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May 2013

The EuroFuture Project

Paper Series
Fiscal Union, Banking Union: Two Opposite Paths for Europe
by Bruno Macaes

Summary: The problems that the eurozone is facing are all of its own making. Not only did the common currency deprive European nations of the ability to adjust to economic shocks, the euro was itself the shock to which it could not respond. Countries on the periphery had access to cheaper credit than they had experienced in living memory, contributing to fiscal imbalances and growing public debt. The current crisis has shown the impracticability of an economic and monetary union in Europe without the essential institutions of a banking or financial union. As the recent cases of Spain and Cyprus already indicate, a banking union will draw on the widespread political reluctance to support euro area bailouts for banks. Electorates in Europe will find it even more difficult to bail out a foreign bank, so we may well expect that a common resolution regime will rest on the bailing in of bank creditors. The feedback loop linking banks and states is not broken from above, but from below, by imposing losses on investors and unsecured bank creditors.

Problems of its own Making As Paul Krugman has noted, one of the bitterest ironies in the crisis of the eurozone is that the problems it is facing were all of its own making. Not only did the common currency deprive European nations of the ability to adjust to economic shocks, the euro was itself the shock to which it could not respond.1 Suddenly, countries on the periphery had access to cheaper credit than they had experienced in living memory. Governance structures are badly prepared to deal with radically new conditions, so we should not be surprised that easier access to financing greatly contributed to fiscal imbalances and growing public debt. But the problem was not limited to public debt. In some countries, it was even on the whole much more serious in the private sector, fuelling housing bubbles and lax lending standards. Under the euro, banks remained under national supervision and took increasing risks with their balance sheets. Investors were very much willing to turn a blind eye in the face of growing imbalances because the old exchange risk had disappeared and the new risks created by the
1 Paul Krugman, Revenge of the Optimum Currency Area. NBER Macroeconomics Annual 2012, Volume 27 (Chicago: University of Chicago Press, 2012).

single currency were, for the moment, difficult to fathom. In the absence of a productivity boom, money growth will manifest itself as inflation: rising wages, prices, and real exchange rate misalignments. This in turn lowered real interest rates even more, so the process fed on itself. Currency depreciation would have worked as an adjustment mechanism after the shock, but it could have almost certainly worked even before, as currency and inflation risk would have put a break on these huge, destabilizing capital flows. As for the new risks, it seems that almost no one was fully conscious that countries belonging to a currency area are no longer fully sovereign in economic matters. They have no control over their currency, so the risk of sovereign default stops being an abstract possibility. As a result, their ability to fully stand behind their national banking systems should also be regarded with fresh skepticism. Before the crisis erupted, no one seemed interested in pricing risks according to the new political situation, but to be fair, this new situation was never made clear the way it should have been with new rules, new institutions, and new principles.

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It is important to point out that optimum currency area theory sees two main ways in which a currency area might be able to survive without the flexibility offered by different national currencies. To speak very broadly, a currency area needs to be able to adequately respond to asymmetric shocks and correct imbalances before fragmentation is allowed to set in. The theory stipulates two main response mechanisms: the market and the state. While one does not always look at it in these terms, it helps to understand how the problems posed by the introduction of the euro leave us with two opposing solutions. They correspond more or less exactly to the ideas of a banking and a fiscal union. Thus, it may be argued that an essential ingredient of a common currency is a high degree of factor mobility. It may be added that the crucial factor for the eurozone is capital rather than labor, since we know that labor mobility in Europe faces a number of cultural, linguistic, and even, to some extent, administrative or regulatory limits. The available empirical studies seem to support the claim that in successful currency areas, like the United States, shocks to gross national product are mostly smoothed by credit and capital markets, with only a small percentage being addressed by federal government spending. The sum of capital market and credit market smoothing constitutes the fraction of shocks smoothed through the market mechanism. The two differ in that capital markets are able to deal with asymmetric shocks through ex ante arrangements. By holding claims to output in other states, citizens are able to smooth shocks to their home gross product, while residents in other states are forced to share in the downside.2 The third channel is, of course, the federal budget. Here, we have an alternative that is conceptually distinct from, and even opposed to, the market mechanism. It relies on the notion of economic sovereignty, the combination of a single monetary policy with the instruments of fiscal policy: fiscal and monetary policies must go hand-in-hand. For the defenders of a fiscal union, there should always be a treasury, opposite to each central bank, that is empowered to tax and spend and capable of compensating for regional differences using both sides of the budget.3
2 See Pierfederico Asdrubal, Bent E. Srensen, and Oved Yosha, Channels of interstate risk sharing: United States 19631990, The Quarterly Journal of Economics (1996): 1081-1110. 3 See Peter Kenen, The theory of optimum currency areas: an eclectic view, reprinted in Exchange Rates and the Monetary System: Selected Essays of Peter B. Kenen (Aldershot: Elgar, 1994), 3-22.

