Introduction Global consequences of the crisis Origins of the Eurozone and ECB. The recent fall of the Eurozone Conclusion

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1 A POTENTIAL BREAKDOWN OF THE EUROZONE Dr. Petr Teplý Charles University in Prague, Czech Republic University of Economics in Prague, Czech Republic Massey University Palmerston North, New Zealand 31 August 2011

2 Agenda Introduction Global consequences of the crisis Origins of the Eurozone and ECB The Eurozone and ECB during crisis The recent fall of the Eurozone Conclusion 31 August 2011 A potential breakdown of the Eurozone 2

3 Presenter Dr. Petr Teplý Education 2000 JKU in Linz, Austria 2006 University of Otago, New Zealand 2006 State University of New York, New Paltz, USA 2009 Ph.D. in Finance, Charles University, Czech Rep. Research interests: banking, finance, risk management, financial stability, public finance, RIA (Co)author of over 60 articles and 10 books Guest lectures in New Zealand, Turkey, USA Presentations at Harvard University, State University of New York, China, Dubai, India, London, India, Nepal, Singapore etc. Job experience CSOB Bank, Czech Rep Spencer Clarke, New York, USA EEIP, a.s., Czech Rep. 3

4 Introduction to The Czech Republic (1/2) 4

5 Introduction to The Czech Republic (2/2) Three Main Czech Icons Czech TOP Sports (wo)men Czech Beer Petra KVITOVA 5

6 CUNI = public university founded in 1348 now 17 faculties, 51,000 students, 7,500 employees, 300 accredited degree programms and 660 study disciplines My affiliation: Department of Finance and Capital Markets/Institute of Economic Studies/Faculty of Social Sciences Source: Academic Ranking of World Universities 2011, 6

7 1. Introduction Three aims of the presentation 1) To present my view on the global crisis, the ECB and the Eurozone 2) To provide info on origins of the ECB and the Eurozone 3) To welcome comments from the opposite side of the globe 7

8 1. Introduction Global political governance Source: Petr Teply (2010)

9 1. Introduction Politicians catching power or money?both Both? 9

10 1. Introduction Taxpayers did, do and will always cry!!!

11 1. Introduction plus ineffective regulation of financial markets

12 1. Introduction G2 G20 G0 and no coordination on a global level! 12 Source: The Economist 12

13 Agenda Introduction Global consequences of the crisis Origins of the Eurozone and ECB The Eurozone and ECB during crisis The recent fall of the Eurozone Conclusion 31 August 2011 A potential breakdown of the Eurozone 13

14 2. Global consequences of the crisis Déjà vu to the Asian crisis in 1997 Source: IMF 14

15 2. Global consequences of the crisis Key players during the crisis 1. Mortgage originators Lenders Commercial banks 2. Risk shifters/ transformers Commercial banks Investment banks/prime brokers Government-sponsored enterprises SPVs (ABCP/SIV/conduits) 3. Investors Commercial/investment banks Hedge/pension funds Insurance companies Investment funds Private investors 4. Insurers Insurance companies Monoline insurers Reinsurence companies 5. Rescuers Central banks Governmental institutions Sovereign wealth funds International Monetary Fund Private investors 6. Others Rating agencies US government Regulatory bodies Source: Teply, P., Pecena M. (2010). Credit risk and financial crises 15

16 2. Global consequences of the crisis Fairy tale about credit and liquidity risks Credit risk Liquidity risk Reinsurer $$$ Central bank International Institutions $$$ $$$ Borrower US Government Insurance company $$$ Government institutions $$$ $$$ Mortgage Guarantees Insurance $$$ Mortgage CDO Lender/Bank GSE SPV $$$ $$$ ST debt $$$ Commercial bank $$$ $$$ CDO $$$ ST debt $$$ ST debt $$$ $$$ Sovereign Wealth Funds Investors Hedge funds Source: Teply, P., Pecena M. (2010). Credit risk and financial crises 16

17 2. Global consequences of the crisis Four stages of the pending global crisis 17

18 2. Global consequences of the crisis Tsunami of sovereign bankruptcies in the EMU Who and when will be next? 18

