November 30th, 2010
03:04 PM GMT
Share this on:

The EU bailout for Irish banks failed to quell financial markets. Borrowing costs for Portugal, Spain and others continue to rise, because structural problems created by the euro and single European market remain unaddressed and more crises are inevitable.

In the United States, banks engage in dollar-denominated deposit gathering and lending. The smooth functioning of the banking and payments systems are guaranteed by the Federal Deposit Insurance Corporation, the Treasury and Federal Reserve.

When banks fail, the FDIC makes good on deposits up to $250,000 by subsidizing mergers with healthy banks.

If banks are too big to be merged-for example, the recent Citigroup and Bank of America rescues-the Treasury and Federal Reserve can step in. Such extraordinary measures are possible, because the Treasury can issue dollar denominated bonds and the Federal Reserve can print dollars. The latter was critical during the recent crisis.

In the EU, individual member states regulate and guarantee the banks that take deposits and lend in euro. The Irish government guarantees covers all liabilities – not just deposits up to $250,000.

Major banks in smaller member states have grown too large for their Treasuries to act. They simply can't issue enough euro denominated bonds without driving up their borrowing costs to prohibitive levels and thrusting regular government operations into insolvency.

In Ireland, the government is potentially on the hook for liabilities equal to two times GDP-no government, big or small, can borrow that much money.

The analog in the United States would have been for North Carolina to have been responsible for all the liabilities of Bank of America.

Prior to its banking crisis, Ireland had sound finances and a balanced budget. Now it has a deficit exceeding 30 percent of GDP, and even with the EU aid package, it faces draconian budget cuts. Along with lost banking business, those will reduce GDP by more than 10 percent and impose grave hardships on citizens who neither profited from the bank industry nor were responsible for its reckless behavior.

Without European wide bank regulation and deposit insurance, reasonable ceilings on government guarantees, real EU taxing authority, and a mandate for the EU Treasury and European Central Bank to use bonding and currency printing authority to ensure the stability of banks, Ireland's banking crisis won't be the last of its kind.

Similarly, the budget problems in Portugal, Italy, Greece, and Spain stem from social spending, health care and pensions more generous than their economies can finance with any conceivable national tax regime-if national taxes are raised too high, businesses will flee, and GDP and tax revenues actually fall.

Whether social benefits are too high throughout Europe is an important issue, but the creation of the single European market has heightened expectations that benefits in southern Europe more nearly approximate the norm established in Germany, Holland and other rich countries.

However, the creation of the single European market for goods and services was not accompanied by pan European taxation to finance social spending, health care and pensions. Even though Germany and others are richer by virtue of their participation in the single EU market, they don't assist poorer countries in the manner that New York subsidies social security and Medicaid in Mississippi as part and parcel to the benefits its banking, advertizing and other service industries receive from participation in a single market across the fifty states.

The austerity now planned for poorer counties will not solve their basic fiscal problems-those will shrink their economies and tax bases. The $750 billion EU bailout fund is nothing more than a quick fix that boots the problem to the next generation of national leaders.

In the days before the euro, national government debt was denominated in national currencies, and governments could inflate and devalue their way out of a fiscal mess. That's just a stealth way of imposing losses on bond holders but in a more gradual, economically less costly, and politically palatable manner.

Now the EU has announced plans for private investors to take losses on bonds issued after 2013 if the weaker governments need another round of bailouts. The fact is sovereign governments in Athens, Lisbon and elsewhere already can enforce such losses on bondholders, and if they choose, boot the euro, reinstate national currencies and start over.

A common currency and single market in Europe simply won't work without continental institutions to guarantee the solvency of banks and share social spending, health care and pensions. Until then, the bonds of individual member states carry high risk of eventual default, and investors would do well to demand much higher interest rates than have been offered in the recent past.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.

Posted by:
Filed under: BusinessFinancial crisisFinancial markets


soundoff (One Response)
  1. Jack Quann - Dublin, Ireland

    I do really like the comparison of "North Carolina to have been responsible for all the liabilities of Bank of America" when speaking of Ireland and Irish banks. There is a worry now, however, that Ireland will become the blame for all problems in the Eurozone. Although there is already talk of problems in Portugal (and to a lesser extent in Spain), a large part of that is due to their own fiscal policies. As you say above, "individual member states regulate and guarantee the banks that take deposits"; this means any issues in Portugal et al are due to Portuguese problems. Ireland is not totally blameless by any means; but let’s keep blame in perspective also.

    November 30, 2010 at 4:35 pm |

Post a comment


 

CNN welcomes a lively and courteous discussion as long as you follow the Rules of Conduct set forth in our Terms of Service. Comments are not pre-screened before they post. You agree that anything you post may be used, along with your name and profile picture, in accordance with our Privacy Policy and the license you have granted pursuant to our Terms of Service.

About Business 360

CNN International's business anchors and correspondents get to grips with the issues affecting world business, and they want your questions and feedback.

 
 
Powered by WordPress.com VIP