For Europe, There Are No Shortcuts to Fiscal Union

Transfers are hard to agree, but the alternative won't be easier.

Home bias.

Photographer: LLUIS GENE/AFP/Getty Images

European Commission President Jean-Claude Juncker made clear in his State of the Union speech today that he wants more Europe, including an expanded euro zone club. That will require a degree of economic and financial integration Europe currently lacks. The central question, with German elections nearly two weeks away, is whether Berlin will finally agree to the creation of some form of fiscal union, which would help member states deal with economic shocks before these turn into full-fledged crises.

One optimistic take is that this question may not matter all that much. Even if Germany continues to refuse to pool tax revenues to fund measures such as a joint unemployment benefit scheme, there are other ways to ensure that risks are spread more evenly across the euro zone. In particular, the speedy completion of the banking union and the creation of the EU's capital markets union can ensure that private investors from across the monetary union take a hit when a country suffers a shock. So long as governments do not step in to cover these losses, the argument goes, the euro zone can thrive without a fiscal union.

The main appeal of this view is that it appears politically realistic. Last week at a conference in Brussels organized by the economic think tank Bruegel, the consensus seemed to be that we should not expect a great leap forward once a new government is in place in Berlin. "Is everybody around the table ready to accept a delegation of power to the European level? For these kind of steps to be taken now, it is a difficult period of time," said Belgian Finance Minister Johan Van Overtveldt, pouring water over the idea that greater integration, particularly on the fiscal front, may be just behind the corner.

But the problem with any "private" solution to the completion of the monetary union is that there is little sign that governments and regulators are truly open to the idea of domestic investors taking sizable risks in the rest of the euro zone. Moreover, some politicians continue to find it hard to resist the urgency to bail out investors, especially in the case of banks. The "doom loop" between lenders and sovereigns is still alive.

The amount of financial integration at the European level is, unfortunately, still unsatisfactory. Data from the European Central Bank show that the amount of cross-border financial transactions within the euro zone has not recovered after collapsing during the sovereign debt crisis. The ECB's main "quantity-based" indicator of financial integration stood at the end of 2016 where it was in 2003. Cross-border loans to companies accounted for merely 9 percent of the total. At the end of last year, the share of assets that investors allocated to bond securities from other euro zone countries continued to decline and was less than two-thirds of the proportion of bond securities from their own domestic market.

Looking at deals, since the creation of the banking union in 2014, there has not been a single takeover of a significant bank by a euro zone rival. Conversely, there have been several high-profile domestic deals, including the decision by Banco Santander to acquire Banco Popular in the euro zone's first ever resolution. The so-called "home bias" will be very hard to overcome.

Nor is it clear that governments are willing to let investors take losses when troubles arise. The Italian authorities have done all they could to protect senior bondholders when it became clear that two Venetian banks would fail. The "bail in" instrument, which is at the heart of any well-functioning private risk-sharing mechanism, will continue to prove contentious. So will any mechanism to restructure government debt in an orderly manner, which is also essential if investors are to shoulder some of the weight of a sovereign debt crisis.

The euro zone is right to remove barriers which still stand between national financial and capital markets. Demanding that bondholders face the true risk of their bets is not only efficient but also fair. However, it is hard to see how these aspirations are sufficient to insure weaker member states against the risk of a full-blown crisis. The case for pushing toward some form of fiscal union after Germany's elections remains compelling.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Ferdinando Giugliano at

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    Therese Raphael at

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