European Disunion

Europe’s leaders just committed a blunder known in the literary world as “Chekhov’s Gun.” The Russian playwright would put a rifle on stage only if someone was going to fire it. Translated into politics this means, don’t convene a summit on the financial crisis unless you are going to agree on a solid plan.

Instead of reassuring markets that the European Union is united, the message from the weekend meeting in Paris was: Every country for itself. “Each government will act in its own way, but will have to coordinate with others,” French President Nicolas Sarkozy told reporters.

The current panic goes well beyond Europe’s shores, just as the credit mania that preceded it was global in nature. The plunge in stock markets world-wide yesterday, as well as in commodity prices, indicates that investors believe the credit and banking crisis is spreading to real economies. Europe and the U.S. are probably falling into recession, and Japan is already there. For all the talk about continued strength in China and India, those economies will be hard-pressed to keep the global economy going if the big three of America, Europe and Japan are stalled.

The ink on Saturday’s nondeal wasn’t even dry when Berlin violated even that vague promise of coordination. Following Ireland’s move last week to secure all deposits, bonds, senior debt and lower Tier-II debt for its six biggest banks, Germany upped the ante Sunday night when it decided to guarantee all private deposits.

British media report that British Prime Minister Gordon Brown is furious that Chancellor Angela Merkel apparently gave no indication the day before that she was planning anything like this. Dublin’s beggar-thy-neighbor move had already put pressure on London to follow suit as British savers flooded the supposedly safer shores of Ireland. The U.K. Friday raised its deposit insurance to £50,000 from £35,000, and Berlin’s move may force London to raise the stakes again in Europe’s bailout poker. If new limits were going to be introduced, a unified announcement would have been much more effective in staving off a European bank run.

Let’s hope depositors won’t call their leaders’ bluff. Deposit insurance is designed to prevent bank runs from occurring in the first place. To do that, they have to be credible and therefore limited. Berlin’s step secures more than €1 trillion of savings, equivalent to around half of its GDP. By guaranteeing such astronomical sums, Berlin may cause more panic, not less, if savers conclude that the insurance can’t be upheld — at least not without ruining public finances for generations.

Also on Sunday night — the late hours just before Asia’s market opening have become the preferred time for European rescue deals — Berlin had to resuscitate a bailout plan for Hypo Real Estate. A consortium of private banks had stepped back from the original €35 billion deal; Berlin’s arm-twisting got them back on board with a new €50 billion credit line.

Hypo’s troubles show that Europe’s ad hoc bailouts aren’t working as smoothly as originally hoped. The Fortis bank rescue negotiated 10 days ago between the Benelux governments almost came undone, too, when the Dutch decided to take over all of Fortis’s operations in the Netherlands. That forced Belgium to quickly find a solution for its stake. Early yesterday, BNP Paribas agreed to take control of Fortis’s operations in Belgium and Luxembourg in a €14.5 billion cash-and-shares transaction.

The developments with Fortis show that public intervention can open the doors for private capital to follow, which is the preferred solution. But the Dutch move could have left the Belgians standing in the rain. If even The Hague and Brussels, with decades of experience with cooperation, can’t rely on each other, how much hope is there that other capitals will be able to quickly save a bank with cross-border operations?

Europe would fare better with a more comprehensive approach. That doesn’t mean copying the Paulson plan. Ideally, a Continental resolution authority with enough money would help recapitalize the banks. Such funding is crucial as the financials of European banks are even more overleveraged than their U.S. competitors. Though BNP stepped up in the Fortis case, it’s more likely that public capital will be needed as long as much private money is heading for the exits.

Cooperation makes sense, too, because national solutions may outstrip any one government’s resources. Non-EU member Iceland is the most urgent case. Reykjavik is struggling to rescue its banks, whose assets dwarf the island’s GDP.

German Finance Minister Peer Steinbrück acknowledged late yesterday that “at some point individual solutions are no longer enough.” He said Berlin was looking at putting up an “umbrella for Germany as a whole.” That at least has the ring of a more comprehensive national approach, even if the details are still unclear.

The reason the money markets have seized is that banks don’t trust each other. The reason Europe struggles to find a systemic solution to this crisis is that governments don’t trust each other. This is a poor record for the EU 51 years after its founding, one that may cost it dearly.

Advertisements
Post a comment or leave a trackback: Trackback URL.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: