Rising tide of German anger.

• Author: Engelen, Klaus C.

Fierce opposition threatens the eurozone's ECB bank supervision and debt mutualization scheme. Can Merkel politically survive?

From a German perspective, the battle over EU banking union will be heating up during the months stretching into next year's national election campaign, when the coalition government of Angela Merkel, sometime in September 2013, will face deeply worried voters. "If you tell German voters that they should support a pan-European deposit scheme with their savings, you surely will lose the election," predicts a pollster, who notes that 84 percent of Germans expect a worsening of the euro crisis and fear future losses due to the eurozone turbulence. As the opposition Social Democrats and Greens begin positioning themselves for next year's elections, the Berlin government's maneuvering room to come up with more bailout money and direct bank recapitalization for countries such as Spain is shrinking. Now that former Finance Minister Peer Steinbruck--who proposed radical financial reforms--has been designated as the SPD candidate for the chancellor's office, Merkel will meet an experienced financial crisis manager as challenger.

But for the millions of citizens in debt-stricken eurozone countries suffering under never-ending austerity programs, it sounded too good to be true when in the waning hours of June 28, at their summit in Brussels, the leaders of the seventeen member states that form the European Monetary Union unexpectedly agreed to establish a European banking union--and do it in a rush. In a first unexpected step, a pan-European single supervisory mechanism would be set up at the European Central Bank under which all six thousand banks in the eurozone would be supervised. As soon as this supranational supervision regime becomes operational in Frankfurt where the European Central Bank is located, the European Stability Mechanism would be in a position to lend directly to banks, which so far has not been possible.

Financial markets reacted with euphoria because this would open the way to direct bank recapitalization in Spain and other strained member states. Aiming at implementing a single rulebook for the European Union, the eurozone leaders committed themselves not only to establishing supranational supervision, but also to working on a pan-European resolution regime and fund and more harmonized deposit guarantee schemes.

And what some call the "SSM monster"--pushed by the Brussels bureaucracy, the ECB establishment, and Europe's parliamentarians with zealousness--is rolling forward. At their last EU summit on October 19 in Brussels, European leaders moved further toward ECB-led bank supervision by committing to seek to agree on a legal framework by January 1, 2013. And draft banking legislation tabled in the Economic and Monetary Affairs Committee of the European Parliament already is being discussed by journalists. The ECB signals that "several task forces are working on various issues of the European banking union."

To understand what happened from a German perspective, it is crucial to look at the paragraph on financial supervision in the June summit communique: "We affirm that it is imperative to break the vicious cycle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127 (6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which could be institution-specific, sector-specific, or economy-wide and would be formalized in a Memorandum of Understanding."

For some Merkel watchers, her consenting to this paragraph at the June EU summit may turn out to be the biggest political blunder of her illustrious career. Addressing Berlin lawmakers on the eve of the summit, Merkel not only made her famous statement rejecting eurobonds "as long as I live," but also asserted again that "the euro rescue funds will only lend to governments and not directly to banks that need recapitalization."

Returning from Brussels afterwards--in the perception of everyone reading the summit news--she was blackmailed into opening the door to EU banking union in order to use the euro rescue funds for a 100 billion [euro] Spanish bank recapitalization program, supervised under EFSF/ESM guidelines and an EU surveillance. Merkel met fierce condemnation at home. Observers saw a stunning--for some unbelievable--reversal of a long-held German position.

Merkel's Waterloo at the Brussels summit deepened the sinking feeling of millions of German savers and taxpayers. More Germans become convinced that the European Central Bank as lead bank supervisor, under former Italian central bank Governor Mario Draghi, will get an even bigger role in facilitating the transfer of wealth from Germany and other northern Eurozone countries into the debt-laden euro member states.

EU LEADERS' CREDIBILITY AT STAKE

Beyond deepening worries in Germany and other northern eurozone countries as they watch the ECB evolving into Europe's "mega bad bank," the EU summit decision at the end of June to suddenly transfer bank supervision to the ECB in order to facilitate direct bank recapitalization has confidence-shattering implications.

This development deepens the divisions in the European Union, since London, the largest European financial center, will be left out. This means putting the ten EU members outside the seventeen-member eurozone into bank supervision limbo, since the role of the present banking watchdog, the European Banking Authority, which became operational in January 2011 and is headquartered in London, is put in doubt. Loading the crisis-stressed ECB with the additional task of becoming lead banking supervisor in the first phase of a more integrated EU banking union opens a Pandora's box in terms of conflict of interest, transparency issues, litigation risks, and--last but not least--mind-boggling democratic legitimacy problems. The EU leaders have changed the rules and the power equation in the eurozone and the wider European Union, with the financially strong countries such as Germany left holding the short end of the stick.

ECB President Draghi is seen, as he works closely with the leaders of Italy, Spain, and France, as the key mover and shaker in this power grab for an ECB-led pan-European single supervisory system. He will get--by a highly questionable political compromise and on a questionable legal basis--supranational control powers beyond what the founders of monetary union ever intended.

After breaking the no-bailout rule by setting up a temporary European rescue fund in response to the Greek insolvency in the spring of 2010, EU leaders are again ready to break the European Treaty in a major way.

It is stunning that they are prepared to entrust such a huge task to an ECB supranational apparatus. In its first decade of existence, the ECB might have preserved a good measure of price stability, but on the way may also have wrecked European monetary union in another way. It clung to an unrealistic notion of a monetary area where large imbalances were sustainable and country risks--despite an unsustainable external private and public debt buildup--could be neglected. In this way, the ECB was part of the monumental governance failure of other EU institutions such as the EU Council and the EU...