Saving Europe’s real hegemon

MUNICH ― Last June, the European Commission announced its about-face on bank restructuring. The money for recapitalizing distressed banks would now come primarily from creditors, not European taxpayers, with a pecking order to specify which lenders would be repaid first. All of this is welcome, at least in principle. In practice, however, the scheme leaves much to be desired.

The problem is that a very long list of exceptions reduces the recoverable assets to such an extent that in many cases it will still be impossible to make do without public money. The long-term plan is that this money should come from a fund created by European banks themselves. But the Eurogroup (a meeting of eurozone finance ministers attended by the European Union’s economic and monetary affairs commissioner and the European Central Bank president) is suggesting that, until then, the European Stability Mechanism ― and thus the taxpayers ― will fill the gap.

Given that taxpayers are thus supposed to finance guarantees for deposits up to €100,000 ($133,000) ― the median level of Dutch household wealth and twice the German median ― the Eurogroup’s proposal boils down to a massive redistribution of wealth in Europe, the dimensions of which are not understood by the public.

The idea of exempting banks’ secured debt from the pecking order for repayment is extremely problematic as well. While this proposal may sound harmless and almost self-evident, it is not; secured debt needs no further protection, because it is already secured. Viewed from this perspective, the additional protection afforded by the exemption is highly surprising.

The exemption for secured debt undoubtedly concerns mainly the refinancing loans that the ECB has extended to commercial banks against increasingly weak collateral. For the eurozone’s crisis-ridden economies (Cyprus, Greece, Ireland, Italy, Portugal, and Spain), the combined total is €732 billion. These loans extend far beyond providing the liquidity that these countries need for internal circulation, for which a maximum of €335 billion ― their available stock of central-bank money ― would have sufficed. Instead, by weakening safety standards, bailing out foreign investors, and financing current-account deficits, the ECB has undercut and replaced the private European interbank market.

With several banks in the crisis countries on the verge of bankruptcy, many of these loans have now turned toxic. After all, if one takes the average of estimates reported by reputable sources, the write-off losses of the six crisis countries’ banks amount to about €670 billion. Participating in these write-offs would put huge strain on the Eurosystem (the ECB and the central banks of the eurozone member states), which has only around €500 billion in equity capital. The riskiness of the ECB’s strategy of using the printing press to bail out banks, including their public and private clients, would become apparent to everyone.

Thus, it is clear how the losses incurred by the ECB’s de facto regional fiscal policy are to be avoided: the write-off costs will be transferred from the ECB to the ESM. This makes no difference to taxpayers, who will have to pay for both institutions’ losses in the same manner. But it has the advantage of allowing the ECB to present itself as having a clean balance sheet, thereby enabling it to maintain its current policy.

Ultimately, this is merely a new round of the eurozone’s old game of financial hide-and-seek, whereby losses are obscured by distributing them among different institutions and time horizons. The game started with the bailout fund for Greece, which was followed by the European Financial Stability Facility, the European Financial Stability Mechanism, and the International Monetary Fund, which in turn were relieved by the ESM. In each case, a major objective was to reduce the burden on the ECB, which had advanced the money by printing it and would have run into serious difficulties without help.

The entire arrangement is highly problematic from the standpoint of democracy, because the initial decisions about undercutting the capital markets by means of public credit were taken by the ECB’s Governing Council, in which large countries like France or Germany have the same voting power as Cyprus or Malta. Indeed, the national central banks’ allocation of emergency liquidity assistance required approval by only one-third of the Governing Council’s members, and the six crisis countries had these votes. According to the Eurogroup’s proposal, these self-awarded loans, too, are now to be secured by ESM funds.

While the European Union’s national parliaments must still decide on the scheme, they essentially have no option but to assent, because to do otherwise would severely harm the ECB. When they finally get to vote on the matter ― years after the ECB’s risky credit maneuvers ― they will have no choice but to bail out the ECB, the true hegemon of the eurozone.

By Hans-Werner Sinn

Hans-Werner Sinn is professor of economics and public finance, University of Munich, and president of the Ifo Institute. ― Ed.

(Project Syndicate)