Transcript Folie 1 - Warsaw School of Economics

European Economic Integration - 110451-0992 - 2014
IX EU‘s Sovereign Debt Crisis
European Recession Slowing Global Economy
Austerity Europeeri
OECD
Greece and the EURO
Governments across the region are taking action
to eliminate unsustainable budget deficits
Source: http://www.ft.com/intl/indepth/euro-in-crisis
Prof. Dr. Günter S. Heiduk
Kipper Williams
1
Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of economic Perspectives, 26(3), p. 51.
Government EDP debt in the Euro area countries, selected years (percentage GDP)
Source: Lojsch et al (2011). The Size and Composition of Government Debt in the Euro Area, Occasional Paper Series, No 132, ECB, p. 17.
Source: EUROSTAT, News Release – Euroindicators, No 153-2013, p. 2.
Source: EUROSTAT, News Release – Euroindicators, No 153-2013, p. 3.
Eurozone, European and/or Global Debt Crisis?
Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 2.
The Share of Foreign Government Bonds in Bank’s Sovereign Bond Portfolios, 2011
Source: Gabor, D. (2012), The Power of Collateral: The ECB and Bank Funding Strategies in Crisis, p. 20.
Financial Imbalances and External Imbalances
“A key predictor of a banking crisis is the scale of the preceding domestic credit boom….. The European
periphery experienced strong credit booms, in part because joining the euro zone meant that their banks
could raise funds from international sources in their own currency—the euro— rather than their previous
situation of borrowing in a currency not their own (say, U.S. dollars or German marks or British pounds)
and then hoping that exchange rates would not move against them. In related fashion, lower interest rates
and easier availability of credit stimulated consumption-related and property-related borrowing.
A related phenomenon was the increase in the dispersion and persistence of current account imbalances
across the euro area….. (The) current account imbalances were quite small in the pre-euro 1993 –1997
period. But, by the
2003 –2007 period, Portugal (– 9.2 percent of GDP), Greece (– 9.1 percent), and Spain (–7.0 percent)
were all running very large external deficits. Conversely, Germany ran very large external surpluses
averaging 5.1 percent of GDP, while the overall euro area current account balance was close to zero.”
Private Credit Dynamics
Current Account Balances (% GDP)
Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of Economic Perspectives, 26(3), p. 52.
EU‘s twin crisis
Blundell-Wignall, A. and Slovik, P. (2011). A Market Perspective on the European Sovereign Debt and Banking Crisis,
OECD Journal: Financial Market Trends, Vol. 20(2), p. 2.
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The Risk of Contagion
The immediate trouble
Greece amassed a huge debt that it has scant hope of repaying. A chaotic Greek default could
hurt all European banks and pension funds that have extended Greece credit and cause a wider
bank panic. A financial firewall might halt contagion by backstopping the credit of four other
shaky nations — Ireland, Portugal, Spain and Italy
The risk of contagion
If there is no firewall or if it is inadequate, it would be easy to imagine a run on banks. The
euro zone’s single currency makes it easy to shift money across borders from risky economies
to safer ones. That and the lack of central banks in each country -- those went away in 1999
with the arrival of the euro — make the euro zone “the ultimate contagion machine,” says
Kenneth Rogoff, a Harvard economist
A possible scenario
If no preventative measures are taken, a chain of events like this could unfold: In reaction to a
Greek collapse, investors become worried about their exposure to other risks in the region.
Borrowing costs rise for Ireland, Italy, Portugal and Spain, adding to their debt loads
Continental contagion
Italy may not be able to protect its banks if there is a loss of confidence. French banks,
burdened with all manner of Italian debt, could totter. Money could flee to safer countries like
Germany in a matter of hours.
Global reverberations
Losses could extend to American banks, which have large exposures to debt in France and
Italy. On top of this, American exports to the European Union — collectively the biggest
American trading partner — could suffer if the crisis slows European growth and causes the
euro to depreciate against the dollar. Exposure to French banks could lead to other losses
beyond the Continent.
It Started in the U.S.

2007
US sub-prime crisis
 2008
Spillover to Europe
- Spain
Burst of real estate bubble
- Irland
Banking crisis
 2009
- Greek
Correction of the budget deficit
from 6% to 12%
 2010
- Portugal
Speculative attacks in domestic
financial markets
 2011
- Italy
Fears of debt spiral
 2012
- France, Austria, Italy
 2012/2013 – Cyprus
Downgraded by US rating agency
Banking crisis – exposure to Greek crisis
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From National Crisis to Crisis of the Euro
The brief characterization of the countries at risk shows that
their crisis history differs in origin and course. The outcome
is the same, namely a sovereign debt crisis. The common
peg between these countries is the Euro. Therefore, it is
obvious that the national crises merged into the crisis of
the Euro Area, last but not least because the other Euro
Area members - under the lead of Germany and France –
are expected to demonstrate solidarity.
The Euro Area members have to fear firstly internal contagion
effects and secondly the collapse of the Euro as the symbol of
integration of unequal countries.
