The European Arm of the International Financial Crisis

Transcription

1 The European Arm of the International Financial Crisis Gikas A. Hardouvelis Conference on The Global Financial Crisis Revisited, Friday, October 5, 2018, Center for International Securities & Derivatives Markets, Isenberg School of Management, University of Massachusetts Amherst

2 The European Arm of the International Financial Crisis Table of Contents I. A brief history: Three legs of the crisis Two separate phases in its European arm II. Euro Area at threat III. Greek troubles Three crisis stages IV. Summary Isenberg School of Management, October 5, 2018

3 Introduction: The worldwide Great Recession years ago, in Sept. 2008, the Lehman episode caught everyone by surprise: Economists, central bankers, regulators, rating agencies % World real GDP growth Source: IMF, World Bank It led to a -2 collapse in int/al trade and the biggest world-wide recession since the 1930s The international financial crisis, which had started in August 2007, stopped in 2009 thanks to heavy US intervention USA faced two legs of the crisis: Financial & Real Economy Europe faced three legs: : Financial, Real Economy, Sovereign 3 3,9-0,8

4 I. THE UNHOLY TRINITY: THREE INTERELATED LEGS OF THE EMU CRISIS The three legs of a crisis Sovereign Debt Crisis Austerity measures, rise in interest rates Sovereign solvency questions Real Economy under Stress Large bank failures bankrupt sovereigns as they try to support banks Began as a financial crisis in US & Europe Moved to the real economies and to European sovereign debts Then formed into a major Euro Area crisis A Sovereign default bankrupts banks with sizable gov. bonds Banking Crisis Reduced supply of credit Falling asset prices, reduced loan demand Source: Shambaugh, BPEA (2012) 4

5 Europe faces two consecutive crises itraxx 5-yr CDS spreads of senior European financials bps Mar Northern Rock Bear Stearns Incidents Sep Lehman Brothers collapse Mar AIG record quarterly losses Dec ECB announces 3-yr LTROs May st Greek bailout program May 2012 Greek Elections Jul Draghi: whatever it takes Mar Monte dei Paschi incident Diagram shows the cost of buying insurance for holding a bond issued by a European bank /2/2018 Source: Bloomberg Jan-07 Aug-08 Mar-10 Oct-11 May-13 Dec-14 Jul-16 Feb-18 The second phase is more serious: It threatens the existence of the Euro Area 5

6 Euro Area torn by the bond markets Sep-92 Oct-96 Nov-00 Dec-04 Jan-09 Feb bps (GR) 10-yr spreads over bunds (September 1992 February 2013) bps Euro Area is formed Note: Greek spreads are measured on the left axis Note: Data are monthly averages Source: Eurostat 600 Greece Italy 400 Spain Ireland 200 Portugal 0 0

7 II. I. A brief history: Three legs of the crisis Two separate phases in its European arm II. Euro Area at threat III. Greek troubles Three crisis stages IV. Summary 7

8 Why an EMU crisis? Aggregate EMU statistics not necessarily worse than in the US Euro Area in better shape than USA 1. Smaller Public Debt/GDP 2. Same story in Private debt 3. Balanced current account vs. negative in USA A crisis of cohesion in Euro Area USA EA -0.2 Current Account Balance (% of GDP, avg.) Japan UK Greece -9.0 Portugal -9.5 Ireland -1.6 Source: Eurostat, IMF Spain % Cyprus USA EA Japan UK Greece Portugal Ireland Spain Cyprus USA EZ Public & Private Debt (% of GDP, 2011) Japan Source: Eurostat, IMF, FRB, BoJ, ECB UK Greece Public Debt (% GDP) Portugal Ireland Source: Eurostat, IMF Households Non Fin. Corporations Public Spain Cyprus 8

