The big idea that won’t fix Europe’s banks

That is the topic of my latest Bloomberg column, and that idea is banking union:

Imagine a pan-European version of the FDIC…By making depositors indifferent to the risks banks take on, the guarantee would eventually spread to other parts of the economy. A financially troubled government, for example, could easily pressure banks to buy its securities — effectively relying on the insurance to support its fiscally questionable behavior. If the government ultimately defaulted, other countries’ taxpayers would be responsible for making the depositors whole — not quite the same as a fiscal union, but pretty close.

Experience suggests this is entirely possible. Around the time of the 2011 sovereign-debt crisis, European banks were very heavily loaded with government securities, in part because fiscally weak domestic governments had encouraged it. Some commentators compared this arrangement to two drunks leaning against each other, with no lamppost in sight. The incentives for such a dangerous dependence would be stronger yet if bank deposits were guaranteed at the euro area level.

Governments could also take advantage of deposit insurance more directly, through state-owned banks. Suppose Portugal expanded the operations of the government-owned Caixa Geral de Depósitos, the largest bank in the country, to attract deposits and invest the money in infrastructure and other state projects. By insuring the deposits, the EU authority would in essence be guaranteeing a bond issue of the Portuguese government, even though the funds would be channeled through a bank. This wouldn’t be a fiscal guarantee of the entire Portuguese government budget, but it could prop up spending at the margin.

Do read the whole thing.

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