European leaders held their fall council in Brussels [pdf] last week, normally a pro forma exercise of applying a rubber stamp to noncontroversial policies while allowing each leader to claim a political victory. This time the issues included the digital economy, innovation, services, combating youth unemployment, improving financing conditions for small and medium enterprises (SMEs), and the ever-present fight against regulatory red tape emanating from Brussels.
But the summit did reveal three important developments.
1. Intelligence Issues Matter Politically
The recent revelations concerning alleged NSA eavesdropping on the mobile phone calls of Chancellor Angela Merkel of Germany and millions of European citizens mattered enough for the leaders to spend most of their first working dinner on the issue [pdf]. The fallout will not be immediate or dramatic, but will instead come in several forms.
A critical distinction exists between EU governments (which, like all governments, generally like secrecy and amassing information about their own residents) and European legislatures. The revelation of the existence of these NSA programs (apparently approved not by President Obama or the congressional oversight committees but at the “agency level” inside the intelligence community) will likely make it more difficult to win approval in EU national and European-wide legislatures of new agreements with the United States, particularly the Transatlantic Trade and Investment Partnership (TTIP). In addition, US information technology services and internet companies will have a tougher time championing changes in EU regulations over data privacy issues in the face of this legislative sensitivity to US government actions.
Merkel, who is personally invested in the success of the TTIP, is unlikely to kick up a big storm, despite having her phone bugged in a way that will remind Germans of STASI. Ironically, the revelations might actually give her and EU executive powers and their intelligence services better access to information about Europeans collected by the United States, so there is a fair degree of hypocrisy involved in the “tempered reaction” of top-EU leaders so far.
Germany, France, and other countries seek talks with the United States about intelligence gathering. Traditionally, the United States has had privileged intelligence sharing relations with the four other main Anglo-Saxon countries—the United Kingdom, Canada, Australia, and New Zealand, along with a mutual agreement not to spy on each other. Germany and France will now likely seek the same understandings with Washington, their case enhanced by the fact that France has been a more reliable recent partner in Mali and Syria than the British. Instead of major political disruptions from EU leaders over the issue, there will more likely be an agreement on curbing US spying in return for better intelligence sharing.
2. Another Incremental ‘Grand Bargain’ in the Making?
The EU leaders were surprisingly optimistic about reaching the outstanding policy deadlines related to the banking union, especially the still to be agreed upon single resolution mechanism (SRM) for the dissolution or consolidation of failing banks. The Council Conclusions read [pdf]:
Completing the Banking Union is urgent and requires not only a Single Supervisory Mechanism but also a Single Resolution Mechanism. The European Council calls on the legislators to adopt the Bank Recovery and Resolution Directive and the Deposit Guarantee Directive by the end of the year. The European Council underlines the need to align the Single Resolution Mechanism and the Bank Recovery and Resolution Directive as finally adopted. It also underlines the commitment to reach a general approach by the Council on the Commission’s proposal for a Single Resolution Mechanism by the end of the year in order to allow for its adoption before the end of the current legislative period.
Many might scoff at such statements and point out that the euro area crisis is far from solved, but that would be a mistake. The European Union’s record of fulfilling its commitments has been good. A political agreement on the SRM will likely be achieved by the end of 2013.
The shape of such an agreement depends on what Merkel wants and what she is willing to offer in return. Her government has two goals.
First, any banking accord must be robust enough to survive inevitable challenges at the German Constitutional Court. This means that to the extent that SRM decisions require German taxpayers’ money, the German Bundestag must approve. Eventually, the SRM is to be backed by an industry-financed fund. Until such an arrangement is established, it cannot take quick decisions on bank resolutions, and may never act independently on systemic sized banks, whose resolution costs could exceed the capacity of any industry-financed fund. There will, in other words, need to be a new political agreement in the euro area, to deal with future systemic financial crises. But once the SRM phase-in period of industry-contributions is completed, and taxpayer money is no longer required, the SRM can tackle individual medium-sized bank collapses in the euro area.
In return for offering German financial assistance during an SRM phase-in period, when European Stability Mechanisms may be needed to recapitalize banks that fail next year’s bank stress tests, Merkel is likely to demand political commitments on institutional and structural reforms in Europe. The EU Council Conclusions agreed [pdf] that:
Work will be carried forward to strengthen economic policy coordination, with the objective of taking decisions in December on the main features of contractual arrangements and of associated solidarity mechanisms.
The contractual arrangements between the commission and individual member states, where national governments legally commit themselves to implementing agreed structural reforms in return for access to “associated solidarity mechanisms” is an old Merkel proposal. Its time now seems to have arrived. It further resembles the recent quid pro quos in which the European Commission and the euro group permitted looser fiscal targets for some member states in return for their commitment to structural reforms.
In effect, German flexibility on the single resolution mechanism can be seen as another down payment granted in return for the Merkel agenda of long-term institutional changes in the euro area. Merkel noted, moreover, that the principle of contractual arrangements has been endorsed by other EU leaders.
3. The ECB Has Lost the Debate About Bank Creditor Bail-Ins
In recent weeks, an older debate about the prospects of creditor bail-ins in viable euro area banks has resurfaced in the leaked July 2013 letter from European Central Bank (ECB) President Mario Draghi to Competition Commissioner Joaquín Almunia. At stake is whether euro area banks deemed viable by regulators, but also needing new capital, should tap public sources without imposing losses on junior bond-holders first. The EU Commission state-aid rules from August 2013 envision extremely rare exceptions, when “systemic risks” are present.
Draghi’s letter suggested that bail-ins might impair the subordinated euro area debt market. He advised a more lenient approach, sparing creditors out of fear of contagion. Now it is clear that the European Commission did not much care about the ECB’s concerns, as it proceeded to publish new rules dictating the opposite. The disparity of views recalls the 2011–12 debate between the ECB and euro area governments (especially Germany), over whether haircuts should be imposed on Greek bondholders. The ECB opposed such costs but lost the debate—showing how even the most politically powerful central bank in the world fails when its demands have fiscal implications for euro area governments.
Why Draghi’s letter found its way into the European press months after it was sent, and just before the EU Council, is hard to say. But a “strategic leak” cannot be ruled out, even from the ECB. Perhaps the ECB was hoping that the renewed debate would swing consensus back in its favor, or perhaps it was just trying to politically position itself for any resulting market turmoil. President Draghi has made it clear that “some banks need to fail” to prove the credibility of the upcoming stress tests. The ECB also wants to protect its balance sheet against political demands for continuing liquidity provision to weak euro area banks unable to recapitalize themselves in markets, but which are not weak enough to be liquidated.
Whatever the EU Council’s motivations were, its ruling on the issue [pdf] was clear:
In this context, the European Council recalls the urgency, for the Member States taking part in the Single Supervisory Mechanism, of establishing a coordinated European approach in preparation for the comprehensive assessment of credit institutions by the European Central Bank. Member States should make all appropriate arrangements, including national backstops, applying state aid rules.
In short, current state aid rules will apply. Junior bondholder bail-ins are mandatory in all but the most extreme cases, before any public money can be injected. Moreover, competition commissioner Almunia is unlikely to back off from his now repeated advocacy of bail-ins, and the European Parliament would not likely approve a new competition commissioner favoring more lenient terms on junior bank bondholders.