Wednesday, June 13, 2012

The European Banking Union?

by Hans-Werner Sinn

Project Syndicate

June 13, 2012

In blatant violation of the Maastricht Treaty, the European Commission has come forward with one bailout plan after another for Europe’s distressed economies. Now it wants to socialize not only government debt by introducing Eurobonds, but also banking debt by proclaiming a “banking union.”

Socializing bank debt is both unjust and will result in a future misallocation of resources. Socialization of bank debt across borders implies that a country’s private borrowing costs are artificially reduced below market rates, as insurance (in the form of credit-default swaps) is provided free of charge by other countries. Thus, capital flows from the core to the periphery would continue to exceed the optimal amount, undermining growth for Europe as a whole.

History offers countless examples of the misallocation of resources that can result from socialization of bank debt. One is the 1980’s savings and loan crisis in the United States, which cost US taxpayers more than $100 billion. Under the umbrella of common deposit insurance, US savings banks made a “gamble for resurrection” – borrowing excessively from their depositors and lending the money out to risky enterprises, knowing that potential profits could be paid out as dividends to shareholders while potential losses would be socialized.

In other words, private profits were generated out of socially wasteful activities. And essentially the same happened with US subprime mortgage lending and with the Spanish banking system in the 2000’s. In both cases, banks took excessive risks in the expectation – eventually vindicated – that governments would bail them out.


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