Hugo Dixon

European integration tends to advance first with squabbling then with fudge. Every country has its national interest to defend. Some politicians appreciate the need to create a strong bloc that can compete effectively with the United States, China and other powers. But that imperative typically plays second fiddle to more parochial concerns with the result that time is lost and suboptimal solutions are chosen.

Amidst the europhoria unleashed by the European Central Bank’s bond-buying plan, it is easy to miss the immense challenges posed by two complex dossiers that have just landed on leaders’ desks: the proposed EADS/BAE merger; and a planned single banking supervisor.

Look first at the plan to create a defence and aerospace giant to rival America’s Boeing. This has been under discussion since at least 1997 when the UK’s Tony Blair, France’s Jacques Chirac and Germany’s Helmut Kohl called on the industry to unify in the face of U.S. competition. London, Paris and Berlin are the key players in this game because they have the major assets.

Since 1997, progress has been patchy. Airbus, previously an awkward Franco-German-British consortium, was gradually turned into a proper company wholly owned by EADS – and EADS itself was created by the merger of France’s Aerospatiale and Germany’s Dasa. But Paris and Berlin insisted on a dysfunctional governance structure designed to balance their respective power rather than promote an effective organisation and EADS’ early years were bedevilled by scandal. What’s more, BAE opted to stay out of European integration, instead merging with Britain’s Marconi and going on a U.S. acquisition spree.

The cost of developing new products, such as fighter aeroplanes, is huge: Europe’s last major initiative in this area, the Eurofighter, was developed through another suboptimal consortium. If Europe can’t get its act together, BAE may eventually find itself swept into the arms of a large U.S. group and governments may ultimately be forced to buy American. Being dependent on even such a close ally should not be their first choice. So there is a strategic benefit in creating a streamlined European defence and aerospace group.

The best solution would be to merge EADS and BAE, and run the new group on commercial lines. The politicians would abandon their right to decide who would manage it or where its factories and research centres would be located. The most important interests of France, Germany and Britain could be protected by ring-fencing their secrets and giving each government a veto over any takeover of the group.

To be fair, the planned merger – which leaked last week – takes a big step in this direction. A complex shareholder pact, which balances French and German interests in EADS, would be scrapped. The private shareholders involved in that pact – France’s Lagardere and Germany’s Daimler – are also expected to sell out eventually.

The snag is that Paris would keep a stake of around 9 percent, potentially letting it pull the strings from behind the scenes. Both London and Berlin seem worried about that. Germany may also be queasy about a plan, so far unannounced, to locate the merged company’s defence HQ in the UK and its civilian aerospace HQ in France.

Even if these circles can be squared, Washington may cause trouble. BAE has been able to acquire a substantial U.S. defence business because of the special military relationship between London and Washington. If the U.S. administration concludes that the new group is effectively controlled by Paris, with which relations are cooler, it may put so many controls on its U.S. business that it becomes commercially unattractive.

It would be better if France sold out of the combined group and depoliticised it entirely. But that doesn’t seem on the cards.

Now look at the euro zone’s plans for a banking supervisor, for which the European Commission unveiled a blueprint last week. Again, the idea is sensible, albeit not a silver bullet. A centralised supervisor based on the ECB might be able to clean up the banking cesspit in places like Greece, Spain and Ireland. This could pave the way for struggling lenders to be recapitalised with euro zone money rather than national money. And that, in turn, could play a role in diminishing the euro crisis.

There are, though, at least two major problems. First, Berlin doesn’t want its local savings banks supervised by the ECB. This is largely a matter of protecting vested interests, as the Sparkassen are closely linked to local politicians. But it is precisely such incestuous relationships that caused mayhem with Spain’s savings banks, the cajas. It would set a bad precedent if Germany could cut a special deal for itself merely because it is the biggest boy in the euro class.

Second, how will the interests of the 10 countries that are part of the European Union but don’t use the single currency be protected as the euro zone moves ahead with banking integration? This is of particular concern for the UK, Europe’s financial capital. Under the European Commission’s plans, the 17 members of the euro would caucus together to decide on matters like technical rules for banking which cover the entire EU. London could therefore find itself perpetually outvoted.

There may be ways of squaring these circles. But, as with defence integration, politicians will need to keep their eye on the big picture even as they defend their legitimate national interests. That hasn’t always been their forte.

The European Central Bank’s bond-buying scheme has bought Spain and Italy time to stabilise their finances. But if they drag their heels, the market will sniff them out. It will then be almost impossible to come up with another scheme to rescue the euro zone’s two large problem children and, with them, the single currency.

Mario Draghi’s promise in late July to do “whatever it takes” to preserve the euro has already had a dramatic impact on Madrid’s and Rome’s borrowing costs. Ten-year bond yields, which peaked at 7.6 percent and 6.6 percent respectively a few days before the ECB president made his first comments, had collapsed to 5.7 percent and 5.1 percent on Sept. 7.

Most of the decline came before Draghi spelt out last Thursday the details of how the plan will work. What makes the scheme powerful is that the ECB has not set any cap to the amount of sovereign bonds it will buy in the market. The central bank’s financial firepower is theoretically unlimited, whereas the euro zone governments’ own bailout funds do not have enough money to rescue both Spain and Italy.

But the new type of intervention, christened “Outright Monetary Transactions”, has three important limitations.

First, the ECB will only buy a country’s bonds if its government agrees to a bailout programme with the euro zone, and sticks to “strict and effective” conditions detailed in such a deal. Second, the central bank will focus its purchases on bonds with a maturity of one to three years. Finally, Draghi has not specified how much he wants to drive down Madrid’s and Rome’s borrowing costs.

This fine print makes sense. But it also means that there is no free lunch. While the ECB seems unlikely to dream up new economic reforms for Spain and Italy, it will probably want their governments to put more precise time frames around what they are already supposed to be doing. The involvement of the International Monetary Fund, which has a somewhat unfounded reputation as a bogeyman, will also be sought. No wonder neither Spain’s Mariano Rajoy nor Italy’s Mario Monti is rushing to take advantage of the scheme.

