They have a.
Let me welcome Shaun Berrigan. This is his first time he's come and spoken in Oxford.
Sean has spent a majority of his career at the European Commission.
In the mid-nineties, I think he was given a few years off for good behaviour and sent to the IMF and he returned from the IMF.
He spent most of his time working firstly on monetary issues and erm too and the run up to the
euro project and the design of the euro project and then later moved on to financial markets.
And subsequently financial stability. And as financial stability director, he has been, I think it's fair to say,
the point man on all of the financial market aspects of the Troika packages, for example.
Shaun was a huge support when I was I spent five years in the in the commission and Sean kept me alive during this in the corridors of power,
in the corridors, because the key to the action conference room was always lost, if I remember rightly so.
We had our meetings in the corridors of power and his sense of humour kept me alive.
And he even lent me one of his staff, Valerie Hertzberg, who is now a PFM associate and in a forthcoming new sheet.
So there's a heritage there. I'm just going to turn over to Shawn, except for reminding you about the podcast rules.
Only Sean and I have signed consent forms, and that means that we will cut the podcast off before the discussion session.
This will observe legal niceties,
and it also means that Sean will be even freer to express himself and in a relaxed manner when you're doing the question and answers.
So without more ado, Sean, the floor is yours.
Well, thank you very much, Max. It's my pleasure to be here in Oxford.
First time ever surrounded by. It's presumably brilliant.
Audience So slightly scary occasion for me. I met Max about eight years ago, I suppose, when you came to Dejection.
We hit it off fairly quickly,
not least because Max is one of the few people outside of my own team who understood what I was talking about inside rejection.
And back then, I suppose we worried about the things that we now regret.
And some of these regrets will come up in the presentation that I'm going to make.
But I've always valued Mac's advice. And so when he advised me to come here and talk today, I thought, this must be a good idea.
And so I want to address the title he has given me.
Will next time be different? I'm glad you put a question mark at the end. This is not just because, like all good financiers, you hedge your bets,
but also because I think the crisis has genuinely made me less self-confident.
Let's say I was a financial analyst and I think we have to realise that we have to go this time before we can really talk about the next time.
And so I will try in this presentation to draw that bridge between where we are now and where we're trying to go.
And I leave you to conclude at the end whether or not we have a good chance or not of doing it differently next time.
I have a very wide ranging presentation. I have a lot of slides.
I have far too much to say. I'm going to try to be disciplined, but I may chop move faster.
And if I miss something, you of course have every right in the question and answer session to come back and ask me.
Let me see if I can make this an. Work now.
Hope you don't. All right.
Yes, there we go. Okay. I want to cover four things in this presentation.
Four issues, four sets of issues. One is the anatomy of the euro crisis as we see it in the commission.
Then I want to focus a bit on how we are trying to manage and I say try to manage the euro crisis because it's it's easier said than done.
I want to focus then on one specific aspect of crisis management, which is reinforcing EMU.
And in that focus on the banking union, because it is probably the most important aspect of reinforcing EMU and it is the well,
the topic of the day, particularly in the aftermath of Cyprus.
And then I will, if I have time at the end, just briefly go through some of the key challenges that we face in implementing this strategy.
But these tend to come up in question and answer. So I may if I don't have time to move through this and just handle it in the Q&A.
In this session, I want to look at how we see the euro crisis and why there's a euro crisis.
Essentially answering the question whether the euro was the cause of the crisis or whether it's a bit of a casualty of the crisis.
And I suppose, not surprisingly, from a commission official, we favoured the view that it's more a casualty than a cause.
But we're open to discussion on that.
If I can start with the global view of this crisis, I mean, it has been the biggest crisis since the Second World War.
Some people argue it may end up being a bigger crisis than the Second World War, but it started and has evolved rather classically.
It started as something small in a very obscure segment of the US mortgage market for subprime.
It then morphed into a global credit crisis, mainly reflecting the degree of interconnection that there is now in financial markets.
Between sectors, but also across countries.
It then affected the real economy, triggering a fairly sharp economic recession, then led to a sovereign debt crisis.
And then phase five, of course, is the last phase is a currency crisis.
Now, when I was first shown this list of phases, it was by a US economist, and as he was presenting it, he had in mind the US dollar.
But as I was sitting on the other side that time I had in mind another currency which
I thought was a lot more vulnerable to these kinds of evolution than the US dollar.
And that of course was the currency that I spent a lot of time trying to to launch in the 1990s.
And that leads me to, you know, ask the question, why was the euro particularly vulnerable?
