BAE/EADS deal collapse shows national interests still rule when it comes to defence

A lot of people on both sides of the Europe debate got very excited last month about the ‘Future of Europe’ report produced by a group of EU Foreign Ministers chaired by Germany’s Guido Westerwelle. The report was certainly controversial, not least for suggesting “more majority decisions in the Common Security and Defence Policy sphere… and in the longer-term a European defence policy which for some members could eventually involve a European army.”

As we argued after the report was published:

“There is significant momentum for more integration in economic, fiscal and banking affairs, but its hugely unlikely to spill over into foreign policy which exists in a parallel political sphere… The context for this whole initiative is effectively German domestic politics… For Merkel this serves as a useful exercise at a time when the German government is über-sensitive to accusations that it is not sufficiently ‘pro-European’ - but without actually having to do anything."

This interpretation has arguably been supported by Merkel’s actions over the BAE/EADS merger, when she pulled the plug on the deal. As the Guardian reported:

“Sources close to the deal said that the German chancellor, Angela Merkel, had emerged as the most significant obstacle to an ambitious transaction that would have created an industrial behemoth with 220,000 employees worldwide, making products from nuclear submarines and Typhoon fighter jets to the A380 superjumbo.”

“Speaking before the deal was officially terminated, the source said: "The fundamental problem is that Merkel does not feel comfortable with the deal, full stop. The source added that the German leader appeared to have deep concerns over the notion of merging a civil aerospace manufacturer with a defence group.”

So national interest considerations when it comes to defence are not dead yet it appears… even in Germany.

Perhaps the UK should join the banking union after all (here's why...)

Update 11/10/2012:
For the avoidance of doubt, this post was clearly meant to be lighthearted, we have pointed out plenty of flaws and inconsistencies in the banking union proposals both from the UK perspective and the eurozone's (see here, here and here). The idea, which we seem to have failed to express clearly, is to highlight the inconsistencies in the banking union proposals but also that a concept, weighting votes according to shares of a specific sector, which people in the UK have previously suggested and been laughed out the room for is now being suggested by Germany.

**************

Negotiations on establishing the ECB as the eurozone's single banking supervisor, the first stage of the much heralded (but yet to make much progress) proposals for banking union, made little headway at yesterday’s meeting of EU finance ministers.

As we noted on our blog last month - and reported by the FT today - Germany has been insisting on altering the ECB’s one-country, one-vote governance system by matching voting weights on the ECB's proposed supervisory board to the size of countries’ financial sectors. This would radically increase its power and ensure it cannot be held hostage to member states who have much less to lose if eurozone/EU-level banking rules don’t go their way.

Wait a minute. Should the UK not take up the Germans on their offer? Linking voting weight in the EU to the size of member states’ financial sectors - in the European Banking Authority or in the Council for example - would immediately eliminate fears over the eurozone writing the rules for all 27 using an inbuilt majority (a scare amongst British diplomats and officials).

And in a spectacular fashion. The graph below (click to enlarge), taken from our report on EU financial regulation, published in December 2011, charts member states’ share of the wholesale finance market against their voting weights under QMV. The blue column - share of wholesale finance - would represent the new voting weight under a German-style system (if it was directly proportional).

Perhaps the UK should join the banking union after all...

Berlusconi's farewell?

Over the past few months, Silvio Berlusconi repeatedly suggested (but never 'officially' confirmed) that he intended to run for Prime Minister in next year's general elections. However, he now seems to have backed down over his planned return. In a TV interview his morning, he made a couple of unequivocal remarks:

I want the unity of [Italian] moderates, and in order to achieve it, if necessary, I'm even ready not to run [in next year's elections]. 

What's strange about it? I intend to do what's good and useful to my country and...if I need to step aside, I'll do it. 

There's no trick or room for second thoughts. 

In other words, Il Cavaliere's well-known (albeit slightly anachronistic) obsessive fear of 'leaving the country in the Communists' hands' seems to have prevailed in the end. But this was by far the most interesting part of the interview,

I wouldn't rule out [Italian Prime Minister] Mario Monti as the leader of this moderate front. Monti has always moved within this political area.

Berlusconi is clearly not averse to U-turns - but, as we pointed out on this blog before, he is also a seasoned politician. Now, the latest opinion polls have all signalled that his party is in a free fall, as it would win only 15% of votes if elections were to take place now. However, the same opinion polls also show that centre-left Democratic Party only commands around 25% of support.

With comedian Beppe Grillo's Five-Star Movement consistently polling at around 20% and consistently ruling out post-election alliances with the 'old political establishment', Italy's two mainstream parties may ultimately have to go for some sort of German-style 'grand coalition' (possibly including a couple of smaller, pro-reform centre parties) if they want to achieve a sufficient majority - which, incidentally, now appears to be the only chance for Berlusconi's party to stay in government after the elections.

If confirmed, Berlusconi's decision not to stand in next year's election would therefore clear what would, otherwise, arguably be the main obstacle to such a solution. And Monti? Well, he is clearly not keen to stand in the elections - not least because that would involve picking up a political party to back his candidacy.

However, under Italian law, it is the Italian President who is responsible for tasking someone with forming the new government - and the person does not necessarily have to be the leader of one of the political parties that contested the elections. Therefore, if Italian party leaders converge on a second mandate for Monti, he may have to follow up on his pledge to "be there" for Italy, if the country's political forces ask him to stay on.
        

How to make Cameron's EU veto threat actually count

On the Telegraph blog, we argue,

Europe has just sailed up the agenda at the Tory party conference, with Theresa May suggesting curbs on EU immigration and David Cameron hinting at another EU veto. Speaking of the ongoing talks over the EU’s long-term budget (2014-2020), Cameron said: "If it comes to saying no to a deal that isn't right for Britain, I'll say no." 

The problem for Cameron is that unless anything changes, the EU budget talks will almost certainly generate a bad deal for Britain, both in terms of content and cash contribution. 

For various reasons, EU budget talks are always biased towards the status quo, as special interests – such as the farming lobby – block meaningful reform through individual member states’ vetoes. Therefore, on its current path, the UK will keep its rebate from the EU budget, but the EU’s odd spending priorities will remain. This means that around a third of the EU budget will continue to go towards subsidising landowners – irrespective of whether they’re engaged in any meaningful economic activity. 

Another large portion – the so-called structural funds – will continue to see cash pointlessly recycled between some of Europe’s richer regions and countries and spent on projects with little, no or negative impact (though another chunk goes to Europe’s genuinely poor regions). 

The EU’s new long term budget could account for roughly €130-140 billion a year – not a huge amount in the grand scheme of things – but with Europe facing a solvency, competitiveness and banking crisis all at once, this money could still make a big difference if targeted properly. It’s therefore absolutely maddening that the EU budget remains unreformed on its content. 

