How to fix the European financial system: David Tepper

Europe's financial system is a mess right now compared to its US counterpart. However, it doesn't have to be this way, according to hedge fund heavyweight David Tepper, who spoke on CNBC.

The basic problem with the European banking system is that they're under-capitalized, hold sovereign debt of peripheral countries that could significantly deteriorate, and face the risk of having their European Central Bank (ECB) liquidity funding cut off.

To fix this, Tepper suggests that the ECB commit to keeping their lending facilities open for longer stretches of time. The Federal Reserve, for example, kept theirs open for three years.

Tepper said offering the market the assurance of the available of ECB lending will allow banks to actually borrow from the market.

The Germans don't have to worry about that, the market will take care of it, he said.

Indeed, Europe's sovereign debt situation is paradoxical because so much is based on investor confidence. So the more European leaders threaten to withdraw government support -- the more the market tanks, the more likely the government will have to eventually foot the bailout money.

However, according to Tepper's logic, if European officials just promise to be supportive, they may actually avert crises and thusavoid bailout costs.

Tepper stressed that the ECB lending facility he's suggesting isn't free money, but collateralized lending for the purpose of supporting liquidity.

He also said Spain's regional banks -- called cajas -- need to be recapitalized. He calculates the funding gap to be about 40 billion euros, which isn't that large compared to the dollar amount of past bailouts.

He said a program that partners the government with the private sector to inject capital can work.

Keeping the lending facility open and recapitalizing cajas would solve 90 percent of the problem, said Tepper.

On top of that, if the global economy improves, he thinks Ireland, Spain, and probably Portugal will be fine. (He's a little skeptical about Greece, though.)

Tepper's fund currently owns Spain's Banco Santander.

Email Hao Li at hao.li@ibtimes.com