The EU Should Forget the Politics of Small Steps
Ralitsa Kovacheva, June 21, 2012
The European Union was late with solving the banking problems, although they had long been known and these developments could have been expected, said Dimitar Ashikov, an economist, in our regular feature euOUTside*. Regarding the situation of Spanish banks, he explained that there were several problems to be solved. First is the internal problem - how will the government "sell" the idea of rescuing the banking system to its own voters. The Spanish government was elected only six months ago and now it has to explain to people why the banking system needs rescue from the outside after only a few days ago there were lively statements that Spain would manage alone, the economist noted.
He explained that Spanish banks have a disproportionately large part in the US financial system, with a balance number of about 120 to 150 billion euro, which means that if something happens to the Spanish banks the US financial system has to be prepared to bear this shock. The economist is adamant that it is impossible the eurozone bailout funds to provide money for direct recapitalisation of banks without placing certain conditions on the financial sector. And that there is no way countries to continue to supervise their own financial sectors since they are apparently unable to deal with it.
As for the European Commission proposal for resolving banking crises, Mr Ashikov said that the proposed measures were not new but the deadlines for their implementation were "frustrating" - from 2015 onwards and from 1 January 2018 for clearing the bank balance sheets, "which is something like a science fiction."
He said the main problem of the EU was "the policy of small steps" which, on top of that, was not tailored according to the specifics of individual countries but was "one size fits all." You cannot treat patients with various diseases in the same way, the economist argued. He said the crisis in Europe had evolved and currently we were at the stage of realising that the political system was actually a bubble similar to the housing bubble, because it was devalued.
The price of a political system in a certain country is determined by its credibility and its capacity to govern, moreover to do it well and when this doesn`t happen there is a political bubble in this particular country, the economist explained. He said that it was not about looking for a radical change of the political system but that the subject must be discussed. Moreover, the political bubble is based on some parameters of sovereignty, for example, if the countries do not have fiscal sovereignty then the political system and the political struggle will be radically different.
Once the domino effect in terms of public debt is a fact and there are fears of domino effect in the banking system, which is very closely intertwined in Europe, there are already early indications of a domino effect in the industrial sector, Dimitar Ashikov noted. He predicted that once the industrial skeleton of Europe was affected the damage would be severe and would be correctable in a very long period of time. So he believes that at the upcoming European Council summit in late June, EU leaders must undertake very serious, big steps or otherwise they would have to solve the same problems later but in much more difficult circumstances.
*euoutside is realised with the support of Coffee Roasting Boutique Domani in Sofia, 4 Dimitar Hadzhikotsev St.
Full transcript of the conversation:
euinside: Hello, we haven`t seen each other for a long time but now we are here to discuss a very unpleasant subject, as the crisis in the euro area has returned to its starting point and we again have a banking crisis. There are many things to talk about with our host at Domani Coffee Roasting Boutique Dimitar Ashikov. As you already know, I suppose from our posts in our Free Talk Corner, the European Commission presented a long-awaited proposal to rescue troubled banks. This proposal was highly expected in view of the situation that is unfolding in Spain, but the EC hastily poured cold water on all expectations, saying - do not rush, that has nothing to do with the Spanish case, wait until 2015 because democracy needs time to vote on all texts. Meanwhile, however, a Spanish minister mentioned that Spain could no longer resist and would seek help for its banks. Cyprus, as you have predicted two months ago, is also about to ask for help and overall the mechanism which we have been talking about for two years, is now in motion but it seems we fell back on it, the mechanism of the domino - who will fall first. So let`s start from here, what exactly is the situation of the Spanish banks, especially considering the fact that there is no decision at European level on how to save them.
Dimitar Ashikov: The situation of Spanish banks is like a hot potato that is being tossed for quite a long time, since the global financial crisis has started. Hope was that not only Spanish banks but other banks as well in Europe and North America will manage in some way to restructure, to transform their bad loans, related to the housing bubble and other processes, and somehow in several years to balance themselves. This was not the case. As we see, banks still have serious problems with bad loans and we are now in another phase which has started somewhere in the last autumn and is being little commented. This phase is characterised by the fact that there is no interbank market in Europe. Since last autumn it has been clear that all banks are holding their money at the ECB while searching liquidity there, they didn`t trade among themselves.
euinside: And they were waiting for Mario Draghi to sit in the ECB president’s chair.