At the same time, even if the UK manages to get what it’s pushing for – an inflation-adjusted cash freeze (based on 2011 payment levels) – the UK’s net contribution will still increase, since more money will (rightly) go to newer member states which aren’t covered by the UK’s rebate. In turn, any actual increase – and it’s heading in that direction in the ongoing EU talks – will naturally mean an even larger net contribution for the UK. 

 Therefore, Cameron is a very unenviable situation: even if he gets what he wants in negotiations, UK taxpayers will still be forced to cough up more cash to pay for the EU (in net terms). Clearly, this could be politically damaging. 

So how can he get out of this? 

As I’ve argued before, he should instead use the veto to seek the repatriation of the structural funds for richer member states (with a GDP of 90 per cent or above the EU average). This would reduce the UK’s net contribution substantially – possibly by several billions over next budget framework. At the same time, the UK would remain committed to support Europe’s poorest, as all post-communist member states that joined in 2004 and 2007 would do better from the funds (for how to deal with Italy, Spain and Greece – the only countries in the EU actually losing out under this proposal – see here). 

UK regions and urban areas also need far better tailored and targeted cash than what is offered by EU funding. In addition, as this was originally a Labour policy, it has the potential to gain cross-party support at home.

Now, as ever in EU politics, this isn’t uncomplicated. If Cameron insists on the veto, it won’t necessarily stop the process. At worst, it could lead to an ad hoc deal decided on a year-by-year basis through Qualified Majority Voting. But most member states have a huge incentive to avoid this happening. It would be extremely messy and most of them would lose out substantially compared to a new deal. 

Therefore, targeting the structural funds for reform remains the best option for Cameron – by far. Beyond party politics, it’s the right policy to pursue, as it would benefit both the UK and Europe – and finally inject some common economic sense into the EU budget.

Birmingham: Three things Cameron should say on Europe and three he should not

Over on Conservative Home, we argue,

Conservative Party conferences are too often overshadowed by Europe. This has, in the recent past, led the leadership to attempts to avoid discussion, clamp down on debate and hope nobody notices. Given the changes currently going on in the eurozone I think it would be a mistake to try that again this year. If the Conservative leadership does not set out a strong narrative it will be in danger of again being held hostage by those who do. So here are three things David Cameron should do to take the initiative and set out a distinctive Conservative position on Europe and three he should not. 

Firstly, and most importantly, David Cameron should set out an overall vision of the UK in the EU post-eurozone crisis. This should be based on being in the single market but not in the Euro, with new membership terms that recognise the UK is not headed towards further integration, whatever the speed may be. He should be honest about the need for re-negotiation, the chances of success and the timescale, but set out that as the EU is changing there is no other option - the UK cannot cling to the status quo. 

Secondly, he can build credibility for his renegotiations by re-emphasising that the UK will use its right to opt out of 130 crime and policing measures and will not opt back in to any of them while the threat of ECJ jurisdiction remains. He should explain that as the UK is not on route to becoming a part of a unified EU political entity it cannot allow the European Court of Justice to have a role in this sensitive area. He can be open to further cooperation, but given recent history not within the current EU legal structure. 

Thirdly, David Cameron should set out the case for a new EU budget that recognises the need for fiscal responsibility and shares the tough decisions being made in some parts of Europe. We have argued before that this should involve the repatriation of regional policy, saving the UK billions, an idea other donor states like Germany would also appreciate. If no reform is initially forthcoming David Cameron should say he will use the UK veto to force the pace. 

There are also three things that David Cameron should avoid doing. 

Firstly, David Cameron should neither promise an in/out referendum nor rule one out. Promising one will, split the Conservative Party, close down all sensible discussion of reform and potentially lock the UK into an unreformed EU if it votes to stay in. Ruling one out would equally be wrong; we cannot prejudge the UK’s renegotiation of its membership terms nor know the future direction of the EU. 

Secondly, David Cameron should avoid talk of Coalitions beyond 2015. On this more than any other subject the Coalition agreement has already been overtaken by events. When the time comes for an election the Conservatives will need their own distinctive policies based on renegotiation and giving people a say. If discussed in the context of a ‘continuity coalition’ they will lack all credibility. 

Lastly, he should avoid the pitfalls of insulting those who have strong view on the EU. Terms such as “bastards”, “nutters, fruitcakes and racists”, “head bangers” or simply “nasty” (or as Nick Clegg would have it "insular", "chauvinistic" and "short-sighted") are not only deeply unfair to those who have often been proven right, but will further polarise the debate, acting as a recruiting sergeant for UKIP.

David Cameron should instead reach for the middle ground, and say something like, "I want an EU that concentrates on trade, fiscal responsibility and structural economic reform and want it to stop doing everything else. You want it to stop the EU doing everything else but will need to come to an agreement on trade, so we share a similar end point, the difference being I wish to use this opportunity to see if the EU is capable of reform." 

Another cold front on the way from Europe?

Ofgem's 'Electricity Capacity Assessment', published today, makes for some interesting reading as we enter the winter.

This is from the executive summary:

The high level of spare capacity in the GB electricity market is set to end quite rapidly over the next few years. As identified in our 2009 Project Discovery analysis the impacts of replacing older coal and oil power stations under EU environmental legislation together with changes to the generation mix over the next decade pose new challenges to security of supply. Recent developments have strengthened this view. Indeed, power stations 'opted out' under the [EU's Large Combustion Plant Directive] are using up their running hours faster than expected: most LCPD opted out plant will come off the system well before the 2015 deadline.

In short, a mixture of EU environmental legislation and a change in the UK's energy mix, also driven in large part by EU renewables targets, means that the UK's spare energy generating capacity could fall from 14% now to only 4% in three years, under Ofgem's baseline scenario. The graph below shows that in a 'high winter peak demand' scenario, the situation could get far worse, with the UK having no spare capacity in 2015/16, which could very likely to lead to blackouts.

So, as well as trying to get a lot more gas and nuclear power stations built, the UK Government may also need to choose between complying with EU environmental legislation and keeping the lights on.

EU Summit: Everyone is a winner... for now

As is traditional, a leaked copy of the next EU Summit Conclusions has already been making its way around the media long before the summit has even commenced (due on 17-18 October).

As it is still an early draft, little can be drawn from these 'conlcusions' but so far the officials charged with drawing them up seem to have dropped in something for everyone:

France, has received a mention of an EU Financial Transaction Tax despite, as we reported yesterday morning, it still being far short of the nine states needed for the project to get off the ground.

Germany, has received an assurance that there will remain a "clear separation" between the ECB's monetary policy and its new supervisory functions - another clear hat tip to Bundesbank demands that price stability (inflation) remains the ECB's primary focus.

The UK and other non-euro states, have recieved an assurance that there will be a "level-playing field" (an English expression) in the new supervisory structures under the proposed eurozone banking union and that the "integrity of the single market" will be preserved for financial services.

