Photo: Bloomberg TV
It’s been an extremely busy September on the euro crisis front.After a few weeks of relative calm in August as European leaders went on holiday, the ECB announced an unprecedented bond-buying scheme to quell rising government funding costs, the German Constitutional Court ratified the eurozone’s permanent European Stability Mechanism (ESM) bailout fund, and the Netherlands elected a pro-European government in an exciting race.
All of these developments have been viewed as mostly positive by the market so far.
Citi chief economist Willem Buiter also welcomes the progress Europe has made this month, but he warns in his latest note to clients that “even just reaching the end of the periodic financial market ‘cardiac arrest’ phase of the sovereign and banking crisis will still take at least two to three years.”
The biggest reason Europe isn’t out of the woods, according to Buiter: the debt levels in the eurozone are still just too high, and a growing divide between Germany and the rest of the euro area on the matter of banking union is “extremely serious.”
On the first point, Buiter writes that “because there is simply too much debt in the euro area as a whole (private and public), mutualisation of enough of the excessive private and public debt of the periphery to restore the solvency of the sovereigns and of the systemically important private entities is not possible in our view.”
The other big problem highlighted in the note is the growing divide between Germany and the euro area on a plan for designing a banking union, which Buiter sees as a crucial next step to ensuring the sustainability of the common currency.
Buiter explains how fragmented the euro area banking system is right now and why it’s so important that progress be made on forming a banking union:
Without the first step (the single supervisory mechanism (SSM) that Germany is now trying to emasculate), the next step – the ESM as bank recapitalisation fund and proto-bank resolution fund, cannot take place. This is extremely serious. National supervisors in the core EA nations have, under the guise of prudential regulation, imposed de facto capital controls on interbank flows from the core to the periphery, including flows between subsidiaries of the same cross-border bank and between subsidiaries and parent.
This results in cross-border bank X lending in South Tirol (Italy) to corporate clients at rates 350bps higher than for comparable corporate risks in North Tirol (Austria). When the Austrian subsidiary tries to send funds to its Italian parent it is stopped by the Austrian supervisor/regulator. With banking union, and with the ECB in charge of supervision, it will come down heavily on capital market “balkanizing” national supervisors, whose actions destroy the monetary transmission mechanism in the euro area.
In concluding the note, Buiter also issues a stark warning on the dangers of the current policy status quo endemic among central banks worldwide:
This combination of near-zero or indeed negative interest rates at maturities of up to 2 or 3 years and unlimited liquidity makes markets other than short-term debt markets happy and creates the risk of financial asset booms, bubbles and busts almost anywhere in the world, even with the real economy performing, at best, in a disappointing manner. With official liquidity the main driver of generous asset valuations, the risk of asset market collapse is always with us.
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