A currency union requires a unified banking sector. With one supervisory authority that keeps banks in check (and, hopefully, in awe), re-capitalises them when the need arises and, when this happens, takes a stake in them in exchange for the capital injected into the banks.
It was an act of gross omission on behalf of the eurozone’s ‘founding fathers’ to allow national banking sector supervision to co-exist with the new common currency. And it is an act of scandalous commission to maintain now, in the face of our acute euro crisis, that things must remain as they are.
Suppose that, in the Fall of 2008, the various states comprising the US had to refloat and recapitalize, through state borrowing, the banks whose seat was located on their territory. The result would be that both the states and the banks would have sunk without a trace in the quicksand of bankruptcy. Ireland and Spain provide an excellent case-in-study on the other side of the Atlantic. And they confirm that the euro-system’s founders were bordering on the criminally negligent.
Euro-optimists tell me that “it will be alright on the night”. That this is how Europe evolves: A bad design is put in place, a crisis occurs, Europe responds haphazardly and equivocally but, eventually, it “does the right thing” by itself and by its survivalist interests. My concern is that the fact that it has done so so far does not guarantee that it will “do the right thing” this time around. But I am prepared to keep an open mind. However, the manner I which it deals with bank recapitalisations now, and whether it will push for the direct recapitalisation of banks by the EFSF, will be a decisive litmus test.
Our Modest Proposal has been steadfast in its insistence that such a transformation of the EFSF (and consequently of the eurozone’s banking sector) is sine qua non: that the EFSF should be transformed into a body that re-capitalises directly Europe’s banks.[1] This would mean that capital (which the EFSF borrows from the money markets, effectively, on behalf of triple-A countries) is injected directly into the banks; that the EFSF receives common stock in return; that, once such recapitalisation is complete, these shares are auctioned off to the highest bidders (thus repaying the taxpayers who put up the guarantees on the back of which the EFSF borrowed).
Last week Adair Turner, Head of Britain’s Financial Services Authority (FSA), suggested exactly the same solution to the Eurozone banking crisis: That “…the European Financial Stability Facility and the European Stability Mechanism [ought] to funnel cash directly to struggling lenders [so as to] help solve the region’s debt crisis and be a ‘limited but vital’ step on the road to greater fiscal integration among the 17 nations that use the euro.”[2]
Wolfgang Munchau seems to agree with both us and Adair. In a recent FT article, entitled ‘The sadly unpalatable solution for the eurozone’, he sums up this proposal thus: “The idea is essentially to take the nation state out of banking and to make the eurozone – or the European Union – responsible for everything. The notion of, say, a Spanish bank would cease to exist.” However, quite correctly, Munchau points out the reasons why this common sense approach has not been adopted, and why it is meeting with incredible resistance amongst politicians: “It is hard to conceive of Germany’s corporate sector without its cosy relations with the banks”, he points out. And of Greece, of Spain, of Italy etc., I would add, as I have been arguing in this blog repeatedly over the past two years.
As if on cue, eurocrats came out (after our recommendation was floated in Berlin, at the INET Conference) to pour cold water on the idea. Here is a Reuters title that captures their reaction succinctly: “Direct bank recapitalisation by euro zone funds unlikely, say officials”. Indeed, Klaus Regling, the EFSF’s chief (admittedly not the sharpest knife in the eurocracy’s drawer) had this to say: “ “If I were asked to give money directly to banks I would have to manage banks… We are just not set up for that.” Well, be that as it may Mr Regling, perhaps it is time to become ‘set up for that’! For the alternative, is (to use Munchau’s expression) uttetly unpalatable: Having the Greek, Spanish and Irish governments pile even more debt on their puny shoulders on behalf of ‘national’ banks, is to fly in the face of basic architectural principles. It is akin to leaning a super-heavy scaffold against a collapsing building in a manner that guarantees the collapse of both the scaffold and the building.
So, here is the crux, the ultimate litmus test, for euro-optimists who think that this Crisis will force our leaders/officials out of their torpor, and into action: Will Europe allow the EFSF directly to recapitalise the banks, transforming itself into a proper Eurozone banking authority in the process? If not, all talk of a Europe that eventually ‘does the right thing’ will be proven to be little more than hot air.
[1] This policy proposal first appeared in Version 2.0 of the Modest Proposal (March 2011) and has been an integral part of all subsequent versions – e.g. here and here.
[2] Victor Mallet, reporting from Madrid for the FT, also suggested something similar: a form of a ‘bad bank’ for Spain’s crippled banks (and the mortgages that have blown up in their faces) to be financed directly by the EFSF. “The EFSF can do it and that’s not a bad idea… The point is, they have to avoid a whole troika programme where Spain’s access to markets gets frozen and all financing is provided by official lenders.”