19 2. Global consequences of the crisis Magical triangle of exit strategies and financial stability Monetary policy Fiscal policy Financial sector The magical triangle of exit strategies International coordination needed! Importance of competitiveness of economies Different time schedules of exits Source: Petr Teplý (2010) G0 G20 19

20 2. Global consequences of the crisis Timing of exit strategies/expansive monetary policy Odysseus dilemma: Scylla a Charybdis higher inflation/asset bubbles or recession? 20

21 2. Global consequences of the crisis Expansive monetary policies around the world Source: Petr Teplý (2010) 21

22 2. Global consequences of the crisis Monetary policy High engagement of many central banks Financial sector Fiscal policy Source: Economist (2011), FITCH (2011) 22

23 2. Global consequences of the crisis Quantitative easing 1,2,3 Monetary policy Financial sector Fiscal policy The Federal Reserve announced that it would buy $600 billion in Treasuries over the next eight months in a second round of quantitative easing. The decision to pump more liquidity into the American economy to bring down longterm interest rates and spur growth prompted modest rises in stockmarkets around the world. Source: The Economist on 4 November

24 2. Global consequences of the crisis Deteriorating reputation of central banks Source: The Economist (2011) 24

25 Agenda Introduction Global consequences of the crisis Origins of the Eurozone and ECB The Eurozone and ECB during crisis The recent fall of the Eurozone Conclusion 31 August 2011 A potential breakdown of the Eurozone 25

26 3. Origins of the Eurozone and ECB Origins of the EU and the Eurozone o European Union (now 27 countries) objective of economic integration. o Idea of European Monetary Union (EMU) has been around since early 1970s. o Exchange Rate Mechanism (ERM): system of fixed exchange rates. o German Unication - ERM collapsed in early 1990s o The 1992 Maastricht Treaty set up the EMU with the EURO o 1 January 1999: o Conversion rates are established o ECB assumes responsibility for a single monetary policy 26

27 3. Origins of the Eurozone and ECB ECB s basic capital distribution Source: 27

28 3. Origins of the Eurozone and ECB Eurozone countries Source: The Economist (2010) 28

29 3. Origins of the Eurozone and ECB (In)dependence of the ECB Source: 29

30 3. Origins of the Eurozone and ECB Political pressure on the ECB I know! Sure! I am independant! 30

31 3. Origins of the Eurozone and ECB How should the regulator react on under/mispricing risk??? Source: Mejstřík, Teplý (2011) 31

32 3. Origins of the Eurozone and ECB Bankruptcies of Ireland and Greece

33 3. Origins of the Eurozone and ECB but different causes Source: Fitch (2010), DB Research (2010)

34 3. Origins of the Eurozone and ECB Ddifferent macroeconomic developments in the EMU Source: DB Research (2010)

35 3. Origins of the Eurozone and ECB has widened gaps in competitiveness Source: DB Research (2010)

36 3. Origins of the Eurozone and ECB increased public deficits Source: DB Research (2010)

37 3. Origins of the Eurozone and ECB and related high gross fiscal financing needs Source: Fitch (2010) 37

38 3. Origins of the Eurozone and ECB Greece long-term fiscal and external imbalances Source: Fitch (2010) 38

39 3. Origins of the Eurozone and ECB Irish and Greek public debt held by foreigners!!! Source: IMF (2011) 39

40 3. Origins of the Eurozone and ECB Ireland overheated financial sector Source: Fitch (2010) 40

41 3. Origins of the Eurozone and ECB skyrocketing bank credits Source: The Economist (2010) 41

42 3. Origins of the Eurozone and ECB financing real estate buble Source: The Economist (2010) 42

43 Agenda Introduction Global consequences of the crisis Origins of the Eurozone and ECB The Eurozone and ECB during crisis The recent fall of the Eurozone Conclusion 31 August 2011 A potential breakdown of the Eurozone 43

44 4. The Eurozone and ECB during crisis ECB s help to PIGS Source: FITCH (2011) 44 44

45 4. The Eurozone and ECB during crisis Future expected problems in Europe The dark future of Greece: bank runs, demonstration, riots, followed by anarchy/revolution/dictatorship like in the past... And what about other PIGS? Source: Petr Teplý (2011) 45