Germany’s and (former) France’s leaders set as their
common priority a sustainable solution for the continuation of
the common currency.
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Macroeconomic Imbalances (1)
Quarterly GDP, Change over Previous Quarter, in %, Selected Countries, Q3-2007 – Q1-2013
2
1,8
1,6
1,4
1,2
1
0,8
0,6
0,4
0,2
0
-0,2
-0,4
-0,6
-0,8
-1
-1,2
-1,4
-1,6
-1,8
-2
-2,2
-2,4
-2,6
-2,8
-3
-3,2
-3,4
-3,6
-3,8
-4
-4,2
-4,4
-4,6
-4,8
-5
-5,2
-5,4
-5,6
-5,8
-6
1
Q3-07
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
US
UK
Spain
Portugal
Ireland
Greece
Germany
France
17
18
19
20
Q2-12
21
Italy
13
Source: Own calculations on OECD National Accounts Statistics.
Macroeconomic Imbalances (2)
Unemployment Rate (Number of Unemployed as a Percentage of Total Labor Force),
Selected Countries, 2007-2011, 2013
X
X
X
X
X
2013
14
Source: Own calculation on European Commission, 2011a; U.S.A.: United States Department of Labor
Macroeconomic Imbalances (3)
Current Account Balance (as Percentage of GDP), Selected Countries, 1999-2012
15
Source: Kam and Shambough (2013), The Evolution of Current Account Deficits in the Euro Area Periphery and the Baltics, WP13/169, IMF,p. 19.
Fiscal Imbalances (1)
Since 2007 the fiscal balance in most EU Member States as well as
in the USA has worsened.
Primary Deficit-GDP Ratio, Selected Countries, 2007-2011
Source: Own calculations on OECD Economic Outlook data.
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Fiscal Imbalances (2)
The global recession called in many countries for implementing fiscal stimulus
packages. The drastic fiscal slump in Greece, Portugal, Ireland, Spain required
external funding which contributed to a significant increase in the government debt.
Government Debt-GDP Ratio for Selected Countries, 2007-2011
Source: Own calculations on OECD Economic Outlook data.
Forecast 2012 (except U.S.A.): European Commission, 2011a. U.S.A: www.usgovernmentspending.com/federal_debt_chart.html
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Fiscal Imbalances (3)
There are still risks that burden the economies of the debt-ridden countries:
increasing interest expenditures, high unemployment rates, current account deficits.
Interest Expenditure, General Government (% of GDP), Selected Countries, 20072013
Source: Own calculation on European Commission, 2011a. 2011-2013: Forecast.
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Policy Options to Deal with the Problem of Explosive Debt Scenarios
1. Cutting spending and raising taxes
2. Causing inflation to rise
No option as long as the monetary policy is in hands of the ECB
3. Carrying out structural reforms
- Increasing labor market flexibility
- Reform of EU pension systems
- Improving competition policy: consistency of regulations and governance
4. Restructuring the level op outstanding debt
Potentially promising, if the primary deficit is small, the need for the
governments to return to the capital market is low, the amount of the
sovereign debt held by domestic banks is low.
Fiscal Response to the Global Crisis:
2009 Discretionary Stimulus, % GDP, Selected Countries
Government Support Measures to Financial Institutions, October 2008 May 2010, in % of 2008 GDP
The downfall of the US investment bank Lehman Brothers on September 15, 2008 changed the
latest banking crisis into a global financial crisis. Because of the globally integrated financial
markets, banks in Europe and Asia got instantly caught in this downward maelstrom. Central
banks, primarily the FED and the European Central Bank (ECB), and governments reacted with
money injections into the banking sector, bailouts and fiscal stimulus packages.
Souce: Alter, A. and Schüler, Y.S. (2012). Credit Spread Interdependencies of European States and Banks during the Financial Crisis. Draft, 13.01.2012.
Interest Rates Spreads Mirror the Differences in Public Debt (1)
Bailouts did not solve the crisis situation. The four countries’ performance regarding the
fiscal consolidation did not lead to an easing of tensions.
Higher credit default risks increased the interest rates of new government loans
especially for Greece, Ireland, Portugal, Spain, and since the end of 2011 also for Italy.
Spreads (in Basis Points) of 10-Year Euro Area Government Bond Yields to German Bonds, 2009-2011
22
Source: Arroyo, 2011, p. 15.
Interest Rates Spreads Mirror the Differences in Public Debt (2)
Yields on Ten-Year Sovereign Bonds, Oct. 2009 to June 2012 (percent)
Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of economic Perspectives, 26(3), p. 57.
Do Markets Believe in Contagion: Who is Next?