9 Answer: Serious imbalances within EMU Post-EMU, a competitive North and an uncompetitive South emerged Politicians interpreted the EMU crisis as a fiscal crisis only There was no automatic mechanism to correct the imbalances as before 1999 The South borrowed cheaply and Banks of the North were happy to expand: Everyone happy Markets did not pricein those imbalances Average annual external and fiscal balance in EA-12 (plus Cyprus) before the Greek/EMU crisis hit in early 2010 Greece was among the biggest outliers, needed to improve competitiveness and its fiscal balances TWIN DEFICITS TWIN SURPLUSES Source: European Commission 9

10 Why EMU? A historical background EMU was a political project created by the Maastricht Treaty quickly after the fall of the Berlin Wall, initiated by the French, who viewed EMU as the first step toward the political integration in Europe, with Optimum Currency Area (OCA) considerations expected to be fulfilled endogenously over time OCA requires: 1) Highly interconnected external trade sectors with free cross-country mobility of financial capital, labor, and products & services 2) Adequate degree of uniformity across domestic economic structures and policies a. Common economic policy criteria, synchronization in fiscal policies b. Similarity in the structure of the real economy,e.g. price and labor market flexibility, pension system rules, competitiveness rules, uniform degree of state intervention in the private sector, etc c. Common bank regulation and supervision 3) Existence of a fiscal mechanism to smoothen the effects of asymmetric shocks, e.g. on the terms of trade, on size of foreign demand, on asynchronous domestic business cycle developments 10

11 The Greek crisis exposed EMU faults During the international crisis many financial rescue decisions were taken within the G-20 forum the crisis did not raise concern about the stability of the Euro Area It was the Greek crisis which raised awareness of the EA faults as it caught Euro Area unprepared Europeans rushed to rescue Greece in May 2010, abandoning the no bail-out principle; created the EFSF. Some argue it was their bank exposures to a Greek default that pushed them. I think it was the fear of an EMU break up. GREXIT became a possibility and was priced in the bond markets. The BIG FEAR: What if a large country were to leave EMU immediately after once the precedent was established? Yet at Deauville in October 2010 Merkel-Sarkozy wavered back, afraid of moral hazard and fiscally irresponsible copy-cat countries, hence claiming bail-ins, not bail-outs, would be the rule in the future Since the Greek crisis, European politicians continue to be torn between crisis mitigation and crisis prevention, trying to design a better architecture Gikas A. Hardouvelis 11

12 A moral hazard rationale dominated the response to the Greek crisis Crisis brought to the surface two needs, not necessarily complementary: 1) Need for actions to contain the crisis 2) Need for reform, for a better long-run framework, which would ensure long-term stability of the euro and prevent a future crisis Academics agree: Solve the crisis first and then worry about the long-run architecture and the adverse incentive problems European politicians chose a mid-way path, hence tackling the crisis on a piecemeal basis, always running behind the curve of events When the crisis hit Greece, the country seemed too small to impact the rest of EMU Moral hazard reasons and austerity prescriptions dominated the discussions Politicians also catered to their domestic constituencies and the domestic populist press, which painted the Greeks as lazy and corrupt, who are taking their money. They confused the EMU imbalances with moral arguments about the Greeks. They never took decisive actions, and were thus continuously behind the curve in their responses 12

13 New Institutions are created in EMU Emergency safety net: 1) ESM (European Stability Mechanism, a continuation of EFSF) was activated in Sept 2012, modeled after the IMF, namely provides funds to Euro Area members under an MoU vetted by the Troika 2) OMT (Outright Monetary Transactions) announced in July 2012, after the decision on the Banking Union and before the Mario Draghi s speech on whatever it takes. Never utilized thus far. Monetary backstop. ECB can purchase unlimited amounts of member state s government bonds when under an ESM program and yields are under stress. Banking Union decision in June 2012 (see next page). Yet bank supervision more lax relative to the US, as capital rules on large banks are softer, allowing internal models to reduce the required capital. Stricter fiscal rules in the Stability and Growth Pact. An alphabet soup of pacts. Creation of independent national Fiscal Councils. Early submission to EC of annual budgets. Targets on the cyclically adjusted fiscal balance. Voting procedure on sanctions. Yet, no transfer mechanisms initiated or envisaged Gikas A. Hardouvelis 13

