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TheStreet Open House

3 Key Elements to Watch for European Solution

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Behind the scenes, there is a regulatory power play developing that could solve the European debt crisis once and for all. The mainstream media has done a terrible job of detailing the fundamentals of this probable solution.

Prevailing sentiment suggests that any kind of Greek default is bad news for the global financial system because of the stress it will cause to banks that hold Greek, Portuguese, Spanish, Irish or Italian (mostly Italian banks) debt. However, Germany also knows that the current debt landscape will require bailout after bailout after bailout and German citizens will eventually revolt against such lunacy. A new plan is needed.

Any long-term solution to the European debt crisis must provide solutions for the following three economic elements:

1. Bank capitalization. If the German plan of restructuring (default) wins out, a simultaneous change in accounting standards must accompany the plan. If not, we will see a crisis on par with the financial crisis of 2008/2009. Banks must be permitted to remain solvent in the short run even if they have high exposure to troubled European sovereign debt.

The biggest barrier of the 2008/2009 crisis was mark to market accounting; CDOs were marked to market and the banks were forced to raise capital every time the value of those holdings dropped, which caused bear raids on those banks that could not raise adequate capital quickly enough.

It wasn't until mark to market regulatory requirements were relaxed in April 2009 that the banks finally stabilized and an economic recovery began. Regulatory accounting requirements do not get enough credit from the media. Most analysts don't understand them and most investors are ignorant of the impact.

Mark to market was the primary cause of the Great Depression in the 1930s. It wasn't until FDR relaxed the short-term liquidity requirements on banks that the U.S. was able to recover. Europe's problems are long-term in nature and the struggling countries in the Eurozone must be given ample time to recover from those problems. The restructuring of debt combined with relaxed accounting regulations for the banks will put Europe on the road to recovery.

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