19 April 2013

Graham Bishop: Reflections after a visit to Berlin - German Politics, Banking Union, FTT, Economic Governance, UK

CONFIDENTIAL

German Politics

The Election on September 23rd now dominates all political planning so European policy is also operated through that filter – Banking Union,'Liikanen'-Lite law (though still awaiting SPD-controlled Bundesrat agreement), financial transaction tax etc. However, the recently-founded anti-euro political party has injected a new uncertainty into the situation. Despite opinion polls showing that a significant part of the electorate could imagine supporting “Alternative for Germany” at this early stage of its development, the general assessment seems to be that - as a single issue party - it will struggle to reach the 5 per cent threshold for Bundestag representation. Moreover, it will have to struggle to avoid being ensnared by the far-right neo-Nazi National Democratic Party (NPD).

However, the established political parties will have to wrestle with permutations of whether it draws support away primarily from the CDU or where some comes from the SPD. Will the FDP get across the 5 per cent hurdle? Despite Chancellor Merkel’s commanding personal standing, the parliamentary vote seems too close to call. But I remind you of the recent Forsa opinion poll (link) showing a very strong majority in favour of keeping the euro!

Banking Union

Banking Union stands on three legs: the Single Supervisory mechanism (SSM); Single Resolution Mechanism (SRM) and Single Deposit Guarantee Scheme (DGS). Taking them separately:

• A DGS at the European level seems largely to have been dropped after a powerful campaign by the savings banks (and to a lesser extent, the co-operative banks) to attack the notion on the grounds that the essence of their business model is that of separate units glued together with a DGS. However, no-one seems to be able to answer how much of the deposits in non-ECB-supervised banks will be over €100k? In practice would the euro area not split between the big banks (where depositors rely on capital strength/good supervison) and the small/national banks where the state-backed €100k guarantee would cover the great bulk of depositors? If citizens can rely on their state, then there is little need for a European DGS! What would the case be if the deposit guarantee were lifted to say €200k (roughly equal to the FDIC limit in the US?)
• SSM: The implication of the ECB’s stated intention of substantial stress-testing (even of individual banking assets?) before taking them under its supervison may be profound. But what happens to the `bad assets’ that are left behind? They will be identified as an obvious charge on the home government. Not much thought given to this yet! However, an obvious side effect is that the chances of an ECB-supervised bank needing the services of a European-level SRA in this credit cycle should be modest. (Fingers crossed!) Another implication is that the ECB should favour a branching system that spans the single market and thus eliminates the fragmentation that has occurred in the last couple of years. Probably the quickest and biggest benefit for the EU economy from banking union.
• SRA/M: I have argued for some time that the intensely political question of the SRA/M is THE cross-over point to a political union – the key step to a Genuine Economic and Monetary Union. But the dynamics of the looming European Parliament dissolution and the German Election both point to this problem only being solved in the longer term.  I accept the argument that this is bound to be a lengthy process as national insolvency laws may need a degree of harmonisation – but will this really need a Treaty change? (but only a small, technical one so as not to open the way to UK 'demands'). If the Mechanism were to include a Resolution Fund that 'assumed the liabilities of Member States' – so breaching the no bailout rule of Article 125 TFEU – then indeed a Treaty change would be needed. So the ECB may just have to live with the inelegant solution of having to request a national resolution authority to act if the need arises for resolution of a major bank. The key element to make this acceptable may be that nearly all Member States participate in the SSM part of the banking union so that a collective decision about action on a specific bank would still fall to the national authorities to decide for themselves if they wished to inject capital or go the resolution route.

Financial Transaction Tax (FTT)

The recent research report by London Economics (link) for the City of London has highlighted the cascade effect of this tax and thus the impact on long chains of securities transactions – for example including those operated by the savings banks/Landesbanken system. The process in Germany is being driven by the tax office as a revenue-raising activity so it seems that the market implications have not yet been taken fully into account. It would be a pity if this were to kill off the market mechanisms that would enable Long-Term Investment (LTI) to flourish. These considerations could come back into play once the extreme political factors diminish in the autumn.

Economic Governance

Does Germany have a clear vision of how it would like the EU to develop over the next say decade? The simple answer seems to be No! However, Finance Minister Schäuble (a long-standing visionary) has raised again the idea of Treaty change – after a period in which that concept suddenly went out of fashion for fear of giving the UK an opportunity to 'extract' concessions. There seem to be two aspects to his concept: (i) a smaller Treaty change to enable completion of banking union – see above - and (ii) a reversion to a longer term concept of a `European Finance Minster’ that he floated last summer.

The latter may be necessary for any move to a fiscal union in order to ensure proper democratic control. Berlin is the right place to contemplate the consequences of the absence of that condition. Amidst the gleaming new buildings, there are still many bullet-riddled, shrapnel-scarred buildings to acts as a powerful reminder of 1945, as well as places that are relics of the old East German 'Democratic' Republic.

Long before any such Treaty change can possibly happen; there are more immediate matters of concern. In particular, there can be no doubt about the concern felt about the position of France. The European Commission’s “In-Depth Review” (link) laid out the deep-seated problems that appear to be deepening. What would happen if the Commission came to the point that it felt obliged to impose sanctions on France? Supporting such sanctions would be deeply troubling to the German soul – far better that France itself decides that the right steps must be taken before such decisions become necessary.

Italy is in rather a different category as the improvements in policy under Mario Monti are now bearing some fruit so that there is not an imminent crisis. Indeed, I argued that the absence of a new Italian Government could be quite positive as it leaves Monti able to continue to implement the policies that had already been enacted before the elections. However, the Commission’s In-Depth Review of Italy makes it clear that further policy changes are needed.

Naturally, I raised the question of progress on my Temporary Eurobill Fund (link) but this is a question for later in the year.

Relations with the UK

My visit was immediately after the weekend spent by David Cameron (and his family) with Chancellor Merkel in Berlin. The silence about the visit was quite deafening so one can only imagine that Cameron’s begging bowl of powers to be repatriated remained empty. Downing Street talked of discussion on reform of the EU to make it more competitive – but that is a 'motherhood and apple pie' topic. The Chancellor’s website features only a photograph of a working dinner. However, there seems no wish to push Britain out of the EU, and agreeing to more opt-outs in future could be envisaged. But, in my view, that will just deepen the marginalisation of Britain and make it ever less attractive to inward investment deigned to serve the European market.

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© Graham Bishop