Meanwhile, the ECB’s focus on short-term bonds means that Madrid and Rome would have to find some other way of issuing long-term debt – which accounts for 66 percent and 62 percent of outstanding debt respectively. If they lost access to the markets, the zone’s bailout funds would have to ride to the rescue. But they still wouldn’t have enough money for both countries.

What’s more, Spain’s and Italy’s borrowing costs are still too high for comfort. The ECB’s main justification for bond-buying is that investors are unfairly punishing them because of fears that the euro will break up. But it also recognises that the spread between their bond yields and Germany’s 1.5 percent 10-year borrowing costs is only partly due to such “convertibility risk”. It is also because of bad economic policies.

While there aren’t any scientific measures of convertibility risk, it seems like the bulk of it has disappeared since Draghi’s comments in late July. A reasonable guesstimate is that the risk of euro breakup might still be inflating Spanish yields by 1 percentage point and Italian ones by perhaps 0.75 percentage points. If the ECB used those numbers to guide its bond-buying programme, 10-year borrowing costs would drop to 4.7 percent and 4.4 percent respectively. To fall further, the countries would need to take more action themselves.

Although investors are currently relatively bullish about Spain and Italy, they are notoriously fickle. Rajoy and Monti should remember how the good mood, engineered at the start of the year by the ECB’s 1 trillion euros of cheap long-term loans to the zone’s banks, vanished with the spring. What’s more, both are facing tougher political challenges than they did at the start of the year when they were enjoying their honeymoons as new prime ministers. Each of their economies has declined this year and will continue to do so next year – shrinking roughly 5 percent over the two-year period, according to Citigroup.

For all these reasons, it is vital that Rajoy and Monti don’t dawdle. Assuming the German constitutional court this week backs the creation of the European Stability Mechanism, the zone’s permanent bailout fund, the Spanish prime minister should apply immediately for a programme.

Italy, a rich country, should still be able to avoid a bailout. But to do so it needs to cut its public debt, ideally with a vigorous privatisation programme and the creation of a wealth tax. With elections due next April and no guarantee that an effective government can be formed thereafter, there is only a tiny window for action. Monti’s technocratic government needs to jump through it.

The ECB has put its credibility on the line with its new bond-buying plan. Germany’s central bank, the Bundesbank, has attacked it on the grounds that it has come close to breaking treaty provisions banning the ECB from bailing out governments. For now, Draghi can withstand the criticism, as long as Angela Merkel keeps backing him. But if Rajoy and Monti don’t move fast, the ECB’s magic will wear off. And if its medicine then fails, it will be hard to conjure up the political will for an even more powerful concoction.

Five years after the credit crunch erupted in August 2007, banking still looks like an industry running amok. Scandals keep tumbling out of the closet: an alleged ring of banks including Barclays that attempted to rig interest rates; money laundering by HSBC; insider tips passed by Nomura to its clients; and terrible risk management by JPMorgan, where traders have so far lost $5.8 billion.

True, some of these scandals date from the rip-roaring days of the bubble. And the industry is now being reformed. But the public is growing impatient with the slow pace of change, especially as recession bites in large parts of the industrialised world. Some observers therefore want to clear out the entire old guard. The idea is that only new teams can clean the cesspit. There are also increasing calls to break up banks into supposedly low-risk retail banks and casino-style investment banks. Even Sandy Weill, the man who created Citigroup, now advocates splitting up financial conglomerates.

Something must be done. The financial industry has made a mockery of capitalism. Despite endless bailouts, bankers are still paid far too much. Profits are privatised, while losses get socialised.

The regulatory noose around the industry is tightening. After the credit crunch, there was a global push to jack up capital and liquidity buffers, while reining in risk-taking. If lenders get into trouble in future, the idea is that they will be wound down safely rather than bailed out. Bankers’ compensation is also being modified – for example, allowing pay to be clawed back in future years if there are losses.

This battery of new regulations is putting pressure on the industry’s profitability – and its pay. Banks are reviewing their business models. They are cutting back on proprietary risk-taking, slashing jobs, and even pulling out of some business lines.

The snag is that it will take until the end of the decade for all these changes to be implemented. That’s partly because the technicalities are complex; and partly because policymakers fear that, if they come down too hard on such a crucial industry, their economies will be driven even deeper into recession.

In the circumstances, proposals for wholesale management change and breakups have strong popular appeal. But they are not the best options.

Last month, both Bob Diamond, Barclays’ chief executive, and Kenichi Watanabe, Nomura’s chief executive, rightly fell on their swords. But if everybody with a senior position in a troubled firm departed, novices would be in charge. That’s just too dangerous.

If managers are tainted by scandal, however remotely, they clearly need to go. They must also quit if they are unable to shift their mindset from the money-grabbing culture of the past to the more service-orientated culture of the future or can’t apologise sincerely for the excesses of the past.

These yardsticks should be used to determine whether the managers currently in the firing line – such as JPMorgan’s Jamie Dimon and Deutsche Bank’s co-chief executive Anshu Jain, whose chairman has just cleared him of involvement in the Libor scandal – should walk the plank.

Meanwhile, it is naive to think that breaking up banks would be a quick fix to the sector’s problems. It’s just not true that a combination of investment and retail banking caused the crisis. Plenty of retail-only banks – the UK’s Northern Rock and America’s Washington Mutual, not to mention Spain’s savings banks – got into trouble. And remember: the biggest failure of all was a pure investment bank, Lehman Brothers.

What’s more, breakups can’t happen fast. Given the continued euro crisis, a standalone investment bank such as Barclays Capital would struggle to finance itself in the market. The only way it could survive would be through liquidity injections from the public sector. It might even need to be nationalised. Once these investment banks are shrunk, de-risked and recapitalised, breakups may be possible. But that’s at least a five-year job.

