Breaking the Sovereign
Banking Feed Back Loop
Public Hearing
Success and Failures in Crisis Countries
Committee on Economic and
Monetary Affairs
European Parliament
Brussels, November 5, 2013
Fernando Fernández
fernando.fernandez@ie.edu
Europe: the solution to a self inflicted problem
•
•
•
•
What is wrong with Europe?: an alternative narrative
Understanding the euro project
Why is Banking Union so important?
A brief note on Spain
2
© Fernando Fernández 2013
Macro imbalances around the world
Source: Barclays, European Economics Quarterly, July 2013
3
© Fernando Fernández 2013
The Euro unsustainability as seen from the outside
Source: Institute of International Finance, Eurobrief, March 2013. IMF EuroArea Consultation, July 2013
© Fernando Fernández 2013
4
Aggravated by Financial Fragmentation
Source: IMF, WEO, October 2013
5
© Fernando Fernández 2013
Interest Rates in the Euro Area
Source: IMF, Global Financial Stability Report, October 2013
6
© Fernando Fernández 2013
And the vicious circle of bank-sovereign-corporate deterioration
Source: IMF, Global Financial Stability Report, October 2013
7
© Fernando Fernández 2013
The Maastricht Treaty: a strange animal by design
• Independent monetary policy by the ECB
• ECB response is not really that different, but the environment is
• No safe European asset for monetary policy
• No lender of last resort facility until OMT was improvised
• No fiscal policy coordination
• National regulation and supervision of financial systems
• No European approach to banking regulation, supervision and
resolution until late 2013 and still in the works
• National regulators, facing a textbook collective action problem,
acted to aggravate the Euro crisis
• National fiscal policies subject to non-binding rules
• The Stability and Growth Pact unenforceable ex-post
• No bail-out, why can California default but Greece could not?
• No exit works both ways
8
© Fernando Fernández, 2013
The crisis showed the Euro was naked
• The Greek fiscal problem and what it reveals of EMU
• Open fiscal contingencies
• No stabilization fund
• Ireland and its banking problem
• No national lender of last resort
• Banking problems become sovereign problems
• Reflation is not possible, so default the only alternative
• No growth, loss of competitiveness in Portugal
• The “Argentina syndrome”
• How to ensure/impose structural reform?
• Internal devaluations are painful and take time
• Cyprus:
• Sequencing issues: Bail in before Resolution Authority and
Common Deposit Guarantee
• Capital controls cannot be part of the tool kit
© Fernando Fernández, 2013
9
The Cost of the Banking Crisis
Source: IMF, Fiscal Monitor, October 2013
© Fernando Fernández 2013
10
Understanding Europe: Likely scenarios
 Monetary Union as envisaged in Maastricht is dead
 For good reasons. It was never an optimum currency area
 But it is taking a long and painful time to go
 Normative Economics: what should happen
•
•
•
•
Banking Union
Fiscal Union
Political Union: No taxation without representation
And even so, everything is possible, because growth is of
essence in a democratic Union
 Positive Economics: what is likely to happen
• Muddle through, playing at the edge
• Uncertainty, volatility, sudden events and prolonged subdued
growth
 But an accident may always happen
• Despite today being highly unlikely
© Fernando Fernández, 2013
11
Banking Union
 A single supervisor. Basically agreed but
• Will markets wait for late 2014? Too much national discretion
• AQR, Balance sheet assessment and Stress testing dangerous
without a common fiscal back stop
 A Common Resolution Authority
• A 3 stage approach: prevention, restructuring and liquidation
• Will the pecking order of losses be applied uniformly?
• It entails, by definition, mutualization of the debt. (quasi-fiscal)
• It cannot be the Commission: No country allows Bank
recapitalization to be decided by the Competition Authority
• An European Deposit Guarantee Fund is missing




To break the vicious cycle of banking ad sovereign crisis
To allow fair competition to the benefit of the consumer
To avoid extensions of “bank holidays”
Three decisions: coverage, funding and institutional
12
© Fernando Fernández, 2013
A Limited Fiscal Union
– A Fiscal Union does not mean full tax or expenditure harmonization
• but simply avoiding externalities
– Euro Treasure
• Common monetary policy requires an euro risk free asset
• An asset that has to meet strict requirements: (i) depth and liquidity (ii)
ample references at all maturities; (iii) actively traded in liquid markets;
(iv) available in the short run for existing debt and not only for future
debt, the legacy problem; and (v) its emission to be the sole responsibility
of the Euro Treasure
• An Euro Treasure issuing an euro asset leads to decide on:
– (i) the source of funds: Euro Tax (new or old) vs. revenue sharing mechanisms
– (ii) the use of funds: the European Stabilization Fund
– Fiscal rules for the Euro Zone,
• Rationale: To avoid national policies impeding adequate functioning of
common monetary policy
• Implication: A binding restriction on national budgetary aggregates
• Evolution: Complex structural rules increasing implementation risk
© Fernando Fernández, 2013
13
A note on Spain
 The case of Spain is an euro crisis
• It could not have happened without the euro
• It will not be solved without addressing the mistakes in Maastricht
 Spain adjustment is work in progress.
• A proven willingness to reform, however reluctantly
• A significant turn around in banks solvency and profitability, fiscal
consolidation and external competitiveness.
• Foreign Investment, both debt and equity flows, coming in
• Institutional stability
• But employment growth remain and will remain elusive.
 Challenges and priorities for the future
• Restore and maintain fiscal balances in a highly decentralized state
• Job creation and additional labor market and education reform
• And creating a more business friendly environment
14
© Fernando Fernández, 2013