Just when you thought it was safe to get back in the water…

June 24, 2013

A worrying weekend for the euro zone.

Greece’s coalition government – the guarantor of the country’s bailout deal with its EU and IMF lenders – is down to a wafer-thin, three-seat majority in parliament after the Democratic Left walked out in protest at the shutdown of state broadcaster ERT.

Prime Minister Antonis Samaras insists his New Democracy can govern more effectively with just one partner – socialist PASOK – but the numbers look dicey, although it’s possible some independent lawmakers and even the Democratic Left could lend support on an ad hoc basis.

Samaras has ruled out early elections and says the bailout – without which default looms – will stay on track. If the government fell and elections were forced, the likely beneficiaries would include the anti-bailout leftist Syriza party which, if it got into government or formed part of one, really would upset the applecart.

Just as alarming was the failure of EU finance ministers – after talks that went through the night well into Saturday – to agree how the bill for future bank failures should be paid. There were problems with those countries outside the euro zone as to how they should fit into the mechanism. But the disagreement was chiefly between France and Germany, principally on how much leeway countries should have to impose losses on bondholders and/or large depositors.

As one would expect, Berlin wants minimal wiggle room is order to spare the currency bloc’s taxpayers in future, Paris significantly more. A fresh attempt will be made by the ministers on Wednesday in an attempt to clear it up before their leaders meet on Thursday.

This is big stuff. The Thursday/Friday EU summit is supposed to rubber-stamp the new rules. When the euro zone crisis was raging last year, this summit was set as the target date for plans for a euro banking union to be fleshed out in all its aspects. The bloc’s powers have been backing off that for some time and now ministers are falling short even beforehand over a fundamental issue — how to shut failed banks without sowing panic or burdening taxpayers.

An agreement on European rules for closing banks is also a step required by Germany before it will sign off on a scheme for the 17-nation euro zone’s bailout fund to help banks in trouble.
A full cross-border banking union would amount to the last vital plank in the defences being built around the currency bloc to banish future existential threats. With the European Central Bank effectively underwriting the bloc’s governments with its bond-buying pledge, a cross-border body to restructure or wind up failing banks, backstopped jointly by euro zone governments, would do the same for the financial sector.

It has been apparent for some time that a bank “resolution fund” with pooled risk has not got a cat in hell’s chance of being created in the foreseeable future, so the “doom loop” of weak banks and sovereigns weighing on each other will not be broken.

Not unreasonably, Germany does not want to fall liable for the failure of a bank in a weaker country. Instead, it is pressing for a “resolution board” involving national authorities to take decisions on winding up failed banks. Berlin will certainly not budge before German elections in September. The big question is whether it will do thereafter. Angela Merkel’s party releases its election campaign programme today.

Having said that, the fact that the European Central Bank will become the cross-border supervisor of key euro zone banks, probably from September 2014, is a step forward, as is agreement that the euro zone’s ESM rescue fund will be able to offer direct aid to struggling banks from that point too. However, even there it seems bondholders and governments will always have to contribute heavily too, so the state/bank link remains, and the ESM’s funds are limited.

The danger surrounding all this is that markets are back into turbulent mode. After the Federal Reserve made doubly clear that it might not be printing any more money by this time next year, peripheral euro zone borrowing costs are on the rise after 10 months of calm, imposed by the ECB’s unused bond-buying plan. The constant theme of this crisis is that it has been market pressure that has pushed the currency area to the brink.

Turmoil is already spreading far and wide. China’s money market rates have spiked alarmingly with the People’s Bank of China – which is trying to rein in excessive credit growth – seemingly disinclined to act. The Bank for International Settlements said on Sunday that its central bank constituents should not be deterred by fears of market volatility when the time came to start turning off the money-printing machines. It expects some market disruption but said delaying was only likely to make that worse. Bundesbank chief Jens Weidmann was out over the weekend warning the currency bloc it cannot count on ultra-low interest rates forever.


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