Category: ECB

THE EURO CRISIS – WHERE WILL IT VISIT NEXT?

On June 13, 2012

The bailout of Spain’s banks over the past weekend was necessary, but it may not be sufficient.
Spanish banks are carrying a lot of bad debt from the construction bubble there. The banks have not properly acknowledged this debt in their books, and this has sapped investor confidence in them.

House prices in Spain have not adjusted downwards as much as they have in Ireland, and Spanish competitiveness has not improved as much as Irelands’ has. Unit labour costs remain high, although Spanish exports have been fairly buoyant.
The new Spanish Government has introduced sweeping labour market reforms that will improve Spanish growth potential in the next few years, but that is not immediate enough to kick start the Spanish economy today. The true financial position of many Spanish regional governments is obscure, and that saps confidence too.
Greece, despite all the austerity, still has a big balance of payments deficit. In other words, Greeks are buying more abroad than they are selling there. Until that is tackled, nobody will want to lend to Greece. It seems Greek banks are using cheap ECB money to lend to some Greek consumers who are spending it abroad.
Meanwhile, other Greeks have experienced big wage cuts, but, because the distribution system in Greece is riddled with monopolies and restrictive practices, Greek prices have not come down along with wages. This is why many Greeks are angry.

It is not so much that Greece has had too much austerity, it is that it has had the austerity in the wrong places. So far, that problem has only been tackled on paper, because the Greek system of public administration is weak.
Portuguese banks have a big exposure to a possible Greek collapse. Total Portuguese exposure to Greek debt comes to 7% of Portuguese GDP, as against a comparable exposure of 5% for France, 4% for Germany, and 2% for Ireland. Relative unit labour costs in Portugal have hardly come down at all since 2007, whereas they have come down substantially in Ireland and Greece. All this makes Portugal particularly vulnerable to a loss of confidence that might come, if Greece defaults again.
The recent decline in voter confidence in the government of Mario Monti in Italy is also a big worry. His reform programme is only beginning to take effect, and the fear has to be of a return to populist politics, of a kind that would stop long overdue action Monti is taking to clear the arteries of the Italian economy, and lift its growth potential .
Two issues, growth potential and political capacity to implement decisions, are at the centre of our present dilemma.
The OECD has done some calculations on the growth potential of various countries from 2016 to 2025, making assumptions based on growth or decline in the working age population and likely productivity growth. These estimates show huge differences between euro area countries. OECD thinks Ireland has a growth potential in that period of 2.7% per year, whereas Germany only has a growth potential of 1.2%! This is explained by the likely decline in Germany’s working age population.
Interestingly, Spain has a growth potential of 2.3%, whereas Greece and the Netherlands are deemed to have a potential of just 1.4%, and Italy 1.5%, almost as low as Germany. These figures, if valid, may explain why Germany is emphasising productivity and is unwilling to underwrite the debts of other countries, unless and until it is first fully convinced that those countries will achieve or, better still, improve their growth potential.

These figures also imply that some of the countries receiving help today, might be the ones having to help others in 15 years time! They should also be taken into account by the outsiders who are offering so much self interested free advice to Germany
The other part of the problem is capacity to make and implement decisions at EU level. A currency depends on confidence, and confidence comes from knowing that quick action can be taken in a crisis.

Although the European Union has done a lot, in the past three years ,to remedy the original design flaws in the euro, it still has a very long way to go, and the markets may not wait another three years.

For example, a banking union in the euro zone would need strong capacity to close down banks in individual countries, to require agreed bail ins by bondholders, as well as the provision of funds to guarantee depositors. The difficulty is that the decision making system of the European Union is not designed to make, and implement, complex and controversial decisions like this, quickly.
The EU system is designed for deliberative and consensual legislation, not speedy crisis management.
To make decisions, the EU has to bring along countries that are in the euro, countries that are not yet in the euro, and also countries that never want to be in the euro at all but want to share in all the benefits of the single market.
If an unforeseen problem comes up, the EU has to amend its treaties, and that requires ratification in 27 countries (and a referendum in at least one of them!).

The EU has to cope with a decision making process that emphasises the national, over the collective European, interest.

Not only is the Council of Ministers structured to favour the pursuit of national interest, even the European Parliament still allocates its own big jobs on the basis of national quotas, something it would be quick to condemn if it happened anywhere else in Europe!
Increasingly, because no European leader, like the President of the Commission, has a direct mandate from the European people, the really important decisions are being made by the 27 heads of Government, who each do have such democratic mandates in their own countries.