I mean, the crisis was a global phenomenon. It wasn't just in the euro area.
It affected the United States and affected this country here. It affected Iceland with the mother of all crises.
And then if you look inside the euro area, you see that it was not the euro area as a whole doesn't have the crisis.
In fact, in aggregate, the euro area looks quite okay from a crisis perspective.
You have some countries inside like Greece, like my own country, like Spain, which have had a bad period,
although other countries like Germany and Finland, which came through this without a specific, you know, without a comparable crisis.
So I don't believe that it was something that the euro somehow was at the fundamental cause of this crisis.
But we were, as a euro area, fundamentally vulnerable to the effects of the crisis.
And I here just list for reasons why we think we were vulnerable.
Firstly, the policy discipline, which was to be the characteristic of EMU.
It was how it was set up. It was a rules based, discipline based.
Framework was to some extent undermined by what came to be known as the Great Moderation.
The Great Moderation was this period of steady growth, low inflation that characterised the late nineties and a large part of 2000.
This meant that there were mispricing of risk, of course, throughout the world.
It meant that Greek bonds were trading 25 basis points over bond,
which made it very difficult for someone like me to go into a meeting of ministers and say, I think there's a problem in Greece.
Because the ministers would look at you and say, but you're getting 25 basis points over bond.
It just wasn't credible from their point of view. The second I think weakness was that we we did not put in place the new architecture.
We expected to do so after the crisis, after the launch of the euro.
We didn't succeed in putting it in place quickly enough to manage the crisis to prevent us emerging in the first place.
This meant then that the capital flows, which had gone from the core to the periphery during the good times, abruptly reversed.
Back from the periphery to the core. And this this reversal, of course, has led to a massive fragmentation in the EU financial markets.
And the key characteristic, of course of the euro area crisis has been this, you know, I would not say unique,
but characteristic nexus between the banking sector and the sovereign in the euro area.
This link between banks and sovereigns. And I have come back to some of these issues as I'm going through my my presentation.
Now we really have a problem doing the work.
It works down. This is a phrase which I picked up from the OECD.
It's the pernicious triangle. I think they got tired of the vicious circle, so they went for something different.
This is what you call modern finance. Essentially, this is where we find ourselves in euro.
We have this. The vicious circle or triangle of a weak economy, sovereign stress and fragile banks.
Now, I have put arrows in this direction because that's how I want to handle this triangle today.
But in fact, it works in nearly all directions.
You can find these feedback loops, as they're called, these negative interactions between these various phenomena in Europe.
But that we do it in the direction of the arrows.
I mean, that it starts with, you know, a weak economy given the scale of the financial crisis we've just had.
It's not so surprising that the economy is weak afterwards.
If you look through history, such financial crises are always followed by periods of sustained low growth,
mainly because the banking intermediation channel is damaged, is broken and takes time to repair.
What this chart shows you is that we the blue line shows you that we've not exactly been doing spectacularly well since 2010.
But I think more importantly is this red bar. These are the contributions to growth, and the red bar is the contribution of domestic demand.
And so you can see that what lies at the heart of the weak EU euro area economy is demand compression.
It's weakness in demand. We have had a balance sheet recession and essentially a balance sheet crisis and a balance sheet recession.
We have a level of savings now or a level of net financial wealth, which is below what is desired.
And so people not just in the public sector, but in the private sector, everybody is now trying to adjust to saving more, consuming less.
And what we're finding is demand compression. Everybody wants to export their way out of this crisis.
I always find it interesting that the UK complained that the euro area is not buying enough of its exports.
Well, you're not buying so many of the euro area as exports either.
So and the US, of course, is engaged in the ultimate escape route through exports.
So basically everybody is trying to export to everybody else.
This is a standard chart. It's so seen. It's so often I'm tired of it.
But this just shows what happened to sovereign spreads as the crisis kicked in.
So that chart goes way back out to 1999 as the launch of Euro and even before.
And you see that all the spreads in Europe are fairly convergent. But around the middle of 2009, markets, sovereign debt markets began to.
Change in the way they were functioning.
I mean, what essentially happened here was that private risk transferred into the public sector in the banking crisis.
People ran out of the banks, into the public sector in a flight to quality.
But having arrived there, they realised that a lot of the risks they ran away from had been transferred ahead of them.
So there was what you had would call a flight to quality within a flight to quality.
So people were happy to be in public sector debt but not happy to be in all public sector debt.
They began to discriminate and slowly and then not so slowly cut certain member states out of the sovereign debt market.