So what should be done in the meantime? Further action is possible on at least three fronts.

First, pay. Capping bonuses, as the European Parliament is proposing, is not sensible as it merely encourages banks to boost salaries. A better idea is to require lenders to pay a big chunk of their managers’ compensation in the form of the bank’s own subordinated debt. If the bank then got into trouble, executives would lose a lot of money. That should concentrate their minds on better risk management.

Second, the industry is under-taxed. The best solution here is not the financial transaction or “Robin Hood” tax proposed by the European Commission. That wouldn’t make the industry safer. Better options are to impose VAT on financial services and require banks to pay a levy to the extent that they finance themselves with hot money – a tax that has so far only been adopted in some countries.

Third, boards have too often failed to hold powerful executives to account. That was a big weakness at Barclays and other banks such as Britain’s RBS. Both regulators and shareholders need to insist that bank boards have more clout.

If the existing regulatory package was supplemented along these lines, some of the public’s indignation would be sated. There would also be less chance of the industry running amok in the future.

Can Super Mario save the euro? Mario Draghi said last Thursday that the European Central Bank’s job is to stop sovereign bond yields rising if these increases are caused by fears of a euro break-up. While this represents a sea-change in the ECB president’s thinking, it risks sowing dissension within his ranks. He will struggle to come up with the right tools to achieve his goals.

Draghi seemingly stared into the abyss and had a fright. Spanish 10-year bond yields shot up to 7.6 percent on July 24 while Italian ones rose to 6.6 percent. The high borrowing costs are not simply a reflection of the two countries’ high debts and struggling economies. Investors also fear “convertibility risk” – or the possibility that the euro will break up and they will get repaid in devalued pesetas and liras.

The central banker’s statement that dealing with convertibility risk is part of the ECB’s mandate is therefore highly significant. He rammed home his message, saying: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

Markets responded swiftly. Spain’s borrowing costs fell to 6.8 percent, while Italy’s dropped just below six percent. But these yields have to drop below five percent – and stay there – before confidence in the euro project will return. What’s more, it’s unclear what Draghi will actually do.

One possibility, immediately latched onto by investors, is that the ECB will relaunch its programme of buying government bonds in the market. But such an operation would be tough to calibrate. If the ECB was prepared to do whatever it took to drive yields below a certain level, the pressure would certainly be off Spain and Italy. But politicians might then stop reforming their economies. When the ECB bought Italian bonds last summer, that’s precisely what happened.

That’s why Germany’s Bundesbank, which has a powerful voice within the ECB but no veto over its actions, is opposed to bond-buying – potentially setting the stage for a stormy meeting when the ECB governing council meets to discuss what to do on Aug. 2. It’s not yet clear how big a spoke the German central bank will be able to put into Draghi’s plans.

On the other hand, if the ECB made its support conditional on good behaviour, investors might not be reassured. Their anxiety would be heightened if central bank bond-buying pushed private creditors down the pecking order. That’s what happened when Greece’s debt was restructured earlier this year: private bondholders suffered big losses while the ECB theoretically stands to make a profit. A half-hearted bond-buying programme might therefore simply encourage investors to dump their holdings on the ECB while having no lasting effect on Spain’s and Italy’s borrowing costs.

Draghi may think that the two countries’ current leaders – Spain’s Mariano Rajoy and Italy’s Mario Monti – are more serious about reform than their predecessors Jose Luis Rodriguez Zapatero and Silvio Berlusconi. But even the new leaders have shown signs of losing momentum. Rajoy’s latest spurt of action – further budget-tightening and a plan to recapitalise the country’s struggling banks – only occurred because his back was to the wall. In Italy, meanwhile, Monti says he will stop being prime minister next spring. It’s not clear whether his successor will be committed to reform.

For these reasons, Draghi seems reluctant for the ECB just to buy bonds on its own. Rather, he seems to want to do so in combination with the euro zone’s bailout funds, which have the ability to buy bonds directly from governments – something the ECB is banned from doing. One advantage is that Madrid and Rome would have to sign memorandums of understanding setting out their reform plans in order to access the bailout funds. It would then be easier to hold them to their commitments.

A further idea, reported by Reuters, could help deal with private creditors being pushed down the pecking order. Policymakers are working on a “last chance” option to cut Athens’ debt – involving the ECB taking a haircut on its Greek bond holdings. If that happened, investors would worry less about being unfairly treated if Spain or Italy ever needed to restructure their debts. They might then not view bond-buying as the perfect chance to offload their holdings onto the public sector.

The two-pronged approach is preferable to the ECB buying bonds solo. But it would still put the central bank in the front line of rescuing governments. A better approach would be to scale up the euro zone’s bailout funds and get them to do the entire job of lending to Spain and Italy, if they need help. This could be achieved by letting the soon-to-be-created European Stability Mechanism (ESM) borrow money from the ECB.

Draghi should prefer lending to the ESM than buying Spanish or Italian bonds because, if either country got into trouble, the bailout fund not the ECB would take the first losses. Unfortunately, the ECB said last year that extending loans to the ESM would contravene the Maastricht Treaty – a position Draghi himself repeated after he took over as president, even though there are plenty of lawyers who think the opposite.

Super Mario is now warming to the idea of lending to the ESM, according to Bloomberg, even though that’s not part of his immediate plan. If Draghi does this, he’ll have to find a way to eat his words without losing credibility. If not, he will have to rely on second-best options with all their drawbacks. Mind you, it’s the job of super heroes to get out of tight spots.

The euro crisis is to a great extent a confidence crisis. Sure, there are big underlying problems such as excessive debt and lack of competitiveness in the peripheral economies. But these can be addressed and, to some extent, this is happening already. Meanwhile, a quick fix for the confidence crisis is needed.

The harsh medicine of reform is required but is undermining confidence on multiple levels. Businesses, bankers, ordinary citizens and politicians are losing faith in both the immediate economic future and the whole single-currency project. That is creating interconnected vicious spirals.