The “PIGS+1“
The Case of SPAIN
In order to enter the Euro Area, Spain had to fulfil the convergence criteria of the
Maastricht Treaty. The government reduced the budget deficit and achieved the first
surplus in 2005. From 1998-2007 the average deficit ratios had been significantly lower
than the average of the Euro Area. The public net debt ratio declined from 57% of GDP in
1998 to 26.5% of GDP in 2007. The Central Bank reduced the long-term interest rates to
meet the respective Maastricht criteria. The favourable borrowing conditions motivated
more and more young people to take a mortgage to purchase homes. Furthermore, the
demand for housing increased because of immigration. In the years 2000-2007,
approximately 730,000 people a year immigrated to Spain. Prices of houses increased
considerably and demand for loans as well. The average level of household debt tripled
since the beginning of this century. The intransparent structure of the Spanish banking
system masked up the growing lending to the real estate market even after the beginning
of the crisis in 2007. The gap between increasing supply and decreasing demand in the
real estate market after 2007 resulted in a sharp decline of housing prices, bankruptcy of
unlisted regional saving and loan banks and construction firms, growing unemployment in
the construction industry, increasing government expenditures on unemployment
benefits, decreasing tax revenue, and finally the reversal of the budget surplus of 2% of
GDP in 2006 into a deficit of 8.5% of GDP in 2010. Beginning 2010, the run on the banks
forced the government to bail out regional savings and loan banks. Estimations on bad
loans range from 40 billion Euros to more than 100 billion Euros. The housing market is
estimated to reach balance of supply and demand not before 2017. This negative
perspective puts further pressure on housing prices. Banks are forced to offer huge
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discounts for selling their real estate assets.
The Case of Ireland
Similar to Spain, Ireland had been one of the above-average performing
economies in the EU. From 1998 – 2006 the pre-crisis public deficits corresponded
closely to the respective average ratios of the Euro Area. Similar to Spain, during
this period Ireland’s public debt/GDP ratios declined. But its competitiveness was
built on fragile, while wage-sensitive, exports. Funding of infrastructure projects
by EU’s Cohesion Policy, increasing wages, tax reductions and a sharp decline of
interest rates after joining the Euro Area fuelled the construction and housing
sector and resulted in a property and construction bubble. Despite warnings
with respect to the sustainability of Ireland’s growth, banks continued to ease
loan conditions due to weak bank regulation.
They funded the increasing loan demand by extensive foreign borrowing.
The U.S. sub-prime crisis fully struck Ireland’s banks, especially the Anglo Irish
Bank. The government decided to rescue this bank and to introduce a
system-wide bank guarantee. The burst of the bubble instantly led to a sharp
fall in tax revenue. Spending could not have been reduced at the same speed.
Therefore, the budget deficit exploded in 2008.
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The Case of Portugal
In December 2009 the IMF stated that Portugal’s exposure to the global
economic crisis is enhanced by its pre-existing, home-grown problems
such as low productivity growth, large gap in competitiveness, and high
levels of debt (IMF, 2009). In contrast to Spain, Ireland and Greece,
Portugal’s banking sector did not experience similar bank crashes,
predominantly because of the absence of a property bubble and stricter
bank regulations. The increasing public deficit ratios between 1998 and
2006 raised the susceptibility towards economic shocks. The public
debt/GDP ratio also increased but till 2007 remained under the
Maastricht criteria threshold of 60%. It has to be noted that the
debt burden ratios turned out to be higher than in Spain, Ireland,
and even Greece.
The case of Greece
In contrast to Spain and Ireland, the crisis in Greece has its main roots in
long-term deficits in its budget and current account. Compared to the
aforementioned Euro Area members, Greece experienced by far the highest
increase in and the highest ratios of its budget deficit between 1998 and 2006.
Since the introduction of the Euro in 2001 the budget deficit averaged 5% of GDP
per year until 2008. During the same period of time the Euro Area average
amounted to 2% of GDP only. The public debt/GDP ratio climbed between 1998
and 2006 from 72% to 80%. The former government managed to hide the total
amount of the budget deficit in order to fulfil the Maastricht convergence criteria
for joining the Euro Area. Statistical revisions in the negative direction
undermined the confidence of actors in financial markets. “The roots of Greece’s
fiscal calamity lie in prolonged deficit spending, economic mismanagement,
government misreporting, and tax evasion” (Sandoval et al., 2011, p. 4).
According to the former Prime Minister George Papandreou, inefficient allocation
of money resulted from corruption, cronyism and clientalistic politics. The current
account deficits averaged 9% per year compared to the Euro Area average of 1%.
The case of Italy
Italy’s late appearance on the map of severely crisis-stricken European
countries is obviously due to the pure size of its economy. Finally, the
exposure to the global economic crisis dismantled the long-standing
structural weaknesses (IMF, 2010). Low productivity, inefficient and
expensive public services – to a large extent responsible for the high
deficit -, out-dated infrastructure, rigid labour markets are the main
shortcomings of Italy’s economy. Up to now, the banking sector did
not need substantial government capital injections. Low confidence
in the crisis management forced the former Prime Minister Silvio
Berlusconi to resign. At the beginning of December 2011, the new
Prime Minister Mario Monti quickly worked out an austerity package
of Euro 30 billion that had been accepted by Italy’s Senate on
December 21, 2011.