There is a common diagnosis of the ongoing crisis in the eurozone that essentially views it as the result of the weakness and contradiction of having a monetary union that is not also a fiscal union. In a sense this is true: the euro was founded on the understanding that a number of independent states could share the same currency, the same monetary policy, and build fully integrated financial markets, without having to share their tax bases and budget decisions. The problem of having a monetary union without a fiscal union is that states lose the ability to soften asymmetric choices by allowing the value of their currency to adjust, while not being able to use a federal budget for that same purpose. Let us clarify at the outset that fiscal union refers to the sharing of revenue and expenditures among regions or member states. This may take different forms: a federal unemployment insurance program, for example, but also common debt issuance or even common debt guarantees. In all cases, a fiscal union would be marked by two significant developments. First, the commitment to share revenue and transfers would dramatically reconfigure national budgets. Until now, the European budget has remained the object of periodic negotiation and kept at a very modest size. Second, once revenue and transfers are even partially shared among member states, fiscal sovereignty the power to allocate revenue will have to be moved from the states to the center. Control at the center is obviously necessary in order to avoid free riding by member states that stand to benefit from access to a common pool of taxes and transfers. Thus, it is perhaps to be expected that any progress towards a genuine fiscal union would have to include establishing a European treasury with the power to raise taxes, the power to decide on how to spend these monies, and the power to issue joint and several guaranteed euro bonds. A federal fiscal union with a central authority having discretionary spending, taxing, and borrowing powers would decisively move the European Union towards a genuine political union a supranational state, calling for the corresponding democratic mechanisms necessary to ensure its political legitimacy. On the other hand, when recalling that the original sin of the euro was the unlimited access to cheap credit across the periphery, it is hard not to conclude that what is offered as a solution to the crisis, an explicit joint liability for public debt, was in fact, albeit

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implicitly, the real source of the crisis. Now, the answer to this problem might be a renewed effort to bring about real convergence at a higher level. Perhaps member states could agree that what was lacking before was convergence in economic structures and institutions. Lucas Papademos liked to argue that this is the most profound meaning of real convergence.4 To ensure that the process would not be resisted or postponed, national states would have to surrender part of their sovereignty to a federal authority capable of bringing about this institutional or structural convergence. Needless to say, this would be pure folly. It would exacerbate tensions between member states and commit the economic fortunes of the continent to a process of political transformation for which it lacks both the instruments and the will. As a general idea, it has already been tried. In fact, the first ten years of the euro were a conscious bet on the real convergence between member states. Wagering every chip they had on this outcome, politicians and market participants rushed headlong into a disastrous financial crisis from which we have yet to recover. The Age of Credit Equality Once the process of monetary integration eliminated currency and inflation risks, it might have been thought that any lack of convergence on fiscal policy would necessarily imply that highly indebted countries would be paying higher interest rates. Fiscal discipline would be imposed by high market borrowing costs.5 But even at the time, there were serious doubts about this. First, one should not assume that lenders will react quickly to the risk of fiscal collapse or outright default, which most market participants will consider an extreme case, and one that policymakers will in any case want to prevent. Sovereign default in a developed economy is an almost unthinkable possibility, not least because public debt is owned in such significant amounts by domestic financial institutions. Second, it is not clear whether higher borrowing costs have sufficient dissuasive power to break a spiral of excessive borrowing. It is only in the long run that higher borrowing
4 See, for instance, On the Road to the Euro: Progress and Prospects of the New Member States, speech by Lucas Papademos, vice president of the European Central Bank,intervention at a panel discussion at the conference The ECB and its Watchers, Frankfurt am Main, May 5, 2006. 5 Alberto Alesina, Mark De Broeck, Alessando Prati, and Guido Tabellini, Default risk on government debt in OECD countries, Economic Policy (1992): 429.