14 Banking Union in Europe SSM since November 2014, looks over 128 large banks, first stress tests 10/2014 SRM since 1/1/2016, it will have 55bn when fully funded, would first bail-in uninsured lenders up to a % of bank assets Daniele Nouy Elke König Gikas A. Hardouvelis 14

15 Euro Area reform has stalled: Why? As the European economy rebounded, reform pressure subsided: Not much is done since the Single Resolution Mechanism of July 2014, which is part of the Banking Union, and was initiated in the midst of the crisis in 2012 Two sides to the debate (crisis mitigation vs. prevention): (A) France, Italy and the European South worry about crisis mitigation; they support additional mechanisms of risksharing and stabilization, stronger governance (B) Germany, Netherlands, and others worry about moral hazard and crisis prevention; they oppose additional risk sharing, and instead propose tougher enforcement of fiscal rules, market discipline Gikas A. Hardouvelis 15

16 Euro Area reform: Yes, it can continue The IMF came out in Feb 2018 with a proposal for a tighter fiscal union In Jan 2018, a dozen French & German CEPR economists offer ideas on a number of financial, fiscal and institutional reforms that would improve both crisis prevention and crisis mitigation, i.e. both market discipline ( lower moral hazard) and risk sharing ( mitigate a crisis) in the Euro Area: 1) Break the Bank-Sovereign doom loop via sovereign bond concentration charges for banks and a common deposit insurance 2) Switch to fiscal targets based on simple expenditure rules & finance possible planned deviations from those targets with junior debt 3) Make the no-bailout clause time-consistent by designing orderly debt restructurings through legal and economic means 4) Create a Euro Area fund to absorb large economic disruptions, with contributions proportional to its possible use 5) Create a synthetic Euro Area safe asset (like a CDO) 6) Reform the Euro Area institutional architecture by separating the watchdogs from the political decision makers Gikas A. Hardouvelis 16

17 III. I. A brief history: Three legs of the crisis Two separate phases in its European arm II. Euro Area at threat III. Greek troubles Three crisis stages IV. Summary 17

18 Two stages prolong the Greek crisis: Economic imbalances drive the first Politics the second Phase ΙΙ costs annually 7.8 ppts or 18bn Was unnecessary Real GDP at 100 in 1929 for USA 2007 for Greece After 10 years, USA at in 1939, but Greece at 74.6 in 2017 Forecast as of Fall 2014: Greece at 82.4 in USA Int/nal Crisis Source: Ameco, EC, BEA Crisis Stage I Greece Crisis Stage II Annual opportunity cost due to Phase II Annual loss 25.4% relative to year 0 EC Spring 2018 forecasts Years after recession started 18

19 Fiscal imbalances are corrected by 2014 Peek imbalance in 2009 (primary deficit at -10.1% of GDP) By 2013 the primary balance was at a surplus of 0.4% of GDP % GDP 5,9 6,7 4,4 4,5 1,5 2,2 10,2 4,8 5,4 15,1 5,0 10,1 11,2 10,3 5,9 5,3 7,3 3,0 5,1 1,5 6,6 3,6 4,0 5,7 4,0 4,0 6,4-0,4 0,0 Primary Fiscal Balance Interest expenditure Overall Fiscal Balance -0,7 3,3 3,4 3,4 3,3 3,2 3,3 3,3-0,6-0,8-0,1-0,2-0,3-0,2-0,2-3,9-4,2-3,5-3,5-3,5-3,5-3,5-6 Source: IMF, ESM, MTFS