The UK has also managed to insert a phrase regarding the "voting modalities" in the European Banking Authority, which the document suggests will be looked at to ensure non-eurozone countries will not be prejudiced by a Eurozone caucus.

The MEPs, often an obstacle when it comes to financial regulation, have been promised that the ECB will have "appropriate accountability" in its newly widened role. This is unlikely to placate their desire for new powers but might buy some peace.

Spain, has received wording designed to calm its bond market by raising the prospect of ESM direct bank recapitalisation including 'legacy assets' (i.e. bank bailouts which have already taken place being shifted onto the ESM books). The draft wording calls on the Eurogroup (read Germany, Finland and the Netherlands) to "agree on the exact operational criteria that will guide bank recapitalisation by the ESM in full respect of the 29 June Euro Area Statement". This could still go either way, but Commission President Jose Manuel Barroso has made it clear that he wants Germany to stick to the plan as was originally envisioned/interpreted.

This is, of course, all well and good, but we find it hard to imagine that the final conclusions will be able to maintain what everyone wants. There are likely to be some fights along the way (not least over the last point), lets hope the UK Government is ready to ensure its needs remain included.

EP Vice-President: send the military police to Catalonia

What happened to the EU as a peace project? 

To many of our readers, Alejo Vidal-Quadras (see picture) will not ring a bell, but he is one of the Vice-Presidents of the European Parliament, and a member of Spanish Prime Minister Mariano Rajoy's Partido Popular. In the category 'unhelpful comments', Señor Vidal-Quadras has hit the jackpot.

Commenting on the tense situation in Catalonia - and the recent calls for a referendum on independence - he said,

Things must be said clearly. The [pledge to call a] referendum is illegal. An institution of the Spanish government, the Catalan parliament, has made a decision against the existing system.

Further to taking this decision to court, the government has to get in touch with [Catalan President Artur] Mas and tell him, ‘What you’ve done breaches the law. Rectify it, or else we will have to intervene’. If [Mas] refuses to do so, the [Spanish] Senate seats, votes, the [Catalan] parliament is dissolved, the Catalan government goes home and a delegation of the [central] government takes over power in Catalonia.

A Brigade General [of the Spanish Guardia Civil]…takes over from the Mossos d’Esquadra [Catalonia’s regional police corps]. And that’s it. If people take to the street, so be it, but they can’t go on demonstrating for more than a month. Demonstrations don’t feed the people. If [the Catalans] persist with this rebel attitude, the government has to intervene in the rebel region.

Vidal-Quadras is Catalan himself, by the way...

Now, this is a very tricky debate involving a huge number of aspects. But, unsurprisingly, Vidal-Quadras was shut down by his own party. In a TV interview this morning, Alicia Sánchez-Camacho (the leader of the Catalan branch of Partido Popular) said Vidal-Quadras was speaking in his personal capacity, as he does not hold any 'significant' position within the party - which goes to show how important many national politicians consider the European Parliament to be... 
 

The quest for a healthy European banking sector

Yesterday saw the release of the hefty Liikanen report (a dense 153 pages) on the European banking sector. We’re yet to fully sift through the report but there a quite a few eye catching graphs and statistics which we thought worth flagging up.

In brief, the Group recommends actions in the five following areas:

• Mandatory separation of proprietary trading and other high-risk trading activities. 
• Possible additional separation of activities conditional on the recovery and resolution plan. 
• Possible amendments to the use of bail-in instruments as a resolution tool. 
• A review of capital requirements on trading assets and real estate related loans. 
• A strengthening of the governance and control of banks. 

Many ideas which will be familiar to those in the UK and there are plenty of reasonable suggestions - which we'll return to. We would note though that in Europe even small banks caused problems while the largest banks which caused the initial financial crisis were investment banks with no retail element. In some cases better supervision and enforcement of regulations is more important than the actual structure of the banking sector itself. But for now, take a look at these graphs - from the report - which raise some interesting questions over the proposition of a eurozone banking union:

The table and graphs above demonstrate the simply massive size of some of Europe's banks, even in comparison to those in the US and Japan. This drives home the fact that, for a banking union to ever really work or be effective there must be combined deposit and resolution fund backing it up, something which the eurozone is now shying away from. This is also a much larger decision than the eurozone is currently making out the banking union and single supervisor creation out to be.

Spanish deficit: The saga continues

Keeping count of how many times Spain's deficit targets and forecasts have been revised has become a challenging exercise. Following the publication of its draft budget for 2013, the Spanish government has admitted that Spanish deficit at the end of this year will be as high as 7.4% of GDP - with the EU-mandated target fixed at 6.3% of GDP - once the potential losses on the government's recent cash injections in the banking sector are taken into account.

However, pending official confirmation from the EU's statistics body, Eurostat, it looks like aid to banks will not be counted in the Excessive Deficit Procedure (EDP) currently open against Spain. Speaking after his meeting with Spanish Prime Minister Mariano Rajoy yesterday, EU Economic and Monetary Affairs Commissioner Olli Rehn suggested,

It can be expected that this kind of element of increase in the fiscal deficit related to bank capitalisation will be treated as a one-off and will not affect the structural deficit.  

We would not be too sure that this settles the question, though. First of all, the EDP covers more than just the structural deficit while other one off impacts (such as Portugal's transfers from its pension funds) have counted towards reducing the deficit. Secondly, it will be interesting to see how Germany, Finland and others will react - given that, in practice, Spain has just said that it will fail to meet its deficit target again.

In the meantime, as we pointed out on this blog last week, the time for big decisions is approaching for Rajoy. The results of the stress tests have been published, and the draft budget for 2013 has been unveiled. In particular, both the European Commission and Spanish Economy Minister Luis de Guindos have stressed that the measures planned by Madrid for next year go "beyond" the recommendations Spain has been made under the new 'European Semester' - potentially paving the way for an EFSF/ECB bond-buying request without unexpected additional conditions attached to it.

Unsurprisingly, rumours of an imminent request have kicked off. According to a senior European source quoted by Reuters,

The Spanish were a bit hesitant but now they are ready to request aid.

With the next meeting of eurozone finance ministers taking place on Monday, this weekend looked perfect for Madrid to apply for an EFSF/ECB bond-buying programme. However, Rajoy reportedly told a meeting of regional Presidents from his party that he would not make the request this weekend. During a press conference less than an hour ago, he also replied with a curt 'No' to a journalist asking whether the request was "imminent."

The domestic political reasons for a delay in the decision (key regional elections in Basque Country, Galicia and Catalonia over the next two months, plus the obsession with avoiding humiliación) are well-known. Apparently, Germany is also standing in the way. Sources have suggested that the German government is keen to "bundle" Spain, Cyprus and Greece into a single dossier, rather than submitting individual aid requests to the Bundestag for approval.