costs become punitive for a government, especially in the form of resistance to new or higher taxes. As Otmar Issing put it, a small rise in interest rates is unlikely to have any significant disciplinary impact on the fiscal policy of the deficit country.6 Faced with doubts about the effectiveness of market discipline, the choice was to establish a regulatory framework to impose limits on fiscal policy in the member states. There was, perhaps, a touch of incoherence in this choice. After all, if market discipline was deemed too weak in the absence of a regulatory framework, then it might disappear altogether if such a framework were put in place, committing the monetary union to a collective zero-risk goal for sovereign debt. Unsurprisingly, this was precisely what happened. It is disingenuous to blame market participants for excessive complacency in the decade up to the crisis when market discipline was explicitly ruled out as the political and financial architecture for the monetary union was being put in place. Alexandre Lamfalussy pointed out that closer economic and solidarity ties, implied by membership of the union, could generate market expectations that the member state would be bailed out, entirely wrecking the market mechanism.7 But if it was not possible to rely on market forces to differentiate the cost of funds, then such differentiation would have to be abandoned. It certainly could not be imposed politically. The choice was incoherent in a second respect. We must remember that this fiscal framework was designed not to interfere extensively with domestic economic and fiscal policies, which were still thought to belong to the irreducible core of national sovereignty. National autonomy should be infringed upon as little as possible, in accordance with the limited degree of political integration and democratic legitimacy at the union level. Zero risk was to be a blanket assurance extended to member states, even if fiscal and economic conditions still varied widely among them. In fact, the European capital requirements directive allows banks to apply a granular approach to corporate, mortgage, and retail exposures, while applying a uniform zero risk weight to the sovereign debt of member states.
6 Otmar Issing, The birth of the euro (Cambridge: Cambridge University Press, 2008), 195. 7 See Alexandre Lamfalussy, Macro-coordination of fiscal policies in an economic and monetary union in Europe. Paper annexed to the Report on Economic and Monetary Union in the European Community (commonly called the Delors Report), Committee for the Study of Economic and Monetary Union (1989).

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To determine sovereign default risk, a number of variables must be considered: degree of indebtedness, revenue sources, the diversity of these sources, implicit and explicit external backing, and, last but not least, political risk. How could it be assumed that countries with very different institutional arrangements and political and fiscal systems would benefit from essentially the same risk assessment? It is always sound method not to proclaim a certain law as universally valid, as valid under all possible conditions. It is the only way to avoid seeing it refuted. In the case of the zero risk status of sovereign debt in the monetary union, it was clear that no test had yet been performed. The test, which alone could justify such a pronouncement, would come much later. The whole financial architecture of the monetary union rested on wishful thinking. It rested, as a matter of fact, in a single proposition which, by itself, implies the denial of risk analysis: the proposition that sovereign debt has zero risk no matter what the underlying national economic and political conditions turn out to be. This proposition was quickly and duly refuted.

