Last summer it was Italy and government borrowing. This year it’s Spain, and banking. In both cases markets discovered that the problems were too big and might bring the euro down. Still, the euro has survived and, in spite of the turmoil, it looks like it’s here to stay.
Last summer brought the first bailout package for Greece, announced on July 21, 2011, but never applied. It also brought the ‘commitment’ among European leaders, mainly promoted by the Merkozy group, to move quickly towards a fiscal union, which never happened either.
This summer, the keyword is ‘banking union,’ as the ultimate solution to all the euro’s problems—will this one happen? Hard to tell, especially in light of the many and complex steps that have to be taken, and the conflicting views about its nature and extent among the main European countries.
Since the adoption of the euro in 1999, monetary policy, that is: the responsibility for setting the interest rates level and shaping the exchange rate of the currency, was moved from ‘local’ central banks to the Euopean Central Bank, in Frankfurt. What was left to the member-states’ central banks was banking supervision, as the local institutions were supposed to have the specific know-how of their home markets. The ECB never really got involved in the supervision of member-states’ banks, even if some of them were big enough to present a systemic risk; nor did the ECB even try to supervise the quality of supervision exerted by the central banks.
More to that, the ECB never intervened in the handling of banking crises when they erupted in various member states. This led to very different situations, even though the causes of such crises were roughly the same. Take for example Ireland and Spain, both hit by the burst of acute real estate bubbles, that evolved into severe banking crises.
Ireland reacted promptly and decisively by nationalizing the troubled banks, transferring their bad loans into a specialized institution (the ‘bad bank’), and thus restoring their solvency. The price to pay was a sharp decline in real estate prices, and a recession across the board.
Spain faced the same issue, but handled it in a different way, more consistent with southern European practices. In fact, under the previous government of José Luis Zapatero, it preferred to sweep the problem under the rug: banks contracted new loans to developers in order to repay the old ones, and offered super easy credit to buyers of foreclosed properties. In other words, they bought time by throwing more bad money after bad money. And of course, after pushing this reckless policy to its limits, they went and got a € 100 billion bailout from Europe. It goes without saying that all of the above happened under the ‘wise’ supervision of the Spanish central bank, and the ‘benign neglect’ of the ECB.
A ‘banking union’ will certainly take many complex steps to materialize, including the creation of a common supervisory authority, a common resolution authority, and a common deposit guarantee fund. But the real difficulty doesn’t lie in the complexity of the mechanisms. A banking union means that member-states will no longer be able to hide their problems for political reasons; it also means that national governments will have to transfer the power of taking tough political decisions to the common authorities, such as imposing heavy losses to troubled banks’ retail shareholders, or selling stakes in big industrial companies held by banks to foreign groups.
In other terms, the real issue is the extent of sacrifices in national sovereignty in exchange for saving the country’s banking system. And above all, will the timing for taking such decisions about abandoning national sovereignty be compatible with the time limits for action set by the markets in order to keep the euro afloat?