Beginning with Greece, then Ireland, then Portugal.
And you see those lines moving up from around 2009. The brown, green, blue lines.
This chart is not enough, is not the scale, is not right to show you the effect of the OMT.
What since, let's say the middle of last year and the ECB's decision to put in place a commitment to buy bonds in certain markets,
those spreads have come back down again. But what this chart shows is that, you know, the crisis has been associated with sovereign stress.
That sovereign stress, of course, is aggravated by the fact that you cannot grow in the economy because your debt
sustainability becomes even more of a problem for the markets looking forward.
The effect then, of course, is that weak sovereigns feed into the banking sector.
They feed if you in two ways directly because European banks are loaded up typically with government debt on their balance sheet,
but also the quality of the guarantee of the public sector on the banks weakens.
And what you see here is these are just two random indicators of stress in the banking sector.
The one on the left I'm not going to go into a detail here is just an indicator of the relative price of money,
which does not have collateral against money, which does have collateral.
So basically, it's an indicator of stress in what's called the interbank market.
The heavy blue line is Europe as a euro area.
And you can see that it has experienced more stress on the corresponding markets in the UK and the United States.
You also see it has gone up and then sharply down. And this again is the effect of the ECB introducing long term refinancing operations,
which was basically giving liquidity to the markets at low prices when the market would not give liquidity to itself.
So you see, we're now in a much better position than we were, let's say, at the peak towards the middle end of 2011.
So funding conditions are better than they were, but they're still very fragile.
On the right, this is a measure of default risk in banks, senior debt and subordinated debt.
Again, it reflects an improvement vis a vis peaks around the time of the the labour chart.
So it's the same phenomenon. What we see is that it's not quite as good.
So what the oh, what the ECB has done is has taken out acute liquidity risk and the risk that that would turn into an insolvency risk.
But it has not completely taken out the insolvency risk from the banking system.
And that's because there's still a lot of stuff on the banking sheet balance sheets,
the banking sector balance sheets that markets don't like, investors don't like, and they still see risks there.
And I'll come back to that later when I discuss banking union. The effect of all of this, of course, is that we have a fragmented credit market.
Put another way, this is the disintegration of the single market.
This is the undoing of almost ten years of my work in trying to make this market into a single market.
And it is rapidly unravelling. These charts show you relative financing costs in different countries.
You can you see the lines were close together and now are starting to spread out.
Since 2009, this means that the costs of lending in different countries is different.
And similarly on the right, these are loans to corporates. So these are just I'm not going to go into too much detail in these charts.
But just to show you that you now have fragmented markets where.
Banks can borrow, but at different rates in different countries, and they lend on at different rates in different countries.
This means that two companies of the same credit quality can face very different lending conditions in two different countries,
which have nothing to do with their intrinsic credit quality, what to do with the geographical location, the strength of their sovereign.
And this has not really turned down since. No, I mean, the euro has helped.
But of course, these are the roles are being given to banks in countries where there is a problem.
So what the banks are doing, of course, is they're not passing this on. They're using the gap between this and their lending rate to recapitalise.
The OMT has helped on the sovereign side, which has had no effect from here.
To be to be honest with you, an interesting new. And then this is this famous nexus.
I'm just going to do this in these graphs for Ireland, Portugal, Spain and Italy.
We have plotted the CDSs. I will not tell you what CDSs is.
I think you can tell us later. These are measures of risk.
Okay. And so it plots measures of risk for the sovereign against measures of risk for large banks in the same country.
And you can see that they are pretty highly correlated, suggesting that the markets see these two things as correlated.
This doesn't tell you which way to look at it, because in some countries they look at banks as driving the sovereign risk in other countries.
They look at in Spain, for example, the increasing look at sovereign sorry, not Spain, I should say, in in Portugal they increase.
We look at the sovereign is driving the bank risk. Okay.
So that's just to let you know how I think we got into the mess we're in now and the mess that we we are in now trying to get out of.
And what I want to do now is focus a little bit on how we're trying to manage our way out of this crisis,
how we're trying to reverse this fragmentation in financial markets.
Because let's be clear, if we do not reverse this fragmentation in financial markets, the single market is under threat.
The recovery in the periphery is under threat for sure. And that means the recovery in the euro area as a whole.
And I would say the functioning of economic and monetary union is under threat.
So it's it's a high stakes game. I begin by getting my retaliation enforced,
by expanding all the reasons why it's so difficult to manage the crisis before I tell you how I am managing it.
Um. We have a very challenging context for crisis management in the euro area.