It turns out that the persistence of different domestic banking systems was only compatible with a zero risk assessment. Once this has been corrected, the increase in sovereign risk is concentrated in some of the member states and acquires a number of reinforcing feedback loops, since every correction in risk assessment is both a reflection of the underlying fundamentals and a factor shaping their future development. From this standpoint, the euro crisis appears as a result of rapidly increasing fragmentation along national lines. It is sometimes said that the crisis may lead to a reversal of the integration process in Europe. It is much more correct to say that it already reflects this reversal. On one hand, we find a clear channel of risk transmission from banks to sovereigns. The anticipation by financial markets of the likely costs of a bank rescue translates into doubts about the sustainability and credit worthiness of public debt. As long as the cost of recapitalizing ailing banks remains with the individual sovereign, the implied debt burden will respond to weaknesses in its own financial sector. On the other hand, banks tend to have sizeable exposures to the home sovereign and financial markets have quickly reacted to this fact by forcing risk premia of banks exposed to troubled sovereigns to rise accordingly, which in turn will increase the odds of a costly bank rescue. In addition to the direct impact on balance sheets, increases in sovereign risk make it more difficult for banks to use government securities as collateral. In fact, if the security is already posted with a central bank or a private repo market, a downgrade or a drop in price could trigger a margin call. Another channel of transmission from sovereigns to banks takes place through the ratings mechanism: it is very rare, as we know, for a bank to exceed the rating of the sovereign or to avoid a downgrade within a few months following a sovereign downgrade. Finally, the worsening of sovereign credit positions will reduce the value of the explicit and implicit guarantees given to banks, which raises their funding costs. As noted, these channels work in both directions at once. A correction in the assessment of sovereign risk will be amplified by the impact it has on bank risk and the reverse transmission mechanism from the banks back to the sovereign. The same is true when assessing bank risk. When the Irish government announced that it would guarantee all bank liabilities, financial risk was transferred to the govern-

The whole financial architecture of the monetary union rested on wishful thinking.
Heterogeneity and its Causes One might argue that the differentiation in sovereign bond yields was no more than a return to sanity and a necessary incentive for countries to put their own houses in order. But things are not that simple. Such differentiation, once adopted and anchored, would permeate all the way down to the domestic banking sector and its links to the real economy. It is a measure of how ingrained the interdependence between banks and sovereigns has become in continental Europe that, until very recently, it was repeatedly assumed that a greater amount of economic and financial integration between member states has to take the form of a fiscal union. In fact, integration can be pursued at a different level by disconnecting states from the banks operating in their jurisdictions.

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ment balance sheet, while at the same time creating new sources of risk for banks resulting directly from increased sovereign weakness. One cannot ignore either the taxpayer cost of significant bailout packages or the indirect cost for the banking sector itself. The process gets more complicated if we consider macroeconomic channels. Banking crises have an obvious impact on economic activity and therefore on negative trends in tax revenues. Sovereign credit weaknesses will affect the cost and availability of funding for banks, forcing them to deleverage and rebuild capital ratios. This in turn will impact the real economy, increasing the pressure on tax revenues and casting further doubts on the sovereign. Conversely, the need for fiscal consolidation following a sovereign crisis may weaken economic activity, affecting credit quality and profitability in the banking sector. Outright Monetary Transactions Financial market fragmentation is clearly incompatible with a monetary union. If banks resident in distressed countries face funding pressures, while banks resident in other countries benefit from funding surpluses, monetary policy will not be equally transmitted to the whole currency area. It may even be feared that some countries or regions will effectively be excluded from the currency area in the sense that financial and economic conditions there become entirely impervious to monetary policy decisions, as the funding constraints on banks in the periphery significantly reduce the amount of loans they are able to supply to households and firms. Also, as banks try to counter the adverse impact of funding pressures on their earnings, lending margins tend to increase, having a very powerful negative impact on economic activity. As Banque de France Governor Christian Noyer has convincingly argued, there is no logic in a situation in which some banks are heavily penalized in their funding and activities solely because the governments of the countries where they happen to be located have been fiscally irresponsible in the past.8 This in turn will affect economic conditions for companies and families, adding to unemployment pressures. It is clear that the problem is not just about banks, which is why financial union may be a better term than the more common banking union. The
8 See, for instance, The Next Step for Europe Is Financial Union, Wall Street Journal, June 11, 2012.