The twin epicentres of the crisis are Spain and Italy. The boost they received from last month’s euro zone summit has been more than wiped out. Spanish 10-year bond yields equalled their euro-era record of 7.3 percent on July 20; Italy’s had also rebounded to a slightly less terrifying but still worrying 6.2 percent.

As ever, the explanation is that the summiteers came up with only a partial solution and even that was hedged with caveats. Although the euro zone will probably inject capital into Spain’s bust banks, relieving Madrid of the cost of doing so, the path will be tortuous. Meanwhile, a scheme which could help Italy finance its debt will come with strings attached – and there still isn’t enough money in the euro zone’s bailout fund to do this for more than a short time.

The two countries’ high bond yields aren’t just a thermometer of how sick they are. They push up the cost of capital for everybody in Spain and Italy, while sowing doubts about whether the whole show can be kept on the road. Capital flight continues at an alarming rate, especially in Spain. The so-called Target 2 imbalances, which measure the credits and debits of national central banks within the euro zone, are a good proxy for this. Spain’s Target 2 debt had grown to 408 billion euros at the end of June, up from 303 billion only two months earlier. The Italian one was roughly stable but still high at 272 billion euros.

The loss of confidence is harming the economy. Spain’s GDP is expected to shrink by 2.1 percent this year and a further 3.1 percent next year, according to Citigroup, one of the more pessimistic forecasters. The prospects for Italy are not much better: a predicted 2.6 percent decline this year followed by 2 percent next year.

Shrinking economies are, in turn, pushing up debt/GDP ratios. Citigroup expects Spain’s to jump from 69 percent at the end of last year to 101 percent at the end of 2013, in part because of the cost of bailing out its banks, while Italy’s will shoot up from 120 percent to 135 percent. These eye-popping numbers then reinforce anxiety in the markets.

All of this is having a corrosive effect on the political landscape. In Italy, the situation is especially precarious as Mario Monti, the technocratic prime minister, has repeatedly said he will resign after next spring’s elections. The centre-left Democratic Party, which is leading in the opinion polls, is still committed to the euro. But the second and third most popular political groups – the Five Star movement led by comedian Beppe Grillo, and Silvio Berlusconi’s PdL – are either outright eurosceptics or toying with becoming so.

The situation is slightly better in Spain because Mariano Rajoy has a solid majority and doesn’t officially have to face the electorate for three and a half years. But hundreds of thousands of demonstrators took to the streets last week to protest against the latest austerity measures. Pundits are starting to speculate that Rajoy may not last his full term. And if the Italian and Spanish governments can’t carry their people with them along the reform path, the fear is that Germany may no longer support them.

High borrowing costs, capital flight, and economic and political weakness: to escape this vortex, the immediate priority is to get Spain’s and Italy’s bond yields back down. The goal should be to cut borrowing costs below 5 percent – a level that would no longer be that worrying. While most of the ways of doing this have been vetoed by Germany, at least two haven’t.

One is to leverage up the European Stabilisation Mechanism, the region’s bailout fund, so that it has enough money to fund both Madrid and Rome. Neither Germany nor the European Central Bank want to let the ESM borrow money from the ECB itself. But what about lifting the cap on how much it can borrow from the market?

Another option would be for the core countries, led by Germany and France, to subsidise Spain’s and Italy’s interest rates directly – giving back to the southern Europeans part of the benefit they are enjoying from their own extremely low borrowing costs. If they agreed to close half the gap between the core and the periphery, such a scheme would cost around 75 billion euros over seven years, according to a Breakingviews’ calculation. An interest-rate subsidy would also give markets the confidence that Madrid and Rome would be able to finance their debts and so could further lower their borrowing costs.

There would, of course, have to be conditions. In Italy, Monti needs to embark on a second wave of reforms. In particular, he should launch a mass multi-year privatisation programme and a big one-off wealth tax to cut Italy’s debt. But after Spain’s recent plan to clean up its banking sector and further tighten its belt, there is little more to be asked of it.

Germany is right to insist on reforms. But it should balance the stick with a bigger carrot. Otherwise, the single currency from which it benefits so much could collapse.

A year ago Rupert Murdoch was probably the most powerful unelected person operating in Britain. The media baron could seemingly choose prime ministers. Then came the phone hacking and police bribery scandal, after which politicians sought to distance themselves from him.

The title of most powerful unelected Briton now probably belongs to Mervyn King, the governor of the Bank of England. Witness the way he dispatched Barclays’ chief executive Bob Diamond two weeks ago in connection with the Libor rate-rigging scandal. Whoever succeeds King next year will have even greater powers. After all, responsibility for financial stability and banking supervision is about to be added to the central bank’s main task of running monetary policy. It’s vital for democracy that this authority is exercised effectively, transparently and fairly.

Who will be King’s successor when he steps down? And how will the new governor be made accountable? These questions have been brought into sharp relief by the Libor scandal. The front runner for King’s job has seen his chances knocked, while doubts have been raised about the central bank’s effectiveness and transparency.

The next governor will need to be something of a superman. Expertise in how to manage financial crises is probably the top requirement given that the euro could blow up and there wouldn’t be time for on-the-job learning. Strong management skills are also important as failure to delegate effectively would lead the incumbent to be swamped. Finally, the governor will have to be a good communicator.

Until the Libor scandal broke, Paul Tucker, one of the BoE’s deputy governors, was the favourite. He has a strong track record as a crisis manager. But his apparent failure to recognise early warnings that the Libor interest rate was being rigged has made him look naive.

Another candidate is Adair Turner, chairman of the Financial Services Authority, a large chunk of whose functions are about to be merged into the central bank. Although the FSA hasn’t covered itself with glory in investigating the Libor affair, most of the abuses occurred before Turner took the helm.

