11 June 2012

Douglas J Elliott: Europe’s Spanish bank rescue - One step in the right direction

Elliott sees the Spanish bank rescue as important, as it begins to break the links between the governments of troubled eurozone countries and their often equally troubled banks by moving, very modestly, towards a so-called "banking union" to supplement the monetary union.

In Greece, Ireland, Spain and elsewhere, fiscal problems of the national governments have harmed the banks, and troubles at the banks have harmed their governments, in a vicious circle. Interposing the strength of the eurozone as whole is important.

The political and psychological benefits of the agreement are also important. This substantial act of solidarity may help restore confidence that the eurozone leaders will do what needs to be done in a time of crisis. Further, it sends a signal to the Greek voters that they should not count on being able to coerce the rest of the eurozone into completely rewriting the current bailout agreement by making explicit and implicit threats to bring down the rest of the monetary union through financial contagion. 

All that said, the weekend’s agreement in principle on Spain retains a great capacity to disappoint, as other eurozone crisis responses have, depending on the details. First, it would be a much stronger signal if the funds were being channelled directly into the Spanish banks, rather than being lent to what is effectively an arm of the Spanish government, thereby increasing its debt burden. Second, we do not know which eurozone-level entity will be lending the money, the European Financial Stability Fund or the European Stability Mechanism. This matters significantly, for technical reasons that are too complicated for a blog posting, but which carry political and economic consequences. Third, we do not know what conditions will be placed on the loans, in terms of their maturity, interest rate and requirements for policy action. The early word is that there will be few additional policy constraints, but this may be a matter of semantics, since Spain has already committed to a great number of actions as part of the new requirements for coordination among European countries. It may be harder for them to alter these commitments now that they are taking large amounts of European funding.

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