The case of Cyprus
“After more than a week of messy negotiations, the Troika (made up of the
European Union, the International Monetary Fund and the European
Central Bank) and the government of Cyprus agreed on a bailout package
for Cyprus on 24 March. Cyprus is set to receive a €10 billion loan, on the
condition that it shrinks its financial sector and implements austerity policies.
Private bank deposits above €100,000 will be taxed at 40% in order to raise
the additional €5.8 billion needed to stabilise the country’s de facto bankrupt
banks.
Euro banking crisis chapter four
Cyprus has become the fourth European nation to fall victim to a banking
crisis that was caused by irresponsible lending and lax financial regulation –
following on the heels of Iceland, Ireland and Spain. Cyprus’ status as a
de facto tax haven also played a role in attracting huge amounts of foreign
deposits, mainly from Russia and the UK, which inflated the banking sector
to such an extent that lending reached 900% of Gross Domestic Product
(GDP) in 2011.”
Todoulos, C. and Elmers, B. Cyprus – the next chapter of dysfunctional EU debt crisis management, eurodat, 28 March 2013
http://eurodad.org/1545029/
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Multidimensional crisis?
In Europe, those countries were hit first by the financial crisis where
governments since the beginning of the decade have been trapped in
budget bottlenecks. But also formerly healthy government budgets
came under heavy pressure of the financial burden of the stimulus
packages. Public revenues could not cover the additional expenses,
firstly because of the huge sudden amount due, and secondly because
of the declining tax income. The sovereign debt crisis coupled with a
currency crisis emerged in many countries as a new type of twin-crisis.
This situation was getting even worse when credit-rating agencies
downgraded sovereign bonds, especially in several Euro Area member
countries. Downgrading hits its preliminary peak on January 13, 2012
when one credit-rating agency lowered the credit-worthiness of nine
Euro Area countries.
Shortly afterwards, this agency also downgraded the European
Financial Stability Facility (EFSF).
Primary Origins and Developments Toward the Sovereign Debt Crisis
Country
Pre-crisis situation
(budget, debt)
Origins of crisis
Type of initial
crisis
Development of
crisis
U.S.A.
High budget and
current account
deficit, even though
strong overall
competitiveness
Housing and
banking sector
Banking crisis
Sovereign debt
crisis
Spain
Better than Euro
Area average
Housing and
banking sector
Banking crisis
Sovereign debt
crisis, currency
crisis
Ireland
Similar to Euro Area
average
Banking sector,
low
competitiveness
Banking crisis
Sovereign debt
crisis, currency
crisis
Portugal
Lower than Euro
Area
Budget deficit,
low
competitiveness
Budget crisis
Sovereign debt
crisis, currency
crisis
Greece
Lower than Euro area
average
Budget deficit,
current account
deficit, low
competitiveness
Budget crisis
State crisis,
currency crisis
Italy
Between core and
periphery Euro Area
members
Budget deficit
Budget crisis
Sovereign debt
crisis, currency
crisis
It immediately catches everbodys eye that the trend of
bank liabilities as well as household debt increased stronger
than the government debt, especially since 2002.
34
Source: Paul de Grauwe http://www.voxeu.org/index.php?q=node/5062
Do we fight the
wrong enemy
in the Eurozone?
35
Source: Paul de Grauwe http://www.voxeu.org/index.php?q=node/5062
When generalizing the path of the crisis the following sequencing
seems to be plausible:
- Pre-crisis phase:
Real-estate bubble or “optimism bubble”
-First crisis phase:
Banking crunch or sudden decline in
competitiveness resulting in fast increase of
current account deficit or structural budget
imbalances
-Second crisis phase:
Unexpected recession, drastic drop of tax
income, increasing budget deficit
-Third crisis phase:
Stimulus package, increasing debt, time lag
in re-structuring public revenues and
expenditures
- Fourth crisis phase:
-
Sovereign debt leads to solvency at risk, flight of
capital, currency crisis
- Sixth crisis phase:
Political crisis? See Greece after the latest elections
Policy Options
 Fiscal consolidation/austerity:
Increase taxes, cut government
spending
 Debt restructuring:
Lower payments for borrower
via renegotiating the debt
 Inflation:
Reducing the “real“ value of
the debt
 Growth:
Structural reforms; investment
 Financial repression:
Forcing the private sector to
buy government bonds at
artificially low interest rates
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Which way is the right one?
Austerity policy
Bailout policy?
Banking union?
Common Fiscal Policy?
ECB bond buyer?
Expansionary policy?
Moving toward social union?
Rule-based sanktions?
38
European Commission‘s Proposals
PROGRAMS
Financial assistance for
countries in difficulty
(but with conditions
attached)
BANKS
Strengthen the banking
system, including
stronger supervision at
the EU level
Banking Union
FIREWALL
A permanent
mechanism (ESM)
to stem the risk of
contagion to other
countries
Fiscal Union
?
?
RULES
Stronger, more effective
fiscal rules and greater
coordination of
economic policies
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Vicious circle of crisis?