But each of these women and men are “part time Europeans”, so to speak. Their day job is running their own countries (and getting re elected if they can). They meet less frequently together than national cabinets do, and when they do meet, there are 27 of them in the room. That makes it difficult to get into the depths of any question, or to look beyond the immediate problem.
I believe the crisis is of a seriousness that it requires us to step outside the conventional ways of thinking, and tackle the economic and political problems of Europe together in one package. If necessary, leaders should continue meeting until they have worked out a global blueprint, covering the present banking crisis, the Greek issue, structural reforms to lift growth potential, and enhancing democratic decision implementation. Sometimes, the more issues are in the mix, the easier it becomes to find balancing compromises.

We do not have much time, and we need to remember that we could lose, in five months, something it took over 50 years to create.

THE EURO CRISIS—WHAT COULD GO WRONG?

By John Bruton

On December 3, 2011

In Chancellor Merkel, Crisis, ECB, Euro, European Council, Eurozone, Mario Draghi, President Sarkozy, Prime Minister Rutte

The European Union is facing a crisis because of the loss of confidence in the debts issued by several member states. This is related directly to the problems and activities of Europe’s banks.
On 9 December in Brussels, the Heads of Government of the 27 EU member states meet, yet again, to come forward with a solution to the escalating loss of confidence in the debts owed by European banks and governments. Each time leaders meet, and come forward with proposals that, within days, prove to be inadequate, further confidence is lost both in the leaders themselves, and in the European Union, as a functioning and competent political authority capable of managing the affairs of its peoples.

This is corrosive. It undermines political solidarity within and between Europeans, and it encourages reversion to 1930s style nationalism, and to general anti politician sentiment, which could eventually erode the tolerance that is essential to democracy itself.
There is a limit to the number of failed government bond auctions we can endure. Many further such bond auctions are due in January and February. In February there will be a General Election in Greece, and the campaign in that election will be critically influenced by the perceived effectiveness of present EU arrangements and the steps Greeks are having to take to comply with these arrangements. If there is to be a good result in that election, the EU needs to show electors that it is in control of the situation.

THE ECB CAN ACT NOW, AND SHOULD DO SO

The European Central Bank needs to take note of the situation. It has a mandate under EU Treaties to maintain price stability, defined as around 2% inflation. There is a growing risk that the problem Europe will face next year will be deflation, not inflation.
If industrial orders and consumer confidence continue to decline, prices and incomes will start to fall, and the situation of those in debt will worsen further because, even if they pay all interest, the real value of their debts will increase as a consequence of the fall in prices and incomes relative to the unchanged level of their debts.
If these circumstances are likely to arise, the ECB has a duty, in the interests of price stability, and in full accord with its Treaty mandate, to initiate quantitative easing to prevent it. An immediate statement to that effect from the ECB would go a long way towards resolving the short term crisis.

CONSEQUENCES OF A BREAKUP OF EURO

Failure to act could lead to a break up of the euro. This could be devastating , because a lot of the debts owed by Europeans are owed in euro to other Europeans. With the euro gone, the uncertainty about who owed how much, in what currency, to whom could lead to endless legal dispute.
Governments trying to establish new national currencies could face huge problems stopping outflows, which could lead to limitations on bank withdrawals, reintroduction of exchange controls, and tariff walls against their exports by other countries in the EU aimed at countering competitive devaluations of one new currency against another.
The legal order on which the EU is based could break down. We should not forget how inherently fragile that legal order has always been. If one country refuses to implement a judgement of the European Court of Justice in an important matter, and gets away with it, the EU has no meaning anymore because the EU has no police force to enforce its rules. Everything is based on consent.
Against this background, one must ask oneself if further EU Treaty change could be part of the answer. Treaty change could take, at the very least, a year to effect. But we do not have that much time. So the best we can hope for is a political commitment by Governments to seek consent to a Treaty change from their parliaments or peoples.

SPEECHES OF CHANCELLOR MERKEL AND PRESIDENT SARKOZY

There has been agreement that a proposal to improve the governance of the euro zone would be presented by the President of the European Council, Hermann Van Rompuy to the EU Summit on 9 December. In advance of this, the leaders of the two biggest euro area states have set out their requirements.
In her speech today, Chancellor Merkel has called for Treaty changes that would make sanctions on states who breach debt and deficit limits automatic and capable of being enforced directly through the European Court of Justice. It would take the issue out of politics and make it a legal one. This would require a change in the Treaties.
President Sarkozy, on the other hand, said yesterday that European integration must be pursued, and the problem has to be solved , inter governmentally. This is because he believes that only elected heads of national governments have the required political legitimacy to make the necessary decisions.
These two positions are quite far apart, and there are difficulties with both of them.
The difficulty with Chancellor Merkel’s approach is that it will involve the European Court of Justice in making economic judgements.

