Banking union and the euro's future For the past two and a half years, Europeans have lived with a slow-burning crisis in the single-currency area. There have been flare-ups that have sometimes threatened to spread. But as these involved only smaller peripheral nations, they have been doused. Now, however, the flames are licking closer to the eurozone's combustible core. It is no longer just the smaller countries that are in peril, but two of the currency bloc's largest members - Spain and Italy. Spain in particular faces a banking crisis that could - if unresolved - set off a full-blown banking panic around Europe's periphery. Such a crisis would overwhelm the mechanisms the eurozone has put in place to help countries that are denied access to the markets. Nor could the currency area rely on the European Central Bank to stamp out the flames. Last week the bank's president, Mario Draghi, warned that it could not "fill the vacuum" created by governments" inactivity. The resulting uncertainty is fuelling fears of a break-up of the single currency. European leaders have shied away from articulating a plan that would deal with the single currency's shortcomings precisely because they fear that this would be unpopular with electorates. It is hard to sell the idea of fiscal transfers to creditor nations. Meanwhile, peripheral states fear the loss of economic sovereignty that greater federalism entails. The only new policy that has been considered is a growth effort that is too small and too slow. European leaders need to have a more hard-headed discourse before it is too late. The euro presents political problems to any would-be rescuer. Even its supporters admit that it was poorly designed, and has not functioned as intended. The task of fixing its shortcomings is fraught with political peril. The way the EU has been constructed, through a series of elite-led technical measures, has left it lacking in popular legitimacy at the very moment when this is most needed. While some see the euro crisis as an opportunity to push forward to a much more integrated and federal Europe, that is a misreading of the electorate's desires. But a total eurozone collapse could have devastating consequences, with European economies potentially shrinking by double-digit percentages. Beyond the initial shock, the collapse could usher in a period of stagnation and volatility akin to that which swept western economies in the 1970s after the ending of the Bretton Woods system. The fixes the eurozone needs may be less radical than feared. The near-term priority must be to avoid bank runs. A sovereign debt crisis becomes devastating if it is allowed to bring down the banking system. When this happens, the entire economy suffers a cardiac arrest. Perhaps the best way out now is to sever the link between the sovereign and the banking system by moving to a eurozone-wide banking union. This would involve moving the supervision and support of banks away from national to European regulators. It would require an agency with the authority and capacity to restructure or close failing banks, including the ability to write down bondholders. There would also need to be a pan-European deposit insurance scheme backed, at least initially, by the rescue funds. True, this would involve a substantial pooling of sovereignty, albeit less than what would be required for full fiscal union. But it should be sufficient to stabilise the currency area. It would, for instance, make it easier to let over-indebted states such as Greece default within the eurozone rather than be forced out. Voters would still retain the choice of whether to move to the next level of integration, which would be to mutualise eurozone governments" sovereign debt. There is a case for this, although it would move the eurozone a long way towards full fiscal federalism - which would require real consent if it were to be made to stick. Issuing eurozone bonds would help over-indebted countries to get over the transition period while structural reforms were taking effect. The debt sustainability of the currency area would be beyond doubt. Banks would have a "safe," euro-wide class of assets in which to invest. But politically this is much less realistic, and there may not be a will for it. Banking union is the more important goal. If the eurozone cannot resolve these issues, there is no point in adding another storey to the structure.