Spain’s cajas, Banking Union and British EU exit
In Frankfurt, late last year, the high priests of the Eurozone had a fundamental change of view.
For years the presumption had been that a flawed and incomplete Eurozone would work, if only fiscal policy – tax, spend, and government borrowing – were also coordinated and eventually controlled at the European level.
Such disciplines would help the coordination of macroeconomic policy, and provide cover for transfer payments from rich to poor countries, such as occurs in the US and UK.
A splenetic attempt at that (the Stability and Growth Pact) was made and then ignored in the first decade of the single currency. It is being reheated now as the “Fiscal Compact”.
The theological foundation of the Eurozone is “the Theory of Optimal Currency Areas” advanced in the 1960s by Nobel prize-winning economist Robert Mundell. Over fifty years, the theory made clear that a geographical area needed to fulfil four characteristics to be suitable for a common currency: labour mobility, capital mobility, a synchronised economic cycle, and the ability to share fiscal risks.
Well the good burghers of Frankfurt have decided this is no longer enough (even as it is debatable that these four characteristics have been achieved). The experience of the past decade has led them to conclude that a further factor: financial union is required.
As it has been put to me – by very senior officials – Spain and Ireland were not the Euro’s fiscal criminals. They adhered to the strictures of the ignored Stability Pact. It did not prevent disaster and the need for bailout. In both these countries, it was a poorly regulated financial sector (in Spain’s case, a specific part of the financial sector, the building societies or cajas) that led to both economies’ troubles. So the lesson being taken from the Spanish crisis is that financial regulation matters as much as fiscal sobriety.
Immediately that manifests itself in the Eurozone-wide deposit guarantee system that will be required to innoculate against contagious bank runs. After all would you trust a 2008 Northern Rock-style government deposit guarantee, if it came from a newly-elected Greek government? But then if it becomes an EU-wide guarantee, there are huge implications for German and French banks who would eventually pay for any pan-eurozone deposit insurance scheme.
As Britain learned with Iceland, cross border deposit insurance only works if you assume that foreign bank regulators are competent.
In the case of the Spanish cajas, they were part-regulated by regional government, not solely the Bank of Spain and the Economy ministry. Their massive disastrous real estate investments were often driven by boards full of regional political appointees.
If German of Finnish banks, are in the future, to be liable to pay fees into deposit protection funds that might pay out for a Spanish Caja, then a more thorough supranational bank regulation regime is necessary.
So in the medium term, the Eurozone will be rebuilt on three, not two pillars. Monetary union, fiscal union, and banking union.
The mood music that I detect, is that Eurozone banking union will not function properly without some oversight of the wilder activities of the City of London casino. The shadow banking system in particular is disproportionately run from the Thames.
But the conventional commercial bank lending of HBoS and RBS also had a large impact on Ireland. The ECB might also want to impose counter cyclical limitations on mortgage lending, for example.
The degree of this oversight or control will be the fundamental sticking point for Britain’s relationship within the European Union. For those that see Britain’s interest as synonymous with that of the City, it begins to mark a passage out of a new Eurocentric EU for Britain.
It might begin to explain what happened with David Cameron’s intriguing veto of the fiscal compact treaty last December, despite that treaty having no mention of banking or finance.
The attempt by the European Central Bank to limit the activity of London based clearing houses in euro derivatives, and the Treasury’s court case against this, are a taste of things to come. Expect more treaty changes and referenda.
Clearly the immediate eurozone issue is its very integrity.
Spain seems to have played hardball and won some concessions. This will only encourage Greece’s bailout rejectionists in next Sunday’s election re-run. But the medium term changes to strategic thinking are happening right now. And they will have a profound impact here.
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