The march folly continues: the ill-conceived plans for European banking supervision.

• Author: Vaubel, Roland

Wolfgang Schauble, the German minister of finance, told the New York Times in November, "We can only achieve political union if we have a crisis." He wants to exploit the sovereign debt crisis to confer additional competencies on the European Union and build new European institutions. He started with the temporary bail-out fund, the European Financial Stability Facility, he then managed to perpetuate it in the shape of the European Stability Mechanism, and he now pushes for a "Single Supervisory Mechanism" under the roof of the European Central Bank. After that, he intends to establish a European Rescue and Resolution Mechanism at the European Stability Mechanism. Other mechanisms are likely to follow if he stays in office.

Schauble argues that if the European Stability Mechanism is to directly finance the recapitalization of Greek, Spanish, and many other eurozone banks, the systemic eurozone banks must be supervised by a common eurozone authority, because the national supervisors would lack the incentive to be strict enough. He regards the Single Supervisory Mechanism as necessary to prevent "moral hazard." He is wrong. The incentive to be strict depends on the price of the bail-out loans. A lender of last resort, according to essayist Walter Bagehot, ought to lend at a penalty. If the European Stability Mechanism, instead of subsidizing its loans by a large margin, charged a punitive rate of interest (to be paid sometime in the future), the moral hazard problem would be solved, and the national supervisors would have a sufficient incentive to do a good job. In addition, there is no need for the European Stability Mechanism recapitalizing banks in countries such as Spain where the government is perfectly solvent and has access to the capital market. Spain is not Greece.

Another argument in favor of a European supervisory authority asserts that the national supervision of banks creates "a vicious circle" due to "regulatory capture." According to this story, the banks--especially those in the southern eurozone--persuade their supervisors to be lax. In exchange, they promise to buy large amounts of government bonds at low interest rates. This then leads to a vicious circle: when a banking crisis causes a budgetary crisis, the budgetary crisis, that is, the collapse of government bond prices, feeds back to the banks' balance sheets, thus aggravating the banking crisis. To interrupt the circle, so the argument goes, European bank supervision must prevent the regulatory capture. This justification is not convincing either, for a number of reasons.

First, the budgetary problems of most southern eurozone governments have not been caused by a need to support their banks. The...