In the case of a disputes, is the Court really qualified to judge whether a deficit is excessive by reference to the point at which a country is at in its economic cycle? Can it adjudicate on whether estimates of future revenue are valid or not?
Even economists have difficulty with these issues. So the framing of a Treaty change in this area will could be challenging.
President Sarkozy’s preference inter governmentalism will bring economic judgements into the realm of power politics, the sort of power politics that prevented any sanctions being imposed on France and Germany when they became the first to breach the original Stability and Growth Pact. His approach would diminish the role of the European Commission.
Both the Chancellor and the President are paying too little attention to what has been already agreed in the “six pack” regulations. These, which require no Treaty change, will already make it more likely that a state, with and excessive deficit ,will be fined, because a qualified majority (66%) would have to be found to agree NOT to impose a fine.
Neither the Chancellor nor the President pay enough attention to the huge failure of EU wide banking supervision that allowed all this foolish cross border lending to take place within the single currency area. Neither of them addressed the lack of implementation, from the very outset of the euro, of the ECB’s responsibilities in the Treaties , to supervise the activities of banks and the impact those activities have had on the stability of the European economy. Both of them spoke as if the problem today was solely one of Government finances ,when it is also a problem of bank finances

THE GERMAN AND DUTCH PROPOSALS TO CHANGE THE EU TREATIES – HOW RELEVANT ARE THEY TO THE PROBLEMS WE FACE?

But what of the more detailed proposals for Treaty change advanced so far. How relevant and helpful are they? It is suggested that we must amend the EU Treaties, because it is argued that the existing Treaties either

a) prevent us doing what is necessary to resolve the situation, or
b) provide us with insufficient assurance that we will not get into the same difficulties again.

The German CDU has demanded Treaty changes to provide for

automatic sanctions for breaches of the Stability and Growth Pact( 3% deficit and 60% debt/GDP ratio),
a procedure for insolvency of EU states,
the direct election by the people of the EU of the President of the European Commission,
taking away the exclusive right to initiate EU legislation from the Commission, and allowing the Parliament and the Council an equal right with the Commission to initiate legislation,
more seats for bigger countries in the European Parliament based on their bigger populations.

They also want Europe to unilaterally introduce a tax on financial transactions.
The Dutch Prime Minister has suggested Treaty changes that would

allow a European Commissioner for budgetary discipline to force states running excessive deficits adjust their policies and
to impose sanctions including reduced payments from Cohesion and Structural Funds, national budgets requiring EU approval before introduction, suspension of voting rights in EU institutions, and ultimately expulsion from the Euro zone.

It is important that any proposals for Treaty change are based on an honest appraisal of what our problems actually are, and are not put forward as tokens to soothe domestic opinion in particular countries. Our problems are too serious now for that sort of thing.

Given that Treaty changes in the EU require all members states to ratify them, the way proposals are put forward is almost as important as the proposals themselves.

If proposals seem to be one sided, or to emanate from a small cabal of big countries, rather than from an inclusive process of which all member states have equal ownership, then the proposed Treaty changes may be doomed from the start, whatever their merits.
On the specifics of the CDU and Dutch proposals, I would respond as follows.

THE CDU PROPOSALS

The difficulty with automatic sanctions for supposed breaches of the Stability and Growth Pact is that, if the country on whom they were to be imposed objected, the dispute would go to the European Court of Justice, not to the Council of Ministers for arbitration. Breaches of the Pact would include questions about whether assumptions about future economic growth and thus revenue were too optimistic, the point at which a country was on in its economic cycle, and the like. These are questions on which economists, who are studying these matter all the time, usually cannot agree. There is little chance that the judges in the ECJ, many of whom have no background at all in economics, will make sensible judgements in such cases.
A treaty provision for the insolvency of states, as suggested by the CDU, will be very difficult to draft and will be highly controversial. There may be some merit in establishing rules in this field, but I wonder if this is the time to be doing it. The issue will not be being debated in an academic setting, but in the midst of febrile market conditions. There is a strong risk that the twists and turns in a public debate on the state insolvency will have a negative and unintended influence on the markets.
We should not forget that ,when the issue of so called private sector involvement in resolving the Greek debt crisis was first mooted by Germany , it had an immediately damaging effect on the capacity of some other smaller countries to borrow.