Both men will be grilled by members of parliament this week, Tucker for the second time. If neither impresses, the field will be wide open for other candidates like Gus O’Donnell, formerly Britain’s top civil servant, and Mark Carney, governor of the Bank of Canada.

Holding the next governor accountable will be as important as choosing one. The Bank of England was rightly given considerable independence in 1997 to prevent politicians meddling in monetary policy in order to advance their electoral interests. But the institution and its leader have slipped up on enough occasions that leaving them entirely to their own devices isn’t a good option either.

For example, King didn’t sound the alarm loudly enough during the credit bubble and was slow to act when there was a run on Northern Rock, the mortgage bank, in 2007. He then long resisted any investigations into the Bank of England’s own failings in managing the crisis. Now its hands-off approach to the Libor scandal is being revealed.

Based purely on its record, the central bank wouldn’t be receiving extra powers. However, the Conservative-led government has tried to pin the blame for the credit crunch on the previous Labour government’s policies – in particular, its decision to take away the central bank’s responsibility for banking supervision. Hence, it has become politically convenient to reverse that move.

Given this, the priority should be to enhance the Bank of England’s accountability. Under the current system, the government sets inflation targets and picks the governor. It also chooses the deputy governors and members of two committees: the monetary policy committee which sets interest rates; and the financial policy committee which will soon be responsible for financial stability. Their independent members help prevent the governor becoming too dominant.

The Bank of England also has a board, called the Court. But this has been largely ineffective. Though it has recently stepped up its scrutiny of the central bank’s executives, it is hamstrung because it rightly has no say over policy or who is the governor.

Meanwhile, parliament can call the governor and other senior officials in to give evidence. Although this is a potentially important check to the central bank’s power, MPs haven’t yet used this tool effectively. Take the ongoing hearings over the Libor scandal. They did a poor job of interrogating Diamond, failing to coordinate their questions and seeming more intent on grabbing headlines than getting to the truth. While the subsequent sessions were better planned, they were still not penetrating enough.

MPs have a chance to raise their game in this week’s hearings. A key line of questioning ought to be how exactly King managed to persuade Barclays to get rid of Diamond. Few people will shed tears at Diamond’s departure given that he epitomised the City of London’s greed. But the FSA – not the central bank – is still Barclays’ primary regulator. Parliamentarians should satisfy themselves that the governor did not overstep his authority.

One way of improving democratic control would be to give MPs the right to hold nomination hearings and, in extremis, reject the government’s choice for governor and other top positions. Indeed, that’s what parliamentarians want. But the government is resisting. If MPs are to change its mind, they must first show they are up to the job.

It won’t just be the Bank of England on trial this week. Parliament too will be in the dock.

Was Bob Diamond really irreplaceable? Barclays’ board operated for 15 years on the assumption that he was. As a result, the UK bank’s chief executive became more powerful – and ever harder to replace. Now that he has been kicked out in the wake of the Libor rate-rigging scandal, Barclays is struggling to find new leadership.

This is an object lesson for all companies, not just banks. Think of two other UK-listed groups which have recently provoked shareholder anger over their bosses’ high pay packages: WPP, the advertising giant; and miner Xstrata. In both cases, the boards paid their chief executives so much because they thought they were indispensable.

Barclays is now in a mess. Not only has Diamond quit, his chairman, Marcus Agius, has also said he will resign. Both men ultimately had to go: Diamond had come to epitomise the worst of the City of London’s greed, while Agius seemed unable to hold his chief executive in check. Neither man responded to requests for comment.

The manner of their going means the bank is now rudderless at a time when a political storm is swirling around it and a financial crisis is bubbling across the English Channel.

It will be hard to find a good candidate to replace Diamond, given that Barclays has now become a political football and the next boss will have to put up with intense media scrutiny. Attracting a good chairman won’t be easy either, although the deputy chairman, Michael Rake, seems prepared to step into the breach.

Diamond was undoubtedly an entrepreneurial banker. When he took over Barclays Capital in late 1997, the lender’s investment banking unit had 135 billion pounds in assets and made 252 million pounds in pre-tax profit. By last year, assets were 1.2 trillion pounds and profit was 3 billion pounds.

This dramatic growth was largely a function of two factors: the multi-year credit boom that lasted until 2007; and Diamond’s ability to persuade the Barclays board to pour resources into investment banking. This expansion continued after the crunch, when the bank acquired the largest chunk of Lehman Brothers out of bankruptcy.

Barclays’ share price performance, however, has been miserable, more than halving over the near-15 year period. During that time, Diamond and his key lieutenants received hundreds of millions of pounds in compensation. Diamond himself has earned at least 120 million pounds since he joined the board in 2005, according to Manifest, the corporate governance group.

Diamond ran BarCap as a fiefdom, with seemingly little oversight from a series of chairmen and chief executives at the parent bank. Despite the successes, there were problems: sometimes excessive risks were run; the organisation developed fiendishly complicated tax-minimisation schemes for its clients that went right to the border of what was legal; and, of course, it has now emerged that some Barclays traders attempted to manipulate Libor.

Diamond’s first slip came in 1998 when BarCap expanded its exposure to Russia just before the Kremlin defaulted and devalued. But Barclays kept him on, fearing that the investment bank would be too fragile if he quit. The idea of Diamond the indispensable was born.

Over the next six years, BarCap expanded so rapidly that Diamond was considered a candidate to be the next Barclays chief executive. In the end, the board chose John Varley. But directors were worried that Diamond would leave and, soon afterwards, gave him the title of president of Barclays in addition to that of BarCap chief executive. That seems to have undermined Varley’s authority.

When Varley retired at the end of 2010, BarCap was contributing 79 percent of the whole bank’s profit and Diamond was the obvious successor. He then became an even more dominant force in the bank.

In theory, a strong chairman could have acted as a counterweight. But, in Agius, Barclays doesn’t seem to have had such a chairman. This became apparent when Diamond was awarded 80 percent of his bonus for last year despite himself describing the results as unacceptable. Almost 27 percent of shareholders voted against the Barclays remuneration report.

