MPI Collective Goods
Martin Hellwig
Why is the Eurozone Crisis so Difficult to
Deal With
http://www.coll.mpg.de/pdf_dat/2011_12online.pdf
http://www.cesifogroup.de/portal/pls/portal/docs/1/1191406.PDF
Introductory Remarks
 European integration has always involved a
strange mixture of idealism and pursuit of
national interest with a lot of log rolling
 Example: The Schuman Plan 1950 (Coal and
Steel Community):
 Co-operation as a basis for trust
 De-nationalization of control over the (German) war
industries (coal and steel)
 Re-integration of Germany into the international
community
 The quintessential bumble bee.
The „Euro Crisis“
 Not a currency crisis!
 A sovereign debt crisis of the usual type in
Greece, Portugal, and perhaps Italy
 A banking crisis, due to a real-estate boom
and bust, in Ireland and Spain,
 … inducing a sovereign debt crisis in Ireland
and perhaps also Spain
 A latent banking crisis in Germany and France
where banks have relatively little equity and a
lot of involvement with GPIIS
Spring 2010:
Why were the rules broken?
 The Treaty has a no-bailout clause
 Why was it not applied?
 The European Commission did not want to
 By not applying the rules they could increase their
own turf
 France did not want to: French banks were
strongly exposed to Greece
 Germany? … gave in to pressure from France
 To save German banks without appearing to do so?
 Because Greece had only a „liquidity“ problem?
Why is there no long-run
strategy?
 March 2010: guarantees for 110 bn. EUR Greek debt
 May 2010: creation of EFSF with funds of 60 bn. from
EU, 440 bn. from member states, 250 bn. from IMF
 May 2010: beginning of SMP
 October 2010: Merkel/Sarkozy: Future Bailins
 November 2010: Finance Ministers: Bailins only in
Solvency Crises
 Ireland (November), Portugal (April 2011)
 March 2011: Agreement on ESM (=permanent EFSF),
 July 21, 2011: New Package for Greece, new
competence for EFSF/ESM additional leverage; PSI
Why is there no long-run
strategy?
 August 2011: Barroso: Package is not enough
 ... Stock market declines… doubts about banks
… Withdrawal of short-term $ funding (MMFs)... „Runs“
(?) on Italian and Spanish government debt
 October 2011: Summit „Six Pack“, including call for
repitalization on banks by June 30, 2012 ....
 November 2011: Recapitalization requirement fixed as a
ratio requirement..... Deleveraging
 December 2011/January 2012: ECB‘s LTRO launched
 ... banks buy sovereign debt....
 February/March 2012: New Greek rescue package with
significant PSI; Fiscal Pact concluded
Why is there no long-run
strategy?
 Multiplicity of conflict lines





Commission – Member States
Borrowers – Lenders
France – Germany (personalities, interests)
Governments – Banks
ECB - Governments
 Delay as a strategy
 „Guarantees do not cost anything“ (cameralistic
accounting at the German finance ministry)
 Intransparency as a means of hiding costs
 Difficulty of the Problem
Institutional Framework
 European Union:
Commission, Council, Parliament jointly have
legislative power under the Treaty
The Commission has (limited) executive power
 Monetary Union:
European Central Bank is independent
 Fiscal Policy:




National competence
… subject to the stability and growth pact
… and the no-bailout clause of the Treaty
... and in the future the new fiscal pact (!  !)
Difficulty of the Problem
 Large haircuts on sovereign debt or interbank
debt
 … would endanger or destroy banking systems
 … could lead to a huge write-off at ECB
 … would not re-establish competitiveness in
international markets
In the Greek case, many of the losses have been
socialized – Greek banks are encompassed in the
rescue package
Difficulty of the Problem
 A re-introduction of the drachma would do the
job, but then how would the Greek
government finance its primary deficit? And
how would Greece cope with the twin run on
banks and currency?
 Constellations in other countries are similar,
with a strong concentration of holdings of
sovereign debt in the country‘s own banks,
 … but with Spain or Italy, there would be
substantial second-round effects from
interconnectedness of banking systems
Role of the ECB
 Inaction of fiscal authorities has left the ECB
as the only institution in a position to act
quickly
 Like the Fed, ECB has expanded its balance
sheet through lending on collateral and buying
 It holds large amounts of sovereign debt and
bank debt, directly and a scollateral
 LTRO programs have accelerated the process
 Addresses liquidity problems... Solvency??
 Target 2 positions?
