Monday, November 24, 2014

One Big Union

PARIS – In the last few weeks, the idea of establishing a European banking union has become the latest remedy advanced as a solution to the long-running euro crisis. But, whatever the merits of a banking union – and there are many – proposals to establish one raise more questions than can currently be answered.

The motivations of those who advocate a banking union differ markedly. For some, particularly in southern Europe, it is seen as a means of shifting the burden of supporting their indigent banks to those with deeper pockets. For others, especially in the European Union’s Brussels Eurocracy, it is seen as another leap forward in the construction of a European super-state. Taking their cue from the sacred Rome Treaty’s reference to “ever closer union,” the European Commission’s theologians view every crisis as an opportunity to advance their federalist agenda.

The European Central Bank has been more thoughtful, though no less enthusiastic, arguing that a banking union should have three objectives. First, stronger eurozone-wide supervision should reinforce financial integration, “mitigate macroeconomic imbalances,” and improve the conduct of monetary policy. How a single EU supervisor would address the problem of imbalances is not explained, but it is surely a worthy aim.

The second objective should be to “break the link between banks and sovereigns,” which has been a particularly dangerous feature of the last year, while the third is to “minimize the risks for taxpayers through adequate contributions by the financial industry.” The third aim could be achieved country by country, but it is certainly arguable that an across-the-board banking levy, or a Europe-wide financial-transaction tax, would eliminate competitive distortions.

How might these laudable objectives be achieved? The European Commission has argued that a fully-fledged banking union would need to rest on four pillars: a single deposit protection scheme covering all EU (or eurozone) banks; a common resolution authority and common resolution fund, at least for systemically important and cross-border banks; a single European supervisor for the same banks; and a uniform rule book for prudential supervision of all banks in Europe.

Anyone who has been involved in banking supervision can see at once that these four pillars will require careful construction. Many individual countries have taken a generation to develop their own domestic schemes. And, in this case, three big political issues have yet to be resolved.

First, the identity of the single European banking supervisor remains undecided, and the ECB has seen an opportunity for a power grab. Central bankers in Europe have always resented the narrow monetary-policy mandate given to the ECB under the Maastricht Treaty. Banking supervision was not included among the ECB’s objectives, though one article of the treaty gives the system of European central banks as a whole the task of contributing to effective supervision. They now argue that the simplest solution would be to expand that remit and make the ECB the de facto pan-European supervisor.

That is not the outcome favored by the European Commission, which has only just set up the European Banking Authority. The EBA is closely linked to the Commission itself, and is seen as the natural candidate for a broader role.

The Commission has a case, but it also has a problem. During the political horse-trading that preceded the creation of the EBA (together with two equivalent bodies for securities and insurance), it was agreed that the new authority would be based in London. That seemed logical at the time, but not if the EBA’s role is to be broadened. How could a eurozone supervisor be based outside the eurozone?

The second unresolved question is how to achieve a banking union in legal terms. Constitutional change on this scale would normally require a new European treaty. But that would take time, and Europe’s leaders have run out of it.

Furthermore, there is no guarantee that voters in countries that require a referendum on treaty changes would support a further transfer of sovereignty. So the likely outcome is that, in the EU’s time-honored fashion, the banking union will be constructed using existing powers, finessing the sovereignty question, and avoiding any reference to public opinion. That points towards reliance on the ECB.

The final question is what such a eurozone banking union would mean for the single financial market, and especially for EU countries that are outside the single currency. Many of them would sign up willingly, as they intend to join as soon as possible, in spite of the euro’s difficulties. But that is not the case for the United Kingdom, and London remains the continent’s biggest financial center, by far.

I fear that the French and Germans have now lost patience with the troublesome British, and are reluctant to cut a deal. And Euroskeptic British politicians see this as an opportunity to recast the UK’s relationship with the EU; indeed, for some, it means a chance to negotiate an exit.

