Have you noticed that the half-life of eurozone optimism is getting shorter? It was only three weeks ago that Mario Draghi, the European Central Bank president, announced his outright monetary transactions, a program of sovereign bond purchases with no up-front limit. It seemed that the consensus was that this had either ended the crisis, or its acute phase.
Last week investors – and Spanish journalists – suddenly discovered to their horror that Germany will not after all allow Spain to dump the risk of its banks on to the European Stability Mechanism, the eurozone rescue fund. That seems to contradict the June 29 eurozone leaders’ summit statement, which said it was "imperative to break the vicious circle between banks and sovereigns”. EU leaders reached this agreement in the early hours of the morning after a diplomatic ambush by the Italian and Spanish prime ministers.
Whatever may have been agreed that morning, it was understood differently in Spain than in Germany. The Spanish interpretation had been that the EU would adopt a banking union by the beginning of next year. This would then automatically trigger a shift in the burden of the recapitalisation of the Spanish banking sector from Spain to the ESM.
This is not how Angela Merkel, the German chancellor, and Wolfgang Schuble, her finance minister, understood the deal at all. Over the past few days, they clarified what kind of banking union they want. This is how I would summarise the German position:
First, we do not really want a banking union all, but if we have to have it, we would like to limit the remit of the pan-European supervisor to a few large cross-border banks.
Second, ideally the supervisor should not be the ECB; if it has to be the ECB, there must be safeguards, stronger than those proposed, to ensure that monetary policy remains independent from the banking supervisor.
Third, there shall be no joint deposit insurance.
Fourth, the banking union shall not deal with any legacy risk, only problems that arise in the future. The Spanish bank programme remains a Spanish bank program.
Fifth, the ESM should not be able to undertake direct bank recapitalisations until the banking union is fully implemented. This will take many years.
Whether or not you call this a banking union, or a breach of the June 29 agreement, is irrelevant. The point is that you cannot force through a banking union against the explicit will of the German government, the German parliament, the German public at large and the Bundesbank. I suspect the EU will ultimately agree on a fudge. But it would be irrelevant for the resolution of this crisis.
Jens Weidmann, president of the Bundesbank, last week said a banking union was a disguised transfer mechanism. On this point, he is right. A banking union would recapitalise Spanish banks at the expense of northern European taxpayers. This is the whole point of having it. It would be dishonest to deny that. A banking union, properly constructed, thus constitutes a fiscal union. This is not something you do before Christmas, or through a directive.
I wrote earlier that a banking union is an even bigger deal than a eurozone bond. You can construct a eurozone bond with lots of safeguards. There are even proposals on the table that would turn a eurozone bond into an instrument to deliver austerity – a so-called debt redemption bond. I would rather have a banking union and no eurobonds, than the other way round. I would rather have nothing than a debt redemption bond.
Judging from the political debate, Germany is not ready for a fiscal transfer mechanism of any kind. In particular, Germany is not ready for a banking union. Merkel never made a political case for a banking union in Germany. All she did was play down the implications. I would counsel readers against falling into the trap of thinking that next year’s German elections will miraculously clear all the hurdles. All the various probable outcomes favour a continuation of the present policy.
The dwindling chances of a banking union put Draghi in a tight spot. His OMT program needs a banking union to work. The ECB’s liquidity backstops guarantees the banks, for now. The OMT guarantees the sovereign debt. As these programs run out – which they eventually will – the eurozone needs an institutional framework in place to deal with the two intertwined risks of banks and sovereigns. A banking union would end that vicious circle. But even with a banking union in place, the eurozone still faces an equally formidable vicious circle of austerity and recession. The dynamics of the recession are alarming.
Whenever the ECB helps, the political process slows down. This is the true tragedy of the eurozone’s crisis management. We are now back at the point before Draghi announced his program – where the stated policies are inconsistent with a survival of the eurozone.
Copyright The Financial Times Limited 2012.