The turmoil that struck Italian sovereign debt and bank equity markets on Tuesday, 29 June, is a stark reminder that the potential for another crisis is real, even if not imminent. Important parts of the firewall that separates banks from sovereigns remain incomplete – and central bankers remain vulnerable to political influence as a consequence. Two recent books help illustrate why. One, by former Cypriot Central Bank Governor and Leicester University Professor Panicos Demetriades, reveals the limits of central bank independence. The other, by University of Denver Professor Rachel Epstein, explores the interaction between banks and markets.
When Italy’s voters went to the polls on 4 March, roughly 32.5 percent voted for the Five Star Movement (M5S) and another 17.5 percent voted for the Lega. If we add in the 4.5 percent who voted for the Brothers of Italy, well more than half of the electorate supported openly Euroskeptical movements whose leaders have flirted with the idea of leaving the euro. ‘Europe’ did not play a prominent role in the public debate during the run-up to the elections; according to pre-election polling done by SWG – one of the major national public opinion polling firms – cutting taxes and throwing out the ‘ruling class’ were more important. But the two big winners from the contest strongly advocated policies like rolling back pension reforms (Lega) or introducing a basic minimum income (M5S) that would quickly bring Italy into conflict with the European Commission over fiscal consolidation. Moreover, any future Italian government will have to draw support from one or both of these parliamentary groups. The question is what this means for relations between Italy and Europe.
The German grand coalition agreement promises to breathe new life into the debate about European macroeconomic governance reform. The German Social Democratic Party (SPD) will hold the ministries for foreign affairs and finance; SPD leader Martin Schulz has made it clear that he is in favor of further integration; and the bullet-point version of the agreement includes a number of eye-catching suggestions that seem to cross over a number of previous German red lines. Although emphasis on risk-reduction (and national responsibility) remains prominent, risk-sharing, stabilization, and some kind of common backstop for banking resolution and deposit insurance seems more likely now than ever in the past. Nevertheless, I remain unconvinced. The problem is not whether the SPD rank-and-file will vote in favor of the agreement. That remains to be seen. My doubts arise from the categorical difference between engineering and ethics.
Europe’s heads of state or government have launched a new conversation about reforming the financial structures of the European Union in order to prevent another economic and financial crisis like the one that consumed the last decade. They have a number of ambitious proposals on the table — to complete the European Banking Union, to strengthen the European Stability Mechanism, and to enhance political accountability at the European level. Not all of these proposals are sure to be adopted, and progress is likely to be incremental. The goal of ensuring financial market stability is nevertheless apparent.
Earlier this week, French President Emmanuel Macron gave a speech outlining his proposals to reform the European Union. And there were a lot of proposals in that speech. Surprisingly, though, not many of them focused on the euro area or on the process of European macroeconomic governance. Macron talked about creating some kind of common budget and naming a European Minister of Finance, but he did not touch on the major issues sketched in European Commission President Jean-Claude Juncker’s State of the Union address or the letter of intent and reflection papers that the Commission has produced as well.
The Italian government passed a series of decrees yesterday to allow Intesa San Paolo to buy the healthy assets of two small banks from the Veneto region – Banca popolare di Vicenza and Veneto Banca. The state will move the distressed assets into a ‘bad bank’ for orderly liquidation. This action closes a chapter on the Italian banking crisis that started in late 2015 when regulators made it clear that the two small Veneto banks needed more capital. Over the intervening period, investors threw good money after bad as the banks continued to haemorrhage deposits and mount up non-performing loans. The government did not want to step in because it did not want to impose losses on large depositors or junior bond holders. Ultimately, though, the situation for the two institutions was unsustainable. Now we know what the solution looks like. The question is what we learned from the process. The short answer is that Europe’s banking union is still dangerously incomplete.
As we approach another round of talks on the third Greek bailout package, I thought it would be appropriate to share two thoughts on the importance of debt forgiveness and on Europe’s preparedness in case this all goes wrong. My basic line is that debt-forgiveness is the only pragmatic choice. I also worry that Europe is not as prepared for the alternative as it should be.