The fiasco over this year’s pay finally persuaded Barclays’ non-executive directors that they needed a new chairman. They told Agius that they wanted him to step down at next year’s shareholder meeting. But before they could implement the plan, the Libor scandal blew up.

The board initially decided to hang onto Diamond – in part because there was nobody obvious to replace him. His two top lieutenants – Rich Ricci, BarCap’s chief executive, and Jerry Del Missier, Barclays’ chief operating officer – were both part of the same brash culture and out of tune with the current zeitgeist.

Agius himself decided to fall on his sword, seemingly thinking this would take the heat off Diamond even though the rate-rigging was an operational matter and so nothing to do with the chairman. But the Bank of England made clear this was not the right response and that Diamond would have to go.

Agius is, therefore, hanging on and running the executive committee on a stopgap basis even though he doesn’t appear to have the necessary skills. Meanwhile, the bank is looking for both a new chairman and chief executive.

And the moral of the story? Boards must always counterbalance strong chief executives with strong chairmen and have good succession plans in place. Most importantly, they should never treat anybody as indispensable – in case that is what they become.

Cuando despertó, el dinosaurio todavía estaba allí. “Upon waking, the dinosaur was still there.”

This extremely short story by Guatemalan writer Augusto Monterroso sums up the state of play on the euro crisis. Last week’s summit took important steps to stop the immediate panic. But the big economies of Italy and Spain are shrinking and there is no agreed long-term vision for the zone. In other words, the crisis is still there.

The summit’s decisions are not to be sniffed at. The agreement that the euro zone’s bailout fund should, in time, be able to recapitalise banks directly rather than via national governments will help break the so-called doom loop binding troubled lenders and troubled governments. That is a shot in the arm for both Spain and Ireland. Meanwhile, unleashing the bailout fund to stabilise sovereign bond markets could stop Rome’s and Madrid’s bond yields rising to unsustainable levels.

Insofar as this restores investors’ confidence, Spain and Italy could avoid the need to obtain a full bailout or restructure their debts. And Ireland, which is in a full bailout programme, could exit that and fund itself in the market again.

The immediate market reaction on Friday was positive. The yield on 10-year bonds fell: for Spain from 6.9 percent to 6.3 percent, for Italy from 6.2 percent to 5.8 percent and for Ireland from 7.1 percent to 6.4 percent. But these rates are still high. And, with the exception of Ireland, Friday’s market movements only take prices back to where they were in May.

What’s more, as the details of Friday’s agreement are picked over, some of the market euphoria may well fade. After all, Germany, the zone’s paymaster, hasn’t written a blank cheque.

Take the bank recapitalisation plan. Madrid is planning to inject up to 100 billion euros into its banks and Dublin has already sunk 64 billion euros into its lenders. The big question is whether the euro zone will reimburse them the full amount invested, given that the stakes in the banks aren’t worth as much. That seems unlikely. But if the full sum isn’t paid, the debt relief for Spain and Ireland may not be as big as some are hoping.

Or look at the market stabilisation mechanism. The euro zone bailout fund’s resources are limited, so it might not be able to keep Italian and Spanish borrowing costs down in the long run. What’s more, to access this mechanism, a country would have to agree to a memorandum of understanding setting out its policy commitments to reform its economy. This means that there will still be some stigma attached to the scheme – which probably explains why Rome and Madrid aren’t rushing to sign up.

To point out that Germany’s Angela Merkel hasn’t agreed a blank cheque is not to criticise the summit compromise. It is essential that Italy’s Mario Monti and Spain’s Mariano Rajoy take further measures to restore their countries’ competitiveness. A second wave of reforms is needed, but both prime ministers have lost momentum in recent months. Money for nothing will take away pressure to do more.

However, the continued uncertainty about exactly how bank bailouts and market stabilisation will work means that the summit did not produce a neat package. As the loose ends are tied up, there could be further wrangling that unnerves investors.

Meanwhile, GDP in both Italy and Spain are continuing to shrink. This means that they won’t hit their deficit reduction targets and that their debts and unemployment will rise further. The summit’s 120 billion euro growth pact isn’t likely to move the needle. More may need to be done to shore up growth. One obvious suggestion would be still looser monetary policy from the European Central Bank.

Recession also has political consequences, especially in Italy, where elections are due next spring at the latest. Both Beppe Grillo, a comedian whose populist Cinque Stelle movement has come from virtually nowhere to 20 percent in the opinion polls in recent months, and Silvio Berlusconi, the former prime minister, are playing the eurosceptic card. In the circumstances, Monti’s technocratic government will struggle to gain political support for any more reforms. Investors and Italy’s euro partners will, in turn, worry about what comes after him.

The euro zone leaders also agreed, in principle, on the first step towards a long-term vision for the region: the creation of a single banking supervisor “involving the ECB”. If this cleans up the mess in large parts of the European financial system, it will be good. But some countries will not wish to surrender control over their banks to a centralised authority and so it is quite possible that some messy fudge will emerge.

If the question of a single banking supervisor is likely to be subject to future disputes, even more disagreement can be expected over whether there should be a full political and fiscal union. Some countries like Germany want much more common decision making, but others fear the loss of sovereignty. Meanwhile, many weaker nations want to pool their debts – an idea rightly rejected by Merkel.

Europe’s people are not ready for full political union. So the best solution would be to keep the loss of sovereignty and debt-sharing down to the minimum. But the summit kicked these big issues into touch.

The dinosaur is less terrifying than it was a few weeks ago. But it is still there.

This piece first appeared in Reuters Magazine.

Is it possible that rebel leaders are overrated? In the wake of the Arab Spring, the Occupy Wall Street movement, and other populist uprisings around the world against autocracy and corruption, geopolitical analysts are asking fundamental questions about what leadership means in such struggles. What sort of leadership is needed in nonviolent uprisings? And in this digital age, do rebellions even need leaders?

