A step at last in the right direction

by Martin Wolf

Financial Times
July 3, 2012

I was in Ischia, off the coast of Naples, during the latest eurozone summit. Many of the Italians present during the award of this year’s Ischia prizes for journalism thought that Italy had won two victories over Germany: in football, at the European championships, and in economics, at the European summit. Then came the football final, against Spain. How much is likely to be left of the summit euphoria a few months from now? The answer, I believe, is: something, but not all that much. The 19th crisis summit was better than many of its disappointing predecessors. But the game has not yet changed.

Helpful steps were taken. The most important were the agreements to allow the eurozone’s rescue funds to recapitalise undercapitalised banks directly, rather than provide money via vulnerable governments (of particular benefit to Spain and potentially enormous benefit to Ireland) and to buy sovereign bonds in the market (of apparent benefit to Italy and Spain). It was also agreed that loans from rescue funds would not be senior to existing loans, which should reduce the risk of panics by lenders. Leaders also agreed a €120bn ($151bn) package of measures to promote growth. On the principle that support should coincide with control, the European Central Bank is to be given responsibility for a new system of European banking supervision, as a step towards what protagonists hope will be a true banking union.

Yet what was not agreed is even more important. The list includes any increase in the funds available for the European Stability Mechanism (capped at €500bn); eurozone bonds, in any form; and a eurozone-wide deposit guarantee or bank resolution regime. Beyond this, the challenge of rebalancing competitiveness within the eurozone remains huge and, in the best of circumstances, long-lasting. Meanwhile, it needs to be stressed, the ECB has no intention of being buyer of last resort of sovereign bonds.

Thus the most important positive element is the movement towards breaking the mutually destructive links between banks and sovereigns. This is a step towards the eurozone equivalent of the US troubled asset relief programme, or Tarp. A consequence must be to take the responsibility for supervision out of the hands of national governments. The result is also going to be a huge further increase in the powers of the ECB. At the same time, this is only a small step towards a full banking union, which would require a bigger fiscal back-up than anything now available. Rational Spaniards and Italians still cannot regard a euro in one of their banks as being as safe as a euro in a German one, largely because elevated insolvency and break-up risks evidently remain.

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