Firstly, we are, as I said earlier, not institutionally very well equipped.
We did not complete the architecture quickly enough after we launched the euro.
I think secondly,
the systemic response to the crisis has been hindered by the fact that some member states are experiencing entirely different crises to others.
It's very difficult to tell a central banker in Germany that he has to do things which are against the law.
But if you say the same things to the central banker in Spain,
he has a much deeper understanding of why maybe he might want to relax that law, bring them together, and you get long discussions.
But ultimately, we get to the right answer. I think that has been the piecemeal approach.
This has been identified and we have accepted it. We have sought to address the crisis by winning battles.
So we first went to Greece in the hope that if we won the battle in Greece, we could prevent contagion to other parts.
We didn't. We went to Ireland with a similar idea.
We didn't. So this piecemeal approach, of course, has again meant that we are not able to get a systemic response.
We have not been able to get a systemic response as quickly as we would want.
There are also important distributional aspects, and these have created political constraints.
There is a perception in in Europe and some member states that the loans they are giving to other member states are not loans, but are grants.
But this money is never going to come back.
And this is creating political problems at home because it's not so easy for a country politician in a country to say,
I am giving money to another country when there are, of course, domestic political agendas for which that money might also be used.
And even though we have tried to explain to people in these countries that are actually making money from these loans.
It doesn't really work. And there is a strong sense that this is a sort of distribution issue and this is creating prison constraints.
And these political constraints, of course, have left. It means it's difficult to achieve consensus.
It means the policy response tends to be at very best at the core of and very often behind the curve.
This means that we have to make decisions rather quickly, sometimes very quickly, and then we're left to repair those decisions over time.
A good example of this is the FSF.
We invented the FSF 4 hours before Tokyo opening and then spent six months replacing it with what we wanted to put in place in the first place,
which was the ESM. This is the strategy.
Believe it or not, we have a strategy below all the noise, all the bad press.
There is a strategy, and this strategy has been there since about the end of 2010.
It has five points and we try to address short term and medium term issues.
The short term focus is about eliminating volatility or reducing volatility from the markets.
These three strands strategy was firstly to address the economic and financial problems in the vulnerable Member States.
So we have used programmes to do that. We have tried to address uncertainty related to the EU euro area banking sector.
This we have done through a series of stress tests which have been to a greater extent or lesser extent.
Successful. Credible. What's not always known is that there has been a very substantial recapitalisation of the euro area banking system.
We did not do it like the United States in a big bang in 2009.
But over the years, a lot of capital has gone in to the euro area banking sector.
Unfortunately, this has not been enough, I think,
to eliminate what I would say our persistent doubts about the quality of banking balance sheets of banks in Europe.
I think this is probably unfair. I do not think there's a generalised problem of balance sheets in European banks,
but of course if you don't have transparency and you don't know where those problems are, then rotten apples in barrels come to mind.
And there's a problem for the whole sector. And the last point then was provides what is in the jargon is called firewalls.
And these are basically instruments that allow us to lend from Europe to member states.
So this is the ESM, the European Stability Mechanism.
And these are designed to prevent crises in one member state spilling over into the euro area as a whole.
And here we have two main firewalls.
We have the OMT, which is the ECB's firewall, their commitment to buy bonds in countries like Spain and Italy if necessary.
And we have our firewall, which is under, let's say, the fiscal side, which is the European Stability Mechanism.
And this is a mechanism which allows the euro area to raise money collectively on the market and on lend to member states.
It's kind of like our Monetary Fund, except the IMF get to tap central banks and we have to go to the market.
So it's a bit more difficult. In the medium term, I think there are two main focus of the strategy.
One is to improve the framework for economic adjustment. I said earlier on that we did not have in place what we needed to manage the crisis.
One of the things we're doing to put in place and sorry,
one of those problems was that we focussed almost exclusively on the public sector and we did not take much attention to the private sector.
So while we were very happy with public sector debt moving down and Max remembers this,
we were less focussed on what was happening on the private side and the imbalances were emerging on the private side.
And in fact some of these imbalances were giving false signals about the strength of the public side.
We have now put in place frameworks which address that. We have a more balanced framework.
We address both the public and the private sector, and we have strengthened those frameworks.
And then the second part of the EMU. Of the reinforcing.
The framework is on EMU itself and here we have notably banking union.
And that's the most important thing we're doing, at least in the near term. What I'll show you later on that there's a few other points as well.
But as I said, this five point strategy has been there all along.
It gets lost a little bit in the noise. There's a lot of static around it, but it has been there since 2010 and it has been gradually implemented.