FINANCIAL
STRESSES
and
ECONOMY
SLOWING
?
FINANCIAL
CRISIS 2008
EURO
SOVEREIGN
DEBT CRISIS
ECONOMIC
CRISIS 2009
SURGE IN
GOVERNMENT DEBT
POLICY
RESPONSE:
STIMULUS
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Governing the Sovereign Debt Crisis
In the EU the core activities on the supranational and national level are
aiming at rescuing banks from getting bankrupt (mainly in 2008/2009) and
financing governments’ debt (since 2009).
Within the Euro Area the rescue of the “systemic” banks
and the maintenance of the public solvency are the top short-term priorities.
1. Crisis prevention
• Stricter bank regulations
It became evident that stricter global bank regulations are not in the
interest of the U.S. and British governments because of the political
power and economic importance of the financial centers of New York
and London. The new Basel III Accord will introduce tighter
requirements for bank capital and liquidity. Furthermore, banks have
to pass “stress tests”. The rules will be put into force in 2013.
The controversial discussion in the EU on the role of the ECB in
financing of governments concluded that the Lisbon Treaty
prohibits the ECB being a lender of last resort to governments.
• Stricter budget rules
Maastricht Treaty convergence criteria seem to lack enforcement and
sanctions mechanisms.
Fiscal Stability Treaty: intergovernmental treaty which was signed by
all of the member state of the EU European Unio except Czech Republic
and the United Kingdom on 2 March 2012. The treaty will enter into
force on 1 January 2013, if by that time 12 members of the euro area
have ratified it. The treaty requires its parties to introduce a national
requirement to have national budgets that are in balance or in surplus.
General government budgets shall be balanced or in surplus. The annual
structural deficitmust not exceed 0.5% of nominal GDP. Countries with
government debt levels significantly below 60 % and where risks in terms
of long-term sustainability of public finances are low, can reach a structural
deficit of at most 1.0 % of GDP.
The European Court of Justice would fine a country up to 0.1 % of GDP
if this was not done a year after ratification.
Once a country has ratified the Treaty it has another year, until 1 January
2014, to implement a balanced budget rule in their binding legislation.31
Only countries with such rule in their legal code by 1 March 2013 will be
eligible to apply for bailout money from the European Stability Mechanism
(ESM). The aim is to incorporate it into EU law within five years of its entry
into force.30
2. Crisis control/mitigation: “rescue (banks)”, “stimulate (economy)”,
“clean-up (government’s budget)”.
European banks were hit much harder by the crisis than the banks in the U.S.A. and in the Pacific.
Between July 2007 and March 2009 approximately 3.23 trillion US$ of market value in the global
banking sector was destroyed. European banks lost 75% of their market value As long as banks’
undercapitalization cannot be solved by systemic changes, the fragility and vulnerability will
continue.
The largest part of commitments and outlays had been allocated to debt and asset guarantees.
Purchasing bad assets had not been in the forefront of rescue activities. One of the still unsolved
questions is related to the consequences of the restructuring of the banking sector. The crisis has
increased the market share of large banks. More banks may reach the size of too-big-to-fail, but at
the same time the size of too big to be saved.
The discussion on separating universal banks into investment and retail
banks may mitigate this problem. Another unsolved question concerns the participation
of banks in funding government debt. Despite strong reservations, at the end of 2011 the
ECB injected almost 500 billion Euro in loans into the banking sector at a 1% interest rate.
More than 500 banks took this money.
The sudden increase in liquidity may motivate banks to buy European sovereign bonds.
At the end of 2011 the EC stated that “European countries also undertook significant interventions to
stabilize their financial sectors. Together, the EU countries injected nearly €300 billion worth of
capital into financial institutions and extended €2.5 trillion worth of guarantees. The EU adopted
new rules on hedge funds and private equity, and as of January 2011 a new financial supervision
system is in place for the 27 Member States.
43
In late 2008 the European Commission took the initiative to propose a
European Economic Recovery Plan (EERP) – adopted on December 08, 2008 aiming to swiftly stimulate demand and boost consumer confidence as well as
to prepare the European economy for the future challenges of tougher
competition on the global markets (European Commission, 2008). On the one
hand, the plan addresses the current causes of the crisis that result from
insufficient competitiveness (Greece, Portugal, Ireland), on the other hand the
measures should build-up a protective barrier against future recessions.
According to the EC’s intention, the plan should guarantee a “counter-cyclical
macro-economic response to the crisis in the form of an ambitious set of
actions to support the real economy” (European Commission, 2008, p. 6).
The immediate endowment of 200 billion Euro is financed by budgetary
expansion of the Member States (170 billion Euro) and the EU (30 billion Euro).
Member States are explicitly allowed to break the rules of the Stability and
Growth Pact for two to three years. The different crisis histories made it
inappropriate to design and implement a “one size fits all-strategy”.
The plan has been criticized by economists because of its Keynesian
approach.
44
In spring 2010 the increasing sovereign debt in the Euro Area called for a
new response. The EU Member States agreed to establish the
European Financial Stability Facility (EFSF) aiming to regain financial stability.