Opinion in the City of London tends to favor a middle way, which would allow the UK to cling to the benefits of the single market, without conceding unified regulation. That will be hard to pull off.

I suspect that a banking union of some kind will be implemented, and soon. Otherwise, the eurozone banking system will collapse. But the consequences of such a step for Europe’s great free-trade experiment could be serious, and, if not managed carefully, could lead to Britain’s withdrawal. The political stakes are high, and the outcome is likely to reflect that.

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    1. CommentedCarol Maczinsky

      Banking Union is just a phrase for financial regulation. Necessary as Europe suffers from US regulatory failure.

    2. CommentedJohn Brian Shannon

      Hi Howard,

      Thank you for this very informative piece.

      Perhaps a banking regulator should be EU-wide, perhaps only Eurozone-wide -- a reasonable case has been made for each.

      Perhaps the regulator should be EC-backed, EU-backed or Eurozone backed, again, a reasonable case has been made for each of the choices.

      Those discussions are already in play.

      I look at this with a different perspective.

      1) Voluntary membership. Each country in Europe should have the option to join the regulatory framework, or not. If there are enough benefits to membership vs responsibilities of membership of that institution, then there will be plenty of members.

      2) Once an individual country within Europe decides to participate -- both enjoying the benefits and observing the responsibilities from a national perspective, then individual banks within that nation could then join the institution.

      3) Size of bank. Banks under 10 Billion net value (or 100 Billion, or any agreed reasonable threshold) should be free of any obligation to join. This exemption would still allow community-based banking and allow those who want to bank within their own jurisdiction free of European institutional constraints, to do so. If the drafters of such want tacit support from the German public, this would be a good way to get it.

      4) Taking choices away is the completely wrong approach. Adding choices is the way to go. Adding positive solutions to national governments, to banks, to depositors and to the overall economy of Europe should be the driving force behind the creation of any banking authority, anywhere.

      5) Similar could be said about a European debt-mutualization institution. Taking choices away is the completely wrong approach. Adding choices is the way to go. Adding positive solutions for national governments, to banks, to depositors and to the overall economy of Europe should be the driving force behind debt mutualization plans.

      When the benefits of membership exceed the responsibilities, a lineup will form. This IS the very DNA of every entrepreneur.

      Best regards, JBS

    3. CommentedGary Marshall

      Hello Mr. Davies,

      The individual European countries have the means to remedy their current problems with ease. And the means to that end is contained in the little proof below for the abolition of Taxation, which novelty may be absurd on the face of it, but not so when examined.

      If you or anyone can find the flaw in this proof, I shall be more than happy to give the reward of $50,000. None have yet been successful. Perhaps because so few have tried.

      Its not the end of Europe or the world, but a new beginning.



      The costs of borrowing for a nation to fund public expenditures, if it borrows solely from its resident citizens and in the nation's currency, is nil.

      Why? Because if, in adding a financial debt to a community, one adds an equivalent financial asset, the aggregate finances of the community will not in any way be altered. This is simple reasoning confirmed by simple arithmetic.

      The community is the source of the government's funds. The government taxes the community to pay for public services provided by the government.

      Cost of public services is $10 million.

      Scenario 1: The government taxes $10 million.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      No community government debt, no community
      government IOU.

      Scenario 2: The government borrows $10 million from solely community lenders at a certain interest rate.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      Community government debt: $10 million;
      Community government bond: $10 million.

      At x years in the future: the asset held by the community (lenders) will be $10 million + y interest. The deferred liability claimed against the community (taxpayers) will be $10 million + y interest.

      The value of all community government debts when combined with all community government IOUs or bonds is zero for the community. It is the same $0 combined worth whether the community pays its taxes immediately or never pays them at all.

      So if a community borrows from its own citizens to fund worthy public expenditures rather than taxes those citizens, it will not alter the aggregate finances of the community or the wealth of the community any more than taxation would have. Adding a financial debt and an equivalent financial asset to a community will cause the elimination of both when summed.