Beggars cannot be choosers, and Rajoy cannot simply ignore Germany's reservations. Luckily for him, they could even turn out to be convenient on the domestic front. As in previous instances, though, the markets will likely play a big role in the timing of any bailout: a sharp surge in Spain's borrowing costs could certainly precipitate a request. Should this happen, Rajoy would find plenty of occasions to present a formal request for aid - the next one potentially being the EU summit on 18-19 October...  
 

Labour and ‘Europe’: substance or party politics?

Open Europe has just returned from holding two fringe events at the Labour Party Conference (write ups of these to follow here), an occasion that can be a useful barometer for assessing opinion within the party.

Shadow Foreign Secretary Douglas Alexander used our joint event with BNE and CER to state that “there is almost total unanimity for Britain’s continued membership in the European Union.” And, though Alexander made several valid points (including the Tories' poor handling of the announcement of the 2014 EU JHA block opt-out) it's clear that in large part, Europe simply remains a stick with which to beat the Tories. Shadow Cabinet Minister Jim Murphy’s suggestion that, “at some point, there will have to be a referendum on the EU” would seemingly fall into that category. Mr Murphy added "My preference would be an in-or-out referendum when the time comes” and that “almost everyone” in the Labour Party would campaign to stay in the EU, “because it is good for our economy and good for Britain”.

It must be extremely tempting for Labour to go for that in / out referendum and witness the Tories tearing themselves apart (or so the thinking goes). But a) that's hardly a noble motive for putting a hugely important issue to the people (Labour likes to talk about putting national interest before party) and b) it would be an absolutely massive gamble: if held now, the "in" side would almost certainly win, but in 2015-16, all kinds of unpredictable stuff could have happened in Europe that would change the equation. The dropping popularity of Hollande and Rajoy, just months after entering office, is a reminder that 'political honeymoons' are shortlived in European politics these days. Therefore, even calling a referendum right after being elected is no guarantee.

There was much talk of lost ‘influence’ at the conference but little of substance to suggest how Labour’s approach would be different to the current government on the fundamental issues such as the fiscal treaty (would the party opposed to 'mindless austerity' really want to sign a treaty enshrining the doctrine?), the EU budget (Labour recognise the need for reform as do the Lib Dems and the Conservatives), and banking union (Although it does not necessary like to admit it, a Labour government would need to go out to bat for the City in Europe).

However, encouragingly, there are some senior figures in the party who are willing to enter into a debate about the future of the EU. Shadow Treasury Minister Chris Leslie told our joint fringe meeting that the tensions between Eurozone-level decision making and national democracy were “at risk of undermining the European settlement.” He added that the Eurozone needed to find an answer to the question of how to “hold accountable those who make executive decisions in the Eurozone.”

He said that the continuing EU budget negotiations were the “next big diplomatic test” for the UK and that he was disappointed that there was not enough focus on the content of the budget – an argument we have made both of the CAP but also the Structural Funds, where a previous Labour Government policy would actually save the UK around £4bn over the budget period and better focus the remaining EU funds. In contrast, the current government has taken a somewhat less assertive approach (contrary to popular belief).

Some preliminary thoughts on the stress tests for Spanish banks: lots of optimistic assumptions...

Here is the full report (and the bank-by-bank results) from the latest Spanish bank stress test exercise. Below we provide the key points and our initial thoughts on them.

The tests put the total capital needs of Spanish banks at €59.3bn, but Spanish Deputy Finance Minister Fernando Jiménez Latorre (in the picture) just told journalists during the press conference that, assuming that Spanish banks manage to raise part of the money from other sources, the Spanish government could ask the EFSF for "around €40bn" (as we anticipated here).

Key points: 

• 14 banks assessed, 7 found to be well capitalised, 7 found to need capital injection. Total needs put at €59.3bn. This falls to €53.75bn when the mergers under way and the tax effects are considered;

• €24.7bn of the total amount is earmarked for Bankia alone, with a further €10.8bn for CatalunyaCaixa and €7.2bn for NovaGalicia;

• The adverse economic scenario assessed was: 6.5% cumulative GDP drop, unemployment reaching 27.2% and additional drops in house and land price indices of 25% and 60% respectively, for the three-year period from 2012 to 2014;

• Cumulative credit losses for the in-scope domestic back book of lending assets are approximately €270bn for the adverse (stress) scenario, of which €265bn correspond to the existing book. This compares with cumulative credit losses amounting to approximately €183bn under the base scenario.

Open Europe take: 

• The base case scenario seems overly optimistic, the adverse scenario looks more realistic - although we expect a fall in house prices of around 35% rather than the 25% assumed. The prediction that unemployment will peak at 27.2% also seems optimistic given that there is plenty more austerity and internal devaluation to come while the structural labour market reforms are yet to take effect.

• Oliver Wyman's report strongly assumes that all the previous capital buffers and loan loss provisions have been well implemented with suitable quality of assets. However, this is far from assured;

• The level of non-performing mortgage loans seems incredibly low at 3.3% currently with losses only predicted to rise to 4.1% under the adverse scenario. This number could well be distorted by forbearance (delaying foreclosing on loans likely to default to avoid taking losses) by struggling banks. It will also massively increase if unemployment and economic growth turn out to be worse than predicted;

• The levels of recovery on foreclosed assets seem a bit too positive (admittedly a wide range of between 37% - 79% losses depending on type of asset) given the continuing oversupply in the real estate market in Spain. Until the market has fully adjusted, the huge mismatch between supply and demand is likely to keep resale value on foreclosed assets incredibly low;

• These tests do look to be more intense than the previous ones but ultimately the optimistic assumptions do instantly raise questions over their credibility. The structure of the bailout request is also unlikely to enamour investors, who like to see grand gestures, however, it always positive that taxpayer participation may be limited. 

 

What keeps the folks in Brussels and Berlin awake at night?

Possibly this graph - from our new report on the internal devaluation needed in the PIIGS for the euro to remain intact.

Source: Eurobarometer

It shows how trust in the EU amongst voters in the PIIGS has on average fallen from 55%  in 2001 to 25% in 2012, in the wake of EU-mandated cuts. On average, 66% of voters in these countries now mistrust the EU (up from 26% in 2001). And Spain still has half of its internal devaluation ahead of it (not to mention Greece). This won't be easy.