CDU PROPOSAL FOR DIRECT ELECTION OF EU PRESIDENT MOST WELCOME

The direct election of the President of the European Commission by the people of Europe is a vey good idea. I advocated it when I was President of the European Council in 1996, and again when I was a member of the Praesidium of the Convention of the Future of Europe. Interestingly, the only member of the Convention who gave the proposal any support at that time was George Papandreou. It is very good that the CDU is supporting this proposal now.
A direct election of this kind is what we need to create a genuine European demos, or sense of shared destiny, among EU citizens whatever their nationality or language . Without such a demos or shared identity, we will be unable to persuade Europeans to make sacrifices for one another, and that is something we need if Economic and Monetary work.

BUT CDU ATTACK ON COMMISSION VERY DANGEROUS

On the other hand, the CDU proposal to take away from the Commission the exclusive right to propose legislation, and to require it to share that with the European Parliament and the Council of Ministers, is a thoroughly bad idea.
It would weaken the Commission even further than the rampant intergovernmentalism of Europe’s response to the financial crisis has already done.

The European Commission seeks to put forward proposals that will command support from all countries , large and small. It formulates compromises in advance.
If the Parliament and the Council could table competing legislative proposlas on the same subjects as the Commission, this would make the search for subtle compromises much more difficult. It would enhance the power of the bigger delegations of the bigger countries in the European Parliament and would encourage crude nationalistic majoritarianism in that body.

The Commission is the protector of the interests of smaller member states within the EU, and this CDU proposal will be seen by them as provocative and subversive of the community method on which the EU was founded.

CHANGING REPRESENTATION IN PARLIAMENT WOULD UPSET A DELICATE COMPROMISE

The CDU proposal to increase the relative representation in the European Parliament of countries with bigger populations, but without reducing the extra voting weight that bigger countries enjoy in the voting system of the Council of Ministers, overturns one of the central compromises reached in the drafting of the European Constitution and the Lisbon Treaty.
The CDU should remember that ,even if the United States which is a fiscal union, all states have equal representation in the Senate while populations have equal weight in the House of Representatives.
Under the Lisbon Treaty, the EU has struck a similar compromise. Bigger states have bigger representation in both the Parliament and the Council, but there is a system of “degressive proportionality” which compensates smaller states by giving the proportionately bigger representation than their population would strictly justify.
I cannot understand why the CDU wants to reopen this difficult matter, unless of course it want to use the proposal as a negotiating weight to gain traction on some other issue. Frankly, I think our situation is serious enough without that sort of gamesmanship being introduced.

A FINANCIAL TRANSACTIONS TAX

The suggestion of a financial transactions tax has populist appeal. It may slow down financial transactions and allow a little more time for reflection in the markets. It would curb automated transaction systems by making unduly frequent buying and selling slightly more expensive. It could provide the EU with a new source of revenue, which would be very welcome.
But It would also lead to financial sector activities moving out of Europe, and the tax revenues that those activities generate for EU states going into the treasuries of non EU countries. Given that unanimity must be obtained for this proposal to go through, I wonder if it is not, like the proposal to redistribute seats in the European Parliament, being put forward as a negotiating ploy . Again, one must ask if this displays the sort of seriousness that out parlous situation requires.

THE DUTCH PROPOSALS

Turning to the Dutch proposal to enhance the Commission’s control over the budgets of states running excessive deficits, it is hard to argue against the principle of what they are seeking to achieve. The CDU has argues that fines for excess borrowing should be automatic.
But one might wonder how urgent the proposal is.
Financial markets are already imposing very harsh discipline, through demanding higher interest rates of countries with excessive deficits.
It will be a long time before any EU country will ever again be able to borrow money at easy rates of interest unless their fiscal policies are demonstrably sound. Do we really need to reinforce what the markets are already doing with Treaty changes at this stage?
It is also worth noting that the reverse majority procedure now applies to both the Excessive Deficit and the Excessive Imbalance procedure. So a country, that is liable to be fined for running an excessive budget deficit, or an excessive balance of payments surplus or deficit, will automatically have to pay a fine, unless it can persuade a qualified majority in the Council NOT to let the fine go ahead. Perhaps we should see how that new procedure works before going for Treaty change?
In any event, levying a fine on a country, that is already in financial difficulty , will add to the difficulties. It will be too late to be an effective deterrent

CUTTING STRUCTURAL FUNDS?