      Whatever financial benefit taxation possesses is nullified by the fact that borrowing instead of taxation places no greater financial burden on the community.

      However, the costs of Taxation are immense. By ridding the nation of Taxation and instituting borrowing to fund public expenditures, the nation will shed all those costs of Taxation for the negligible fee of borrowing in the financial markets and the administration of public

      Gary Marshall

        CommentedJohn Brian Shannon

        Hi Gary,

        Pretty elementary stuff here and I don't have the time to cover the entire post, but I will cover one incorrect paragraph for you.

        "The costs of borrowing for a nation to fund public expenditures, if it borrows solely from its resident citizens and in the nation's currency, is nil."

        Not true.

        You are forgetting about the interest on the borrowed money.

        Yes, present interest rates ARE low, but they haven't always been, nor will they always be low. Those rates will increase at some point and all of the borrowed money will then be interested at the new rate.

        You could still make a case that the interest doesn't add up to much money at all. But it is still a cost, which means that there IS a cost to borrowing.

        Above that, the U.S. government debt has a lot of zeros behind it -- and even at a low percentage rate, that is still a lot of zeros.

        Much more information here:

        If you look at the larger context, there isn't enough 'resident citizens' money on deposit in America to act as security to cover the government's total debt, deficit and other financial obligations.

        Which means borrowing outside of 'resident citizens' deposits.

        To make up that difference by additional taxation could (at present) choke-off any nascent recovery underway -- if there is any recovery underway, it is still too early to tell. One thing is for certain, to add tax now, would sink the economy.

        To make up the difference with additional taxation (not at present) does place a drag on the economy. That money which gets paid in taxes, is no longer in the hands of consumers, where every study since there were rocks shows that consumer spending stimulates the economy better than any other stimulus -- government, corporate, or private.

        Don't think there are corporate economies that use stimulus in their jurisdictions? Do a Google search on "Levittown" -- the early years.,_Pennsylvania

        Finally, when spending by governments (which, in your quoted statement is necessarily limited by the financing available by community or national 'resident citizens') needs to exceeds those limits, then what?

        Any number of things could cause this, from profligate spending by civic authorities, to corruption, to military invasion or attack, weather-related or climate-related crises, or a taxation rate so high it stalls the economy.

        Not to mention a recession bringing on high unemployment where the number of taxpayers (who would otherwise be regular depositors if they were working) must begin living off their savings, lowering the total available security for the governments already spent money.

        More taxation to make up the difference would only cause more savings withdrawals and which would further slow government spending and thereby increase unemployment.

        I admire your advocacy, but if the piece you quoted was actually a panacea for economic systems, it would have been utilized by economists and politicians long ago.

        Cheers, JBS

    4. CommentedVal Samonis

      Too late for such gradual solutions in EU, I am afraid; confidence in the EU Paradise is lost for long!

      Instead, divide the EuroZone into Neuro and Seuro (N&S) zones to much better reflect the conditionalities (productivity, etc) of the optimum currency areas (OCA), with free flotation of Neuro and Seuro. N&S zones provide a chance to salvage some positive European integration results and, in the longer time, bring the continent to necessarily very gradual correction of the original architectural sins of the EU (no OCA, etc).

      Failing that, nobody is able to keep Germany in the EU; it might quickly opt out and become another Fortress Switzerland trading fully globally.

      Then all hell may break loose in the rest of Europe!

      Val Samonis

    5. CommentedMatt Stillerman

      I think that a banking union will solve some problems and create some new ones. The banks will be much healthier if they are all backed by the currency issuer, the ECB, as the lender-of-last-resort. Euro liquidity guarantees by the ECB can really be believed!

      However, the EU member states are all accustomed to having their national banks buy their bonds. E.g. Greek banks bought Greek bonds, etc. That will come to a screeching halt. So, the fiscal problems of the European soveriegns will be cast into a much harsher light.