20 Current Account was also balanced ,0% 0,0% -2,0% -4,0% -6,0% -8,0% -10,0% -12,0% -14,0% -16,0% Peak imbalance in Complete correction by 2015 % GDP Forecasts 20

21 A second wave of deposit withdrawals During the international crisis deposits were rising Two waves of cash withdrawals since 2010 The second comes with stage II of the Greek crisis Dependency on the Eurosystem climaxed in and again in 2015 bn Two waves of cash withdraws Two waves of ELA use Source: BoG Source: BoG Crisis Phase II Crisis Phase II 21

22 BANK INDICES = 100 at 30/3/2012 Bank stocks reached zero value for a second time in November 2015 Earlier, they had gone to zero in Feb 2012 due to the default: PSI (Private Sector Involvement) 45,0% 40,0% 35,0% 30,0% 25,0% 20,0% 15,0% 10,0% 5,0% 0,0% Greek banks face difficulties 41.4% % Politics drove Greek bank stock prices to zero FTSE/Athex Banks Index 3/30/12 3/30/13 3/30/14 3/30/15 3/30/16 3/30/17 3/30/18 3.4% European Banks GR PT BG IE HU RO ES LT AT SK DK BE DE CZ Stoxx Europe 600 banks Price Index FI LU Greek Banks NPEs including restructured loans, EBA definition (% of total loans, Q1:2018) Greece and Cyprus, highest NPEs in Europe Private sector credit continues to contract 22

23 Will Greece continue as a Euro Area member 10 years ahead? Only if revolutionary fantasies like the 2015 one are not repeated this is probably the case Only if Greece continues to reform (questionable) and remains fiscally prudent (possible) And if banks manage to reduce their NPEs relatively quickly (possible, they have to bring them below 10% to be part of the Banking Union) Yet stagnation is harder to overcome today thanks to the 3- year delay due to the wild 2015 policies and the subsequent over-taxing policies, which brought pessimism and lack of investment drive European enhanced supervision for the foreseeable future 23

24 IV. I. A brief history: Three legs of the crisis Two separate phases in its European arm II. Euro Area at threat III. Greek troubles Three crisis stages IV. Summary 24

25 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 II. Index, September 30, 2004= A summary view from the stock market ΟΙ ΤΡΑΠΕΖΙΚΕΣ ΜΕΤΟΧΕΣ ΧΤΥΠΗΘΗΚΑΝ ΠΕΡΙΣΣΟΤΕΡΟ ΣΕ ΣΧΕΣΗ ΜΙΣ ΥΠΟΛΟΙΠΕΣ ΜΕΤΟΧΕΣ Note: Indices include Dividends Int/nal Crisis begins Greek crisis begins European Non- Financial Stocks European Banks US Banks 50 0 Source: Bloomberg Greek Banks Jan 2018 Euro Stoxx Banks Index Euro Stoxx ex Banks Index Greek Banks Index S&P 500 Banks Index Feb 2018: European financial stocks at 80% of Sept 2004 vs US financial stocks at 147% Yet European non-financials at 280% in Feb 2018 Greek banks at zero at the end of

26 Concluding remarks 10 years after Lehman we observe a different economic and financial landscape EMU faced all three legs of the financial crisis plus went through a double crisis, the second due to its own imbalances, which were triggered by the Greek crisis Financial regulators appear to be stricter in the US relative to Europe Challenging times ahead for Europe the moment cyclical recovery is over or the moment ECB begins restricting monetary policy Yet, EMU will not dissolve as easily as some colleagues of ours tend to think. Its architecture is changing and more is to come Greece can tag along as long as it reforms and keeps fiscal prudency, but has lost valuable time and GDP/income, thanks to an unnecessary and politically driven recession since 2015 that prolonged the crisis, brought capital controls, pessimism and lack of investment. The job for a quick long-term recovery is harder now than it was in

27 27 The European Arm of the International Financial Crisis THANK YOU FOR YOUR ATTENTION!