The Dutch proposal to reduce payments from the Structural Funds to countries with excessive deficits will fall more heavily on poorer countries than on richer ones.
Excessive deficits or economic imbalances in richer countries can be just as damaging as they can be in poorer countries, perhaps more so. For example, the Netherlands is less reliant on structural funds than is Estonia, so a proposal to reduce structural would hurt Estonia proportionately more than it would the Netherlands, even though their excessive deficits might be of the same proportionate scale. That is unbalanced.
The proposal that budgets of deficit countries require advance EU approval is also potentially unbalanced.
One country can only run a trade surplus if another country runs a deficit. If a country is deliberately managing its economy in order run consistent surpluses, it is contributing to deficit problems of other countries. That needs to subject to EU surveillance too.

DUTCH PROPOSAL TO SUSPEND VOTING RIGHTS IS NEO COLONIALIST

The proposal by the Dutch Prime Minister to suspend the voting right in EU institutions of a country which has excessive debts or deficit is tantamount to reintroducing colonialism within Europe, because it would involve imposing decisions, in which they have had no vote, on countries who joined the EU precisely because they thought it was a democratic organisation. The existence in 21st century Europe of a mentality that would make such a proposal is deeply troubling.
I am unclear about the merit of changing the Treaty to allow for the expulsion of a country from the euro zone. It would imply that the euro itself is a temporary expedient. It would aggravate speculative pressure, without any compensating benefits.

CONCLUSION

I believe the proposals from the CDU and from the Dutch Governments to change the Treaties are not adequate to the problems we face, and in some cases are a distraction.
The so called six pack proposals, recently agreed go a long way to strengthen disciplines on fiscal policy, and do not need Treaty change. They should be given a chance to work, before we contemplate additional Treaty changes for control of national budgets.
But the CDU proposal for a direct election of the President of the Commission does deal with an important problem that underlies our present problem, namely the lack of a sense ,on the part of ordinary Europeans, that they can, through their vote, influence the direction of EU policy.
If citizens could directly vote the President of the EU in or out of office , that will give them a much more direct sense of control of the direction of the EU than they get now from just voting for their local or national MEPs.
None of the proposals on the table so far deal with the issue of banking, which is at the heart of our economic difficulties today. It was foolish lending decisions be banks that caused our problem.
The original Maastricht Treaty of 1992 envisaged the ECB taking an overall role in overseeing the prudential supervision of banks, especially banks that were lending across borders within the euro zone. This provision in the Maastricht Treaty was never brought into effect , because activating the ECB’s powers in this matter required unanimity. Some countries did want not anyone else enquiring into their banks, and that reluctance continues even to this day.

Any Treaty change now should include

1.) much tighter EU wide supervision of banks,
2.) restriction on the size of banks, and

3.) an EU wide deposit guarantee scheme.

THE 12 BILLION EURO GAP

By John Bruton

On April 29, 2011

In ECB, market expectations

The former Minister for Finance, Brian Lenihan, feels he was forced to take the loan from the EU/IMF, so that the Irish taxpayer would put capital into the Irish banks. This was done so that these banks could repay money they had borrowed from the European Central Bank. In other words, it is argued that the Irish taxpayer is now rescuing the ECB, as much as the other way around.

There is also the point I made myself in a letter last January to President Barroso. The European banks, who lent foolishly to the Irish banks and thus helped inflate the Irish bubble while hoping to profit from it, were part of the problem too. They were not adequately supervised, either by their own national central banks, or by the European Central Bank.

The ECB has had, from the day it was founded, a clear legal responsibility for supervision of credit institutions, and for the financial stability in the euro zone. Events show that it did not exercise these responsibilities adequately between 2000 and 2008.

Irish taxpayers are paying for the errors of the Irish central bank, when it allowed Irish banks to borrow too much from other European banks to fuel a property bubble. But the taxpayers of those European countries should take a proportionate responsibility for the errors of THEIR central banks, when they allowed their banks to lend this money in the first place.

It is frustrating that none of these points are even being acknowledged by the central bankers, Governments or politicians of other EU countries. They pretend that the problem is purely an Irish one, and that the lending, and bond buying, decisions of their own banks have nothing to do with it.

They act as if Ireland must first be “punished“ for its sins, by being forced to increase its corporation tax rate, before it gets any reduction in the interest rate on the loan .

All this is fine. All these are valid points. But where do they really get us?

Irish history shows that one can nurse a grievance for a long time, and feel morally superior to those who wilfully fail to understand it. But grievances do not pay the bills at the end of the week. Indeed, in all areas of human life, un assuaged grievances often distract attention from things we can actually do something about, and that are our own sole responsibility.

