In April 2011 I wrote a piece, entitled “It is the German banks stupid” in which I claimed that the primary reason why Europe was allowing a preventable debt crisis to engulf the Periphery had to do with the sorry state of the German banks and with the determination of the German government to do nothing that exposes their precarious condition. I called it the Great Banking Conundrum: how to deal with the Periphery’s public debts without revealing the depth of the black holes in Germany’s (and, less so, France’s) private sector banks. In that piece I opined that the powers that be in Frankfurt and Berlin were busy worrying about Germany’s banks:
“Only they do so in secret, behind closed doors, struggling to find a solution to the Great Banking Conundrum behind the European people’s backs and away from the spotlight of publicity. Their deliberations are now in a new phase, taking their cue from the Greek debt crisis. Lest I be misunderstood, the Greek crisis, however monstrous by Greek standards, is in itself no more than an annoyance for Europe’s surplus countries. A gross sum of €200 to €300 billion could be restructured quite easily or at least dealt with somehow. Its significance lies in the opportunity it offers Germany for revisiting the European banking disaster in its entirety. The Greek debt restructure, with its repercussions on Europe’s banks, is a useful case study; a dress rehearsal; an excuse to begin the process of taking the broader Great Banking Conundrum more seriously.”
Since then much water has flowed under the bridge. The Greek debt was restructured almost a year later (soon to be restructured once more) and, more importantly, banking losses have been transferred en masse to the Northern European taxpayer via: (a) gargantuan ‘bailout’ loan agreements with four Eurozone countries (Greece, Ireland, Portugal and, now, Cyprus plus the far more significant country, Spain) and (b) the ECB’s LTROs that have pumped 1 trillion worth of liquidity into largely insolvent Eurozone area banks.
Tragically, this large-scale transfer of ‘pain’ from the banks to the taxpayers, via the institutions of the Eurozone, has done absolutely nothing to stem the Crisis. Why would it? Without putting in place the missing institutional tools for reversing the domino effect, a mere transfer of pain from one insolvent entity to another offers no respite. So, we now find ourselves at a phase of advanced disintegration of the common currency area. Only the other day, the ECB unveiled the extent of the disintegration: small and medium sized firms in Spain pay interest rates that are, on average, 210 basis points greater than those paid by comparable German firms in order to borrow sums of up to one million euros.
Recalling that the idea of a single currency within a single market was to create circumstances for convergent prices of homogenous goods (and money ought to be the most homogeneous of all goods!), a spread of 210 basis points for companies with the same profitability outlook, in the same economic area, is bordering not just on the scandalous but, indeed, on the utterly unsustainable. As long as markets function properly, the ‘price of money’ (the rate of interest) ought to be equalised across different regions of the same currency area when the borrowers are similar in terms of creditworthiness, profitability, prospects etc. When an immense spread of 210 basis points is observed between comparable private sector agents, courtesy only of their geographical location, we know that our currency union has ceased to function.
There is nothing controversial in these views. Our politicians know that this is, indeed, our situation and have, in the June EU summit, said so, in effect, by agreeing to implement a banking union as a means of reversing the disintegration process. A few weeks later, Mr Draghi also confessed to having no doubt about our predicament, stating categorically that the ECB will act decisively, announcing a major… announcement on 6th September. What should we expect? How far off will Mr Draghi’s announcement fall from what he wants to announce?
There is little doubt that Mr Draghi wants the ECB to play a telling role in overseeing the banking union (by supervising banks throughout the Eurozone and also by acquiring the powers to wind them down if they are judged to be insolvent). We know this because he has said so and has, also, expressed a clear ambition to intervene in the bond markets too, especially these of Italy and Spain, so as to put a lid on the huge spreads that prevent the ECB from increasing the money supply to (or reducing interest rates in) the Periphery. But will he be allowed to do these two things? Or will he be stymied by German opposition?
The 6th of September is nigh. So, we shall see. Nevertheless, we already have signs that Mr Draghi will, indeed, be stymied. On 30th August, 2012, the German finance minister took the rare step of writing an article in the Financial Times entitled “How to protect EU taxpayers against bank failures”. A quick reading may mislead the reader into the conclusion that Mr Schauble is all in favour of centralising bank supervision under the auspices of Mr Draghi’s ECB. Alas, the opposite is the case. Read more carefully, his article is a manifesto for stopping the ECB from playing a decisive role in bank supervision and liquidation. “[W]e cannot expect a European watchdog to supervise directly all of the region’s lenders – 6,000 in the eurozone alone – effectively”, wrote the German finance minister. This is code for: National supervision of banks remains as is. The ECB will look over the national supervisor’s shoulders, without any effective powers to fire directors, impose capital injections or, indeed, wind banks down if it thinks it is necessary to do so. Put differently, when Mr Schauble suggests that the ECB “should focus its direct oversight on those banks that can pose a systemic risk at a European level”, he seems to be saying that Deutsche Bank must be supervised by the ECB but the landesbanks, Bankia, Dexia and all the other smaller banks whose fortunes are intertwined with large banks like Deutsche Bank (including their own, often murky, subsidiaries) must be kept off the ECB’s watch.[i] This is equivalent to suggesting that the ECB becomes a bank supervisor only in name. In short, the German finance minister took to the pages of the Financial Times to preempt Mr Draghi with the following concealed statement: “The ECB will be given a ceremonial role as banking supervisor, possibly with a remit to supervise Spanish, Italian and Greek banks but, when it comes to Germany’s banks, it will be told in no uncertain terms to “keep off”. Germany’s banks are not to be subjected to non-German, genuine, oversight. Period.”
Similarly with the bond purchases that Mr Draghi knows are crucial to return to the ECB some control over interest rates in the Periphery. The German government have been keen to see to it that Mr Draghi does what it takes to buy the Eurozone another year or so (just like he did at the end of last year with the LTRO) but not to fix the system once and for all. Such a permanent fix would create an impetus for a true banking union, of the sort that Frankfurt-based private banks want to keep at bay.
So, when you hear Mr Draghi declare that the ECB will (a) have a limited role in supervising banks and (b) purchase only short term Italian and Spanish bonds, targeting a lowering of the spreads for debt with maturity less than 1 or 2 years), feel no surprise. His brief is dictated to him and reflects a singular objective: to remain on the right side of Germany’s bankers.
The common currency area is broken. In fact, it is no longer a common currency area but, rather, an area in which the same currency is used. To begin fixing this broken system, without adopting radical measures like those we suggest in the Modest Proposal, the ECB must become the equivalent of the FDIC and the Fed, plus it must work towards turning the EFSF-ESM into Europe’s TARP. At the same time, it must unleash an asymmetrical quantitative easing (QE) program that targets the Periphery, thus restoring the circuits of a proper monetary union.
Unfortunately, the ECB will not be allowed to do any of this, I very much fear. Unless I am very badly mistaken, Mr Draghi’s announcement on 6th September will show that the ECB’s banking supervision role, crucial as it may be, will be undermined by a Germany determined to keep afloat the cosy and unwholesome relationship between Germany’s private banks and German politicians. As for the QE part, the ECB will only be allowed to embark upon such a purchases program in a limited manner; one that buys Europe a little more time during which to continue to stagnate.
[i] In a more recent article, again in the Financial Times, Wolfgang Munchau, comments that Mr Schauble is treating the banking union as if it were a means of enhancing competition in the banking sector (thus focusing only on the large banks) – when, the issue at hand, is to supervise their speculative strategies and the extent to which they are hiding deeply entrenched insolvency.