Europe’s latest initiative to subdue its financial crisis fell apart in less than a day.
The instant response to the plan for supporting Spanish banks had been euphoric. Even as bond markets pushed the cost of Spanish public borrowing even higher, in effect declaring the country insolvent, politicians were still applauding themselves.
European Union leaders thought the plan would impress the markets because the sum committed to support Spain’s banks, 100 billion euros ($125 billion), looked adequate -- bigger, in fact, than investors expected. The EU thought it was getting ahead of events for once.
It wasn’t. Mistakes in the deal’s design made the plan self-defeating. These errors are worth noting, because they lie at the core of the EU’s larger strategy.
The crucial thing is that the EU gave its support not directly to Spain’s banks but to Spain’s government, which would then lend it on. This had two fatal consequences. First, it added to Spain’s public debt, making its government less creditworthy. Second, depending on how the loans are structured -- a detail left vague as the rescue was announced -- Spain’s new debt to the EU might subordinate existing bondholders. Curbing the risk of a faster run on Spain’s banks was good, investors presumably calculated, but not good enough.
Both dangers were recognized before the deal was put together. Why then did the EU design the rescue this way? Why not simply extend direct EU support to Spain’s banks? The answer is Germany.
Chancellor Angela Merkel and her parliamentary allies insisted that Spain’s government should bear responsibility for the rescue. German taxpayers should not be directly exposed to the costs of helping Spain’s banks. On the same reasoning, Merkel has said that the Spanish rescue funds should come from Europe’s new permanent lending facility, the European Stability Mechanism, on terms that would make the new debt senior.
It’s of a piece with Germany’s whole approach. The overarching fact in this crisis is that German taxpayers feel cheated. They didn’t want the euro in the first place, suspecting it would become a transfer system that would put them on the hook for other countries’ profligacy. That, of course, is exactly what happened. To blunt this resistance, Germany’s leaders promised at the outset there would be no bailouts, and they insisted on lots of rules and mechanisms to back this up. The crisis has blown that structure to pieces, but Merkel is still trying to keep the promise -- even if the EU, and the German economy along with it, collapses as a result.
Germany’s government is in a horrible political bind. Even allowing for this, the country’s response to the crisis now borders on the unintelligible.
On a small scale, the policy simply won’t work. Spain and the other distressed economies can’t manage this crisis without help from their EU partners. The absurdity in Germany’s approach is that it concedes this -- in practice though not in principle. It has already committed its taxpayers to many semidisguised channels of support. The biggest is the commitment that the ECB has made through liquidity support to euro-area banks and the balancing operations of national central banks. If the euro system doesn’t survive, enormous losses will find their way back to German taxpayers.
The choice is no longer between bailouts and no bailouts. It is between bailouts that work and bailouts that fail. The Spanish fiasco is one example. Germany has just put its taxpayers on the line to help Spanish banks. To cloak that commitment, it built failure into the design of the rescue. The politics may be understandable. That doesn’t make the policy defensible.
Seen from a higher altitude, Germany’s strategy is even more perplexing. Merkel, echoing the line of previous German chancellors, says she wants closer European union. With the EU at its present state of integration, she argues, transfers to overspending governments are unacceptable. National governments need to surrender sovereignty to the European center, she says, so that democratic accountability is restored and proper standards of governance can be maintained.
Meaning what? Perhaps she imagines that this new political union would put Germany in command. Let’s call that an idiosyncratic view of political integration. Assuming non-Germans would be allowed to vote, Germany would be less in command than now. It’s the profligate whose political clout would increase. Deeper union would overwhelm the German anomaly of prudent public finance.
Merkel and her northern European allies are right that the EU’s member nations have different views and traditions on taxes, public services, redistribution, risk-sharing, public borrowing and every other aspect of public finance. They are right that these differences put limits on the scope for fiscal cooperation. It wouldn’t be fair, let’s say, to ask German taxpayers to help pay for France’s more generous health-care benefits.
On the other hand, it’s insane -- dangerously insane -- to see full political union as the solution to that problem. Does anybody think that political union would gently smooth away those differences? Far-right nationalism is already resurgent in many EU countries. There’s no demand anywhere, including Germany, for the kind of European Union that Merkel keeps advocating as the price for fuller cooperation. Germany’s policy on the crisis boils down to this: We can’t confront our economic calamity until we’ve agreed on a future for Europe that none of us wants.
In previous columns I’ve said what I think needs to happen: Limited, conditional and explicit debt mutualization to restore confidence, combined with a renewed emphasis on the accountability of national governments to their voters. The first, with the emphasis on “explicit,” is the minimum requirement for avoiding a European economic catastrophe. The second accepts that the basis for a United States of Europe doesn’t exist, and that’s why the debt pooling should be limited and conditional.
The tension between the two parts is obvious. There’s no alternative but to manage it. Union where necessary, sovereignty where possible. It’s Germany’s least-cost choice, and that’s what Merkel should be telling her voters.
(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)
Today’s highlights: The editors on the Bush family’s lessons for Republicans and Jamie Dimon’s day in Congress; Edward Glaeser on what the 1912 election tells us about 2012; Margaret Carlson on the joys and sorrows of being Jeb Bush; Emi Nakamura on how the U.S. could become like Argentina; Robert Hockett on splitting Europe in half.
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