There is one very important thing that is the responsibility of the Irish people themselves. That is the fact that the cost of government services in Ireland, before rescuing any banks or paying any interest on debt, will be 53 billion euros this year while tax revenues will be only 41 billion euros!

So even if all our debts were wiped out by some miraculous act of generosity by the EU, the IMF, and the private banks, Ireland is still 12 billion euros short on its day to day spending on salaries, wages, social welfare etc.

Those who talk about “restructuring” existing debts, should keep that 12 billion gap in the forefront of their minds.

A country that has to borrow 12 billion euros of new money, every year, just to keep going, is not in a great negotiating position to demand concessions on its existing debt. This is because it will be demanding those concessions from the same people from whom it also wants to borrow more new money, on top of its old debts, every year.

Ireland needs to get into a position that it can borrow on the commercial sovereign bond markets on reasonable terms as quickly as possible, if its economic independence is not to be permanently compromised. Delay will not make things easier. Conditions on sovereign bond markets are likely to get harder and harder, year after year. Interest rates are likely to go up, not down. If “restructuring” by any sovereign borrowers take place, interest rates on all new sovereign bond issues will tend to rise even further. There is a lot to be said for accelerating the 2012 budget process, and taking decisions earlier than the financial markets and our EU partners expect them to be taken. Waiting will not make things easier.

The United States, which is 20% of the world economy, is having difficulty maintaining its credit rating. Japan, which is 8% of the world economy, has a debt/GDP ratio of 200%. It may run out of domestic savings as its baby boomers retire, and may enter the international bond markets. Even Germany will have to borrow more to cater for an ageing population.

Competing for funds with these voracious borrowers will not be easy for Ireland, especially if the supply of funds is reduced because the lenders, China and the oil producing nations, have to keep more of their money at home to meet the needs of their own restive populations.

So I believe that it is now time for our economic commentators and pundits to come home, to turn their forensic and investigative skills away from the deficiencies of the ECB, the EU, the foreign banks, our banking exiles, and all those worthy foreign targets, and focus their analytic skills instead on that huge 12 billion euro gap between revenue and spending here at home.

When Ireland has bridged that 12 billion euro gap, it will be in a much better position to talk to the ECB, the EU, and the bondholders.

Ireland urgently needs to surprise the markets with some good news.

Imagine the effect of bringing the 2011 deficit in substantially below market expectations.

Imagine the effect of a 2012 budget that involves less borrowing than the market expects.

Imagine the effect of some speedy sales of distressed assets, and some ghost estates actually being sold.

That is what is needed now, not more finger pointing.

HOW SHOULD RESPONSIBILITY BE SHARED FOR THE BANKING CRISIS?

By John Bruton

On March 29, 2011

In Crisis Management, ECB, Ireland, Irish GDP, John Bruton

DO EU INSTIUTIONS SHARE RESPONSIBILITY?

WHAT IS A SENSIBLE STRESS TEST OF A BANK?

WHAT SHOULD IRELAND AND EUROPE DO NOW?

People in Ireland are awaiting with acute interest the results of stress tests on their banks to be made public on Thursday. Stress tests are estimates, estimates of what assets might be worth at some time in the future .

Estimates can be made on either very pessimistic, or very optimistic, assumptions about economic developments in the future.

The hope in some quarters is that the EU exercise of stress testing banks will generate confidence in banks based on certainty, but we should be careful here. Certainty about the future is a logical and philosophical impossibility. All banking, everywhere and always, is a matter of confidence, not of certainty. If one makes exceptionally pessimistic assumptions these can become avoidably self fulfilling. One must avoid accentuating the economic cycle in the downturn phase, just as much as one should lean against the wind in the up phase!

In Ireland’s case, the credit of the state itself has unfortunately become entangled with that of the banks. It would be no solution to anything to enhance the credit of the banks, by diminishing the credit of the state. This is the issue with which the newly elected Irish Government is working with its EU partners.

I am sure EU decision makers are by now fully aware that the Irish banking problem has been influenced by the requirement of free movement of capital within Europe since 1990, and the deep interdependence that that has created, with all its good and bad aspects.

In a sense, the Irish banking problem is a manifestation of a wider European banking problem that grew in the context of monetary union. We have had, as President Barroso has said, a monetary union without an adequate economic union.

But I would add that we have also had monetary union without adequate monitoring of risks to European financial stability through lax banking practice across borders within the EU . Systemic interdependence between banks was allowed to develop, indeed encouraged, but without systemic supervision of the cross border risks that that created .

