Last Wednesday I was bracing myself for yet another failed EU crisis summit followed immediately by the usual flight of capital courtesy of panicky financial traders. It was a relief to find that Italy scored a surprise diplomatic win over Germany just hours after their football team did the same in Poland.
But after marathon talks, during which Messrs Monti and Rajoy refused to budge until they had obtained measures to reduce their borrowing costs, Angela Markel finally backed down and we have the first significant breakthrough in response to the crisis for over a year. The EU’s permanent bail-out fund, the European Stability Mechanism, will be able to directly recapitalize banks and buy government bonds without tough conditions. The ECB has been appointed as supervisor of the eurozone’s banks and may well have the powers to wind up broken banks.
At last, we have got some realism about how to stave off the crisis.
As ever, the devil will be in the detail, particularly about the new powers for the European Central Bank as the eurozone’s bank supervisor. The current ECB statute and the treaties do have a reference to the bank acting as a ‘prudential supervisory’ role, but I doubt that the draftsmen had the idea of the ECB being a super-regulator in chief of the continent’s banks when they drew up its mandate.
It also remains to be seen how the ESM will directly prop up the banks. There are still no plans to give the EU bail-out fund a banking licence or to increase its size, but I imagine that EU leaders will choose to cross those bridges when the time comes. Once the precedent of buying bonds and propping up banks is established, it will be difficult to put a stop to it.
However, while we undeniably have the tools to stave off bond market pressure onItaly and Spain, and should protect them from needing a full rescue package, the long term future of the euro is still uncertain. For all Merkel’s protestations, it is difficult to believe that some form of debt mutualisation will not be needed. The German Redemption Fund proposal is probably the most likely solution – pooling the excess debt beyond the 60% threshold laid out in the Stability and Growth Pact into a fund that must then be paid off each year. The Redemption Fund uses the same logic as the economic governance’six pack’, with countries required to reduce their excess debt by at least 5% each year.
Crucially, it might well be possible to set up a Redemption Fund without a treaty change, although I wouldn’t recommend saying this to a German politician.
In any case, with any serious talk of debt mutualisation still off limits for Germany, leaders did the smart thing by parking the issue with European Council President Herman Van Rompuy. Van Rompuy, who, as usual, played a quietly important role in brokering the summit compromise, will now draw up a detailed proposal to be discussed in the autumn.
Last week’s summit is just the first step, but for the time being, we should now enjoy a long overdue period of relative calm. Here’s hoping…..