Banking Union and the United Kingdom

If the BBC talks about leaving the EU over banking union, then you know you've hit a nerve. The key concern is that the euro zone will develop its own identity within Europe, and that will be bad for Britain's banks. What this says between the lines is that the prospect of a shift change in the tenor and content of banking regulation in the EU might be more than the City of London can stand.

It's conceivable that the English might vote to exit, deciding they have had enough, and are better suited to a partnership with the EU rather than membership. But if they do that, it's also conceivable that the Scots will vote to exit the UK to stick with the EU. The Prime Minister will have to think about that potential cost.

Banking Supervision is not a Banking Union

At 4 a.m. this morning, heads of government reached an agreement in principle to transfer supervision of banks to the ECB. The details of how far the ECB's powers will go, and how it will relate to the European Banking Authority to and national regulators is unclear at the moment.

This is a statement of intent rather than a substantive agreement, but a step in the right direction nevertheless. The distributional conflicts that have bogged down negotiations until now have not been swept aside. A banking union involves not only supervision of banking activities, but also measures to intervene in the affairs of the banks themselves. There is no agreement on this. More importantly, there is no budget.

The Germans are banking on the introduction of a financial transaction tax to fund cash injections, to avoid using existing tax revenue to fund bailouts. This has  a number of problems associated with it, however. The most important is that if the euro zone manages to introduce such a tax and the EU does not, it will incite euro zone companies and retail investors to move their assets offshore...to the UK or Switzerland, and deter new financial flows from entering. The investment strike will take its toll on the euro zone, if such a thing is not established at the EU level. Reuters reports that only 11 euro zone countries are currently in favour.

Defense, Offense, and the Euro Zone War

Nearly two years ago, I predicted that the main targets of the euro zone crisis would be big countries, not small ones. That has since turned out to be the case. But what does it mean for Greece? And what does it mean for the EU in an economic policy sense?

Briefly, the most important issue at stake is whether Greece will go bankrupt, and/or leave the euro zone. That is not a sure thing, but looking increasingly likely. There are limits on EU funds, and ECB purchases of Greek debt will come with intrusive audits and demands by the IMF. There will be no free lunch within the confines of the euro zone. It may prove unbearable for the Greeks to stay, or brush their pride the wrong way. The alternative of a short, sharp Argentinian crisis may be the alternative.

This means that unless the EU takes the offensive and builds a financial mechanism capable of fighting for large countries and small ones, that it must put a great deal of effort into defensive mechanisms that will help its members (both countries and banks) survive a Greek collapse, and then a Portuguese one, at the very least. Good boxers don't just learn how to hit. They learn to take punches as well.

A decade of austerity

UK Chancellor George Osborne thinks that government will have to continue austerity until 2018, a full decade after the financial crisis started. That's the optimistic view of finding the bottom of a downward spiral of deflation and budget cuts.

Public Talk on the Euro Zone Crisis

Tonight I will be talking about the euro zone crisis at the University of Twente, with a focus on what has and has not been done, and why the consequences are so dire:

http://www.utwente.nl/gw/sg/programma/Europa.doc/

Germany limits the European Stability Mechanism

Germany's consitutional court ruled today that Germany may participate in the European Stability Mechanism, but with strict limits and conditions. The ESM is the permanent fund meant to prop up finances in some of the euro zone's countries.

Condition one is a cap on Germany's contribution at 190 billion euros. No salami tactics in which the commitment becomes larger.

Condition two is full consultation with the German parliament on an ongoing basis. This means the terms of the loans and the compliance with the terms.

Condition three is a new treaty to write those conditions down. Even a modification of the existing treaty is a new one, so that is clear.

These conditions mean that those opposed to the ESM's establishment will not get their way entirely. But they will have it in their power to make the recipients of ESM funds wish they had. Those in Germany that want to cut off Southern Europe entirely will have to settle for cutting them down to size. They will now have the tools do so with all their might. And Europe will suffer again.

Conservative Change in the Euro Zone

There are hurdles to be taken before the decisions are definitive, but EU government leaders made decisions this week that set the course for the future of the euro zone. Austerity has won a host of demands that lock in  debt repayments from Europe's periphery to its richest member states, and that prop up banks in the periphery just enough to prevent them from defaulting on loans, once again to the EU's richest member states.

The European Financial Stability Facility and the European Stability Mechanism (from July 2013) will be changed to make it possible to bail out banks directly. In the current climate, that means bailing out Spanish banks, Bankia in particular. In return, Germany has won creditor countries seniority rights on the loans they've made, which means that if things go badly, they will be paid out first of whatever money is left, before private bond holders. This reduces the risk of throwing good money after bad, at least in principle. It also increases the demand for such subsidies. Ireland has already demanded more. Italy has demanded, and received a commitment to aid for growth in exchange for austerity. These demands will not be the last.

It is a solution of sorts. It is the opposite of what most of the G20 and a transnational coalition have called for, which is a European banking union. Restructuring and recapitalization would take place across national borders, and allow the toxic assets to be dealt with in a way that markets will greet, not continue to punish. At a time when Europe is threatening to drag down the rest of the world economy, calls have become louder for the EU to take the plunge. The main problem, however, is economic nationalism--the fusion of national purpose with bank ownership. That has become much stronger as a result of the crisis, and the EU's member states show no sign of backing off.

Imagine that the political, social and economic revolutions that occurred in the 1930s and ushered in modern economics had never happened. That is why the initial stability that Europe achieved this week is unlikely to last.