I will show that, back in 1992, the framers of the Maastricht Treaty foresaw these risks, and created the necessary powers to monitor them, but that EU institutions failed to follow up on key provisions. of that Treaty. If these provisions had been fully followed up, it would have helped us avoid what happened to European banking in 2008.

As a result of the failure to follow up on some of the Maastricht provisions, there was not adequate Europe wide monitoring of the risks arising from flows of money across borders from countries, with surplus saving, to other countries where banking bubbles developed. Ireland is a country in the latter category, unfortunately.

To make that point is not to argue that Irish institutions should avoid their financial responsibilities, to bondholders or others. A bond is a promise, and promises should not be broken, especially if ones economy is based, as Ireland’s is, on the provision of international services, in which trust is vital. Let me reiterate, of course, that the main responsibility for Ireland’s plight rests with Irish institutions.

In Ireland, private sector institutions were first and foremost responsible for the bubble, especially the property development industry for it’s reckless borrowing, and estate agency community .

The boards and managements of banks for the reckless lending share responsibility, as do the media, with their reliance on property advertising ,for encouraging people to climb the so called property ladder, as if one place on this ladder was a measure of one’s place in society.

The Irish economics profession has a responsibility for, generally speaking, not calling attention to the obvious unsustainability of the borrowing , and of the level of construction activity, which could not possibly have been maintained. The methods of the accounting and auditing professions have also to be called into question.

It is obvious that the Irish Central Bank, the Financial regulator, and Government made major errors.

But , if we are to overcome the crisis and avoid a new one, everybody must be self critical, including the ECB and other European institutions. A single currency for 16 or more separate nations was always a challenging project, intellectually, politically and economically. If there were design flaws in the project, these must be remedied but , even more so, if powers to act existed, and these were not used, that must be acknowledged.

Risks inherently flowed from the decision to allow free movement of capital within the EU. Exchange controls at national level were no longer available as a means of preventing bubbles developing. That gap had to be filled at a higher, EU wide, level.

The ECB has, under its statute, which was appended to the Maastricht Treaty in 1992, a responsibility to oversee supervision of banks. Some in the ECB may feel that that responsibility rests solely with national central banks but a close reading of the statue of the European System of Central Banks shows that that is not so.

A single currency for 16 or more separate nations was always a challenging project, intellectually, politically and economically. If there were design flaws in the project, these must be remedied. If powers to act existed, but were not used, that too must be acknowledged.

To assess what the ECB could ,or should , have done, about the credit bubble in Ireland one should look at the statues under which it was established, which were appended to the Maastricht Treaty in 1992.

Article 3.3 of the statute of the ESCB says that the ECB

“shall contribute to the smooth conduct of policies pursued by the competent authorities relating to prudential supervision of credit institutions , and the stability of the financial system”.

Note two phrases here… “the prudential supervision of credit institutions” and the “stability of the financial system” .

The ECB would claim that this does not give them a frontline or direct responsibility for prudentially supervising individual banks. But it does give them a contributory responsibility, a role that I would construe as including drawing attention to banking practices that threaten the overall stability of the financial system in the euro zone. Forinstance if in one country, credit was growing at 30% a year and lending had reached 300% of GDP, that was something that the ECB would have been aware of, and which would certainly have come within its mandate under Article 3.3.

Furthermore, Article 25.2 of the ESCB statute says that the ECB

“may perform specific tasks relating to prudential supervision of credit institutions”

and Article 34.1 goes on to say that the ECB may make regulations to implement Article 25.2 that is concerning prudential supervision.

Under Article 14, the ECB had power to issue instructions to national central banks.

A normal reading of this would suggest that it was the intention of the framers of the Maastricht Treaty that prudential supervision would be a responsibility of the ECB, in conjunction of course with the central banks of the member states.

Unfortunately these provisions were never activated. This is because the Council of Ministers never adopted the necessary enabling regulations. One really ought to know why.

The Treaty provided that the Council of Ministers, acting by means of regulations in accordance with a special legislative procedure, may unanimously , and after consulting the European Parliament and the ECB, confer specific tasks on the ECB concerning policies relating to the prudential supervision of credit institutions. A proposal from the Commission would have been required. This was never done. We now have a European Systemic Risk Board, but that is 18 years late

It would appear that the ECB found itself with a clear responsibility ,under one article of its statute, to contribute to supervising credit institutions like those in Ireland which have come to pose a systemic risk, but was never given the powers under another article to exercise those powers, as the framers of the Maastricht Treaty expected it would.

An explanation ought to be forthcoming from the European Commission, from each of the member states, and from the ECB itself, as to why these provisions were never activated.