46 4. The Eurozone and ECB during crisis differentiated gov t bond yields 10-year bond yields in the EMU and the CR (%) 10-year bond yields of developed countries (%) Zdroj: Bloomberg, IMF, MARKIT 46

47 4. The Eurozone and ECB during crisis CDS spreads s imply different credit risk of CEE countries and PIGS Credit Default Swap (CDS) spreads (bps) Source: MMF (2011), RB Research (2011) Sovereign CDS (bps), change in April 2011 and April

48 Agenda Introduction Global consequences of the crisis Origins of the Eurozone and ECB The Eurozone and ECB during crisis The recent fall of the Eurozone Conclusion 31 August 2011 A potential breakdown of the Eurozone 48

49 5. The recent fall of the Eurozone Greece s bankruptcy in May 2010 financial markets stopped believing Greek myths and numbers! 49

50 5. The recent fall of the Eurozone and European support started o EUR 500 billion emergency fund with two facilities 1) An existing EU balance of payments facility, previously only available to non euro area members of the EU: this has now been expanded by EUR60bn, funded out of the existing EU budget and made accessible to euro area member states (European Financial Stabilisation Mechanism (EFSM) 2) The second component is a new European Financial Stabilisation Facility (EFSF). The EFSF will access capital markets for up to EUR440bn through a specially created funding facility on the back of sovereign guarantees from euro zone member states, much of which will be available for on lending to those countries facing financing distress. This funding could be supplemented by as much as EUR220bn from the IMF, in addition to the EUR30bn 50 Source: Fitch (2010) already committed to Greece.

51 5. The recent fall of the Eurozone The EFSM structure of funding Source: ECB (2010) 51

52 5. The recent fall of the Eurozone The EFSF structure of funding Source: ECB (2010) 52

53 5. The recent fall of the Eurozone Financial needs and support of the EFSF Source: Fitch (2010) 53

54 5. The recent fall of the Eurozone The ESFS structure of funding Source: Fitch (2010) 54

55 5. The recent fall of the Eurozone European Stability Mechanism (March 2011) Source: Financial Times (2011) 55

56 5. The recent fall of the Eurozone Main Features of the EFSM, EFSF and ESM (1/2) Source: FITCH (2011) 56

57 5. The recent fall of the Eurozone Main Features of the EFSM, EFSF and ESM (2/2) Source: FITCH (2011) 57

58 5. The recent fall of the Eurozone But future financial needs of PIGS Source: The Economist (2010) 58

59 5. The recent fall of the Eurozone..including a road to hell of Spain (cajas!) Source: Fitch (2011) 59

60 5. The recent fall of the Eurozone...lack.lack of capacity of the EFSF Why not Eurobonds? Because of higher financing costs for Germany (IFO: EUR 47bn costs annualy!) Source: The Economist (2011) 60

61 5. The recent fall of the Eurozone Strong connection between Germany and PIGS Zdroj: Wolf: Intolerable choices for the eurozone, Financial Times on 31 May

62 5. The recent fall of the Eurozone Exposures to Greek debt (2010) 62

63 5. The recent fall of the Eurozone restructuralization of PIGS debt needed! the need to fix a situation after > European Stability Mechanism (ESM), but ONLY a partial agreement (due to elections in Finland and Germany) Source: DB Research (2011) 63

64 5. The recent fall of the Eurozone 5 options on Greek debt restructuring Politicians are just buying time (until their elections) but hard restructuring is inevitable Greeks will never repaid all their debts! 64

65 5. Euro a kurzové riziko And what about Germans? In case of Greek debt restructuring German taxpayers will cry, but in different time and different amount 1) Bankruptcy of Ger. banks (bail-out) 2) Recapitalization of the ECB 3) Guarantee mechanisms (EFSF, ESM) 4) International Monetary Funds Optimum for Germans: To keep Greece/PIGS alive until the lections in 2013 and then let them go down (kick-off out of the Eurozone) 65

66 Agenda Introduction Global consequences of the crisis Origins of the Eurozone and ECB The Eurozone and ECB during crisis The recent fall of the Eurozone Conclusion 31 August 2011 A potential breakdown of the Eurozone 66

67 6. Conclusion The Eurozone in its current form will not survive the year of 2013! 67

68 Discussion Many thanks for your kind attention! Any questions? 68

69 Useful sources 69