The euro crisis isn’t Angela Merkel’s fault.
The real culprits are the founding fathers -- Francois Mitterrand, Helmut Kohl, Jacques Delors or Romano Prodi -- who created a common currency based on poor economics and worse politics. They knew their brainchild was flawed, and bet that future crises would force it to evolve. Unfortunately, they willfully ignored the dysfunction of Europe’s political structures, which allow Luxembourg, a country with fewer inhabitants than Tucson, Arizona, to veto any communal decision.
As the impending default of the Spanish regions amply demonstrates, a fiscal union without a transfer of political powers to a central authority is pure folly. Yet no European country is willing to relinquish its sovereignty; this is particularly true of those that have proved most irresponsible.
The euro’s founders designed this game of chicken on purpose, hoping that in a crisis either the periphery countries would blink and relinquish their sovereignty or Germany would cave and open its coffers.
Beyond their willingness to ignore the risks inherent in playing chicken, the euro founders didn’t take into account that even good outcomes of this game could be disastrous. On the one hand, without a transfer of powers, a German rescue would only postpone the disaster. On the other, a transfer of power under duress would fuel such deep national resentment that the idea of Europe would be destroyed for at least a generation.
Still, there remains one bright spot amid the gloom. A European banking union would provide a litmus test of the only viable long-term solution for Europe -- a quid pro quo between financial rescue and transfer of power. The power to be transferred -- the authority to supervise major banks -- isn’t negligible. Regulators, especially in southern Europe, have been known to turn a blind eye to politically affiliated national banks. Relinquishing this prerogative would be a serious loss for local politicians. That is the reason why such a transfer would be no picnic. The devil, as usual, will be in the details.
The first important consideration is the way the bank supervisory authority will be established within the European Central Bank. Would it respond directly to the Governing Council, which is made up of the 17 national central bankers and the six members of the Executive Board? Such a large representative body is ill-suited to making difficult political decisions. The Executive Board is of more appropriate size, but the largest countries tend to dominate it. The danger is that the board would be tough-minded only with banks of the smaller countries, which don’t always have an advocate.
The best solution is for the Governing Council to appoint a head of supervision who will oversee and decide all the cases, except the ones for his or her own country; those decisions would be made by the No. 2 (from a different country).
The second important detail is how European insurance should cover a country’s exit from the euro. The currency’s founders omitted such a contingency from any treaty, hoping to make it impossible. Today, however, this possibility is on the table and deposit insurance should be in place to deal with it.
What would happen to Greek bank depositors if Greece were to leave the euro? If the answer is that they would lose their coverage, then the insurance would be unable to prevent a run because Greeks wouldn’t want their savings redenominated in drachmas. If the answer is that the deposits would be insured in euros, there is a risk of moral hazard by subsidizing a Greek exit.
The solution is unconditional insurance, with the sovereign, senior debt first in line for a clawback if the country leaves the euro. In this way, the insurance would appease fears of an exit, but wouldn’t risk subsidizing it, because the sovereign would still have to pay at least the insurance costs.
The vision of a Europe without nations, with nothing to kill or die for, is very valuable. Although imagining it isn’t hard to do, building it is. By stating the vision, the euro’s fathers claimed all the glory. The difficult details were left to their successors, who must now either make good on Europe’s promise or recognize that this wonderful project was premature and try to unwind it in the least costly way.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
To contact the author of this story:
Luigi Zingales at Luigi.Zingales@chicagobooth.edu
To contact the editor responsible for this story:
Max Berley at email@example.com