current crisis has decisively shown the impracticability of an economic and monetary union in Europe without the essential institutions of a banking or financial union. How should one address this problem? Notice that there are two main possibilities. Assume that, through various channels, different sovereign risk profiles in vulnerable countries have an impact on the funding conditions for domestic banks. Should we try to reintegrate financial markets by trying to break these links or by reducing sovereign risk, so that it is no longer transmitted to the banking sector? Once again the choice is between, as we said, two mechanisms of integration: the market and the state. In order to safeguard the transmission mechanism of monetary policy in all euro area countries, the ECB decided in September 2012 to launch a program of Outright Monetary Transactions (OMT) for sovereign bonds. A number of conditions were specified. Strict and effective conditionality in the form of an adjustment or precautionary program has to be in place and complied with in order to ensure fiscal discipline in countries eligible for OMT. Purchases would be limited to the shorter part of the yield curve and conducted in the secondary market only. The announcement had a powerful impact on investor sentiment. Sovereign yields in the vulnerable member states started to decline almost immediately and have now reached levels not very different from what these countries could obtain before the crisis. What is most extraordinary is that no purchase has yet been made under the program. The market seems satisfied to know that the possibility is there if and when tensions were to resurface. By this

The current crisis has decisively shown the impracticability of an economic and monetary union in Europe without the essential institutions of a banking or financial union.

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standard, it should be considered a notable success, but one should not forget that its declared goal was a different one: to bring about a better alignment of funding conditions for the real economy with the key ECB interest rates. It is perhaps too early to have a final opinion on this score, but the program has so far been incapable of repairing the transmission mechanism of monetary policy. On one hand, the spread in sovereign yields is still significant and, as long as it remains in place, it is difficult to expect that financing conditions for households and firms can start to converge. On the other hand, the banking systems in periphery countries remain considerably impaired and monetary policy can do nothing to address this question. It is not the role of a central bank to recapitalize weak financial institutions or to do away with bad assets. The fundamental flaw in the program is its indirectness. In a sense, the idea behind OMT is the very negation of a banking union, since it is based on the conviction that credit conditions in financial markets can be made similar only if the position of the different sovereigns is also made to converge. This intermediary presence is a source of two distinct problems. First, the impact of the measure is considerably softened before it can develop its desired effects. The measure does not act directly on funding conditions for banks and the real economy. Second, it can only reach its goal by having considerable consequences for the fiscal position of member states. In fact, although OMT were presented as trying to address the uneven or impaired distribution of the monetary policy stance, it is in fact sovereigns that stand to directly gain from the purchases program, while banks and firms must wait for these benefits to cascade down to them. This cannot but raise serious concerns about moral hazard, fiscal complacency, and even, as Bundesbank President Jens Weidmann put it, the redistribution of solvency risks between euro area countries.9 It should be noted that one of the consequences of introducing policy conditionality for central
9 Q: From the outset, you were consistently opposed to ECB purchases of bonds from crisis countries. Since the announcement by ECB president Mario Draghi in the summer to buy, if necessary, an unlimited quantity of bonds, the bond and equity markets have been humming along nicely. Are you now a convert? A: The fact that, as you say, the markets are humming along quite nicely at the moment cannot be the sole determinant. What the ECB ultimately announced is that it is quite willing, if need be, to redistribute solvency risks between euro-area countries without limit. However, a clean dividing line between monetary and fiscal policy is important. In addition, the announcement is a sort of insurance policy backed by the central bank but the insurance is not making the system any more stable. I fear that eagerness to reform will flag if monetary policymakers come to the rescue time and again. Interview with Jens Weidmann, FrankfurterAllgemeineSonntagszeitung, December 30, 2012.

