Authors Iain Begg | Gabriel Glöckler | Anke Hassel ... - The Europaeum

on a USD 800 billion “Emergency Economic Stabilization Act” (the socalled
“Paulson Plan”).
Faced with this dramatic situation, European governments – especially in
those countries with financial institutions that were particularly exposed
to the US financial system – had to react. The Irish government started
by announcing a guarantee that would “safeguard all deposits, covered
bonds, senior debt and dated subordinated debt” with six Irish financial
institutions. 11 While wholly understandable from an Irish political
perspective and given the desire to avoid bank runs and a meltdown in the
domestic financial sector, this measure ignored the “externalities” of this
decision, notably the fact that Ireland, and the Irish financial system, are
part of the euro area and EU financial market.
If other EU countries were to announce measures of that type, it would
lead to fragmentation of the integrated financial and money markets:
savers would naturally withdraw their savings from banks in countries
where these are not guaranteed by the state and channel them to banks in
countries where they are. This type of government action would also spill
over to other segments of the financial markets beyond retail banking,
because banks whose deposits are backed up by a state guarantee exhibit
a different risk profile, and thus differentiate themselves from other
counterparties in financial transactions.
This, in turn, could lead to financial institutions selecting their
counterparties on the grounds of nationality, e.g. banks only lending to
Irish banks (as these had a state guarantee), and shunning counterparties
from countries which did not provide such guarantees to their banks. The
latter banks, in turn, would run into problems, and ask for guarantees from
their governments. If this example were to be repeated – thus unleashing
a vicious spiral of financial sector “beggar-thy-neighbour” measures – the
integrated financial market would re-fragment and renationalise into
individual national financial markets.
This was, then, the first channel of functional spill-over, engendering a
coordinated response: the proper euro area-wide functioning of money
markets had to be ensured so as to shore up EMU – what was needed was
a defence of the state of financial integration already achieved. In other
words, it was a matter of safeguarding the degree of negative integration
attained, rather than any proactive integrative steps to tackle the crisis
(positive integration).
Chapter 3 – Gabriel Glöckler 49