Initial thoughts on Spain's latest austerity budget

We’re still waiting for the full breakdown and figures behind the Spanish budget (which we will analyse and post in due course) but in the meantime here are our initial thoughts:

• The decision to tap the pension/social security reserve fund for €3bn was surprising. Generally this is a fairly last resort approach, but why Spain felt the need to do this to get its hands on only €3bn isn’t clear, especially with short term borrowing costs still low. Could Spain’s liquidity problems be greater than thought?
•  The interest Spain will have to pay on its debt will go up by €9.7bn, compared to a total package of cuts of €40bn (undoing almost a quarter of them). For a country the size of Spain even seemingly substantial cuts can easily be offset by the massive debt burden.
• The majority of the savings (58%) will come from spending cuts rather than tax increases – there is an on-going debate over which is more effective but in the short term spending cuts are likely to harm economic growth (especially given the reliance on the state as an economic driver in Spain).
• Tax revenue is expected to go up by 3.8% - given that growth is likely to falter this seems incredibly optimistic, even with some tax increases.
• The basic macroeconomic forecasts for the budget haven’t changed – this suggests that the overly optimistic growth forecasts are likely still in place, despite most investors and international agencies reducing their forecasts.
• Unemployment is predicted to have topped out this year – again this seems hopelessly optimistic given that structural labour market reforms are yet to take full effect (and there are still more to come) while internal devaluation will need to continue at a rapid pace (see our recent briefing here for more info on this).

So, plenty of issues already, with what seems to be a fairly unconvincing budget given the state of the Spanish economy. 

One final point to note is that Spanish Economy Minister Luis De Guindos kept insisting that the measures were all in line with recommendations from the EU/IMF/ECB troika or in some cases even went further. This looks to be leading into a Spanish reform programme as part of a bailout/bond buying scheme, hinting that Spain may be preparing that request after all.

Not quite a U-turn, but still big news from Monti

Speaking at the Council on Foreign Relations in New York, Italian Prime Minister Mario Monti has made an important announcement regarding his political future after next year's general elections.

He said,

Under special circumstances, which I hope won't occur, I may be asked to come back. I may consider this hypothesis, but I hope not to have to. 

And then went on, 

If requested by [Italian] political forces, I'm available for a second mandate. 

By far the most explicit declaration of intent made by Monti during his time as Italian Prime Minister. But this is not strictly speaking a U-turn. What Monti has said so far (most recently in an interview with the CNN two days ago) is that he will not run in next year's general elections.

However (as we suggested here), he may be willing to stay on, if needed, as the head of a broad coalition of reformist parties.

We're now awaiting the official confirmation of Berlusconi's comeback? 
 

Germans vs Inflation: the battle continues

In our daily review of UK and continental press, we spotted an interesting consumer analysis survey referenced on the front page of Bild yesterday. The survey - conducted by Axel Springer AG and the Bauer Media Group - found that Germans were conservative and prudent in terms of their finances with 67.9% of respondents possessing a savings book, 57.2% setting aside a specific sum every month, with only 33.8% having a credit card.

In contrast, in 2010, 64% of the UK’s adult population had a credit card – almost double that of Germany’s. This could possibly help to explain how the German and UK debates on the eurozone pass each other by so often, especially when it comes to the role of the ECB. The view from Berlin is that the ECB ought to remain as the guardian of price stability and not engage in activist monetary policies such as bond-buying, while the view from London, Washington and indeed other European capitals is that Draghi’s recent actions mark a decisive turning point in the crisis, and that it is good that he has been able to overcome German resistance – as argued by David Laws at an Open Europe fringe event at the Lib Dem conference.

Incidentally, former ECB chief economist Otmar Issing has an interview in yesterday’s Die Welt in which he warns against the social and economic damage of unchecked inflation:

“Many people come up to me on the street. Savers are deeply insecure and they have every reason to be. [The ECB’s] monetary policy has reached its limits [it] risks losing its credibility.” 

"There is no immediate risk of inflation. However I have my doubts that the ECB will stop its immense liquidity at the correct time. If this fails, prices will rise. I do not anticipate hyperinflation. However, even an inflation rate of 4 to 5% disposes savers and creates social problems… The social partnership between employers and unions, everything depends on a reliable monetary policy. Inflation is the most anti-social policy.” 

“[Pumping more liquidity into the system] is a dangerous argument. In putting out a fire, it is also the case that more water is not always better per se. Ultimately it could turn out that the damage caused by the water exceeds the actual fire damage.” 

Speaking to the German Industry Federation (BDI) yesterday, ECB President Mario Draghi defended the ECB’s new bond-buying programme, and in an apparent swipe at German fears of inflation, that in times of crisis “we cannot always look to the past for answers”. While Bundesbank chief Jens Weidmann may have been isolated in voting against the OMT programme, he retains the backing of a huge swathe of German public opinion which is deeply rooted in the country’s culture of savings and financial prudence.

This battle is not over by any stretch of the imagination.

Pressure mounts again for Don Mariano

Spanish Prime Minister Mariano Rajoy's trip to New York for the meeting of the UN General Assembly is coinciding with a particularly eventful week for Spain, on several fronts.

The Rodea el Congreso ('Encircle the Congress') anti-austerity rally outside the Spanish parliament building in Madrid turned violent yesterday, with 35 people arrested and 64 injured. The day before the rally, the Secretary General of Rajoy's party, María Dolores de Cospedal, recalled that the last time the Spanish parliament was 'encircled' was on the occasion of the failed military coup on 23 February 1981. The day after the rally, Spanish Interior Minister Jorge Fernández Díaz congratulated the police for handling the situation "magnificently". We assume these remarks have not done much to placate the protesters.

The demonstrations are clearly not good news for Rajoy and his cabinet. The Spanish government is due to unveil a new reform plan tomorrow, which may constitute the basis of the new Memorandum of Understanding, if (or should we say 'when'?) Spain decides to make its official request for EFSF/ECB bond-buying. As Rajoy himself anticipated in an interview with today's WSJ, the plan will include measures to cut the number of early retirements and the creation of an independent body in charge of monitoring Spain's compliance with EU-mandated deficit targets. Expect further protests fairly soon.

Meanwhile, the deficit of the Spanish central government stood at 4.77% of GDP at the end of August - with the target for the entire 2012 fixed at 4.5% of GDP. The Bank of Spain has this morning warned that, based on data available so far, Spanish GDP is continuing to fall "at a significant pace" during the third quarter of the year.

On the regional front, the rift between the Spanish government and Catalonia seems to be widening by the day. Catalan President Artur Mas announced yesterday that early elections will take place in Catalonia on 25 November. The autumn is going to be very tense, given that the Basque Country and Galicia will also hold early elections on 21 October. Crucially, Mas went one step further this morning, when he made clear that the Catalan people will be consulted on the issue of independence, with or without the authorisation of the Spanish government.

Furthermore, Andalusia's Treasury Minister Carmen Martínez Aguayo said yesterday that the region will “very likely” seek a bailout from the Spanish government. If confirmed, the request would be for a loan of over €4.9 billion. This means that Catalonia, Comunidad Valenciana, Murcia and Andalusia would, in total, need around 80% of the money in the bailout fund set up by the Spanish government to help all the 17 Comunidades Autónomas.

What else? Oh yes, in case you were wondering, Spain's borrowing costs are going up again. The interest rate on ten-year bonds is above 6% today.

In this context, it looks like Rajoy will not be able to hold out for much longer. The time for key decisions looks to be approaching - potentially marking a turning point for the future of Spain and the eurozone crisis. 

