With the financial community now having had several days to scrutinize the details of the European Union (EU) agreement announced last Friday, it appears that the euro plan is producing many more questions than answers.
Paul Donovan, Global Economist for UBS Investment Research, analyzed several of these questions in a report to clients over the weekend (which ZeroHedge also posted).
“As ever with a Euro summit there are unanswered questions,” he began. ”Grandiose statements are what heads of government specialise in – the details are left to later (it is one of the reasons why Maastricht produced a monetary union that was flawed from the outset. Once ‘create a single currency’ had been agreed, politicians lost interest). The statement from the summit itself was woefully inadequate, and most of the details have been fleshed out with press conference statements.”
Among the most significant items that remain without an answer, Donovan discussed the following:
- Will the bank supervisor have real powers? In particular will the bank regulator be able to close down banks, even if those banks are national champions? They should have this power, otherwise the threats that they can make are going to be largely impotent. Ultimately, we would need to see the regulator able to force changes to banks even if they have not asked for capital injections (as happens in every other functioning monetary union). Are Euro area nations prepared to surrender their sovereignty to the extent that “foreigners close our banks / foreclose our mortgages”?
- Chancellor Merkel of Germany has declared that there must be conditions for direct bank recapitalisation. This does not, perhaps, occasion much surprise in financial markets as Chancellor Merkel of Germany is very keen on conditions. But how are these to be imposed? There needs to be a set of “standing conditions”, rather than case-by-case conditions, if the mechanism is to work properly – per the need for an apolitical capital injection process, outlined above.
- What about those countries that have already bailed out banks with Euro area assistance? Assuming that direct recapitalisation does not take place before the end of this year, that list is Greece, Ireland, Portugal, Spain and Cyprus (countries that have or will have used EFSF money to bail out their banking systems). Other countries have bailed out their banks with national funds. Where does the process stop? This is absolutely critical to resolve, and of course has a huge potential impact on sovereign bond markets (because it impacts individual sovereign debt to GDP considerations).
- Who guarantees deposits? This has not been clarified. If deposits are guaranteed nationally, but the banking regulator is supranational, why should a domestic sovereign have to bear the cost (deposit insurance) of a decision (close a bank) that is taken at a supranational level. However there is obviously a cost burden to guaranteeing banks’ deposits at a pan Euro level – and the question “why is our tax money being used to guarantee lax foreign banks’ depositors?” is bound to arise.
Lastly, the UBS economist noted that “A healthy dose of economists’ cynicism is probably best taken at this point. Money market normalisation is likely to take more than a high-flying statement from the Euro area to resolve. As such, the economic effectiveness of liquidity injections is likely to remain low (to nil).”
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