We've put in place all of these things to one extent or another.
Next. I'm back in trouble again. Hmm. Right know it works when this goes away.
Now, this I'm not going to even try to describe. My director general uses this to show how busy we are.
So you can tell them I showed you how busy we are. That is in the middle.
Yeah, that's just basically my standard day. If you can understand that.
Good. I think to be fair, the strategy is working.
If you see how we let's talk before Cyprus. Okay.
Before Cyprus, if you see how we opened up this year, we opened up in much better shape than we ended last year.
There's a definition by S.A.C., I think, of a financial crisis in which he says financial crisis is not when the market loses faith in itself,
but when the market loses faith in the public sector, its ability to rescue it.
And I think in 2012, if we're honest, we came at times close to this perception within the market.
But with the OMT, I think with the ESM being put in place, with taking Greece off the exit list.
I think a lot has been done to reduce tail risks. And that was reflected, I think, in a fairly good opening to the year.
Spreads came down, sovereigns funding conditions improved the stock market here.
I think you should see this booming. If you look at financials within that, it's even stronger.
Sovereign spreads, you see, have come down come down dramatically for some of the vulnerable countries.
My own country, Ireland, is now back in the market, accessing reasonably well.
This is another thing which is not so well known.
Is that underneath all the noise? There is a rebalancing going on in the European economy.
Again, I haven't got time to go through this in great detail, but just to show you that in terms of current account and youth labour costs,
there is a significant adjustment going on in those countries where that adjustment is needed.
So in the periphery in Spain, in Greece and Portugal and Ireland,
and there is also some adjustments, but not as has noticeable going on in in Germany.
Could you tell us what those figures show in that growth?
They are unit labour costs relative to to Germany and you will.
And your annual changes. Yes. Now you can see we're getting adjustment.
But here I'm going to anticipate what someone's going to say to me is that we know how we're getting them and we're getting them through,
as I said earlier, demand adjustment. So these economies, as you can see, look at domestic demand figures.
They have taken some pretty heavy hits. I think if they were not adjusting under these kinds of pressures, we would really be in some difficulty.
But nevertheless, the adjustment is taking place. It's a painful adjustment, but it is under way.
And that's sometimes not always appreciated. There's a sense, again, in the core countries that nothing is happening in the periphery,
that the loans are going out, but that countries are not doing what they're supposed to be doing.
I think the figures just don't really. Stuck up.
I'm not going to spend time here either on this. This is just to basically concede that this is a balance sheet recession.
In balance sheet recessions, we expect protracted periods of low growth and we have a protracted period of low growth.
And I think we will very soon update this forecast for our spring forecast.
And it will be very much the same picture, indeed, slightly weaker, I would expect.
So bottom line is we are in the middle of a protracted period of of low growth.
And this is a complicating factor, seriously complicating factor in terms of crisis management.
So where are we then? We started this year in good shape, I think.
Not in good shape, actually, in better shape than we were in 2012.
But still rather fragile. And.
One of the things we had planned and we do plan to do this year is to work heavily on banking union as part of the reinforcement of of EMU.
I want to before I talk about this, however, go back and talk a little bit about why I think banking union is necessary.
And whether or not, you know, the question is always asked, was EMU a flawed construction and should we not have done banking union to begin with?
And I'll answer that later. But first, I want to just focus on this EMU construction business because again, I'm a commission official,
so perhaps you would expect me to say this, but I don't believe the EMU was, in fact, a flawed construction.
It's a very unique construction, of course. It combines a single monetary policy with coordinated but still very much decentralised fiscal policy.
So it's not like the United States. It's a very different model.
The conventional wisdom was then, and I think still is now, that deep political integration is required for currency unions to be durable.
We didn't accept this conventional wisdom. We thought that we could launch EMU and expect post an endogenous convergence in political preferences,
not political union, but a convergence in political preferences which would allow the union to work.
This, of course, has not materialised as evidence in this crisis.
But I don't think this means that the EMU construction was necessarily flawed from the outset.
The logic of EMU, as we launched, has had both direct and indirect effects.
The direct effect of EMU was the sort of effects we all talked about macro stability, low transaction costs, etc.
More liquid financial markets used to use deep liquid and something else.
Large, deep and liquid was always three or four times. But there were also indirect benefits.
And the indirect benefit was, of course, that it was IMU provided powerful incentives to microeconomic reform.
My ex-boss used to always say that the macro convergence challenge launch EMU was the easy part.
The harder part was going to be the micro reform that would be needed to make it work.