A failure to activate specific Treaty powers, that could have been used to prevent EU wide systemic risks in the banking system, is no minor omission. The omission suggests that responsibility for failing to prevent a banking crisis in a number of EU member states is shared in part by EU institutions.

Clearly, as we now know all too well, the expansion of credit in some countries like Ireland and Spain has affected the “stability of the financial system”, in the words of Article 3.3 of the ESCB statute.

I repeat that this does not mean that the ECB was ever to have, or ever had, the primary responsibility for failures of supervision of individual institutions ,like Anglo Irish Bank. But it does mean that the ECB, the Commission and Council could, could have seen the risk that overall imbalances in banking would upset the stability of the overall financial system, and could have activated the ECB’s Treaty powers to enable it to deal with that. They could have activated the ECBs powers to issue binding instructions to national central banks.

Even if the ECB could not use these powers I have mentioned above, it also had power under Article 4(b) of the statute to submit opinions to national central banks where it saw bubbles developing. It appears that the ECB took a rather narrow interpretation of this power and did not use it ,unless it was specifically consulted by a member state. This is a pity.

The ECB may have been inhibited here by the principle of subsidiarity, but I think it was mistaken in this judgement. We now know these banking risks were in fact not confined within one country, but spread across borders. With the benefit of hindsight, one can thus see that the principle of subsidiarity did not apply.

If the ECB felt it was not getting enough information from national central banks to form a judgement, it also could have used Article 5.3 to obtain better information. But unfortunately the Council regulations to give effect to this power excluded ,until 2009, information about prudential supervision of credit institutions. The Council and the Commission share responsibility for that critical omission.

EU institutions, including the ECB, are now helping to resolve the situation in Ireland and Greece, but this help is in the form of loans which will have to be repaid..

Of course, it would not have been politically easy for the ECB to have used its powers to warn the Irish authorities in 2003 or 2004 to rein in credit. There would have been an outcry from many in Ireland decrying “interference from Frankfurt”, and all that sort of atavistic nonsense. But the ECB can ignore that sort of thing, because it is politically independent under its statute, more politically independent even than the European Commission.

I repeat that I do not make these points to out of any wish to shift blame away from where it belongs. The main blame must be borne in Ireland. But if the EU is to learn from the crisis, it has to look at the whole picture. Part of that picture is the role of the ECB and other EU institutions.

Having said all that, it is important that Ireland approach its European partners in a realistic frame of mind.

Other European countries have problems too.

For example, almost all of them have budget deficits of their own. Many of them have more severe immediate problems with the fiscal cost of the ageing of their societies and workforces than Ireland has. They are also aware that the original justification for the cohesion and regional funds of the EU, to which many were net contributors and we were net recipients, was precisely to prepare countries like Ireland to be able to face the rigours of a single currency. If Ireland now discovers it was ill prepared, the first responsibility is its own.

Other EU countries have domestic political constraints too.

For example, Germans have a justified horror of inflation after their unique experience in the 1920s when inflation peaked at level higher than were seen in Zimbabwe recently, and destroyed the saving of all thrifty families.

Reactionary and nihilistic anti EU sentiment, of the kind we seen in Ireland during the first Nice and Lisbon referenda, is rising in many other countries, and transferring money to countries that can be presented as not having managed their affairs well, feeds those sentiments. This is especially so if the country lending the money has a lower income per head than the recipient.

Irish people must understand these political realities, just as others must be realistic about what Ireland can do on its own about what is part of a systemic European banking problem.

It would make no sense for other EU countries, in their own interests, to make counterproductive demands of Ireland. Demanding that it change our corporation tax system is counterproductive. Corporation tax is one of the ways whereby Ireland will be able to repay the loans it has received. The 12 and a half percent corporation tax raises an amount equivalent to almost 3% of Irelands GDP, more than France collects in corporation tax, and a lot more than Germany collects, which comes to just over 1% of German GDP.

More importantly, low corporation tax rates to attract foreign investment, mainly from outside the EU, has been the core of Ireland economic model since 1956, before the EU had even come into being, and before many of the leaders sitting at the European Council were born! This foreign investment contributes hugely to Irish tax revenues, not only through corporation tax ,but even more so through all the other taxes paid by those working for and supplying these foreign firms. It also has made Ireland, a peripheral island by any standard, one of the most internationalised economies in the world, and that gives it a unique capacity to trade its way out of its current difficulties.

Lending Ireland money, but simultaneously asking it to dismantle the economic model that enables it to repay the money, would not be good banking practice, to put it mildly!