A German euro exit 'not science fiction' for Il Cavaliere

The Huffington Post has decided to go for a lengthy interview with Italy's former Prime Minister Silvio Berlusconi for the launch of its Italian edition. Il Cavaliere sticks to his form on the euro, firing a salvo at Mario Monti (the Italian elections are drawing closer after all), arguing,

"I would have been less servile than Monti to Germany, a hegemonic state which is imposing the rule of rigour and austerity on other European countries - claiming that one can reduce [public] debt through austerity. But this is an illusion: public debt can be reduced by increasing GDP, which means development and growth."

Despite coming from a different political family, this sounds very similar to what France's Socialist President François Hollande said throughout his electoral campaign.

Berlusconi also seems to have revisited previous claims that leaving the euro "wouldn't be the end of the world" for Italy. He now says "it would be hard to exit the eurozone today", adding:

"There are three possibilities. The first one: convince Germany that we can't go on with austerity only. The second one: Germany leaves the eurozone, which is not science fiction given that German banks themselves have considered the possibility of replacing the euro with the D-mark. And the third one: other countries leave the euro, which would, however, mean the end of the single currency and scrapping Europe."

He says he favours the first option. 'Buona fortuna', Silvio.

Asked about his recent criticism of the fiscal treaty - which his party supported in the Italian parliament - Berlusconi claims,

"As the head of the [Italian] government, I fought a solitary battle over the fiscal treaty in Brussels, because France was perfectly aligned with Germany's pro-rigour stance. I even vetoed the inital draft blocking the discussion...In [the Italian] parliament, we voted in favour of the fiscal treaty for sense of responsibility." 

Interesting claim, as Berlusconi stepped down more than a month before the first draft of the fiscal treaty was tabled..  

In other news, Berlusconi is still refusing to officially confirm his comeback.

Westerwelle's journey into fantasy world

The report presented by the so-called ‘Future of Europe’ reflexion group of eleven European foreign ministers, set up by Germany's Guido Westerwelle, hasn't gone down well in all quarters. The initiative was well-intentioned, for sure, but that's what you get when you suggest that Treaty changes should be decided by super-QMV, we suspect.

Der Spiegel quoted a European diplomat "scoffing" at the initiative:

"It is unimportant for the future of Europe, but very important for the future of Westerwelle."

Ouch. The recipe for this report has been largely concocted within domestic German politics with an added pinch of Polish foreign policy - and it's an odd exercise to spend valuable time on. Swedish Social Democrat MEP Marita Ulvskog - hardly anti-EU - described it best:

"I think it's regrettable that the EU spends so much time on something that by my standards are pure fantasies and so incredibly far from reality...there's no popular support [for this] whatsoever."

EU leaders have enough on their plates trying to match austerity with structural reforms and re-jigging the role of the ECB, without entering the realms of fantasy. Herr. Westerwelle might fancy himself as Narninian character but unfortunately we're living in the real world and not in a wardrobe.

UK Government to announce repatriation of EU crime and policing laws (as recomended by Open Europe)

The Sunday Times yesterday claimed that David Cameron will soon announce that the UK government will repatriate some 100+ EU crime and policing laws. According to the paper, the announcement could come before the Corby by-election, expected to take place on 15th November. The idea is to lure Conservative voters away from UKIP (but that's not the only reason for the timing, we might add).

To recap: Under the Lisbon Treaty, the UK has the right to use a ‘block opt-out’ from around 130 EU crime and policing laws, including the European Arrest Warrant, Eurojust and rules on data sharing, or see ultimate jurisdiction over these laws transferred to the ECJ. An unavoidable choice, in other words, between more or less Europe. After using the block opt-out, the UK can then choose to opt back into individual laws on a case-by-case basis.

In a report published in February, we argued in favour of the UK taking the opt-out and then having an honest and open debate about the most crucial laws that it wanted to keep, possibly seeking to renegotiate these so that the ECJ - whose rulings are almost always in favour of 'more Europe' - is left out of the mix. Our recommendation was subsequently backed by over 100 MPs, in a letter to the Telegraph. We have since argued in favour of taking the block opt-out on numerous occasions, calling on the government to announce it this year (giving them enough time to negotiate opt-ins). Absent a major U-turn, the UK government will now follow our recommendation. In truth, it was always going to be difficult for it to avoid taking the opt-out, given the political climate.

The debate has now shifted to what, exactly, the UK government should seek to opt back into, with the Lib Dems and Tories currently in talks, with the former naturally wanting to sign up to more laws than the latter. According to the Sunday Times, "dozens" of measures are on the table - we'll return to what we think the UK should remain part of, in the very near future.

In the meantime, in an exceptionally well-timed debate, Open Europe, alongside Centre Forum, organised a fringe event on Saturday, at the Lib Dem conference in Brighton, looking at this very issue. The debate featured our very own Stephen Booth, Lib Dem MP Tom Brake, Tory MP Nick de Bois and Lib Dem MEP Sarah Ludford. A write-up of the event can be found here.

Meanwhile, in the Far North

One of the consequences of the eurozone crisis is that media, pundits and market analysts have been forced to become experts of what previously would have been seen as the most obscure political events. Thus, the Finnish local elections now have international significance (although they are still not making any headlines) as they serve as a barometer for the extent to which "Europe" as an election issue can trickle through to the local level. The theory being that the closer the issue gets to citizens, the harder for EU leaders to sell more integration.

An opinion poll for Finnish public broadcaster Yle puts the anti-bailout (True) Finns party at 17.2% - three times higher than in local election in 2008. Compared to 2008, all parties except for the Green party and the (True) Finns party would lose voters.

With a majority of voters from all Finnish parties - apart from the small Swedish People's Party - seemingly opposing more eurozone bailouts, expect Finland to remain assertive. Starting with the rumoured leveraging of the ESM.

The view from Sweden: Barroso is making it more difficult to be pro-EU

This is spot-on.

Sara Skyttedal, vice-president of the Youth wing of the European People’s Party – the pan-EU party Commission President Jose Manuel Barroso belongs to – has a blistering piece  in today's Svenska Dagbladet. She takes Barroso to town over his 'State of the Union' address, in which he called for Europe to become a "federation":

"As Vice-Chairman of [the EPP's] youth wing, YEPP, I can only say that representatives such as Barroso make it more difficult to be pro-EU [EU-vän] “

She continues:

"At a time when crises are raging across Europe and when countries need a helping hand, the eurocrats see an opportunity to demand extensive transfers of power and centralisation in return. Barroso suggests the creation of a banking union and argues that the EU in the end must become a federation. This is a frightening development, since even though Barroso himself says that a superstate isn’t the end goal, it is it hard to interpret his vision in any other way.”