Dimitar Ashikov: And they were waiting to get liquidity from somewhere, mostly the ECB, pledging a variety of securities.
euinside: Which are already priceless or devalued?
Dimitar Ashikov: It is now a matter of interpretation. But the problem was clear already last autumn, that the interbank market is gone. No measures were taken then, it was believed that this was not so important.
euinside: Greece was on the agenda then.
Dimitar Ashikov: Yes, but Greece is still a negligible part of the European economy and the banking system in Europe is a serious thing. So, we have a period of 9 months or more in which European banks have been operating in the absence of interbank market. And sooner or later this problem would have sharpened and it already has started to sharpen. We commented back in December here in this place that the deal with Greece is clear, the technical details were discussed and that as of January 1st they to start working hard on solving the problem of the banking system in Europe. Well, it did not happen, the banks received two rounds of liquidity from the ECB, the first quarter passed, everyone was happy ...
euinside: And the leaders were talking about growth, about an exit of the crisis ...
Dimitar Ashikov: But the basic problems remained. It seems now the most acute problems are concentrated in the Spanish banking system, the Spanish banks are known to be some of the victims of the so-called housing bubble because in Spain it was very clearly, very strongly expressed, this process of mortgage lending grew rapidly, as well as the construction in general, and the problem with these bad credits and lopsided balances has most easily emerged in Spain.
euinside: It was known long ago by the way and we've talked many times here that it takes money to recapitalise Spanish banks, but ultimately the government had to rescue the second biggest bank, Bankia. However, this is obviously not enough.
Dimitar Ashikov: It is the fourth largest, it was formed by merging other banks that had to fail, but it's a long story.
euinside: The last shall be first or vice versa.
Dimitar Ashikov: It is actually kind of a sick bank.
euinside: Well, it turns out that we constantly, and not only us, but all institutions that could make a meaningful decision, stand aside, watch and express confidence in the ability of the Spanish government to deal with the crisis. It was said even today [June 6].
Dimitar Ashikov: There are several serious political problems related to the banking crisis in Spain. The first problem is internal, how the government, figuratively speaking, will "sell" to its own voters the idea of saving the banking system. Still, this government was elected about six months ago, if memory serves.
euinside: It is quite fresh.
Dimitar Ashikov: And six months later you have to explain to people how the banking system must be saved from the outside, while only a few days ago there were lively statements that Spain would deal with the problem alone. Incidentally, there are three types of audit ongoing in Spain. One is a financial audit that will be presented to the IMF board on Friday [June 8] and hopefully on Monday [June 11] we will see the text of this financial audit of the fiscal situation in Spain. It will show the public finances, it will show the debt and other things.
euinside: It will show if Spain can handle it alone.
Dimitar Ashikov: It is like a snapshot of the financial situation of Spain. In parallel, there are two other audits going on which are specially commissioned to assess the state of Spanish banks. They will be ready in about two weeks, then you will see the actual condition of the banking system. Currently Spain is in a very awkward position, because on the one hand it sees the plight of banks but on the other it is still waiting to receive these audits and see their result, and only on the basis of these audits to seek help officially. There is also an external political moment related to the fact that if Spain asks for external assistance for its banks, it will create a very serious precedent and that is to change the rules applied to the newly created funds.
euinside: The permanent and the temporary bailout funds ...
Dimitar Ashikov: So they be allowed to directly finance banks.
euinside: Well, this is the big question, Irish Prime Minister Enda Kenny also insisted on that, the temporary, and then from 1 July also the permanent rescue fund to start lending money directly to banks, not to governments, as now.
Dimitar Ashikov: Yes, but it will create a very serious precedent because if that happened on the occasion of Spanish banks we can imagine what a queue will be formed.
euinside: This is why Germany opposed it, right?
Dimitar Ashikov: Then, there are Cypriot banks coming, then the Greek banks, then the Italian banks, no wonder if French banks also line up.
euinside: And is it possible German banks to line up too? I think it was today or yesterday that six German banks were downgraded, as well as three Austrian, including famous names.
Dimitar Ashikov: I doubt it, it is still a matter of image and the Germans and Austrians will hardly allow their banks to seek outside help.
euinside: However, this is part of ...