In a sense, the idea behind OMT is the very negation of a banking union.
bank purchases of sovereign debt is to project these purchases into the future. Thus, while previous government bond purchasing programs allowed eurozone banks to sell those securities to the ECB, the current program allows them to buy bonds with the expectation of selling them in the future at a higher price. This may have a sizable impact on yields, but it is also building up important risks in the system. A Banking Union One could draw the conclusion that the powerful positive feedback loop linking banks and sovereigns shows the necessity of maintaining sound public finances, as stress in the sovereign credit markets will easily affect funding for banks and, as a result, credit conditions in the real economy. Santander is a case in point. Despite being the most profitable bank in Europe for a number of years, the Spanish bank was quickly forced to pay more to borrow in the private markets than some of its weaker counterparts in Germany. The problem may be put in this way: if the strong linkages between banks and sovereigns are to remain, economic and financial convergence in the eurozone would seem to depend on a similar convergence in sovereign risk and fiscal standards. One size must fit all, or the creeping differentiation in sovereign credit quality will foster increasing financial and economic segmentation. If sovereign risk is to be allowed to diverge, the policy implications are naturally quite diverse. The interdependence between banks and sovereigns must be broken up in order to isolate the financial sector from emerging differences in sovereign credit quality. Stresses in the sovereign debt market could then have a disciplining effect, while the danger of having a whole economy held hostage to a long and difficult process of fiscal consolidation would be much abated, perhaps even eliminated. Different sovereigns might take their turn being the focus of investor doubt, but

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next to them, a large and fully integrated common market would go about its business with healthy indifference. The obvious way to bring about a fully integrated banking sector is to set up a common resolution authority, accompanied by a joint supervisory regime. Banks would no longer be dependent on the creditor guarantees provided by their sovereign. These guarantees, or the lack thereof, would be part of a common resolution regime at the euro area level. Other sources of financial fragility, such as the home bias in the holdings of government debt by the financial sector, would also be reduced. After all, if a bank is directly affected by any deterioration in the credit quality of its sovereign, it is economically rational for it to hold a disproportionate amount of domestic debt. A bank will be severely affected if the sovereign loses market confidence whether or not it holds its debt, so it might as well capture a higher yield. Another explanation of home bias is the subtle or less subtle practice by which banks are incentivized, encouraged, or forced to support the financing needs of their sovereigns. A deadly embrace tends to develop, since banks themselves acquire considerable leverage over political authorities by increasing their domestic debt pile; they will be a position to wreak havoc in the secondary market for public securities if and when they decide to unload it. Since the start of the euro, the share of eurozone government bonds held domestically decreased from around three-quarters to just over one-third. This process was then reversed, especially in Spain and Italy, and the question is how to resume financial integration even in the face of persistent bond yield divergence. The solution to this problem must surely include the establishment of a single supervision authority, able to act independently from the demands of national fiscal policy. In addition, the current system of separate supervisors tends to encourage national authorities to underestimate risks to the solvency of their banking sectors, relying on funding from the central bank, and postponing the difficult moment when they might be held responsible for capital injections or deposit insurance. National supervisors may treat their national champions with favor. In trying to preserve international competitiveness or to avoid reputational costs, they may delay addressing existing problems, which as a result will tend to grow worse. Also, in times of financial stress, national supervisors typically encourage home banks with subsidiaries abroad to repatriate as much

capital as possible. A single supervisory mechanism would operate very differently, because it would have access to information about banks in different countries and would be specifically mandated to protect the interests of the euro area as a whole. The second step is a common crisis management framework, including clear rules for bank resolution. It is, in a sense, the crucial step, eliminating the shadow that a banking crisis throws over the integration of financial markets in Europe. European banks are European in life, but national in death. It is enough, then, for a banking crisis to emerge as a possibility and for financial markets to start acquiring a distinctly national shape. Besides, as is well known, the endgame of resolution will always drive the incentives for supervision, so the two processes must go together.

European banks are European in life, but national in death.