In order to achieve this goal the EFSF provides temporary financial assistance to the
members of the Euro Area that are in economic difficulties (EFSF, 2012). The guaranteed
commitment is fixed at Euro 780 billion and borrowing limit at Euro 440 billion. The EFSF
framework came into force on 18th October 2011. The scope of activities includes issuance
of bonds or other debt instruments on the market to raise funds, interventions in the
debt primary and secondary market, actions based on a precautionary programme,
financing the recapitalization of financial institutions through loans to governments. The
financial assistance is linked to appropriate conditionality. The EFSF is part of a wider
rescue net which also includes the Euro 60 billion European Financial Stabilisation
Mechanism (EFSM) and a Euro 250 billion package from the IMF. The EFSM is authorized
to raise funds by the European Commission which are guaranteed by the EU budget. The
Member States share is in accordance with their share in the paid-up capital of the ECB.
In the middle of January 2012 one credit rating agency downgraded the EFSF to “AA+”.
This did not cause a deterioration of the position of the EFSF on the financial market.
After June 2013 the EFSF will not be actively present in the financial market, but it will
continue in an administrative capacity until all outstanding bonds have been repaid. After
controversial discussions the Euro Area member states agreed on leveraging the EFSF in
early 2012 by firstly providing a partial protection certificate to a newly issued bond of a
member state. After initial issuance, the certificate could be traded separately. Secondly,
the creation of one or two Co-Investment Funds would allow the combination of public
45
and private funding.
IRELAND rescue
In November 2010, agreement on the first loan to Ireland could be achieved aiming
to safeguard financial stability in the Euro Area and the EU as a whole. The Euro 85
billion program is financed by Euro 17.5 billion from Ireland, Euro 22.5 billion from IMF,
Euro 22.5 billion from ESFM, Euro 17.7 billion from EFSF and bilateral loan from UK,
Denmark and Sweden. The conditions require an immediate strengthening and
comprehensive overhaul of the banking system(Euro 35 billion), an ambitious fiscal
adjustment and growth enhancing reforms especially in the labour market. In 2011,
the EFSF in total issued Euro 8 billion. The program foresees a 3-year Euro 3 billion
issuance in 2012.
PORTUGAL rescue
The agreement on Euro 78 billion rescue program for Portugal was achieved in
May 2011. The program is equally financed by the IMF, EFSM and EFSF. The three year
program is focussing firstly on restoring fiscal sustainability by strengthening budgetary
discipline, reforming the health system as well as the public administration, privatizing
public assets, secondly on growth and competitiveness enhancing reforms of the
labour market, network industries, housing and services sectors, and thirdly on
measures to ensure a balanced and orderly deleveraging of the financial sector and to
strengthen the capital of banks. In 2011, the ESFS in total issued Euro 8 billion.
In 2012, a three years Euro 3 billion issue will be placed.
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GREECE rescue
First package
In May 2010, Greece got a Euro 110 billion loan within the
framework of the newly established EFSF. The Euro Area Member States contributed Euro
80 billion and the IMF Euro 30 billion to this first Greek bailout. The financial support was
provided under strong policy conditionality. The latter allows the IMF/EU to check Greek’s
performance each quarter. In 2010, Greece has to reduce the fiscal deficit by 5 percentage
points. Measures reducing the deficit include an increase of the VAT, increase in excise
taxes on fuel, cigarettes and drinks, a windfall tax, a property tax, near abolition of 13
and 14th month pay in the public sector, cut of Christmas and Easter bonuses, cuts in
pensions, reducing early retirement.
Second package
March 2012, Eurozone Finance Ministers agreed on a Euro 130 billion rescue after Greek
government agreed to commit to considerable budget cuts as well as to force private
bondholders to waive part of their claims. The IMF contributes Euro 28
billion to the bailout package.
Commitments of the main stakeholders are:
-Buget cuts: Reducing the public debt to 120.5% of GDP by 2020.
-Permanent surveillance by an increased European presence.
- Approximately Euro 100 billion debt written off by banks and insurers (swap bonds for
longer-dated securities at lower interest rates).
-Private sector holders of Greek debt agreed to write-down 50% of the nominal value
which makes up around 70% loss on the net present value of the debt.
47
3. Crisis resolution
The agreement on the establishment of a permanent crisis resolution mechanism – the
European Stability Mechanism (ESM) - was achieved in June 2011. The summit on
January 31, 2012 clarified legal details. UK did not sign the treaty. Czech Republic did not
sign the treaty at that date because of constitutional reasons. The ESM has to execute
the same tasks as the EFSF. The ESM was established on 27. Sept. 2012 as an
international organisation.
The total subscripted capital will be Euro 700 billion with an effective lending capacity of
Euro 500 billion. According to the latest information there seems to be discussions aimed
at combining the ESFS with the ESM instead of replacing the ESFS by the ESM. If the IMF
provides a third Euro 500 billion funding, the total available backstop fund will increase
to Euro 1.5 trillion. The adequacy of this ceiling will be reassessed in spring 2012.