Dimitar Ashikov: But if the rules of the game change, a great precedent will be created and that means that banks have a life-line in the face of these funds and can continue business as usual, having a way to be financed, even saved, recapitalised, etc. by these funds which are normally intended to support euro area countries not banks that are after all private equity companies, there is a big difference. And this is a foreign policy problem because this idea can hardly be sold to German voters and other voters in Northern Europe how their taxes will go to rescue private companies in Southern Europe. However, there are many other problems. I can give you as an example another, already international problem, because Spanish banks have a disproportionately large share in the US financial system either through branches or subsidiaries, or through joint ventures, they may have greater participation than German banks in North America. And a potential rescue means that the European taxpayer should save Spanish banks that continue their operations in the US On the other hand, when Spanish banks are in financial difficulties, I think directly and indirectly, the amount in North America is a balance figure of about 120 to 150 billion euro, which means that the US financial system should be ready to bear this shock if something happens with the Spanish banks.
euinside: And it is not ready to bear it.
Dimitar Ashikov: Because it will suffer from these financial institutions that are directly or indirectly under Spanish control or partially under Spanish control in the US So, it appears that European taxpayers should pay to clean the balance sheets of the Spanish banking system which is a disproportionately and unrealistically large part of the US banking market.
euinside: Is this the reason why everybody awaited so eagerly today's proposal by the European Commission?
Dimitar Ashikov: Everyone expected it, the Americans were also very nervous because not a small part of Wall Street`s financial health depends on it.
euinside: Yes, last week President Obama held video conference calls with four European leaders and send a special envoy to Europe in connection with the forthcoming another life-saving European Council, but anyway, what the EC has proposed is not what everyone wanted to hear.
Dimitar Ashikov: The Commission could not propose anything else because it does something that is the usual "policy of small steps". It has an agenda, it has its topics about banks, about growth, environment, etc. The Commission is working on its agenda and the decisions are, for instance, that a programme will be developed in three stages -the first will be prevention and risk protection, which exists in many places in the national banking supervisory policies.
euinside: But not everywhere.
Dimitar Ashikov: The second, which is influenced by the American events from the beginning of the crisis, is that every bank must write the so called living will, so if a bank is to go bankrupt it must have a detailed plan how to be restructured, whether it will be split, what parts of the business will remain, etc. Because the bank knows best its own situation and must make a plan, something like a post mortem. This is the second stage which was today discussed as a second measure, and the third measure is the so called bailout which means clean up of banks` bad debts. This is nothing new but the terms for the introduction of these things are frustrating - it is planned that they start working on December 31, 2014, which is too late, while the third step to clear balance, I think it was January 1, 2018, which is something like a science fiction.
euinside: And in this situation the other option remains. As there were expectations, in fact, that this Commission proposal would lay the foundations of the so cherished and discussed lately banking union, that will also be discussed by the leaders at the end of June, what does actually remains for them to do - to decide whether the permanent rescue mechanism to be involved, but if it is, as you said earlier, this would be a bad precedent. What option do they have, what can happen?
Dimitar Ashikov: It's not just a bad precedent, what is currently happening is one of the latest attempts to get money without commitment - let`s save the banks because they are in big troubles. Accordingly, in the history of financial crises to date, including the last one, when a financial institution is rescued a number of conditions are placed. The one who gives the money has certain conditions. Take the case of Ireland, take the case of the United Kingdom, where one of the banks became 40 percent state-owned, the other one became 60% state-owned, not to quote names. So, the one who gives money, in this case the state, puts some conditions, strict plans are made and in certain cases the state acquires control over the financial institution. However, there is no such thing in the Spanish claim, with this interpretation. Just these new funds that are created, they have to recapitalise banks and to support them, and what are the conditions? There is no balance.
euinside: So, what is needed is to redefine terms, to know what to do in specific cases.
Dimitar Ashikov: It's like someone to ask for your money without you putting forward any conditions.
euinside: Like for those countries that are under programmes the same to be applied to banks – you will do this and that and we will give you this much money.
Dimitar Ashikov: The conditions are clear, they are most strongly articulated by the German side - there should be common banking supervision, there should be a common banking union, etc., which means accordingly to lose some financial and banking sovereignty.
euinside: Which nobody wants.