To effectively address the root causes of financial fragmentation in the eurozone, the crisis management framework would have to extend to all member states and all systemically important banks. Given that financial fragmentation is ultimately rooted in unaddressed banking fragility, we need a transparent and energetic mechanism to make the triage of strong and weak institutions, impose the recognition of losses, recapitalize viable institutions, and remove bad assets from the system. In all these respects, a common resolution regime would fill an obvious void, but there are two main interpretations of how it could operate. A banking union could simply transfer to the European level most of the practices that were adopted during the crisis by national resolution authorities. This would be enough to break the direct link between sovereigns and their own banking systems, but it would not break the more general risk channels linking banks and sovereigns. Alternatively, a banking union could represent a new way of thinking about the management and financing of failing bank resolution, one that would at least start to sever the umbilical chord connecting euro area banks and political authorities. There are four different reasons why the costs of resolving a failing bank should be shifted from taxpayers to the banks and their creditors:

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When bank risk is capped by sovereign guarantees, we are much more likely to experience destabilizing capital flows of the kind that brought about very high levels of private debt in the first place, as investors will feel encouraged to take excessive risks. Consider what the message to eurozone banks would have been if banks in Cyprus had been bailed out by a European recapitalization fund. To rely on government loans does not reduce the burden of debt, but merely shifts it somewhere else. If we want to break the feedback loop linking sovereign risk and bank risk, we should avoid rebuilding it at the European level. It is not sufficient to argue that risks will be much smaller if shared by all countries. Bank assets are several orders of magnitude larger than existing sovereign debt. Government-funded rescues would not coincide with transfers between states, since troubled banks can be found in every country. Nonetheless, if bank resolution is to be financed by a shared pool of taxpayer money, the distinction between a financial and a fiscal union becomes less clear. A banking union would be introducing a fiscal union through the back door, raising intractable political problems. As the cases of Spain and Cyprus already indicate, a banking union will draw on the widespread political reluctance to support euro area bailouts for banks and add an extra layer to it. Electorates in Europe will find it even more difficult to bail out a foreign bank, so we may well expect that a common resolution regime will, in fact, rest on the bailing in of bank creditors. The feedback loop linking banks and states is not broken from above, but from below. That means not through the infusion of shared European funds, but by imposing losses on investors and unsecured bank creditors. Conceptually, the goal of a resolution regime should be to minimize disruption and even ensure that a failing bank can continue to operate as a going concern by making shareholders and creditors absorb the losses that led to the need for intervention. Ex ante rules replace the political decision to bail out financial institutions, or to abruptly unplug them from public support. From this perspective, a common regime is the result of a collective retreat from

state intervention and, in fact, an extension of existing rules on state aid to the crucial case of banks and financial institutions.10 The goal is to re-establish a level playing field: market participants in different countries will no longer benefit from the implicit guarantees of a more solid sovereign. A level playing field can be viable only if asymmetries in state power become less important. It is important to remember the classic distinction between positive and negative integration. The latter is obtained by removing the obstacles to integration put in place by the member states without erecting a new state at the center. A banking or financial union is a form of negative integration.

10 See Willem Buiter, Three unanticipated consequences of banking union, Citi Research, Economics, Europe, Global Economics View, August 2, 2012.

About the Author

Bruno Macaes teaches politics in Berlin, Germany. For the past two years, he was a senior political advisor to Portugals prime minister, Pedro Passos Coelho. His recent publications concentrate on economic policy and the future of the European Union.

About The EuroFuture Project

The German Marshall Fund of the United States understands the twin crises in Europe and the United States to be a defining moment that will shape the transatlantic partnership and its interactions with the wider world for the long term. GMFs EuroFuture Project therefore aims to understand and explore the economic, governance, and geostrategic dimensions of the EuroCrisis from a transatlantic perspective. The Project addresses the impact, implications, and ripple effects of the crisis in Europe, for the United States, and the world. GMF does this through a combination of initiatives on both sides of the Atlantic, including large and small convening, regional seminars, study tours, paper series, polling, briefings, and media interviews. The Project also integrates its work on the EuroCrisis into several of GMFs existing programs. The Project is led by Thomas KleineBrockhoff, Senior Transatlantic Fellow and Senior Director for Strategy. The group of GMF experts involved in the project consists of several Transatlantic Fellows as well as program staff on both sides of the Atlantic.