She argues that politicians have ”time and again” ignored the subsidiarity principle. Taking aim at the Swedish political class, Skyttedal says:

“Just as there are many signs that the EU makes it harder for member states to fight the centralisation of powers, Sweden has reinforced this tendency on its own”, arguing that the requirement for EU-membership should be deleted from the Swedish Constitution.

“Those of us who are active in the EPP…must take a bigger responsibility for the liberal-conservative family in Europe. In these circles we must dare to bring up the problems that exist. Large parts of our respective parties were once active in the Yes-campaigns, both for EU and euro membership, but it’s time to swallow our pride and take up the fight against supranationalism and to show it’s possible to have a realistic attitude to the EU, which doesn't automatically mean arguing in favour of leaving the project altogether."

“The EPP-family is the biggest one in Europe, but includes members that unfortunately work in the opposite direction to the EU that we rather want to see. What we think the EU needs is less supranationalism, less political interference and definitely not a federation.”

Hear hear.

Sweden isn't exactly a European hegemon (those ambitions pretty much died in 1709) but it's an interesting country for the UK and Europe in at least two respects: first, it's actually doing well, both on the fiscal and banking front. Secondly, how the country responds to the drive for further euro integration will be an interesting proxy for how easy it'll be to reconcile a more tightly knit eurozone block with the EU-27. Most importantly, the banking union with the single market.

70-80% of Swedes oppose joining the euro, and that debate is dead (baring random calls from the occasional politician and opinion former who still cling on to that particular dream - it's almost cute), but the country has fundamental choices ahead of it - such as whether or not it joins the the ECB's banking supervision structure - so Europe needs to be discussed. 

Though a majority of Swedes would echo the sentiment contained in Skyttedal's article, there is still a contingent in Sweden, particularly on the centre-right (associated with Carl Bildt, the Swedish Foreign Minister) that clings on to a vision of an ever-closer integrated EU as a liberal inroads into its dominant domestic social democratic model, and also as a catalyst for Swedish internationalist idealism, i.e. a 'peace project'.

Historically, both of these assumptions contained some truth but firstly, Sweden's social democratic domination has already been broken and secondly, the single currency - clearly - has proven less of a liberal trade project and more an ideological over-reach (think Greece). The eurozone crisis is now causing friction in Europe, rather than the opposite, and it most certainly isn't aiding either Europe in the world or facilitating enlargement (which is a legitimate EU foreign policy tool).

In other words, this traditional Swedish centre-right vision is dated and needs upgrading - which is true for other contingents in the EPP. Skyttedal's article is an important reminder that if we want to save what's good in Europe, Barroso's "federation" vision - which risks a massive popular backlash - is the opposite of what's needed.

The path for true pro-Europeans must lay elsewhere.

ECB's own budgetary discipline not inspiring confidence

With budgetary discipline the only game in town in the eurozone, it must have been a bit of an awkward moment at the ECB when they realised that the bank's new Frankfurt headquarters (pictured), currently under construction and due to be completed in 2014, will come in significantly over budget.

Executive board member Jörg Asmussen let the cat out of the bag in his welcome address at today's 'topping-out' ceremony, revealing in his welcome address that:

We are monitoring the construction progress, costs and price developments very closely, adjusting and adapting where necessary. As a public institution, we are committed to using our resources responsibly. This is essential. So far the ECB has spent approximately €530 million in construction and other costs, including the purchase of the site. In 2005 the overall investment cost was estimated at €850 million at 2005 constant prices. It is anticipated that increases in the price of construction materials and construction activities from 2005 until the completion of the project in 2014 will lead to a €200 million increase in the overall investment cost. 

In addition, there have been a number of unforeseen challenges that needed to be dealt with. The two major challenges unforeseen in 2005 were, first, that the original tender for a general contractor did not yield a satisfactory result and the ECB had to change to a different contractor model, and second, that the Grossmarkthalle – a large industrial heritage building from 1928 – presented a number of challenges that were not detected in the initial examination conducted prior to the acquisition:

• the foundations turned out to be insufficient and required additional support; 

• the roof coverage was found to be contaminated and therefore could not be disposed of as envisaged; 

• and parts of the concrete construction had insufficient steel support.

These factors are likely to account for additional costs of about €100-150 million, or a 10-14% increase in the overall investment cost. The resulting delay in the construction works on the Grossmarkthalle, as well as the entrance building, has been incorporated into the existing time schedule.

So overall the total cost is likely to come in at around €1.2bn, a tidy sum of money, even at a time of multi-billion euro bailout funds. We estimate that the cost of the new building amounts to around half of the outstanding cuts the Greek coalition still has to make in its latest austerity package.

DPA notes that the new building will hold 2,300 personnel, seemingly large enough for a central bank. Although when you consider that the ECB is currently looking to take over the supervision of 6000 financial institutions - a job which national supervisors currently employ tens of thousands of people to do - one does wonder whether another new building could be needed in the near future. 

We can't say the ECB is setting a great example for austerity, especially given that is now a precondition for accessing its new bond-buying programme.

Creative Bailout Thinking, Spanish Style

One should give some credit to the Spanish government for its determination in trying to make bailouts look like something else. Today's El País reports that Spain is planning to request that the unused money from the €100 billion bank bailout package agreed with the Eurogroup a couple of months ago be used to buy Spanish bonds on the primary market.

This, in turn, should be enough - or at least this is what people in Madrid hope - to convince the ECB to start buying Spanish debt on the secondary market. According to the paper, the results of the independent audit of Spain's banking sector - whose publication has been postponed to 28 September - are expected to confirm that Spanish banks need a total capital injection of no more than €60 billion.

Therefore, the Spanish government is confident that, assuming that banks will be able to raise at least part of the money from alternative sources, it will only have to use less than half of the rescue package for bank recapitalisation - which would leave some €55-60 billion available. In other words, Spain sees the possibility of obtaining ECB support without having to apply for a separate EFSF bond-buying programme - i.e. without having to ask for more money.

Good effort, but too many 'ifs' remain. First of all, the results of the audit should not be taken for granted. As we recently argued, the real capital needs of Spanish banks may turn out to be higher than the €60 billion Mariano Rajoy and his cabinet are currently betting on. Furthermore, even if the €60 billion figure were confirmed, it is fair to assume that Spanish banks may face unreasonable borrowing costs on the markets - compared to what is on offer through the bailout funds. Therefore, they may find it much easier to just ask the government for cash.

Secondly, according to the draft agreement that we published on our blog (see here), Spain does indeed have the right to request that part of the €100 billion be used for purposes other than bank recapitalisation. However, in order for this to happen, the Memorandum of Understanding will have to at least be substantially revised and a whole new one may need to be created. Now, Rajoy is assuming that no new conditions would be imposed if Spain were to apply for a bond-buying programme - and the European Commission appears to share his view. However, it is far from clear whether this will actually be the case (see the recent comments from Eurogroup chairman Jean-Claude Juncker and Dutch Finance Minister Jan Kees de Jager).      