The romanticized answer is that nonviolent struggles no longer require a charismatic leader – they can emerge spontaneously as oppressed people rise up and communicate through Facebook and Twitter. This lack of organization or hierarchy is said to be well suited to the goals of such movements. Where insurgents are fighting for democratic rule, it is appropriate that nobody is bossing anybody around. What’s more, this alleged lack of leadership has a side benefit in that it precludes the authorities from destroying a movement by rounding up the ringleaders. You can’t lop off the head if there is no head.

A year ago, in the stirring aftermath of the Egyptian revolution, that paradigm had resonance. But the Arab Spring has run into trouble. It took a long and bloody struggle in Libya to depose Colonel Muammar Gaddafi, and Syria is being inexorably sucked into a civil war. Even Egypt no longer looks like a clear victory for the Facebook revolutionaries: The Muslim Brotherhood, which has a more traditional hierarchy and respect for authority, is poised to scoop up the fruits of the populist occupation of Tahrir Square.

GETTING BEYOND OUTRAGE

“This is a war by other means,” says Robert Helvey, a former U.S. army colonel who has devoted himself to studying nonviolent combat and trains activists in its methods. “If you are going to wage a struggle, everybody needs to be on the same sheet of paper.” The savviest analysts of the recent nonviolent movements never believed they had much chance unless they had leadership, unity, and strategy.

Start with the most basic tenet: No movement is likely to topple an entrenched regime unless it has a strategy. This involves systematically analyzing the opponent’s weaknesses, devising a plan for undermining them, and anticipating how the struggle is likely to unfold. To forge such a strategy, a movement needs leadership. And to follow such a strategy through the hard times ahead – during which nonviolent protests may be met with violence – it will need unity. Srdja Popovic, a leader of Otpor, the Serbian student group that helped bring down Slobodan Milosevic’s dictatorship in 2000, now advises activists on how to organize similar movements. He stresses the importance of unity, and tells them one of the main reasons Otpor succeeded against Milosevic was because it banged together the heads of a bickering group of politicians and got them all to support one candidate.

Leadership is required to plan the different stages of a conflict. Helvey says there are usually three: removing a regime; installing a democratic government, maybe a transitional one; and then defending that new government against coups. He points out that while the Egyptian students brought down Hosni Mubarak, they didn’t have a follow-up plan, which allowed the Muslim Brotherhood to step in and take control. They won an important battle, but had their prize snatched from their hands.

The problem in Egypt was getting beyond regime change, but most movements struggle to get even that far. Again, that’s usually due to a lack of effective leadership. Gene Sharp, a Boston-based academic who has studied nonviolent struggle for over 60 years, says it’s foolhardy to think you don’t need leaders. History supports this argument; few, if any, leaderless nonviolent struggles have been successful, according to Adam Roberts, emeritus professor of international relations at Oxford University. The Occupy Wall Street movement may be a case in point. It was a public relations sensation early on, but the participants didn’t appear to have any strategy beyond pitching tents in public spaces, and public interest fizzled. The ongoing Syrian revolution is another example of the perils of revolt without sound strategy. The activists there didn’t seem to have any plan for what to do when President Bashar al-Assad’s regime fought back with torture, detention, and mass killings – even though that brutal response was predictable.

The Syrian activists made another strategic error: They initially placed too much emphasis on demonstrations against the regime, and while public protests are crucial in revolutionary movements, they expose the participants to brutality. Alternative tactics, such as boycotts and strikes, can be a better way to challenge the regime while keeping your casualties low. It takes leadership to coordinate that kind of strategy. To be fair, the activists in Syria can’t organize or even communicate effectively with anything larger than small cells because as soon as they put their heads above the parapet, they are arrested, tortured or killed. After months of being bludgeoned by the regime, the Syrian activists have increasingly turned to violence themselves.

PROPAGANDISTS AND STRATEGISTS

What sort of leadership is required to sustain a nonviolent revolution? Since headless social-media revolutions appear to be doomed, the temptation is to flip to the opposite extreme – a powerful, charismatic leader. History seems to have smiled upon this tactic: India’s independence movement had Mohandas Gandhi; the U.S. civil rights movement had Martin Luther King; the anti-apartheid movement had Nelson Mandela. More recently, Aung San Suu Kyi has been the face of Burma’s struggle against dictatorship, and Anna Hazare the leader of India’s anti-corruption crusade. Inspirational leaders, all.

“Charismatic leadership makes all the difference in the world when you are running a revolution,” says Helvey. It’s good to have a strong leader who can knock heads together and get everybody to stick to a plan. “You can’t have a democracy to run a war,” he explains. “Once a decision has been made, everybody has to get on with it.”

Still, it would be wrong to jump to the conclusion that successful leadership has to come from a dominant figure. A leadership team has multiple advantages: It will survive if any single leader is captured or killed; it can stop a leader from getting too egotistical or even turning into a new dictator; and it may lead to more innovation, because having an excessively powerful leader can prevent new ideas from percolating.

What’s more, not all of those movements we think of as fronted by charismatic leaders were one-man (or one-woman) bands. Often there were several inspirational leaders. Think of the combination of Jawaharlal Nehru and Gandhi in India; or Viktor Yushchenko and Yulia Tymoshenko in Ukraine’s Orange Revolution in 2004-2005. Even when there is a single strong leader, that person is unlikely to possess all the qualities required to bring a struggle to a successful conclusion. Movements require both brilliant propagandists and shrewd strategists. In very few cases – such as that of Gandhi, who was both a messianic leader and an intuitive strategist – are both qualities found in one person.

The opposite is more typical. For example, Martin Luther King’s brilliant oratory was married to Bayard Rustin’s tactical genius, according to Roberts. Rustin, who had traveled to India in 1948 to learn the lessons of Gandhi’s campaign, taught King a lot of what he knew about nonviolent struggle. (One of his mottos: Never do the same thing twice.)