Dimitar Ashikov: Well, nobody wants it but currently it does not work. You come to a situation where the Spanish state is awaiting an external audit of its banking system to be done. Isn’t it aware of the condition of its own banking system? It has banking supervision and a central bank in Spain, hasn't it? If they cannot supervise and regulate this sector, it is better to give it up and this to be done somewhere in Europe in a centralised way.
euinside: Yes, but all the Nordic countries will scream against it ...
Dimitar Ashikov: Well, if someone cannot manage their banking system, then they do not deserve it.
euinside: Yes, but there must be some criteria to say who cannot handle on their own.
Dimitar Ashikov: Here are the conditions - if you want your banks to be bailed out, you must cede control and supervision. It is clear.
euinside: Like in the Greek case.
Dimitar Ashikov: Let's assume hypothetically that the money is given to Spanish banks from the existing funds, without substantial conditions. This means that the banking supervision in Spain will continue to operate as before, so they would still not know what's happening in the Spanish banking system and would do periodically external audits. How, then, to give them money? It's impossible.
euinside: What is your forecast, where are things going? They do not look good at all.
Dimitar Ashikov: Well, things are going according to the plan. As we discussed months ago, when nothing significant is being done things go in a specific direction.
euinside: Last time you predicted that Spain would ask for a loan after the French elections.
Dimitar Ashikov: Yes, it was simply a political moment, they sort of endured until the French elections not to create political and other shocks, the French elections have passed and altogether I was right. I am not very happy because it was not a rosy outlook, it was negative.
euinside: Not at all.
Dimitar Ashikov: I also thought that the Cypriots would not get stuck this way before the Greek elections but the first election simply failed, now we are waiting for the 17th to see what happens. Currently we have a lull in Portugal.
euinside: But it is doubtful.
Dimitar Ashikov: Yes, it is doubtful. Henceforth, the policy of small steps which Europe was a champion of and the policy of ‘one size fits all’, as clothes in a store, it is clear that things cannot continue like this. Some other formulae should be sought, the steps must be greater, the size must be tailored to every one.
euinside: And steps to be a little bit faster ...
Dimitar Ashikov: You cannot put all countries into a common pattern by making small steps, for example, a pattern of austerity measures or increased retirement age, every country has its own specificities.
euinside: But when taking into account the specifics, they immediately start talking about double standards and things like that, while really there are different specificities.
Dimitar Ashikov: Imagine that three patients with three different diagnoses come to a hospital and you treat them the same way and then you are accused of having double standards. What does it mean? One patient, for example, is suffering from lungs, the other has a broken leg, the third something else and you're saying that an individual treatment plan has to be made for each one, right? And when you declare this thing, then you go to the doctor and say, what are these double standards!
euinside: Yes, exactly.
Dimitar Ashikov: You will treat all of them the same way, wrap them up in a wet sheet ...
euinside: And whoever survives.
Dimitar Ashikov: And whatever happens. So the measures should be tailored to each of the eurozone members.
euinside: Well, they tried to make this through the macroeconomic imbalances procedure, they are trying to do this through the measures for growth and so on, but the situation seems quite out of hand now.
Dimitar Ashikov: One does not need to be an Oxford professor to see that the Greek crisis was a fiscal one - excessive deficit, excessive and uncontrolled debt, so it has fiscal roots.
euinside: Well, not only, it has also political roots.
Dimitar Ashikov: The political issue is a separate one, it is a very long story.
euinside: Yes, it is, but when you impose treatment you should take this into account.
Dimitar Ashikov: Yes, but it was crystal clear that the roots of the crisis in Greece lies in the fiscal area - chronic budget deficit that is deepening, respectively debt is swelling up out of control, etc. But in Spain the crisis does not have fiscal roots yet, even now. It has already started to emerge but this is a secondary symptom. In Spain, the root of the crisis was the banking system with its overly inflated balances, excessive leverage and too many questionable loans related to the construction business and many other things. So you cannot treat Greece and Spain with the same drugs since the genesis, the root of the problem is totally different.
euinside: And Ireland is a third universe.
Dimitar Ashikov: Ireland has a different diagnosis, again, you don`t need to be a professor of economics to see this thing.
euinside: But in general, everything is due to the great interconnectedness and maybe that leads toward common solutions.
