Breaking the Sovereign Banking Feed Back Loop Public Hearing Success and Failures in Crisis Countries Committee on Economic and Monetary Affairs European.

Breaking the Sovereign Banking Feed Back Loop

Public HearingSuccess and Failures in Crisis Countries

Committee on Economic and Monetary Affairs

European Parliament

Brussels, November 5, 2013

Fernando Fernández

[email protected]

• What is wrong with Europe?: an alternative narrative• Understanding the euro project• Why is Banking Union so important?• A brief note on Spain

Europe: the solution to a self inflicted problem

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© Fernando Fernández 2013

Macro imbalances around the world

3© Fernando Fernández 2013

Source: Barclays, European Economics Quarterly, July 2013

The Euro unsustainability as seen from the outside


Source: Institute of International Finance, Eurobrief, March 2013. IMF EuroArea Consultation, July 2013

Aggravated by Financial Fragmentation


Source: IMF, WEO, October 2013

Interest Rates in the Euro Area


Source: IMF, Global Financial Stability Report, October 2013

And the vicious circle of bank-sovereign-corporate deterioration


Source: IMF, Global Financial Stability Report, October 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

© Fernando Fernández, 20138

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


The Cost of the Banking Crisis


Source: IMF, Fiscal Monitor, October 2013

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

Understanding Europe: Likely scenarios


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

A Limited Fiscal Union

13© Fernando Fernández, 2013

– 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

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


Breaking the Sovereign Banking Feed Back Loop Public Hearing Success and Failures in Crisis Countries Committee on Economic and Monetary Affairs European.

Documents

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