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Completing Financial Market Union
Towards a Single Resolution Mechanism: The agreement on a Single Supervisory Mechanism (SSM) by the EU Finance Ministers is an important first step towards a real financial market union. But it is only one component. A financial market union has to involve a Single Supervisory Mechanism and a Single Resolution Mechanism (SRM). This is the only way to ensure that taxpayers do not end up paying for the mistakes of the private sector. Let me explain why.
Banks that are “too big” or “too interconnected” to fail at the national level – making bailout the preferred strategy – would not benefit from this status at the European level. The SRM would have the legal and financial capacity, as well as independence, to ensure that viable banks survive and non-viable banks are closed down.
Moreover, banks that are “too complex” to resolve via cross-border cooperation – making early action impossible – could be dealt with more effectively at the European level. The SRM would create an authority that could concentrate decisions on resolution and act pre-emptively and quickly, helping to preserve the value of the banks and save money for taxpayers.
Principles for European public support: However, a strong resolution mechanism cannot remove risks for taxpayers entirely. Certainly, any costs incurred from resolution should first and foremost be covered by the private sector, through establishing a European Resolution Fund raised by levies on the banking sector. But a real financial market union must also contain a public sector dimension at the European level. In this context, the European Council called for the operational framework for direct bank recapitalisation by the ESM to be ready by the first semester of 2013.
I am aware that the prospect of ESM direct bank recapitalisation raises serious concerns: that European taxpayers will end up paying for the bad assets accumulated over the past decade; that mutualisation will become standard practice for dealing with banking sector problems. But let me reassure you that these concerns can be contained with what I would see as the three key principles for European support.
This pecking order underscores that, the stronger the European resolution framework, the lower the eventual costs for European taxpayers. The more the financial sector can be bailed-in, the less it has to be bailed-out. We see in the US how this can work: the FDIC closed down more than 400 banks during the crisis, without any cost for taxpayers. This is the standard we should be aiming for in Europe – and a real financial market union is the only way to achieve it.
Let me make a final point regarding the institutional set-up of the SRM and Resolution Fund, which is my own personal view: the ESM would be well-suited to perform the tasks of the SRM and to house the European Resolution Fund raised from the banking sector.
Building Economic Union
The [European Council] Conclusions propose to kick-start this much-needed process of reform through three avenues. First, a renewed effort to complete the Single Market, in particular by opening up services and increasing labour mobility. Second, a thorough assessment, carried out in all euro areas countries, of the compatibility of their labour and product markets with membership of EMU. And third, for the issues identified in this assessment to be addressed through the new concept of “Reform Contracts”.
The idea behind the "Reform Contracts" is that countries would commit to specific structural reforms that have a direct positive impact on competitiveness, with those commitments formalised in a legally binding contract. The contract would be multi-annual and, to foster national ownership, initiated by the national government and approved by the national parliament. If the terms of the contract were met, financial support would be provided, targeted at the transitional costs arising from structural reforms – for instance, re-training programmes for displaced workers.
What are the benefits of this approach compared to the status quo? In my view there are three, although they depend very much on how the concept is eventually implemented.
Building a stronger economic union along these lines is necessary to correct what might be called an “original sin” of EMU: the fact that the convergence criteria did not include any structural benchmarks for joining the euro, and hence structural policies remained mainly within the national remit.
What about those areas that were not outcomes of the European Council and where there is room for further progress in the future?
The most important is greater sharing of sovereignty. The importance of credible governance has been starkly demonstrated during the crisis. Countries without credible policies have been forced by markets to consolidate more rapidly than others in the downturn. This is because markets have not trusted that they can run sufficient surpluses in good times, or achieve sufficient growth, to lower debt levels and ensure long-term sustainability. Paradoxically, the lack of strong external constraints on fiscal and economic policies has led to countries losing substantive sovereignty in these areas.
By the same token, countries now need to share more sovereignty in order to regain their sovereignty. By sharing decision-making with the European level, they can restore their policy credibility with investors, while at the same time having a voice over where they are heading. This will mean going beyond the Maastricht logic of national responsibility for fiscal and structural policies, and committing to governance arrangements that are actually enforceable – for instance, allowing for intervention rights by the center to prevent unsound national budgets.
Sharing sovereignty implies a number of other changes to euro area governance. First, there have to be strong institutions in order to exercise that sovereignty effectively. This will require a stronger Eurogroup. Second, those European institutions have to be properly democratically legitimated. This requires changes in the way the citizens participate in the European political process, in particular via the European Parliament.
Let me stress: while I would have liked the outcome of the European Council to be more ambitious, these ideas are not intended as criticism of it. They are orientations to advance further which will need to be properly fleshed out in the years ahead as the integration process evolves. This will require a Treaty change in the medium-term in order to complete EMU in a comprehensive way.