AN MBA IN NONVIOLENT REVOLUTION?

Is it possible to teach people how to run a nonviolent revolution? For traditional warfare, there are military academies – such as West Point in the United States and Sandhurst in Britain – dedicated to teaching the strategies of engagement. After training at such a college, young officers then get an apprenticeship working on military campaigns for senior leaders. There is no nonviolent equivalent of Sandhurst, but there have been attempts to train leaders for nonviolent struggles. During the anti-apartheid movement in South Africa, young leaders were trained at Gandhi’s old Phoenix Settlement near Durban. Sharp’s Albert Einstein Institution has run workshops for some resistance struggles, as has Popovic – his new Centre for Applied Non-Violent Action and Strategies (CANVAS) has trained activists in several countries, including Egypt, Ukraine, and Georgia.

There are also a few academic courses. One is a graduate program on the strategies and methods of nonviolent social change started by CANVAS at the University of Belgrade. Another is the Fletcher Summer Institute for the Advanced Study of Nonviolent Conflict, held at Tufts University in Boston.

More and more academics are also studying the field. Their books and articles are filtering down to activists on the ground, and what those books are telling them is this: To win a nonviolent struggle you must have leadership and solid strategy. Over time, such initiatives will get the relevant know-how to more and more emerging leaders and make them better nonviolent fighters. And that sharing of knowledge makes it more likely that the next nonviolent uprising will not just overthrow a dictator, but will replace him with a viable democratic government.

PHOTO: People gather during the funeral of people whom protesters say were killed by shelling by forces loyal to Syria’s President Bashar al-Assad,  in Dael, near Deraa, June 28, 2012.

The break-up of the euro would be a multi-trillion euro catastrophe. An interest subsidy costing around 50 billion euros over seven years could help save it.

The immediate problem is that Spain’s and Italy’s borrowing costs - 6.3 percent and 5.8 percent respectively for 10-year money - have reached a level where investors are losing confidence in the sustainability of the countries’ finances. A vicious spiral - involving capital flight, lack of investment and recession – is under way.

Ideally, this week’s euro summit would come up with a solution. The snag is that most of the popular ideas for cutting these countries’ borrowing costs have been blocked by Germany, the European Central Bank or both.

Take euro bonds, under which euro zone countries would collectively guarantee each others’ debts. They would allow weak countries to borrow more cheaply. But Germany won’t stand behind other countries’ borrowings unless they agree to a tight fiscal and political union which prevents them racking up excess debts in future. Such a loss of sovereignty France, for one, will find hard to swallow.

Or look at pleas for the ECB to buy Italian and Spanish government bonds in the market. That too would cut their borrowing costs – for a while. But when the bond-buying ends, the yields would just jump up again. Private creditors would merely use the opportunity to offload their bonds onto the public sector. The ECB has already spent 220 billion euros buying sovereign debt with no lasting impact, and is reluctant to do more.

Italy’s idea that the euro zone’s bailout funds should buy bonds in the market has the same drawbacks. What’s more, the bailout funds only have 500 billion euros left. If they use their firepower to bail out private creditors, they will not have enough to fund governments. Giving the bailout funds banking licences and allowing them to borrow from the ECB would solve that problem. Unfortunately, both Germany and the ECB are against the idea.

But what about a direct interest subsidy? Core countries - such as Germany and France – could pay into a pool an amount that depended on how much their cost of funding was below the euro zone’s average. Peripheral countries – such as Italy and Spain – would then take a sum out of the pool depending on how much their cost of funding was above the average.

The idea recently surfaced in an article by Ivo Arnold, programme director of the Erasmus School of Economics in Rotterdam. It has also been touted by Pablo Diaz de Rabago, economics professor at the IE Business School in Madrid. But it has not yet had much oxygen.

Under such a scheme, the final cost of funds paid by all countries could be equalised or just narrowed. The key questions are: would it work, would it be politically acceptable and is it legal?

First, look at workability. An interest subsidy would help the peripheral countries in two ways. They would benefit from cash payments from the core. But the yield they pay on their own bonds would also drop as worries about the sustainability of their finances eased.

The yields on core bonds, by contrast, would rise. Investors would be worried that Germany and others were shouldering part of the burden of bailing out their neighbours. What’s more, some of money that has rushed into German bonds in recent years would flood out. But, in a sense, this would just be giving back to the periphery a windfall Berlin has enjoyed as investors have panicked over the possibility of a euro collapse.

My colleague Neil Unmack and I have crunched the numbers. Suppose the yield on Spanish and Italian bonds fell by one percentage point as a result of the scheme, and that the yield on the bonds of core countries rose by 50 basis points.

Also assume that core countries were willing to make up half the remaining difference between their interest rates and those in the periphery. That would limit the scale of the subsidy while maintaining pressure on peripheral countries to reform. In this scenario, Spain’s cost of borrowing for 10 years would drop to 4.4 percent, while Italy’s would drop to 4.1 percent – no longer worrying levels.

Now look at political acceptability. The interest subsidy would start off being cheap. On the above assumptions, the first year cost would be only 1.9 billion euros, about 60 percent provided by Germany. Each year, of course, the cost would mount, as countries added new debt to the scheme. But the cumulative cost over the first seven years would still be a manageable 53 billion euros.

The core wouldn’t have to guarantee the periphery’s debt. And subsidies could be provided one year at a time. So if a country didn’t keep up with its reform programme, it could be kicked off the scheme. What’s more, if markets settled down, the operation could be wound down.

Such limitations mean the scheme would be unlikely to fall foul of the German Constitution or the no bailout clause in the EU treaty. Of course, investors may not be convinced that the safety net is strong enough. So it wouldn’t remove the need for Europe’s leaders to come up with a credible long-term vision as well as continue with their reforms. But interest subsidies are still a reasonably cheap and practical answer to the zone’s most pressing problem.