While a general set of rules for European banks was progressively established in successive capital requirements directives, substantial flexibility remained in how those rules was interpreted at the national level. The Lamfalussy process was launched in an effort to iron out these differences, but the process rested entirely on cooperation between national supervisors, with no possibilities for binding mediation or enforcement at the European level – and it was fiercely resisted by countries with financial centres. The divergence this permitted in the application of regulatory and supervisory standards allowed serious financial imbalances to build-up in some jurisdictions, which then of course created serious blowback for the euro area. But similar to fiscal policies, an inconsistent framework also undermined the value of prudential policy itself. As, for example, definitions of forbearance and non-performing exposures differed widely across countries, investors simply did not trust in banks’ stated asset values and provisions. In other words, the confidence effects that prudential policy is supposed to provide disappeared when they were most needed. For structural policies there were no binding European rules at all, as they were seen as having a primarily national significance. Inconsistency between policy areas These governance arrangements were not only internally inconsistent, however; they were inconsistent with each other.
Thus, there is a long intellectual tradition linking rule of law and sound money to functioning of free markets. But this connection found perhaps its clearest expression in the ordoliberal school that developed in Germany in the 1930s. Conceived at the University of Freiburg by Walter Eucken and Franz Boehm, the central understanding of ordoliberalism was that a stable and well-functioning market economy required a strong legal and institutional  1  “Moneta debt esse quasi quaedam lex et quaedam ordinacio firma”. Nicolas Oresme, Traité de la première invention des monnaies (ca. 1355). BIS central bankers’ speeches  1  framework. Pure laissez-faire capitalism was unstable and liable to capture by monopolies. Collectivist central planning, on the other hand, led towards waste and totalitarianism. Thus, as the ordoliberals saw it, the role of government was to frame markets in such a way that actual outcomes would approximate the theoretical outcome in a perfectly competitive market. Achieving such outcomes could imply de-regulation, if government was interfering too much in market processes, or re-regulation, if market failures were apparent – a feature that distinguished it from a laissez-faire approach. In other words, the role of government was both to untie the “invisible hand”, and to keep it firmly cuffed to the rule of law. At the same time, ordoliberalism recognised the crucial importance of monetary and economic stability to a well-functioning market.