What did the EU really agree on sovereign and bank debts last summer?

There has been great furor recently over what exactly EU leaders agreed in the June 2012 summit. Some of that furor concerns the issue of separating member states’ liability for sovereign debt, which nobody contests, from their liability for bank debt, which is widely contested. Here in Ireland, where the country’s economic prospects are seriously burdened (some would say hopelessly overwhelmed) by the previous government’s assumption of full liability for the debts of irresponsible banks, everybody is focused on what the EU leaders may have agreed last June on the question of “legacy debt” — that is, liability for bank debts incurred before the summit’s apparent agreement to separate sovereign from bank debt.

To get some clarity on what was, and was not, agreed last June, I contacted a source with unparalleled access to EU decision-making circles but no particular national agenda to promote. This is my source’s tentative report, in my own words: Discussion at the June summit was focused on the urgent need to recapitalise Spanish banks without adding to Madrid’s debts, and to counter the financial market panic over sovereign risk, which threatened to overwhelm EU bailout funds and the ECB’s other policy instruments. The leaders therefore agreed that the European Stability Mechanism, which took effect last week, would be able to recapitalise banks directly without adding to sovereign debt. But the issue of legacy debt was not discussed, neither by the senior diplomats (‘sherpas’) preparing the summit nor by the leaders themselves. At the subsequent Euro Group meeting in July, the finance ministers of the three hardline states — Finland, Germany, Netherlands — insisted that legacy debt was not covered by the June agreement.

It is hardly surprising that the Irish government has been working hard all summer to convince various parties that the June summit had covered legacy debt. But if my source’s report is accurate (as they tend to be), then this will be an uphill battle — not because anybody is backtracking on prior commitments, but because Ireland’s preferred reading of the June agreement is more aspirational than historical. This would also explain why Barroso has agreed with Enda Kenny’s insistence that the June agreement must be implemented but repeatedly declined to comment on whether it covered legacy debt.

Rather than insisting on what was or was not agreed last June, the Irish government may soon have to return to the more principled argument that if the EU separates sovereign debt from bank debt for one member state, it must do the same for another member state that it had previously pressured into assuming such an onerous liability, and to the interest-based argument that the EU cannot afford the contagion effects of failure by Ireland, its poster boy for austerity-based economic reform.