Dimitar Ashikov: You should see what is visible on the surface and what lies beneath the surface as a problem. Ultimately, all problems have flourished as budgetary problems, deficit problems.
euinside: Yes, this was mainly discussed.
Dimitar Ashikov: But when this happens, it's like when one has high temperature. One can have high temperature as a result of many diseases and it would be too airy to think that we should fight to lower this temperature within normal limits.
euinside: Usually this is done until things get to the plight.
Dimitar Ashikov: But the reasons for this high temperature are different in the various countries, they are due to different diseases in general. And it is easily visible. In Italy the main root of the problem was significant decline in productivity. Italy had no serious budgetary and fiscal problems, Italy had no serious banking problems ...
euinside: But Italy has a large debt.
Dimitar Ashikov: Italy has always had a large debt, it should be known. Italy traditionally has a slightly larger debt than others.
euinside: It's like with the blood pressure, some people have slightly higher blood pressure than others.
Dimitar Ashikov: Italy is a little bit hypertonic in this regard. Italy has had in previous periods much larger debt than now. But Italy has a different dynamic of the competitiveness of industrial production that is currently missing.
euinside: Yes, but in a moment of investors' mistrust large debt becomes a problem, right?
Dimitar Ashikov: It is beginning to unfold as a problem because you see a common monetary zone such as the euro area that approaches the different patients with the same recipes. All these investors usually do pretty serious investigations and research before investing and when they see that this area is managed in such inadequate way, they fear and see the bigger risk.
euinside: Well, since we talked earlier this year that something had to be done about banks, moreover immediately, starting on the very first working day and since it did not happen, and once we came to this situation, what can be done and is the satiation avoidable at all? Because everything is repeating, but perhaps far more intensively than last October - they started again to predict how long the eurozone will survive, the euro, two months, three months. How do you see things?
Dimitar Ashikov: I see them evolving, as we talked, just to repeat it for a minute. We started from some specific problems in individual countries that are the most acute and most significant, as we talked about Greece, Spain etc. At one point, everything has evolved in a fiscal crisis, we see large deficits, debt swelling, banks and states being downgraded, rising debt yields, so it is getting increasingly difficult to service this debt, this is the next phase of evolution. A further phase of evolution, which has just begun is the realisation that there is actually something similar to a political bubble. So you have a political system that is being perceived by more and more people and experts as a bubble.
euinside: Honestly, I start feeling worried of this talk about the political system.
Dimitar Ashikov: Well, you have a government in Spain that has been elected six months ago and in the sixth month it is looking for external help. This means that it hangs in the air for various reasons, perhaps not only internal ones, it is not able to cope with the management of the financial system, the budget system, with the governance of the country, in general. We also saw it in Greece, in Italy, we had caretaker governments, expert governments.
euinside: We talked some time ago about how politicians do not respond and adapt to the new realities.
Dimitar Ashikov: Now we come to the next evolutionary phase of the crisis in Europe, where we should clearly outline the problems with the so-called political bubble. So, we have a political system that apparently in this configuration, in its current state, it is not able to solve the current problems.
euinside: What do you mean by political bubble - the constant rotation of elections or?
Dimitar Ashikov: Well, it's like the housing bubble - You think something costs that much but it actually doesn't, it is devalued.
euinside: And what happens when the bubble goes bust?
Dimitar Ashikov: For example, you have hope in the Spanish government, now we hopefully expect the Greeks to choose a government that will have a weight, will have a price, like being gold plated, and to do a certain job.
euinside: We also expected the French.
Dimitar Ashikov: Well, but what if it is a bubble that cannot do any job?
euinside: Yes, this is a very serious question.
Dimitar Ashikov: That`s why we talk about a political bubble. In fact, the price of a policy or a political system in a country is determined by its credibility and its capacity to manage, to do a particular job, moreover according to good standards. When this cannot happen and we see that this is not happening we can qualify that there is in a specific country a political bubble, that means a political system that is so weakened that its credibility is very low, it is very difficult for it to implement certain measures, certain decisions, etc.
euinside: But I think it was Winston Churchill who said this, and I think his words are still valid, that the political system is not perfect but there is no better at this stage.
Dimitar Ashikov: In its current form it is bubble-shaped.
euinside: But anyway, there is no better, are China or Russia a better option?
