Jose Manuel Barroso, the President of the European Commission, pretty much summed up the G20 summit in Mexico when he said “we have not come here to receive lessons in terms of democracy or how to handle the economy.” It’s not hard to understand his frustration.
It can’t be easy to have to explain to the leaders of the world’s twenty largest economies that no, the Eurozone is not about to reach a deal that will magically restore confidence and economic growth.
The rest of the world is getting understandably worried about the EU’s inability to get a handle on its financial crisis. A depressed Eurozone is a drag on global growth, but a disorderly dissolution of the currency union could spread contagion through global financial markets. Europe’s leaders may in fact be making slow but steady process – they now have a Fiscal Compact, the European Stability Mechanism (ESM) is scheduled to come on-stream July 1, and they seem to have averted (for now) a Greek collapse.
And yet the G20 leaders could not have been pleased to hear that the austere fiscal and monetary policies in the Eurozone are being enforced for political, rather than economic reasons. The semi-permanent state of crisis in the Eurozone that has defined the past four years is not the result of some disagreement over the size of the money multiplier, the moral obligations of debtors or the relative merits of Keynes. It is rather
a negotiating tactic being deployed in the debate over the fate of the monetary union. It is a tool in the hands of the ECB, the Germans, and the rest of Europe’s creditors, used to extract concessions from the governments of peripheral Europe and European borrowers more generally.
Only by keeping the pressure on, so the thinking goes, can European leaders be forced to make the tough decisions that a Eurozone fix requires. Very important interests are at stake, namely power and money, and European negotiators are playing a very high stakes game. They are arguing over competing visions of the future of the European Union, who will be forced to pay for bad debts, and political survival.
But keeping the pressure on means continued financial instability, deep recessions and the rise of populist political movements. Markets can move a lot faster than policy makers, and it’s not clear Europe has the time it needs to get its house in order.
With the failure of the mooted Spanish bank bailout to calm the markets, a prospective banking union has finally reached the top of the Eurozone crisis agenda. The
broad outlines of the union are beginning to take shape:
- A common deposit insurance scheme to prevent bank runs.
- A single regulatory body with the authority to permanently shutter failed banks.
- A resolution mechanism for insolvent but systemically important banks, which in the short term must use funds from the ESM to recapitalize banks directly.
A banking union is a necessary component of a sustainable monetary union. But it will take years to build the institutional capacity and legal framework that banking union requires. In the US for example, when the FDIC seizes a bank, it has the institutional capacity, over the course of a weekend, to examine the banks’ books, separate the good loans from the bad, and either reopen a healthy bank on Monday or return depositors money. The Eurozone can build this capacity, but not overnight.
The more serious question is: do they really want a banking union? It might be in the interests of some taxpayers in the periphery, some large financial institutions, and the ECB, but no sovereign government really wants to give up the power that comes from maintaining regulatory authority over domestic financial sectors. European banks, be they large national champions or regional savings banks like the Cajas in Spain and the Landesbanks in Germany, often make loans to state-favored projects, provide jobs to retired politicians, or even invest in sovereign bonds during a crisis.
A single European banking authority would upend these relationships. Smaller countries could lose control of their banking systems outright, as has already happened to several eastern European states now in the EU, whose banks are almost all subsidiaries of foreign banks. And banks are really important in Europe – corporate bond markets on the continent are still much smaller than those in the US. Do Spain, or Germany, really intend to give up control over their banks to a supranational institution?
One country that certainly doesn’t is Britain, which presents a problem of a different sort. A British veto over financial integration at the EU 27 level means the banking union will be a Eurozone affair. Others outside the Eurozone will also likely be wary of signing up to banking union, leaving
many unanswered questions as to the future of the single market in financial services.
In any event, constructing new supranational institutions is not a straightforward process. Euro sausage making is a particularly convoluted process that can require parliamentary approval, a referendum, review by a constitutional court or intergovernmental treaty depending on the country and issue. For Germany in particular, any open-ended fiscal commitments – as would be required of a credible deposit insurance scheme (to say nothing of Eurobonds), would probably be deemed unconstitutional by its courts. Nor is there evidence of much popular support for further financial and fiscal integration among European electorates.
And then there is the issue of who pays. The Germans and the other European countries that have been running current account surpluses are the creditors. Their goal is simple – they want their money back. They don’t care who pays – if the original borrowers can’t make their payments, then taxpayers from the periphery should. They do not want to pay to recapitalize peripheral banks or deposit insurance schemes, even though that means they are asking peripheral taxpayers to pay for the bad investments made by core banks.
Taxpayers in peripheral Europe, meanwhile, couldn’t pay even if they wanted to – they’re already struggling to pay off mortgages after they’ve lost their jobs and had their pension benefits slashed.
One can see these issues at play in the ongoing negotiations over the
Spanish bank bailout. As things currently stand, it looks like Spain’s taxpayers will be left with the bill for the country’s real estate bubble. Prime Minister Rajoy, it seems, did not push hard for a direct recapitalization of Spanish banks through the ESM, as that would have necessitated giving up control over the banks to the troika. Instead, in exchange for a sovereign loan with limited conditionality,
Rajoy appears to have sold out Spanish taxpayers.
If this does prove to be the model for fixing Spain’s banks, then history will be repeating itself. Spain will follow Ireland down the path of botched bank recapitalizations where bank creditors are made whole on the backs of taxpayers, leading to a sovereign debt crisis, yet bigger bailouts, an IMF program, and long years of austerity.
Is this really what the ECB and the Germans want? The ECB surely wants the Euro to survive, and as it is ultimately responsible for financial stability, it is strongly in favor of a banking union. It is, furthermore, wary of moral hazard, and does not want to monetize deficit spending by fiscal authorities, so it is in favor of fiscal union as well.
Perhaps then continued austerity and massive bailouts are the path to banking and fiscal union – full conditionality and troika oversight could impose those very conditions. But what happens if France is dragged into the crosshairs of the bond market vigilantes? Will the ECB be able to keep the pressure on? Or will it be “captured” by the periphery, who will demand the bank act as lender of last resort to sovereign borrowers without submitting to supranational oversight?
Germany might have fewer votes on the ECB board than it believes. Of the Euro 17, only Germany and the Benelux countries have positive net international investment positions. Thus, there are many more debtor than creditor countries in the Eurozone, and potentially many more votes in favor of “fiscal dominance” than meets the eye.
For all the brave talk in Mexico that Europe will do “whatever it takes” to save the Euro, the prospect of a happy ending to the turmoil seems very far off. At best, the Eurozone can muddle through, slowly chipping away at the sovereign prerogatives of its member states as the debt crisis spreads across national borders, eventually emerging as a United States of Europe. But with the stakes so high and market confidence so low, the chances of some mistake being made that derails this process are increasing.
Ben Carliner is a fellow at the Economic Strategy Institute. Prior to joining ESI, Mr. Carliner worked as a financial journalist in New York for Project Finance International. The original article can be found on Ben Carliner’s blog.