TO SUM UP
In principle, the EU and the U.S.A. are facing a similar economic situation:
fiscal deficit, sovereign debt crisis, economic recession. The governance
strategies differ sharply: Whereas in the EU common efforts of the EU, ECB
and IMF to finance budget deficits of the four crisis countries are strongly
conditioned on fiscal consolidation, the U.S. government turns its primary
attention to spur growth by introducing new stimulus measures.
48
European Stability Mechanism
Distribution of
contributions
Germany (27.1464%)
France (20.3859%)
Italy (17.9137%)
Spain (11.9037%)
Netherlands (5.7170%)
Belgium (3.4771%)
Greece (2.8167%)
Austria (2.7834%)
Portugal (2.5092%)
FInland (1.7974%)
Bailout in total since 2008 (Euro billions)
Cyprus I + II
Greece
Hungary
Ireland
Latvia
Portugal
Romania
Spain I
12.5
245.6
15.6
67.5
4.5
78.0
19.6
41.4
______
Total
484.6
49
“Especially the Eurozone needs not only monitoring the
government budget debts and deficits, but also
monitoring the private sector imbalances, in particular
private debt levels.
The issue here is how this monitoring can be made
effective so as to avoid new crises.
One can have doubts whether this can be achieved
without a further transfer of sovereignty to European
Institutions.”
Paul de Grauwe
50
The Role of the European Central Bank (ECB)
In May 2010 it took the following actions:
 It began open market operation buying
government and private debt securities,
reaching €219.5 billion by February of 2012,
though it simultaneously absorbed the
same amount of liquidity to prevent a rise in
inflation.[188]
 It reactivated the dollar swap lines with
Federal Reserve support.[190]
 It changed its policy regarding the necessary credit rating for loan
deposits, accepting as collateral all outstanding and new debt
instruments issued or guaranteed by the Greek government, regardless
of the nation's credit rating.
The move took some pressure off Greek government bonds, which
had just been downgraded to junk status, making it difficult for the
government to raise money on capital markets.
51
Long-Term Refinancing Operation (LTRO)
The ECB's first supplementary LTRO with a six-month maturity was
announced March 2008. The first tender was settled April 3, and was more
than four times oversubscribed. The €25 billion auction drew bids
amounting to €103.1 billion, from 177 banks. Another six-month tender was
allotted on July 9, again to the amount of €25 billion.
The first 1y LTRO in June 2009 had close to 1100 bidders.
On 22 December 2011, the ECB started the biggest infusion of credit into the
European banking system in the euro's 13 year history. Under its LTRO it
loaned €489 billion to 523 banks for an exceptionally long period of three
years at a rate of just one percent. The by far biggest amount of €325 billion
was tapped by banks in Greece, Ireland, Italy and Spain. This way the ECB
tried to make sure that banks have enough cash to pay off €200 billion of
their own maturing debts in the first three months of 2012, and at the same
time keep operating and loaning to businesses so that a credit crunch does
not choke off economic growth. It also hoped that banks would use some of
the money to buy government bonds, effectively easing the debt crisis.[200]
On 29 February 2012, the ECB held a second auction, LTRO2, providing 800
Eurozone banks with further €529.5 billion in cheap loans. Net new
borrowing under the €529.5 billion February auction was around €313
billion; out of a total of €256 billion existing ECB lending (MRO + 3m&6m
LTROs), €215 billion was rolled into LTRO2.
52
Recovery from the crisis
 requires increased competitiveness resulting in
higher growth rates
- short-term measure: lowering wages (down to the
level of low-wage countries
seems to be impossible)
- long-term measure: upgrading the technological
and quality level in production
processes and prodcuts
 and may pave the way for a revision of the Treaty of
Lisbon aiming to strengthen fiscal disciplin finally
resulting in a kind of European Fiscal Union
- 9 Dec.2011 agreement (apart from UK) to join a new
intergovernmental treaty which will introduce strict
caps on government spending and borrowing,
including penalties for violations of the limits.
53
Hottest controversies
 Eurobonds jointly issued by the Eurozone member states
Pro: European Commission – Contra: Germany
 EU Financial Transaction Tax
Pro: Germany – Contra: UK
 European Monetary Fund (similar to the IMF)
At the current stage an academic discussion only
 Excluding Greece from the Eurozone
Pro: Many economists – Contra: Most politicians
 Bankers cause the crisis but didn‘t pay, tax payers are
exposed to the damages but didn‘t get reimbursed
54
 Reducing debt via saving versus increasing debt to create growth
European Financial Stabilisation Mechanism (EFSM)
“This mechanism provides financial assistance to EU Member States in financial difficulties.
The European Financial Stabilisation Mechanism (EFSM) essentially reproduces for the
EU 27 the basic mechanics of the existing Balance of Payments Regulation for non-euro area
Member States. Under EFSM, the Commission is allowed to borrow up to a total of €60 billion
in financial markets on behalf of the Union under an implicit EU budget guarantee. The
Commission then on-lends the proceeds to the beneficiary Member State. This particular
lending arrangement implies that there is no debt-servicing cost for the Union.