Dimitar Ashikov: I'm not saying that it must be changed radically but this issue should be raised somehow, be discussed.
euinside: To be Europeanised.
Dimitar Ashikov: Because you see that we have been having a summit after summit for more than a year, and the same problems have been discussed, periodically they go down and then resurface again. A year ago we talked about what can be done in Europe and I told you that what could be done most easily was what could be done on paper, how much paper has been written ever since?
euinside: A lot of paper.
Dimitar Ashikov: A lot of paper has been written on many issues, projects, plans, discussions, etc.
euinside: Well, only this Commission proposal is 171 pages and it was distributed to journalists!
Dimitar Ashikov: The paper is piling up like a mountain and as you can see, the situation is getting more and more severe and the processes are deepening.
euinside: Apparently, we have really reached a stage where it is very difficult to look ahead. For me personally, and this option is being increasingly discussed, either we go to a super state or we go away.
Dimitar Ashikov: Well, the situation is as in a Bulgarian proverb which says, "a dog guards a plum" – the dog cannot eat the plum, it doesn’t need the plum but still it keeps it. Currently, every country in southern Europe is keeping some sovereignty that it cannot absorb.
euinside: It is unable to.
Dimitar Ashikov: It wants total sovereignty over its own banking system, although it cannot cope with it.
euinside: And in some countries, while guarding dogs are bark, let’s say the nationalists.
Dimitar Ashikov: These countries simply have some idea of sovereignty over something that in fact they cannot absorb.
euinside: And that sovereignty is for long time way beyond the borders they think it spreads within, which is another problem.
Dimitar Ashikov: Of course. However, they defend it because it is an essential element of the construction of the political bubble. The political bubble is based on some parameters of sovereignty. For example, if you don't have fiscal sovereignty then the political system in a country will be radically different. And the political struggle will be radically different if, for example, you are not allowed to do whatever you want in the fiscal area.
euinside: You either can or you cannot, somewhat ...
Dimitar Ashikov: Ultimately, an extreme idea for a European Ministry of Finance and you'll see the real dimension of the political bubbles in Southern Europe.
euinside: These things are much discussed and now we have again very high expectations for the June European Council, do you share these expectations or is there a little bit of exhaustion of this?
Dimitar Ashikov: Well, as we discussed earlier, the policy of small steps and the common pattern do not work.
euinside: So this time there should be a "big bang"?
Dimitar Ashikov: Some very serious big steps must be taken.
euinside: If there is no "big bang" on 28 and 29 June, if there is nothing radical, which you are talking about, what might happen?
Dimitar Ashikov: This means that these problems will have to be addressed at a later stage in much more difficult circumstances.
euinside: How much more?
Dimitar Ashikov: Well, as you can see the trend is not positive, now we talk about the domino effect in terms of sovereign debt, we have a cascade of countries for which it is increasingly difficult to service their debt. Part of this domino effect is that some countries have lost their access to the markets, those under programmes, they cannot refinance on the market, to issue debt and bonds. We have concerns of a domino effect in the banking system. Because it is very closely intertwined in Europe. Now we have early indications of domino effect in the industrial field, because we see how the indices of industrial production and other related indexes are changing. We have distinct industrial zones in Europe, Spain is perhaps the third industrial zone in Europe after Ruhr and Lombardy in northern Italy, Catalonia is the third biggest industrial zone in continental Europe. So, a domino effect could start on the industrial line, which is already much more basic.
euinside: Not to mention the scarcity of lending to small and medium sized business and the nervousness among ordinary people who have lost their jobs, unemployment is high.
Dimitar Ashikov: If Europe's industrial skeleton is affected the damage would be severe and would be correctable in a very long period of time.
euinside: If at all. I didn’t wish us to end up in this extremely pessimistic way, probably your coffee has became bitterer than usual.
Dimitar Ashikov: I drink 7-8 cups of coffee a day, so I am used to.
euinside: Yes, you're a little bit like the Greeks, you take as much loans as possible until something happens. It is not funny, really, the prospects are not good, but anyway, I don't want to accelerate too much the expectations from the June European Council but the fact is that the leaders themselves say that this is the time to take very important decisions. We will see what these decisions would be, so I hope that we will see each other again in order to see how things are and in what world we live in, eventually. So goodbye and see you again.