The Eurozone Crisis and Debt Mutualization: Assessing the Merkel Government View

The north-south divide over the future of the euro is damaging the EU. However, a compromise by which the two sides might settle their differences to mutual advantage is suggested here—after the Merkel government’s approach to the euro crisis solution policies has been sketched. After the European summit of June 2012 decided to break the vicious circle between banks and sovereigns it seemed that political leaders were at last ready to deal with the threat to the euro. But optimism was soon lost in the cacophony of rival interpretations about what had been agreed. Still, the leaders had identified the critical issue: weak banks and weak sovereigns are like two bad swimmers that are pulling each other under water. But which one should be saved first? Advocates of the Southern view, say we should start with the sovereigns, by throwing them the lifejacket of joint-issued debt. In effect, richer countries would guarantee at least part of the debt of weaker ones. Representatives of Northern opinion, especially the Merkel government, reckon instead that it is better to start by saving the banks. This would be done through stronger central supervision and the mutualisation of some liabilities in the banking sector, for instance through a joint fund to wind up failing banks and provide a Europe-wide guarantee of bank deposits. In effect depositors in solid banks would be guaranteeing the savings of those in more fragile ones. The Southern view, held by countries like Greece, Italy, Portugal and Spain and, since François Hollande has taken office, France. The Northern approach is taken by Germany, Austria, Finland and the Netherlands and, while Nicolas Sarkozy was president, France. Both sides recognize the danger that debt mutualisation could bring moral hazard and higher costs for creditor countries. For the North there is no getting around these problems. For the South these risks can be removed, or at least mitigated by a careful design of the system. For instance, the Eurozone could impose conditions on countries seeking the benefit of jointly issued debt. The South sees as the main threat to the Eurozone the panic that can increase borrowing costs and push countries into insolvency. The North reckons that the principal menace stems from removing this market pressure too quickly, dampening the need to reform. Both speak of the political backlash. For the South it is excessive austerity in debtor nations that should be resisted; for the North it is excessive liabilities in creditor states that can cause resentment. In some ways, though, the two sides are not so far apart. The North concedes that it is necessary to have some mutualisation of debt, if only to recapitalize banks. The South accepts that debt mutualisation must be limited to avoid moral hazard.