I always wondered who buys risky assets after one of these "historic” statements from the European Council. Sometimes the rally lasts for hours. Other times it lasts for days. The last one ended after less than a week; Italian and Spanish spreads are now above pre-summit levels.
The consensus among observers had been that the EU had taken an important step in the right direction by agreeing on a pathway towards a banking union, but that they did not do enough on crisis resolution. I disagree with that statement. I think it was a very large step – in the wrong direction. The summit made a concrete crisis resolution decision contingent on a future decision, which will be even harder to reach, and thus even more likely to fail.
They agreed that there shall be no common bank recapitalisation until a full banking union is established. And the Bundesbank has reminded us that the latter is not possible without a political union. The logical implication is that we won’t solve the crisis for the next 20 years.
What we know now is that Germany will not agree to mutualised deposit insurance. It cannot even agree to give the European Stability Mechanism a banking licence so that it can leverage itself. If Germany cannot do the minimum necessary now, why should anybody think it can agree a political union? This is less credible than the promise by an alcoholic to give up drinking in five years.
The politics of the euro rescue has crossed an important threshold in Germany. A narrow majority is still in favour of the euro, but a majority is against further rescues. A group of 160 economists, led by Hans-Werner Sinn, president of the Ifo economics institute, last week published a manifesto against a banking union. It was full of sound and fury, but the importance of this document is that it reflects a consensus view.
Angela Merkel’s answer was revealing. She told them that there is nothing to worry about. The banking union was about joint supervision, she said. There will be no joint deposit insurance. She has a very different understanding of a banking union than the European Central Bank. At most, I expect this new banking union to cover the 25 largest banks, and leave those cajas and Landesbanken in national control. This is like an alcoholic who promises to drink only the better cognacs from now on.
The banking union that is required is the one Germany will not accept: central regulation and supervision, a common restructuring fund and common deposit insurance. It would take years to create. If done properly, it would require a change of national constitutions and European treaties, if only to redefine the role of the ECB. It is sheer madness to make crisis resolution contingent on the success of what would be the biggest European integration exercise in history.
With interest rates on 10-year government bonds over 6 per cent, neither Italy nor Spain can sustain their membership in the eurozone. This is what Mario Monti and Mariano Rajoy should have made clear to Angela Merkel at the summit. They should have told her that their governments would make preparations for a withdrawal from the eurozone if there was no change in policy. A resolution requires either a eurozone bond – or some other form of debt mutualisation – in both the public and private sectors, and ECB bond purchases. Germany does not accept the former. The ECB does not accept the latter.
If something is neither sustainable nor self-correcting, there are only two courses of action left. The first is to wait patiently until the situation breaks down. This is the strategy pursued by the European Council – and by alcoholics. The alternative is to start making preparations – and be careful not to trigger a breakdown in the process. It is hard to envisage an exit without breaching hundreds of national and European laws. This is why nobody is doing it. One would have to use a force majeure defence. One cannot prepare for such an event. It took a decade to create the euro. It will take more than a long weekend to undo it. A collapse would constitute the biggest economic shock of our age. But among a list of bad breakup choices, some are a better than others. I will write about these in a future column.
Back in November, I wrote that the European Council had ten days to save the euro. If they had laid the groundwork for a banking and a fiscal union back then, they might now be in a position to agree to an effective crisis resolution strategy – consisting of bank recapitalisation and bond purchases. They did not do it then. And they are not in a position to solve the crisis now.
The message I took away from the summit is that the eurozone will not resolve the crisis. In that sense, it was indeed a "historic” meeting.
Copyright The Financial Times Limited 2012.
All downhill after EU summit
The latest EU summit saw some decisiveness but it rests on such an unlikely and broad integration that it is bound to fail. As a result, we're now even further from resolution and recovery.