And the idea was that you would take away the exchange rate as a devaluation means to avoid reform.
Of course, we knew we were taking away the normal adjustment mechanism. That was the problem.
But if you look at how the nominal adjustment mechanism had been used in Europe in the previous 20 years,
it had been essentially to run inflation devaluation cycles.
A good example of this is Italy, where the external sector was pretty competitive, but the shelter sector was not.
The sheltered sector would dump its excess costs into the traded sector, which would then become uncompetitive.
There would be a devaluation and the clock would be set. But of course, Italy was gradually becoming relatively poor through this process.
The idea then was to take away this and to force countries to confront the harder political
choices with the better economic choice of economic reform and the construction of EMU.
We thought it was pretty well suited for that because it was decentralised.
It kept the cost of non reform where non reform was.
It did not allow for what you would call is kind of deficit shifting or reform shifting,
pushing the costs of reform up from the periphery to the centre.
It kept the cost of non reform. Down where none reform was.
And we hope that the economic discipline of markets would reinforce this model
and bring about this political this convergence and political preferences.
But in retrospect, I think we assumed that a number of preconditions would be there.
We assume that Member States would comply with this rules based framework that we put in place for coordination.
For fiscal policy in particular, we assume that financial market discipline would be there to incentivise policy coordination.
We assumed that we would be very rapidly able to build a financial stability architecture which would validate the integrated capital markets.
And I think lastly, we assumed that there would be a capacity among Member States to pool resources,
not in some kind of fiscal federalism, but pooling resources for specific.
Policy responses where there were externalities, so notably the financial crisis.
But you could also think of things like the environment.
So the idea the idea was not to move for a fiscal federal model, but to a model where there would be a pooling resources for.
Specific justifiable policy responses.
In fact, we launched EMU almost in Coincidence with the Great Moderation, and that had a number of effects.
Now, I'm not claiming that this was the only effect, but it had an important effect in these following ways.
First of all, in this world where everything was growing and there was no inflation and everybody felt pretty good.
It was very difficult to implement a rules based policy framework.
This was part of the problem in 2003 with Germany and France.
It was part of the problem with Greece. We were never able to point to the markets and say, if you don't change, you're going to have a problem.
Because as I showed you in earlier chart, sovereign bond yields were pretty convergent throughout this entire period.
And ministers would look at you and say. The markets don't agree with you.
So you may see a problem, but the markets don't agree with you.
So market discipline was absent. It was a more globalised mispricing of risk, but it was certainly evident in the euro area, as I said.
Greek bonds were selling pretty well, but also US junk bonds were selling a to 50 basis points over U.S. Treasuries.
Another sign that risk was not exactly being priced globally.
A quiet quite so well. We did not make as much progress in completing financial stability architecture.
I was discussing with Max before we came here in 2005.
I think we put the first paper down for burden sharing. In the sense of burden sharing, the costs of banking.
Yes. So people were talking about the architecture, but they didn't understand that in order to make the architecture work,
you had to talk about the money that underlies the architecture, and they weren't so keen to talk about the money.
And so while we were able to talk about the concept of burden sharing, we never really succeeded in making it an operational concept.
And all of this resulted in deficiencies in the crisis prevention mechanism.
So our rules basically lost credibility and our ability to manage.
We did not have the infrastructure and not the tools available to manage the crisis.
And so what we're doing now is. At the end, you know, as we are trying to manage this crisis,
we're also trying to put in place the framework we should have had before we got into it.
And it's not so easy to kind of put in place the framework for the brave new world when you're still trying to survive the existing world.
The way in which we're going to reinforce EMU construction, there are four elements I will focus on only one.
We have strengthened the policy coordination framework, as I mentioned.
This has to do with the famous. You will not know them. Put the six pack in two packs.
These are packages of legislation which reinforce the economic surveillance framework in Europe.
There is the banking union where we will try to complete the financial stability architecture.
We have established crisis management instruments. So we have the EFSF, we have the ESM.
These are these instruments which allow us to borrow and on lend.
And we've made the first steps, very small steps, I would admit, towards fiscal capacity at the EMU level.
So there has been a concession, but at the euro area level, there can be a fiscal capacity,
capacity, although it's only a concession, there are maybe 20 billion, but it's not a serious step.
But I think the principle is important.
If I can focus on banking union, because as I said, it's the most important one and the one I am most involved in.
We see this as the key reinforcement and it's the key reinforcement because it both addresses the
key characteristic of the current crisis and sets up the framework for preventing future crises.
