Europe faces withered economies and double-digit unemployment rates from Ireland to Italy. Now, after yet another summit, Europe’s wise men and women have hit upon yet another fix. This time, they’re pushing universal deposit insurance across the Eurozone, in which the people of any nation in trouble would be bailed out by people in other euro nations: Spanish bank depositors, for example, would pay for rescues of Greek bank depositors if Greek banks failed, and vice versa. The new idea, like many before it, ignores the problem at the root of the European crisis: the euro itself.
Greece, Spain, and others are in trouble because they—and their banks—borrowed so much money so recklessly during the boom years. Global money managers thought these nations’ euro membership made investment in their debt a sure thing. Strong countries like Germany, the thinking went, would never countenance defaults on government or big-bank debt issued in the common currency. Easy money, in turn, allowed much of Europe to avoid hard questions on unaffordable retirement benefits and inflexible labor markets.
When the bust came, the euro fetters compounded the problem. Fifty years ago, a country like Greece would have dealt with a debt burden by printing up more money to pay off bonds in cheaper drachmas. The subsequent fall in the value of the Greek currency would have encouraged foreigners to buy Greek products and to visit Greece, ameliorating the country’s economic contraction. Of course, such a solution wouldn’t have been good for Greek savers, and it would present tremendous risks if carried too far.
What Greece and the rest of Europe are doing today, though, is hardly an improvement. Greece took the rest of the world on an excruciating two-year journey to its debt default earlier this year. The continued doubt about whether the country can pay back its debt has prolonged economic uncertainty, leading to more joblessness: 21.7 percent of Greeks are out of work. The Greek saga has also stolen attention from other national crises. Greece is tiny; Spain and Ireland are not. The Spanish banking system, with $717.1 billion in liabilities, is nine times as large as Greece’s; the Irish banking system is nearly six times as large. Banks in both nations splurged on property loans during the boom, and both nations, as they struggle to repay bad debt, now have extremely high unemployment rates—14.2 percent in Ireland and a truly scary 24.3 percent in Spain.
Since 2008, the eurocrats have acted only fecklessly to address these issues. Europe’s “leaders”—Germany and France—want Ireland and Spain to force their taxpayers to bail out the lenders who financed the binge. The leaders looked on last year when Spain allowed one flailing bank, Bankia, to snooker small depositors into becoming “little bankers” and buying stakes in the bank to prop it up, exposing them to loss. But the bailouts-at-any-cost method is no longer working. Two weeks ago, when Spain announced it would borrow money from Europe’s rescue fund to prop up its banks, investors weren’t reassured: they sent interest rates on Spain’s government debt soaring.
German and French leaders have never questioned the morality of forcing taxpayers and workers to sacrifice so that investors in banks don’t have to. Nor have they been honest about the choice they have made. They’ve never said, for instance, that for as long as Europe keeps servicing bad debt, growth will remain slow to non-existent, and there’s little anyone can do about it—unless Germany, France, and other strong countries want to make massive, open-ended fiscal transfers to weaker countries.
Europe’s latest announcement is just another distraction. Political leaders now say that they want at least some investors in banks to shoulder the losses, just not right away—that would scare the delicate bankers. Perhaps by 2018 or 2019 they’ll be ready. As one step in that process, Europe will think about implementing an EU-wide deposit scheme: if a bank in Greece or Spain (or France or Germany) fails, and its sophisticated investors take losses, the rest of Europe could step in to make sure that the failed bank’s small depositors didn’t lose money. “We support the intention to consider concrete steps toward a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance,” the leaders of the G-20 international summit, including President Obama, said Tuesday of Europe’s effort.
Europe would model its deposit insurance on America’s Federal Deposit Insurance Corporation, and understandably so. The FDIC works well when Washington allows it to. When a bank fails, its big bondholders and other creditors are supposed to be subject to financial loss, ensuring market discipline. But thanks to the money from a fee levied on all bank deposits, small depositors are protected from losing money. Such loss would be unwarranted punishment of people who never intended to risk their money on an investment, only put it in an account for safekeeping.
Europe is missing something crucial about the U.S. method, though. American deposit insurance works because the United States is one country with one currency. Europe, on the other hand, is many countries with one currency. A bank may fail in California, costing banks elsewhere money. But the state of California is not going to decree, suddenly, that it is no longer in the dollar.
Greece or Spain, on the other hand, could pull out of the euro, and the longer economic stagnation continues, the greater that risk grows. A bank has failed, under any reasonable definition, if its depositors can’t withdraw their funds in the same currency in which they deposited them. In such a case, under an EU-wide deposit scheme, the bank depositors in a country that has just deserted the euro could then call on Europe to give them back their money in euros, not in the nation’s new currency.
Such a wrinkle could quickly change politicians’ and voters’ motivations. Consider that voters in Greece chose implicitly Sunday, with their vote for a relatively moderate party, to stay in the euro. Greeks voted the way they did partly because they don’t want to get stuck with an inflated currency that wipes out their savings. But what if Greeks knew their savings were safe, because Germany had pledged to protect their euro-denominated deposits? They might have voted differently.
Sure, European leaders could exclude forced currency conversions from their cross-border insurance scheme. But then the cross-border deposit insurance wouldn’t really be deposit insurance. Why should a Greek saver indirectly pay a fee, through his bank, for protection, when the biggest risk he faces is the currency risk that isn’t covered? Moreover, any such provision would send a signal to the rest of the world that Europe is acutely worried about currency pull-outs.
Europe, then, is right back where it started. European leaders must first deal with the tens of billions of dollars in bad debt crushing their people. For now, the best protection for European savers would be economic growth. Europe can consider cross-border deposit insurance only after (and if) the Continent graduates to closer fiscal union that ensures the euro’s survival—not before.