People who thought that the head of the Bundesbank had been politically isolated by Draghi in the ECB should pay attention to recent events in the eurozone negotiations.
When the 20th summit to solve all of Europe’s problems ended on June 29, 2012, we were told by the mainstream media that the eurozone had agreed to a banking union. There would be a single supervisor for eurozone banks. More importantly, failing banks would be recapitalized by the ESM so that the associated debt burden would not add to the country’s outstanding liabilities, specifically Spain but applicable to the others.
This was my understanding of the deal, which I shared with many others following the eurocrisis. This is what Bloomberg News had to say:
They also opened the way to recapitalizing lenders directly with bailout funds once Europe sets up a single banking supervisor. Stocks and bonds in Spain and Italy surged and the euro rallied.
The Wall Street Journal thought the same thing:
After 14 hours of wrangling on the summit’s first day, the leaders agreed that the euro zone’s bailout funds should be able to directly boost the capital of struggling banks and said that loans they are planning to help Spain recapitalize its banks wouldn’t be ranked above those of private investors in the creditor pecking order—responding to an issue that appeared to cause a negative reaction to Spain’s request for up to €100.
Our hockey-playing friends to the north at the Globe and Mail also interpreted the agreement in a similar fashion:
In a victory for Spain and Italy, the countries suffering most from soaring sovereign bond yields, the EU agreed to recapitalize banks directly instead of funneling the bank rescue funds to the national governments, which in turn would deploy the money to the banks.
This was the thinking in China, too:
Meanwhile, eurozone leaders, after all-night negotiations in a 17-member summit, agreed to create a single supervisory body for its banks by the end of this year, which is seen as a first step towards a European banking union.
They also agreed that the bloc’s rescue fund would be lent directly to capitalize banks without increasing a country’s debt level, which should bring down the mounting borrowing costs especially for Italy and Spain and those countries will no longer be forced to adopt extra austerity measures.
Not everyone was so optimistic about the agreement from the June 28-29 Summit. We have to venture beyond the mainstream media to find criticism. Mr. Kostohryz wrote in Seeking Alpha:
The most important aspect of the agreement was opening the “possibility” of the ESM (European Stability Mechanism) providing bailout funds directly to banks rather than through loans to sovereigns (which would then recapitalize the banks).
At least one writer read the agreement and realized that there was some wiggle room. Everyone else ate up what the eurozone was cooking. Mr. Kostohryz correctly interpreted the document as discussing the possibility, not the establishment or realization of those goals.
Today Jan Weidmann delivers the northern tier’s understanding of the agreement:
“In order to keep liability and control in balance, only risks that have arisen after common supervision is established can be taken under joint liability,” Weidmann, who heads Germany’s Bundesbank, said at a speech in Berlin today. “The legacy burdens on bank balance sheets have to be underwritten by the countries under whose supervision they have arisen.”
Weidmann is closing the possibility that the ESM will recapitalize banks with the European taxpayer’s money until there is a formal banking union. This new supervision scheme was to start at the beginning of 2013 according to the agreement from the same summit. The eurozone has three months to get the structure in place, but that timetable is too fast for the same northern countries led by Germany:
It’s “not a realistic assumption that the ECB will be able to take up this role by Jan. 1, 2013,” says German Finance Minister Wolfgang Schäuble. The minister’s financial experts consider that starting date overly ambitious, and say the pan-European bank supervisory system will certainly not be ready to launch by then. “That’s wishful thinking,” say those within the German government.
Germany also objects to extending the ECB’s supervision believing that only large, systematically important banks need to be included. The countries can monitor their own regional banks.
All of these tactics are being deployed to delay the banking union indefinitely. The northern tier does not want to be on the hook for all of the bad bank debts currently lurking in the PIIGS financial systems. Weidmann delivered this message in a speech today:
“Mutualization of risks can’t be the primary purpose of a banking union,” Weidmann said. Allowing the euro-area bailout fund to help ease the existing debts of banks would amount to “financial transfers,” he said.
Additionally, Germany has regional banks known as landesbanks and sparkasses. These correspond to savings and loans and small commercial banks in the American system, and they are loaded with questionable loans and bonds from all over the world. In fact, these institutions were the most enthusiastic customers of American subprime debt, and they are still basket cases.
This is the game being played by the north. The ESM is not permitted to bailout banks who got into trouble prior to the establishment of a banking union. Only after the union is established will this fund be permitted to assist banks that run up bad loans after the ECB takes over supervision. The rub is that they will stall indefinitely so that the banking union with ECB supervision is never deployed. They are following this tack because they do not wish to be on the hook for hundreds of billions of euros in bad loans and other dodgy assets.
This change in policy means that Spain will have to request a bailout. Its debt is already ballooning out of control, and now we must add the inevitable bailout of the Spanish financial system to its debts. I do not believe that Spain will be able to raise enough money to save its banks, so it will have to apply for a formal bailout.
Ireland was expecting additional eurozone assistance after adopting austerity measures and doing exactly what it was told by Germany. Now, it is left in the lurch. It’s bonds have already begun depreciating. Portugal is in a similar situation.
Italy can look to the examples of the countries that have gone before it to the bailout window. Perhaps, it will not even bother requesting a bailout.
What we have seen during the Eurocrisis is that the politicians from the rich countries are more than happy to talk about keeping the euro together but when it comes to actually paying euros to do so they continue to prevaricate. If the PIIGS keep getting strung along like this it is only a matter of time before one of these countries decides to engineer a de facto default by readopting its fallow national currency. After all, why go through the pain of an austerity induced depression if the rich countries will not share their resources to save the euro?
This pattern of talk without the requisite action has repeated itself ad nauseam since 2010, and the eurozone has depleted much of its credibility. Does it have enough left to save the euro?