And that is it breaks this link between banks and sovereigns.
This link where a national bank can bring down the national sovereign or as in the case of Greece,
a national sovereign can bring down its entire banking system.
And the way in which it does this is it creates new neutrality across the three main areas of crisis prevention and management.
So there's neutrality and oversight. So you have a central body which takes care of oversight.
So you no longer have national supervisors managing their own banks, so there's less risk of capture.
There's neutrality in bank resolution and allocation of losses among private creditors.
This, by the way, will be a great novelty in Europe. It's not just that we don't have a resolution framework in Europe.
We don't have a resolution culture in Europe. We just don't resolve banks, even little ones.
We tend to rescue them. This will be an important change.
And this allocation of losses among private creditors will be a really important departure in crisis management, in bank crisis management in Europe.
And then lastly, there will be the possibility to neutralise any remaining financial costs after you've allocated losses via a common fiscal backstop.
So we will neutralise and here the logic is that it makes sense to mutualisation at the bottom, i.e. the costs.
If you have neutralised all the other levels as well.
Okay. And all of these things are important.
Here I go again. Okay.
So there are four main components of banking union as we are proposing it from the commission side.
Thirdly, a single supervisory mechanism that means a single supervisor and a network of national supervisors.
That would be the essentially it would be the ECB. There'll be a common resolution framework.
If we have our way, it will have a single resolution authority and a network of national resolution authorities.
There will be a private resolution fund. So there will be a banking sector will generate its own funding, which will be kept in a pool for use.
There will be a common deposit insurance framework, although this will probably come later.
And then there will be the ESM as a common backstop,
and we will have the possibility for the ESM to intervene directly in banks so not only lend to member states,
but to inject capital directly into banks.
And all of these four parts, in our view, are ultimately required to ensure the coherence of the banking union.
Oops. I've gone wrong. Okay.
Read about? Oh, yes. From beginning to end.
I'm going to skip this slide anyway. So it's a good spot.
We have a political agreement now on the single supervisor and we have a political agreement.
On. The rule book, the capital requirements.
So this basically means that we have we we already have agreement to a single supervisor.
Which will be the ECB effectively. And we have agreement on the rule book, at least as that will apply to bank capital.
Okay. So we have the first step done. The next steps is that we need to put in place the rulebook for the resolution.
And for the use of deposit guarantee schemes.
And we already have in the Commission two proposals on the table which are being discussed now by the Council and the European Parliament.
By June, we will the commission will bring forward a legislative proposal for a single European resolution mechanism.
So the mechanism which will run the resolution rulebook.
And in that, we will almost certainly propose a single resolution authority with a network of national authorities.
And lastly, I think what we will try to do over the next months is to confirm the rules of the game in bank resolution.
We didn't think we would have to do this.
But after Cyprus and the confusion which has been caused by Cyprus, we are going to have to now clarify already the rules of the game that will apply,
in the words of Beilein, and will have to determine the timing of got word of bailin.
And that we hope to do over the next two or three months leading up to the summer.
When we have these on the table, then of course there will be another process of negotiation with the European Parliament and the European Council.
But our objective will be to have the bulk of the parts of the banking union in place.
By end 2014 and operational.
That would be the sort of idea we would have. I want to put this chart up to say a little bit about the implications of banking union,
both for those who participate in it and those who will not participate in this.
I think for those who would participate in it,
we might as well be honest and say that is probably the largest transfer of national sovereignty to the centre ever.
I would consider even a greater transfer of sovereignty than the monetary union.
You will recall that most members of the monetary union have already peg their currency to the Deutschmark for some time beforehand.
So the transfer of sovereignty in itself was not so great.
Here you are transferring sovereignty and also a form of sovereignty which is very closely linked to fiscal policy.
You're going to share responsibility for prudential oversight, for crisis management, and for the associated fiscal costs.
So it will have to be full cooperation among the member states. And here I think I go back to the papers we used to do Max.
I still believe that unless we get the money side right, the fiscal side right.
This is the key to aligning incentives to make this cooperation happen.
If you don't have the money right in the member states will not have the right incentives.
So if you're going to have a central body making decisions that impose costs on you.
And there's no mutualisation of these costs.
I'm not convinced that you will always have the incentive to bring to the attention of that central body in a timely manner what you need to do.
There will be an attempt to keep things. So essentially we are trying to convert national authorities into whistleblowers.
And to do that, you must have the right incentives structure.
The implications for non-participants.
Well, the good news is that a more resilient emu is, of course, good for the global financial system as eases the current crisis in the euro.
