Don't expect miracles during big week in EU's battle with depression

David Gow in Brussels
guardian.co.uk, Wednesday 18 February 2009 10.29 GMT


Latvia: staring into the abyss

Is the EU falling apart? Can the euro survive? The coming week is scheduled to deliver some eagerly awaited policy responses to these suddenly urgent questions, but the prospects are that they will fall short of what is required and that the "worst depression for a century" will deepen.

Europe, as in tackling climate change, has preened itself on taking on a global leadership role in confronting, first, the financial crisis and, then, the economic recession. But there is every evidence that, amid the clarion and confusing calls for a co-ordinated response, the 27 EU governments are engaged in a turf war of beggar-thy-neighbour policies.

Economically, the perspectives are dire. The Dutch economy is officially forecast to shrink by 3.5% this year, the German economy by more than 3%, the British by as much as 4% and Latvia is "staring into the abyss" with a 10% shrinkage at least.

Social unrest is growing, notably in eastern Europe. Austrian banks alone face self-inflicted losses of €150bn on their exposures to bad loans and credit rating company Moody's said this week that "a widespread deterioration in the economic health of core markets" could hit other banks such as France's SocGen, Italy's UniCredit and Belgium's KBC.

Moody's said the recession in the region, much of it already bailed out by the IMF, would be the worst in the world because of large currency imbalances. Wealthier EU countries, led by Germany, are refusing to countenance common eurobonds to cover debts and there is little concerted appetite to bail out defaulting countries.

The euro, de facto currency in countries such as non-EU Montenegro, is again under severe pressure, falling this week to a three-month low against the dollar. "There is no doubt that markets have decided that emerging Europe is the sub-prime of Europe and now everybody is running for the door," said Lars Christensen of Danske Bank.

The European Central Bank, still imposing the highest interest rates in "mature" economies, is at sixes and sevens over "non-standard measures" such as quantitative easing.

There's worse news to come as governments grapple with the Everest of toxic and impaired assets still sitting on banks' balance sheets – perhaps as much as €18 trillion in Europe alone. Last week, the EU's 27 finance ministers were told by the European commission that go-it-alone policies and a subsidy race for ailing and sound banks could trigger "a drift towards financial protectionism and fragmentation of the internal market".

In other words, the whole of the EU could be Balkanised, leaving in tatters the single market, the pride of Jacques Delors and engine of relative prosperity, growth and jobs in Europe for two decades.

The commission's "draft guidance paper" on how to treat toxic assets warns dramatically that this drift could develop into a torrent, with weaker banks damaging even further the real economy, requiring even more state aid, sending government borrowing sky-high and necessitating self-defeating tax increases. "Such risks are serious given the likely scale of state exposure," it says.

In the week beginning 22 February, there are three EU events designed to stop the poisonous rot attacking the central nervous system of Europe.

First, Neelie Kroes, the EU competition commissioner, and colleagues could finalise guidance for governments circling around different models: a state-owned bad bank, a public-private fund for holding and disposing of impaired assets or a UK-style liability insurance scheme for banks retaining the poison they manufactured on their trading books.

Kroes, under siege from many governments for allegedly delaying approval of bank and industry rescue schemes, has, in fact, been highly flexible in applying state aid rules as she struggles to reassert the single market. "If every country acts according to 'my way or the highway', the banking sector as a whole – and with it the entire world economy – will suffer for many, many years to come," she told the OECD in Paris.

Secondly, Wednesday sees the commission accept the report of a "high-level expert group on financial supervision" chaired by Jacques de Larosière, the former International Monetary Fund managing director, governor of the Bank of France and president of the European Bank for Reconstruction and Development.

Its report, unusually leak-proof so far, is expected to recommend a single pan-European prudential supervisor to regulate cross-border banks (46 in the EU) and preserve/recreate financial stability through early-warning mechanisms and crisis management.

Phew! What we know is that Brother Jacques has, in this regard, favoured a pivotal role for the ECB – a position that would be endorsed by at least some of the central bank governing council members. Certainly for the 16-strong eurozone and, maybe, for the EU as a whole.

Given the long deadlock over agreeing to more centralised supervision of the EU insurance sector, which generates premium income of €1.11 trillion and invests €7.2 trillion, this seems nigh impossible. The 27 member states will immediately start squabbling and picking apart the recommendations, which are due to be formalised by the EC on 4 March.

Gordon Brown, who proposed a strengthened "college of supervisors" on a global scale back in the autumn of 2008, will resist any proposal to boost the regulatory powers of the ECB. But, unusually and pertinently, a series of City bodies have proposed to the de Larosière team much greater and urgent strengthening of existing "colleges" for securities, banks and insurance.

Stuart Fraser, the head of the City of London's policy and resources committee, has even given a nod to more radical changes "as long as they could demonstrably deliver better outcomes".

The Association of British Insurers says it is willing to countenance a debate on a single prudential supervisor "to overcome the current lack of trust between European regulators".

The UK accountancy body, the ACCA, is a bit more iffy, worried that EU countries are already seeking exemptions from new international standards.

Stage three, in a week billed as momentous but, as ever, likely to deliver a mouse, is the 1 March (Sunday!) emergency EU summit on how to beat the crisis, called by the Czechs, the current EU president, in protest at French moves to rescue their auto industry. They want a "clear no to protectionism" to emerge – as it did at the Washington G20 summit in mid-November with zilch effect.

And the euro? It's clear that the ECB is closing ranks around current members, slamming the door of the "safe haven" shut against would-be entrants not only in eastern Europe but elsewhere (Iceland) for years to come. But the 10-year-old central bank faces its toughest year yet as members such as Ireland and Italy come under severe default pressures.

But, again, my French socialist friend, Pervenche Beres, who heads the European parliament's economic and monetary affairs committee, has the last and, probably, correct response to "catastrophic" comments: "The cost of leaving the eurozone would in fact be so high for the country concerned and for European monetary union that such a scenario is just not possible."

http://www.guardian.co.uk/business/2009 ... ion-policy