Role of the ECB
 Expansion of ECB balance sheet has not been
very inflationary
 Even so, losses taken on ECB losses are costs
to the taxpayer (waste of seigniorage)
 But, in a constellation with system-wide
excessive leverage, this may be the cheapest
way to neutralize the fallout
 … if it were not for the implication that
politicians are finding out that banking
problems provide access to the printing press
Role of the ECB
 Losses from haircuts do not pose a problem
for the ECB as a business unit, but they do
pose a political problem,
 … need to „recapitalize“
 … focuses discussion on the role of the ECB as
a component of the mechanism of fiscal
redistribution
 … gives room for discussion about governance
of central banking in EMU
Why did things go wrong in the
first place?
 Creation of EMU led to a disappearance of
spreads (relative to Germany): from close to
14 % in 1995 for Italy, close to 10 % in 1998
for Greece to close to zero by 2001.
 With less than fully integrated goods markets,
price movements diverged, leading to
differences in real rates of interest across
countries: Ireland/Spain versus
Germany/Netherlands
 Overvaluation of DM relative to other countries
at entry into EUR
Why did things go wrong in the
first place?
 Elimination of exchange rate risk fuelled capital
movements from north to south + Ireland
 Role of differences in real rates: Ireland, Spain (building
booms)
 Role of demography (Germany) + export orientation
 Role of low rates on public sector borrowing (Greece,
Italy, … Germany (!))
 High growth in Ireland, Spain, Greece, low growth in
Germany
Why did things go wrong in the
first place?
 Risk premia began to rise when the subprime
crisis broke.
 The new (?) crisis broke out when in the fall of
2009 the new Greek government declared that
the numbers had been cooked and
government deficit was 13 % rather than 6 –
8 % of GDP (in fact 15 %)
 In 2010, this was followed by the burst of the
real estate bubbles in Ireland and Spain
A puzzle
 Why did risk premia remain close to zero until
2007?
 Von Hagen et al. (2004) already raise this
question
 … didn‘t banks understand that governments
no longer had the ability to print what they
owed?
 … or did they expect that institutions would be
changed to bail them out?
Risk Weights and Leverage
 Zero risk weights on government debt (still in
force)
 Low risk weights on real-estate and interbank
lending
 With a given amount of equity you can invest
arbitrary amounts in government debt if you
can find funding: Dexia (F) has equity equal to
.67 % of total assets. Hypo Real Estate had
around 1 %.
 … the analogues of Fannie and Freddie
… and the authorities?
 … are thinking of „their“ banks as national
champions with whose successes they must
not interfere
 … laxity in Ireland and Spain
 … and in Germany…
 … are thinking of banks as a source of funds
rather than a source of risks... Which is why
zero risk weights are wonderful!
A Comment on German Banks 1
 German banking has severe structural
problems
 Four segments: private, co-operative, publicretail, public-wholesale (Landesbanken)
 Retail is profitable for public savings and cooperative banks.
 Wholesale profitability has been squeezed
since the mid-nineties:
 Landesbanken have no viable business model
 Private Banks are in danger of losing theirs
A Comment on German Banks 2
 Landesbanken have forever been gambling for
survival
 one major scandal per decade
 Probably a 300 bn. involvement in subprime
 Large investments in Southern Europe
 Private Banks have taken very long to
understand the structural change
 Dresdner went under (acquisition by Commerzbank)
 HVB spun off Hypo Real Estate in order to be taken
over by Unicredit
 HRE saved and maintained (!) by Government
 Commerzbank saved by the Government
A Comment on German Banks 3
 Lack of an exit mechanism for the
Landesbanken – political economy
 Destabilization of real-estate/covered-bond
finance system
 … even when they need federal money
 Intransparency about bailouts as a consistent
strategy… Bad banks for West LB and HRE will
take time to do their accounts
 Total expected taxpayer losses from crisis at
this point 80 – 100 bn. EUR
A Comment on German Banks 4
 Difficulties of recapitalization of public banks
….. have shaped the German (and French)
negotiating position in Basel
….. and now
 The notion of the bank as a source of (cheap!)
funds for public purposes drives political
discourse about regulation and supervision…
even now
 Europeanization of supervision may be the
only way to break that link
Summary 1
 Interdependence of three crises, sovereign,
Irish-style banking crisis, German-style
banking problems is hard to disentangle
 Overlapping conflicts between different parties
and different institutions make negotiations
difficult
 …. and contribute to the proliferation of halbaked press announcements that is itself a
source of financial system risk
Summary 2
 Do the major players have the political will to
actually tackle the crisis?
 Are they willing even to identify what the
problems are (solvency vs. liquidity, banking
problems, governance, time.consistency)
 Are they able to so? (dominance of legalistic
thinking, cameralistic accounting)