Italy in order to prevent contagion. The insistence on austerity measures plus the actions by the European Central Banks are helping both Spain and Italy to put some order in their public finances.

Net-net, I think this is a positive development. It is a very slow process, but at least it’s moving the ball in the right direction.

H.L.: How long will it be before Europe is back in balance?

A.L.: It might take a decade to go through rebalancing. The point is if you can see slow but constant progress that will be good news. We need to be realistic about the timing.

Source: Interview With Adolfo Laurenti: European Bank Recapitalization Is Finally Being Discussed