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Euro crisis: Is banking union the way out?

, by FM Arouet

The policy drive towards banking union – as opposed to mutualisation of sovereign debts – has a fair chance of breaking negative feedback loops between sovereigns and banks, and not only because euro area leaders seem to agree on it. However, this is not a long-term fix.


A potentially radical policy shift occurred at the June 2012 Euro Area summit

Euro Area (EA) leaders agreed on the creation of an “effective single supervisory mechanism” for “banks in the euro area” (EA Summit final statement) on 29 June 2012. As soon as this is established, the European Stability Mechanism (ESM) will be able to “recapitalise banks directly”.

Furthermore, heads of state declared themselves ready to use “the existing EFSF/ESM instruments in a flexible and efficient manner (…) for Member States respecting their (…) commitments.” These new policies, along with the €120bn growth package and the possible creation of a single recovery mechanism for banks at EU level, could end up being the great leap forward many expect, to end – at last – the euro crisis. But again, the devil is in the details. Only the implementation of these technical mechanisms will determine whether they are successful in breaking the vicious circle between banks and sovereigns and soothing the crisis.

These words from the EA Summit illustrate the equilibrium heads of state are seeking to establish between financial assistance on the one hand and commitment to reforms and deficit reduction on the other. This equilibrium is essential. Those arguing that Germany should simply underwrite all of Europe’s debt ignore that it simply doesn’t have the capacity to do so.

Furthermore, we should not only ask ourselves “how to solve the debt crisis?” but also “what triggered the debt crisis?” This brings up Europe’s painful truth: lack of structural reforms, structural fiscal irresponsibility and the absence of efficient control by the EU. Even if German Chancellor Angela Merkel concedes to the demands of France and euro-area peripheral countries, will that suddenly boost Spain’s competitiveness? Will it make Italy’s economy grow? Will it stop fiscal evasion in Greece? The answer is dramatically simple: no.

Europe’s euro crisis is deeply existential

Hopefully, the significant policy decisions taken recently by euro area leaders will be successful in inspiring investor confidence in Europe’s bond markets. If they do, it will be a victory for the European economy. But will it be a victory for European politics? Europe is facing radical choices that will shape the continent’s future. Hence, in order to be able to decide efficiently and democratically, we need to strengthen politics at the European level. We need truly European parties, not just confederations of national parties.

A group of 172 German economists recently issued an appeal to their fellow citizens, warning that the pooling together of bank debts – the so-called “banking union” – would be “three times as large as the sovereign debt” (€23 trillion).

It is wrong to ignore these appeals simply because they do not go in the “right” direction. It would be wrong to vote for such measures, hoping that people won’t notice, lost in the technicalities of financial jargon. EU leaders are continuing with the good old Monnet method’s “step by step” approach, and seem to go forward with integration reluctantly.

Angela Merkel doesn’t want to back the debts of peripheral countries, who themselves do not want to release some level of control over their national budgets. Yet they do it. But can you build a union on the mere force of “necessity”? Can you ask European nations to integrate their policies (and other features that go with it, such as socio-economic policies) just because “we have no other choice”? There are better ways to inspire people.

If the crisis is here to stay, let us have a say

This muddling through process doesn’t satisfy anyone. It is not only inefficient, but also potentially very dangerous. It makes extreme-right parties’ anti-EU voices and claims sound not too irrational in light of the never-ending euro crisis. It favours over-simplifications and caricatures that destroy the social links between Europeans, which EU founding fathers took decades to build. The populist parties arguing for euro and EU exit across Europe receive an increasing share of people’s votes. We must not let their intolerance and economic nonsense occupy the public space.

An increasing number of experts argue that Europe’s crisis will last up to 20 years, the time for Southern economies to reduce their deficits and find their way back to economic growth while trying not to default on their sovereign debt. This crisis is complex and likely to last. Hence, the direct election of EU decision-makers by all European citizens is definitely part of the solution. A refusal to go down this path will simply strengthen European citizens’ feeling that they do not have a grip on their future. You never know where such a path can lead.

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  • On 16 July 2012 at 18:50, by Alessio Pisanò Replying to: Euro crisis: Is banking union the way out?

    Nice article. I think you are right when you say there is no right direction even though I do not trust very much the German economists’ teory

  • On 10 August 2012 at 12:55, by Artus Galiay Replying to: Euro crisis: Is banking union the way out?

    Dear Iwantout,

    Everyone now agrees that the main dilemma Europe faces is between euro break-up and becoming a super-state. Both options are “extreme” as this is an unprecedented crisis. The crisis has been going on for sufficiently long to realise that half-measures and political commitments will not save the euro, I’m sure you would agree with this. We are simply arguing in favour of increased European integration, as we believe in the benefits of the euro, and we are very concerned about the economic and political pain which would arise from a euro break-up, the nuclear option being an actual EU break-up. So I do not consider ourselves as extremists when we argue that the EU should take the necessary steps to ensure the continuity of the euro, economic growth in Europe and the stability of the EU.

    As to our “little or no public support”, your point is indeed valid in the UK (I have lived in London long enough to know that the Brits would rather be called stupid than European). However things are different in “continental Europe”: you would be surprised how many mainstream politicians argue in favour of a united Europe (some of them openly refer to a “United States of Europe”). We have public support, but I agree that we have no mandate for the moment. The CER article you posted is right to specify that EU leaders are taking decisions for which they have no mandate. This is exactly the reason why we want the European Commission President to be elected by universal suffrage: his job should not be to shake hands and say everyone agrees, but on the contrary to say why people disagree in Europe and what are the options. Europeans will then decide. If they clearly vote against the euro, then so be it, and the EU should not ask them to vote again like it has in the past. Europe’s reconciliation with democracy will be painful, but it needs to happen one day.

    @ Alessio Pisano:

    As you saw recently there is a massive debate on the euro crisis between 2 clearly defined groups of German economists, one in favour of debt mutualisation, the other againt any “Germany foots the bill” option. The real economic debate here is between Keynesians and classical economists: the former say we should inflate debat away and relaunch the economy through public spending (focus on demand), the latter say we should focus on consolidating the supply side, and hence growth will come out of structural reforms and sound public finances. I agree with the classical option because the “Keynesian bet” (that growth will come out of increased pulbic spending) is too risky: if we inflate debt away and increase spending but growth doesn’t come, then we end up with massive and disruptive defaults and accelerating inflation, which will create recessions that will dwarf the current negative growth numbers in Spain and Italy. I believe the fundamental causes of the crisis are lack of competitiveness due to the absence of structural reform, so focussing on that is the only way we can solve the crisis. The debt/financial crisis is just a side effect, as finance (no matter how powerful it pretends to be) relies on the strength of the economy. On the other hand, while putting pressure on euro peripheral governments to reform their economies is a good thing, Merkel needs to understand that there is a point where these governments’ cost of staying in the euro will be higher than the cost of leaving it. Before this moment comes, she should let the ECB intervene (banking license to ESM is the best option) to ensure low refinancing costs to these countries for a few years: this relieves pain while ensuring reforms are applied.

    All the best,


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