Misconstruing Germany Will Prove to Be Death of the Euro
When I go from one European capital to another, talking to officials and senior politicians about the future of the euro, Germany feels less like another country than a different planet.
In Madrid and Dublin, a euro-area banking union -- the prerequisite for bailing out banks directly -- is discussed as if it were a foregone conclusion. Both Spain and Ireland are hoping their governments ultimately won’t have to finance the rescue of their banks alone.
Top officials in Germany work on the assumption that a meaningful banking union will never happen.
I recently spoke, for example, on a panel about the proposed banking union at a conference in London that was hosted and attended by senior German businessmen, politicians and Finance Ministry staff. After my introduction, one senior official explained the German position on a banking union in just five words: “We do not want it.” I looked around to see a sea of heads nodding in agreement.
This cognitive dissonance within the euro area is potentially fatal, leading to misinterpretation of the intentions of the currency bloc’s indispensable nation: Germany.
Take the last European Union summit, in October. EU summits are ritualized events at which member states’ national leaders sign joint statements and then rush off to their assigned rooms in the building to hold separate news conferences. There, they try to define what the deal really means. German Chancellor Angela Merkel signed the October summit’s conclusions, which committed to start building parts of a banking union, and then started to distance herself from it before she had left the building.
This raised a few eyebrows, but it should have raised the alarm. Most commentators assumed that any backtracking was just about election schedules. Merkel was keen to push off potentially contentious issues until after Germany’s 2013 elections, they argued.
That assumption was probably false. Germany isn’t interested in taking the steps required to establish an effective banking union, not now and not ever. Without a banking union -- and, by extension, some degree of fiscal union -- the euro project stands little chance of survival.
To explain why, you have to go back to the start of the crisis. By 2007, euro-area bank balance sheets ballooned so much that the total assets of the banking system reached more than 300 percent of gross domestic product, compared with less than 100 percent of GDP for banks in the U.S. Given the interconnectedness of Europe’s financial institutions, it was feared that the failure of one lender might bring down the entire system. So a decision was made to avoid the insolvency of any major bank in the euro area at all costs.
As banks were recapitalized by their governments, a negative-feedback loop developed between lenders and their sovereigns. In some countries, states stepped in to prop up their ailing banks, while in others the banks stepped in to prop up their ailing sovereigns.
This was most obvious in Ireland and Greece. The bottomless pit that was the Irish banking system sank the state, as bank debt was foisted onto the Irish sovereign’s balance sheet. In Greece, banks were hit hard, first by deposit flight as savers worried that the country might leave the euro, and then by a hefty “haircut” -- or writedown in value -- imposed on privately owned Greek government bonds, with which Greek banks were stuffed to the gills.
The main objective of a banking union is to break this negative-feedback loop by allowing banks to fail and to be liquidated or recapitalized without contagion to other lenders or to sovereigns. In order to work, the union has two minimum requirements.
The first is a single supervisory mechanism to oversee all banks in the euro area. The second is a bank-resolution plan, which would put processes in place for recapitalizing systemically important banks that get into difficulty, and for liquidating their nonsystemically important counterparts.
Some progress has been made on establishing a supervisory mechanism. At the EU summit in October, euro-area policy makers agreed to legislate one by the end of 2012, and to implement it in 2013. Once this has been done, policy makers agreed that the EU bailout fund, the European Stability Mechanism, will be able to recapitalize banks directly.
Germany only wants the mechanism to supervise systemically important banks. It’s no secret that this is because Merkel doesn’t want euro-area supervisors poking around Germany’s sick Landesbanks and highlighting that Germany’s banking system hasn’t been immune to the crisis. This hurdle is probably surmountable.
The bank-resolution plan is a much bigger stumbling block, because to be able to recapitalize one or more systemically important banks in the euro area, a body with very deep pockets would have to be established. The money in those pockets would, of course, be mainly German.
The euro area already has money in its bailout funds, but that 500 billion euros would probably be too little to recapitalize Europe’s biggest banks. The only way to amass the financial firepower needed is to pool tax revenue. A banking- resolution plan therefore involves some form of fiscal union.
This is where German heels dig in. Merkel has demonstrated over the past few years that she won’t be pushed into a fiscal union as a short-term response to a crisis. She sees this union as the culmination of a very deliberate, long-term process that first involves countries signing up to fiscal checks and balances and establishing a credible track record of sticking to fiscal targets.
Only if those hoops have been jumped through will Germany consider pooling assets across the euro area and, later still, mutualizing debt. Setting up an effective banking union now would require Germany to skip those first steps.
Even if Germany were willing to sign up to pooled assets and joint tax collection, the old U.S. adage “no taxation without representation” applies in Europe, too. A body that could raise taxes across the euro area would have to be firmly embedded within a democratically elected institution at the European level. This would involve a huge transfer of sovereignty from the Bundestag -- Germany’s parliament -- and the German Finance Ministry to the European level, for which there is zero appetite in the German ministries.
If Germany doesn’t change its position, the best we can realistically hope for is that it will continue to pay lip service to eventually establishing an effective banking union, and that the European Central Bank will pretend to believe this fiction in order to continue buying euro-area sovereign bonds. That could keep the wheels on the euro-area project for some time. But it cannot solve the crisis.
(Megan Greene is the director of European economics at Roubini Global Economics. Read more from Greene at www.economistmeg.com. The opinions expressed are her own.)
Today’s highlights: the editors on how California voting reforms hint at wiser politics and on how to achieve a Hamas-Israel cease-fire; Jeffrey Goldberg on Hamas-Israel fighting; William Pesek on Christine Lagarde’s giving short shrift to Asia; Ramesh Ponnuru on Republicans’ leverage in fiscal-cliff negotiations; Betsey Stevenson and Justin Wolfers on the forecasting prowess of crowds; Cass R. Sunstein on the broken Senate confirmation process.
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