Sunday, July 8, 2012

Banking union fallacies 1 - CEPS Daniel Gros on ECB supervision

Daniel Gros, the director of CEPS —'who developed original plans for EMU— wants to put the ECB in charge of a banking union (Nakedcap). His case contains a number of questionable facts/arguments:


Excerpt:
Banks were “international in life, but national in death” in the first couple years of the Global Crisis. [...] How times change. [...] In Spain, the banks’ problems were all national – local savings banks (cajas) financed a huge real estate boom. As the boom turned to bust and the losses threaten to overwhelm the capacity of the Spanish state, the problem became European.
National problem? Reuters reporting that "Spanish banks borrowed heavily to finance a property boom, and still owe their German peers more than 40 billion euros, according to the Bank for International Settlements."?

Excerpt:
Spanish banking regulators did not want to own up to the reality that they had, for more than 10 years, been engaged in oversight – in both senses of the word. The tragic sense of the word is that they overlooked the build-up of a huge construction boom whose bust now threatens to bankrupt the entire nation. Given this predictable tendency of national supervisors not to recognize problems at home it seemed natural that the cost of cleaning up insolvent banks should also be borne at the national level. The need to rectify this situation has now finally been recognized by Europe’s leaders who decided at their last summit that the responsibility for banking supervision in the Eurozone should be transferred to the ECB.
What predictable tendency of national regulators is Daniel Gros talking about?  There is no evidence that Spanish bank regulators engaged in oversight with respect to the Basles Capital Adequacy Ratios. We know, in hindsight, that these ratios were insufficient, but they are drafted by the Bank of International Settlement, approved and closely monitored by the European Central Bank.

Daniel Gros is essentially trying to cast a shadow on national supervisors to aggrandize the ECB, whereas the former were under the responsibility of the latter. In the big picture, however, the ECB has a huge responsibility in the Eurozone crisis that dwarfs that of national supervisors. Jean Claude Trichet hailed Spain and Ireland as exemplary models of fiscal virtue and proof that the Stability and Growth Pact rewarded those that upheld it, ignoring warnings of the exponential expansion of credit concomitant to the housing boom (ECB-Watch). In contrast, the majority opinion of economists since the inception of Euro, and even earlier, was that it would fail in the ways that we are now experiencing (DebtDeflation).  

It makes sense to have an EU banking regulator (obvious), but to suggest that the European Central Bank has the moral authority to take on that task is to reward failure. They have failed the primary mission of financial stability. They have used their immensely powerful intellectual clout to deny the design flaw of the EZ. The disaster that has resulted is in great part their fault.

1 comment:

  1. Article synopsis says

    "... a misrepresentation of the consequences of Greece's exit in a VoxEU article."

    I must have cut off this part so I repeat it here:

    VoxEU - June 23, 2012 - Why [GRexit] isn’t a viable option []: Insights from a small open economy - By Gov. of the Central Bank of Barbados, DeLisle Worrell.

    His reasoning is right but is not likely apply to GR.

    Excerpt of his article:

    "There is a fallacy at the root of most of the discussion of the European economic crisis, and it is that countries like Greece would have the option to grow their economies through exchange rate depreciation, were they outside the Eurozone. In reality, exchange-rate depreciation always depresses output in small open economies, because there is zero elasticity of substitution between internationally traded goods and services and domestically produced goods and services, either in consumption or in production."

    Although the reasoning is convincing, at no point does it specify a size threshold under which it prevails.

    The first reference provided in the article classifies Barbados (0.3M, $4Bn) and Argentina (40M, $368Bn) as micro state and macro state, respectively. The numbers just given in parentheses are population size and GDP. For comparison, Greece’s corresponding data is (11M, $301Bn).

    Lumping together Greece with (the likes of) Barbados, by the standard of the reference, appears to be a misrepresentation. In short, we are unconvinced by this article.

    Self centered perspective.

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