This Policy Contribution reproduces the written statement prepared by the author for the hearing "The European debt and financial crisis: origins, options and implications for the US and global economy" presented at the Subcommittee on Security and International Trade and Finance of the US Senate Committee on Banking, Housing,and Urban Affairs, on 22 September 2011.
Europe’s banking system has been in a state of systemic fragility since 2007-08. The current phase is marked by a sequence of interactions between sovereign problems and banking problems, resulting in gradual contagion to more countriesand more asset classes. The banking and sovereign crises are compounded by a crisis of the European Union institutions.
Successful crisis resolution will need to include at least four components at the European level, in addition to steps to be taken by individual countries: fiscal federalism; banking federalism; a profound overhaul of EU/euro-area institutions; and short-term arrangements that chart a path towards the completion of the previous three points.
These requirements for crisis resolution cannot be met unless political conditions change sharply in their favour, which leaves the United States and the global economyexposed to the risk of financial contagion. However, only the Europeans themselves can solve their current predicament.
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James Buckley 26th September 2011
A critical concern: by further pushing greater integration, the outcome is just as likely in the long term to be worse. At a certain point one has to take a step back and say: “hang on, what are we doing here?”. As per the Hippocratic oath, the maxim of policymakers surely should now be: ‘first, do no harm’.
Limiting my argument to the banking federalism point:
- To be effective, the EBA would have to be completely independent from political interference. A situation as we have just witnessed, where the EBA is not allowed to run stress tests that feature an EEA sovereign default, is a case in point. Yet, it is difficult to see why member states or the Commission would want to relinquish control of the EBA. Its decisions will have billions of euros of implications.
- In order to be independent of member states and the Commission, the EBA will have to be accountable only the European Parliament (as is basically the case now). In its current form, with only limited powers, this is just about acceptable, but to transform through a treaty change the EBA into a fully discretionary body, it is not going to be acceptable. The European Parliament is not driven by the need to make decisions in the public’s interest, ultimately because it itself is too far removed from any accountability over its decision making. Instead it is driven by the overtly political agendas of individuals with no accountability for their actions. This may change if the EU develops a European political demos that replaces the national state focus of citizens, but we are a long way from there at the moment. Thus the EBA will be defined by its ability to meet the demands of a few political-charged individuals in the European Parliament, rather than what may be the best approach overall for European citizens.
- The ESFS is not a slush fund. Citizens whose money is used to bail out a bank demand to have a stake in that bank. It is not acceptable that tax-payer funds in one member state disappear in to a black box and are then used to bail out a bank elsewhere, with no accountability of why the bank failed, who the money is going to, when and if it will be paid back.
- Why does the author think that the EBA will be any good any supervision? Experience to date shows from the Lamfalussy committees and generally in EU decision making is that in order to reach agreement, the path trodden is the one of least resistance. Banking systems are so diverse across the EU that only the lowest common denominator is acceptable in terms of reaching common standards or making decisions that affect all of Europe’s 10000+ banks. This will most likely result in much weaker supervision than would occur at national level. Look at the CRD4 text which prevents national supervisors from being able to go above the 7% core tier one limit.
- Even where this is not the case, it is likely that the EBA will end up making bad decisions. As witnessed by the ECB’s raising interest rates at completely the wrong time early this year on account of the strength of the German industry unbalancing the overall negative eurozone picture, decisions made across a massive diversity of systems are always skewed in favour of the largest, at the expense of the smallest. This is important enough when getting monetary policy right, but where a skewed decision results in bank failures in a member state, it is disastrous.
Ultimately, good decision-making in liberal democratic societies is only ensured by legitimacy and clear lines of control. Without that, there is less incentive to ensure the correct, rather than the most political expedient, decision occurs. And the ultimate consequence of poor decision making given the stakes discussed here is wrecked economies and even disruption of societies. The policy choices the author is suggesting still ignore the elephant in the room: the constant push for political integration is not apparently supported by the masses. At a certain point this has to be addressed, we can’t keep running head long down the path to further integration without addressing the issues it raises.
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