All interest and loan principal is repaid by the beneficiary Member State via the Commission.
The EU budget guarantees the repayment of the bonds through a p.m. line in case of default
by the borrower.
The EFSM has been activated for Ireland and Portugal, for a total amount up to €48.5 billion
(up to €22.5 billion for Ireland and up to €26 billion for Portugal), to be disbursed over 3 years
(2011 – 2013).
The EFSM is a part of the wider safety net. Alongside the EFSM, the European Financial
Stability Facility (EFSF), i.e. funds guaranteed by the euro area Member States, and
funding from the International Monetary Fund (IMF) are available for euro area Member
States. Non-euro area Member States are also eligible for assistance under the Balance of
Payments Regulation.
The EFSM and the EFSF can only be activated after a request for financial assistance has
been made by the concerned Member State and a macroeconomic adjustment programme,
incorporating strict conditionality, has been agreed with the Commission, in liaison with the
55
European Central Bank (ECB).”
http://ec.europa.eu/economy_finance/eu_borrower/efsm/
The European Financial Stability Facility (EFSF)
What Does European Financial Stability Facility - EFSF Mean?
 An organization created by the European Union to provide assistance to member
states with unstable economies. The European Financial Stability
 Facility is a special purpose vehicle (SPV) managed by the European Investment
Bank, a lending institution. The fund raises money by issuing debt, and distributes the
funds to eurozone countries whose lending institutions need to be recapitalized, who
need help managing their sovereign debt or who need financial stabilization.
 European countries have several options outside of the open market to seek financial
help. Other than the European Financial Stability Facility, European countries can seek
money from European Financial Stabilization
 Mechanism (EFSM), which is guaranteed by the European Union's budget, or the
International Monetary Fund (IMF). These funding mechanisms are supported by the EU
because, while not all countries have debt problems, the failure of one European
economy can have a widespread effect on the health of other economies. Starting in
2013, the EFSF will be replaced by the ESM, or the European Stability Mechanism.
http://www.investopedia.com/terms/e/european-financial-stability-facility
56
The European Financial Stability Facility (EFSF)
The European Financial Stability Facility (EFSF) was created by the euro area
Member States following the decisions taken on 9 May 2010 within the framework
of the Ecofin Council.
The EFSF’s mandate is to safeguard financial stability in Europe by providing
financial assistance to euro area Member States.
EFSF is authorised to use the following instruments linked to appropriate
conditionality:
 Provide loans to countries in financial difficulties
 Intervene in the debt primary and secondary markets. Intervention in the
secondary market will be only on the basis of an ECB analysis recognising the
existence of exceptional financial market circumstances and risks to financial
stability
 Act on the basis of a precautionary programme
Finance recapitalisations of financial institutions through loans to governments
To fulfill its mission, EFSF issues bonds or other debt instruments on the capital
markets.
EFSF is backed by guarantee commitments from the euro area Member States for
a total of €780 billion and has a lending capacity of €440 billion.
57
www.efsf.europa.eu/
The European Financial Stability Facility (EFSF)
58
The Programme for Ireland
59
The Programme for Portugal
The European Stability Mechanism (ESM)
“The ESM is a permanent international financial institution that assists in preserving the
financial stability of the European Union monetary union by providing temporary
stability support to euro area Member States. The Treaty Establishing the European
Stability Mechanism was signed on 2nd February 2012, establishing the ESM as an
intergovernmental organisation under public international law. The ESM was finally
inaugurated on 8 October 2012 upon completion of the ratification process by the
participating euro area Member States. The ESM will be the primary support mechanism
to euro area Member States.
The ESM will issue bonds or other debt instruments on the financial markets to raise
capital to provide assistance to Member States. Unlike the EFSF, which was based upon
euro area Member State guarantees, the ESM will have total subscribed capital of €700
billion provided by euro area Member States. €80 billion of this will be in the form of
paid-in capital with the remaining €620 billion as callable capital. This subscribed capital
will provide a lending capacity for the ESM of € 500 billion.
Financial assistance from the ESM will in all cases be activated upon a request from a
Member State to the Chairperson of the ESM's Board of Governors and will be provided
subject to conditionality appropriate to the instrument chosen. The initial instruments
available to the ESM have been modeled upon those available to the EFSF:
• Provide loans to a euro area Member State in financial difficulties;
• Intervene in the debt primary and secondary markets;
• Act on the basis of a precautionary programme;
• Provide loans to governments for the purpose of recapitalisation of financial
institutions.“
http://ec.europa.eu/economy_finance/european_stabilisation_actions/esm/index_en.htm
61
Euro Crisis: The Worst is Over, Isn‘t It?
Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 4.
Euro Crisis: The Worst is Over, Isn‘t It?
Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 5.
Euro Crisis: The Worst is Over, Isn‘t It?
Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 11.