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Draghi´s German Nightmare

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Berlin – Just in time for the May European elections euro area  leaders reached a compromise on the Single Resolution Mechanism (SRM) and the Single Resolution Fund (SRF), the second pillar of the European banking union project.

As  the  ECB  assumed  the key role  in defusing  the eurozone sovereign debt and banking crisis with the levers of monetary policy  and collateral policies  -and now on top of this has been empowered  as the eurozone´s  bank supervisor  – Mario  Draghi  moved  in  the position as the most powerful European in modern history. How much he is  using his  enormous clout on Brussels’ negotiating table to shape the new bank resolution framework along the ECB´s priorities  explains why  Berlin ´s negotiators  – on the final stretch of the negotiations on bank resolution –  were forced to make  major concessions in the direction of accepting much faster debt  mutualisation.. Helped by the European Parliament and the Club Med debtor countries the far-reaching empowerment of the ECB with the Single Supervisory Mechanism (SSM) is dramatically shifting the power balance in the architecture of European institutions with Germany  perceived  as biggest  loser. Those responsible in Berlin failed to make sure that German taxpayers money and savings will be protected in coming years from the newly opened  complex eurozone transfer  channels through the banking union mechanisms.

When presenting the manuscript of my 15-page piece on Draghi´s German Nightmare to the International Economy (see www.international-economy.com) in the last week of February,  Germany´s chief negotiator, the old and new finance minister Wolfgang Schaeuble,  had been able to stick to his much harder position on the pace and the modalities of mutualisation of the Single Resolution Fund (SRF) in the interest of Germany´s financial sector, its taxpayers and savers.  Summing up my findings at the critical juncture of an emerging compromise on the second pillar of the historical project of European banking union in my TIE Piece Draghi´s German Nightmare  I made the following points:

First, the European Central Bank´s leadership  decided to ignore the findings  of the German constitutional court (GCC)  by  stating that “the ECB took note of the German court decision and stood by its (OMT) measures”,  letting ECB board member Yves Mersch who is in charge of  legal services of the bank, add “The court´s decision  did not affect the plan´s credibility ..  “We are very confident”.

Second,  also the prevailing attitude of market actors was –-if one looks at  sovereign bond yields  or credit default swaps – one of benign neglect.  Whether  markets will take the ECB´s legal problems in the future more serious, should the euro sovereign debt crisis return,   remains to be seen.

Third,  this doesn´t change the fact that on the issue of OMT bond –buying the ECB is on a collision course with its largest member country with unforeseen legal, political and economic consequences. In case the European court of justice (ECJ) doesn´t come up with OMT amendments  eurosceptical parties  could profit from a political backlash.

Fourth, as the European Parliament (EP) investigations have shown, the role of the ECB (and the ESCB) in the Troika rescue operations tends to delay needed bank restructurings by sticking to bail-outs as long as possible. Thereby the ECB prevents the return of market interest rates  and an efficient allocation of capital  that are key to  the eurozone regaining its international competitiveness and improving its economic growth prospects.

Fifth,  based on the forthcoming compromises the bank resolution structures will be extremely complex with European burden sharing evolving over a long transition period. Under pressures from Germany national  governments will maintain a major role and keep the overwhelming responsibility in the resolution process. Therefore the  June 2012 EU summit leaders pledge to “break the vicious circle of banks and sovereigns”  won´t be realized  for the foreseeable future.

Sixth,  by assuming the task of lead bank supervisor under the SSM regulation –thereby closely chaining itself  to  the SRM and thus the EU Commission and the EU Council in bank restructurings–the ECB will become part of a huge  European “Gosplan system”  with considerable  fiscal intervention powers but without democratic accountability.

Seventh,  as lead bank supervisor for about 85 per cent of euro area bank assets, the ECB is on the way to start an unprecedented regulatory trial-and- error exercise with unknown economic consequences.  Never before it was tried, to concentrate banking supervision  from seventeen national authorities into one supranational body in just a few month on a questionable legal basis and building  a supervisory organisation from ground-zero. Starting from scratch with newly assembled supervisory staff from many jurisdiction and bureaucratic traditions has considerable risks. The  largest banking area in the world is de facto used as a supranational SSM training ground. This way the ECB will become the most powerful EU institution  but will face major conflicts with national supervisory authorities and possibly a wave of suits from private sector investors and intermediaries  before the ECJ.  All this will  worsen  the ECB s reputation risks and may undermine the euro area´s financial stability.

Finally, growing strains and stresses in the ECB´s relations with its largest creditor member country – Germany – are not boding well for the euro and the functioning of European banking union.  Draghi´s nightmares with the Germans may get worse.

In a forthcoming piece in www.central-banking.com I am looking at  “Draghi and his German Problem” on the basis of the final compromise on SRM/SRF with the much faster debt mutualisation on bank resolution at German expense.

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