Monday, August 6, 2012

Banking union fallacies 2 - ECB, last repository of faith

Paul De Grauwe, who is an eminent economist on EMU, thinks the ECB can save the Euro (VoxEU), and the idea is making headway (Spiegel).  At the same time, Barnier promises a banking union for 2013, that pools deposit insurance across all EZ states and puts the ECB in charge, its greatest expansion of power since its creation (Libé). Some pointers to help understand and questions about whether the taxpayer is getting a good deal out of it. This posts refers to our tutorial on central banking, 'Fed's printing press, fact vs fiction' (ECB-Watch).

Flattening out sovereign risk

To understand Paul De Grauwe's position, we have to introduce subtleties arising from the EZ's unique situation that are not in our tutorial, which assumes a US monetary set up where the Fed implements monetary policy trading US treasuries.

In the EZ gov bonds vary in credit quality across states. The ECB's OM operations are in the form of repo, that is it lends against collateral in the form of government bonds, which is not fundamentally different from the initial set up.

The contentious issue is that the ECB accepts some bonds as collateral (DE, FR), but not others (GR, ES etc.). By doing in so, it penalizes the second group of states. PDG argues it is neither fair nor efficient, and that the ECB should, in fact, even out credit spreads across the EZ. PDG rules out ESM because it has limited resources that will empty quickly. The market wants—you've guessed it—more 'firepower' and PDG thinks the ECB has it.

PDG's thesis has some merit, but, as with ESM, the debate is predicated on the assumption—wrong, I think—, that if we please the market, we will buy ourselves some peace. Bailouts, whether in the form of ECB support of taxpayer funded, have become a chronic disease instead of an emergency measure. It just exacerbates the debt overhang. For 08—11, the EU Commission approved €4.5T (37% EU GDP) bailout of financials institution (EU portal).

Banking union institutionalizes moral hazard

The proposed banking union is a dream come true for the market (pooling of deposit insurance throughout the EZ). There is little in the way of the reform. Banking resolution, debt-equity-swap included in the plan (took some notes) is not due for implementation until 2018 (as I recall) and has been dismissed for the current ES crisis. See our 

Neither the break up of banks, nor the separation of commercial from investment banking are on the table. That, too, is a dream come true for universal banking. Barnier promised he would study it and failed to so, betting, correctly, no one would take notice.

It is all too obvious to me the EU Commission is controlled by financial interests, but not to progressives who fell under spell of sirens by believing  'risk sharing', 'solidarity', 'breaking between the contagion from banks to government', 'bigger firewall'.  'Bigger firewall' means exactly its opposite: it's putting the taxpayer on the hook for increasing levels of debt. 'risk sharing' is accepting to take abuse from creditors and bankers. etc.


  1. About

    "Barnier promised he would study it and failed to so, betting, correctly, no one would take notice."

    Had written an UPDATE here:

    ECB-Watch, July 6, 2012: Is banking union endgame or not?

  2. FT - Feb 29, 2013 - Euro banking union deeply flawed - H-W Sinn and Harald Hau

    FT - Feb 3, 2013 – A misunderstanding of the banking union initiative - Response from Jonathan Faull


    Sir, Hans-Werner Sinn and Harald Hau are confusing two separate legislative initiatives on bank resolution from the European Commission.
    - National resolution systems (proposed, not yet adopted).
    - Integrated resolution system for the eurozone (not even yet proposed). [This will the second leg, after single bank supervisory mechanism, of the banking union]

    1. About resolution regime,

      ECB-Watch - Aug 22, 2012 (transferred from a post in mymini blog)

      In the banking union proposal, the chapter on bank recovery and resolution proposal contains an early intervention clause (III.9). It allows the regulator to supersede bank managers in certain areas when the bank that "breaches" or "is about to breach" a capital ratio directive (CRD). This already exists in current law, which means there is little substance to the proposal in this area. In the case of France, see Code Monétaire et Financier, Art. L612-33.

  3. On flattening bond yields:

    Businessinsider - Feb 2, 2013 - Mario Draghi can't stop the bubble in Europe from bursting

    Synopsis: French economist P. Artus likens ECB's defense of #Euro to Greenspan's put

    WSJ - Feb 22, 2013 - Why the Euro Crisis Isn't Over

    Synopsis: Ex ECFIN commissioner Connolly reflects on his prophecy € would fail: short of DE subsidizing it forever, it will.

  4. On flattening bond yields:

    European Council - Feb 28, 2013 - Address to the Policy Network Conference

    Good grief, @euHvR echoes #Euro market sentiment: "talk of breakup vanished, sinking in here to stay."