It will reduce probabilities of future crises. I think banking union is consistent with the single market,
but I don't think anybody can sit here and tell you that it's entirely neutral in terms of its impacts for the single market.
There will be some inside this banking union and there'll be some in the single market, but outside of banking union.
I think the pooling of sovereignty inside the banking union may imply changes in the way both public and private bodies manage risk.
If you can think of the banking union as essentially drawing a fiscal boundary around
your financial system and saying any costs that arise in this financial system we share.
And then you live in a world where some of your risk is outside of your physical boundary.
This is also true of the United States, by the way. Then you have a lot of risk for which you are fiscally responsible, but outside of your purview.
There are two ways you can approach this. You can share oversight.
Or you can try to repatriate the risk. This is also the problem, which also relies on under Dodd-Frank,
where the Fed is being given extraterritorial responsibilities and it's trying to work
out how it's going to meet those responsibilities because a lot of U.S. dollar risk,
of course, lives outside of the United States.
All that being said, I think on terms in terms of private actors, it may well be that banks will look at the banking union and non-banking union.
Look at the arrangements inside banking union in terms of quality of oversight,
but also quality of backstop and the side that they would prefer to have their risk managed.
They're running them here. There's nothing certain about this, but it's one of the things we have to think about.
And in the commission,
we will do everything we can to ensure that the dynamics which may be created by a banking union remain consistent with the single market.
So we're going to do but I just want it to be clear that we are not naive in the sense that this has no effect.
Do I have time for challenges if I leave them to afterwards? Just maybe just comment on them and then we should take.
Okay. I just finished this chart up because as we go forward in all of this crisis management, banking union responding to the economics.
We have a set of challenges, I think, which relate to the policy environment and relate to policy implementation.
Just list them here if you are not going to too much detail on them.
But the policy environment is that we live now in Europe in a very risk averse world.
We have lost the confidence of financial markets throughout the crisis.
We have regained that somewhat. We have to see how Cyprus is going to impact on that.
The noise below the surface is not necessarily positive on this, but we live in a risk averse and this makes crisis management.
That bit more difficult, even much more volatile environment.
We live in a low economic growth environment.
This is not unexpected after a financial crisis, but it's also an environment in which you have to endogenous to generate your growth.
You cannot expect external sources to give you that growth.
And the way you endogenous to generate, of course, is through credible, consistent policy implementation,
something we are learning to do but have not been so good at in the last couple of years.
And then there's financial fragmentation, which I've mentioned earlier.
This is a real threat. Too, I think the functioning of monetary union and to recovery in the periphery because clearly the cost structure is faced
by operators in the periphery are dramatically different to those that are now mentioned and being faced in the centre.
And this fragmentation is not an equilibrium position. It is not.
I mean,
those are the conditions in the centre are lower than they should be and the conditions in the periphery are higher than the than they should be.
In terms of policy implementation. I've touched on some of these already.
We have a set of political constraints which make policy consensus difficult.
And that means that policy consistency is difficult.
And that means that sometimes we have diminished credibility of policy.
I am on Cyprus. I should say that we have not seen what we fear who would see in Cyprus in dramatic moves in market indicators?
But if you speak to market participants and one or two of them may be here, there has been an impact of Cyprus.
We have to some extent confuse the markets again.
And there is going to have to be some work done to restore that, um, that credibility.
Another important problem we have is short term flexibility versus long term credibility.
I mentioned earlier that we're putting in place new frameworks for the New World for reinforcing EMU.
The problem is these flavours, these frameworks require discipline.
And of course, we're asking countries who are significantly out of equilibrium to observe these disciplines.
Some of them are finding it difficult to do so. So we're faced with this choice.
Do we let countries off these rules because they're in a difficult short term position?
And if we do that, to what extent do we undermine the credibility of the framework that we have just put in place?
So the classic is the member state with fiscal adjustment problems.
Do we allow it to have an easier fiscal adjustment? What that means in the first time we try to apply our new rules, we bend the rules.
So this is another problem we face. And then lastly is a problem of time consistency.
And that, of course, is that during crisis periods, Member States are willing to buy up and buy in to a lot of processes, a lot of reform processes.
The question is whether or not those member states will continue to buy into these processes if and when the crisis begins to ease.
And that's very important for the sort of into temporal bargains we are doing between creditor countries and what we call vulnerable countries.
It's important that both sides have a framework in which they believe the behaviour of the other will be time consistent.
So, Max, I think I will leave it there. And thank you for.
The potential. Thank you very much.