Finally, it remains to be seen whether the ECB or Germany will agree to such a plan, especially since it further muddies the water between bailouts and conditionality - not exactly clear cut as it is under the ECB's bond-buying programme.

Rajoy may have to make a decision fairly soon. The markets do not like prolonged uncertainty, and the first signs of impatience are already visible. Whatever the solution, it will need political approval from all the parties involved, as much as creatively adjusting current plans may seem, there is no circumventing this fact. 

Westerwelle's Future of Europe report - worth getting excited over?

The so-called ‘Future of Europe’ reflexion group of eleven European foreign ministers, set up by Germany's Guido Westerwelle, to discuss and propose ideas on organisational and structural change in the EU held its closing meeting on Monday. Yesterday it released its final report and conclusions, the broad thrust of which is that, to emerge from the crisis, Europe needs more economic and political integration.

In terms of the economic and fiscal side, the majority of the proposals in the document have already been agreed or proposed, such as the “reinforced economic governance framework” – i.e. the fiscal treaty and a single supervisory mechanism for eurozone banks. Even the possibility of making the ESM into a fully-fledged European Monetary Fund has already been voiced. Furthermore, these proposals will only apply to eurozone members and any non-euro members who participate voluntarily.

It is therefore the political/institutional side that is the most interesting and here are the key points that we’ve picked out:

• More powers for Baroness Ashton and the EU’s External Action Service;
• More majority decisions in the Common Security and Defence Policy sphere including joint representation in international organizations where possible, and in the longer-term a European defence policy which for some members could eventually involve a European army;
• Strengthening the Commission should be strengthened so it can fully and effectively fulfil its role as the engine of the Community method;
• Moving to a super-qualified majority for future EU Treaty revisions (with the exception of enlargement) which would be binding for those Member States that have ratified them;
• A more “streamlined and efficient system” of EU governance which could include a directly elected Commission President, a European Parliament with the powers to initiate legislation and a second chamber for the member states.

Most of these proposals have been around the block once before but some journalists have gotten very excited about this, with the Guardian splashing the story on its front page. Running with a "Britain is isolated" theme it also noted that:

"The likelihood is that the 11-country consensus will swell into a majority among the EU's 27. Britain also stands apart from this. The 11 include Germany and France, the big ones, plus Italy, Spain and Poland – after Britain the biggest EU countries.”

Well, not quite.

Sure, some of these proposals are conspicuous, and certainly they pose a challenge for Britain. However, many of them have almost no chance of going ahead, certainly not in the immediate future. Firstly, the report represents less of a consensus amongst the relevent states and more of a brainstorming session with lots of dissenting views. As the note itself states:

“The report reflects our personal thoughts. We wish to underline that not all participating Ministers agree with all proposals that have been put forward in the course of our discussions, and that the Member States’ individual treaty obligations and rights within the various policy areas have to be taken into account.”

As stated above, there is significant momentum for more integration in economic, fiscal and banking affairs, but its hugely unlikely to spill over into foreign policy which exists in a parallel political sphere. This is simply a way to re-state the long-standing German desire for a Europeanised foreign policy (the practical difficulties of which have been made clear many times, most recently over Libya).

Super-QMV for treaty change won't happen either - not least since Berlin itself would block it if push comes to shove, as would Paris - unless they would be willing to risk - for example - QMV on the European Parliament's second seat in Strasbourg. 

Banking union, and calls for EU treaty negotiations to be opened by 2014 - as called for by Barroso in his 'state of the union' speech last week - is where the story is at.

The context for this whole initiative is effectively German domestic politics. While no one can question Guido Westerwelle’s European credentials, he is arguably one of the most side-lined Foreign Ministers in the whole EU, and the Future of Europe group is a way for him to show he's still a player.  For Merkel this serves as a useful exercise at a time when the German government is über-sensitive to accusations that it is not sufficiently ‘pro-European’ - but without actually having to do anything. 

Finally, it is worth contrasting the lofty idealism of such - and similar - proposals with the cold, harsh realities of public opinion. As we reported on Monday, support for the EU and the euro has hit an all-time low in Germany, in France a majority of those surveyed said that given the opportunity now, they would vote against ratifying the Maastricht treaty, while the EU debate in the Netherlands is also become more complex.

Germany and banking union: building the chinese wall

Update 14.15: Reuters has seen an internal document drafted by German MPs from Angela Merkel's ruling coalition - setting out their views on plans for a eurozone banking union. The MPs focus on three main aspects:

• ECB oversight should be limited to systemically important and cross-border banks;

• Monetary policy and banking supervision tasks should be clearly separated within the ECB;

• The document also makes clear that deposit guarantees "will not be unified across Europe". They "may be harmonised, but the responsibility must remain national."  

And here is our original post from this morning: 

Yesterday's Die Welt claimed that Germany is pushing a proposal which would see less powers for the ECB's Governing Council under the Eurozone's banking union. Under the Commission's proposal, the ECB's Governing Council would have the final say over both monetary policy and matters of supervision. This could trigger a series of conflicts of interests as the Governing Council would in effect become the judge, jury and executioner - i.e. it would simultaneously make decisions on bond-buying, bank liquidity provisions and whether banks should be recapitalised or closed down (the latter could trigger losses due to the first two). That incentive structure does not feel right, and the 2009 de Laroisière report for the Commission explicitly warned against it.

The Commission's proposal sees supervision responsibilities being outsourced by the ECB Governing Council to a new  Supervisory Board - consisting of representatives from national authorities - but with the Governing Council still having the final say. In addition, the Chairperson and the Vice-Chairperson of the Supervisory Board would be elected from the members of the Governing Council.

According to Die Welt, during last week's meeting of EU finance ministers in Cyprus, Germany put forward a counter-proposal designed to address these concerns. It involves the creation of a completely independent committee within the ECB consisting of national authorities, where voting weights would mirror the size of each member country's financial markets (and therefore their share of the cost). All of this is unconfirmed, but such an arrangement would take care of two issues:

Firstly, a Chinese Wall would be erected between supervision and monetary policy (at least in theory). 

Secondly, unlike the Commission's proposal which fails to spell out whether non-euro countries joining the single supervisory mechanism (SSM) would get voting rights on the new Supervisory Board (an ambiguity which attracted the wrath of Swedish Finance Minister Anders Borg), this arrangement would make joining far more attractive for the likes of Sweden and Poland.

According to Die Welt, the German proposal would give non-euro members a vote on the supervisory board in return for subjecting their banks to the SSM.  There are a huge number of other issues that non-euro countries will still have to consider, such as the constant risk of being outvoted by a eurozone caucus and no discretion on tailored national regulation, i.e. capital requirements (hello Sweden). It is also unclear how this proposal reads legally (the ECB's statute will have to change anyway, but still).

What's clear is that the Commission's proposal still needs a lot of brushing up.