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12 30 May 2013 COMMENT FLEMING ON FINANCE REUTERS Resolving to end European stagnation Cleaning up Europe’s banking sector is an essential step on the road to economic recovery, writes Stewart Fleming The speed of recovery in the economy of the United States demonstrates that governments can combine economic and fiscal reform – so-called “austerity” – with growth. It also contradicts the arguments of fiscal stimulus junkies, such as American professors Larry Summers and Paul Krugman and, sotto voce, the chief economist of the International Monetary Fund, Olivier Blanchard, a Frenchman. There are various reasons for the US upswing (European Voice, 29 November 2012), but a financial system that was quickly purged of its excesses after the 2007-08 crash is unquestionably one of them, a factor highlighted by the latest OECD Economic Outlook (29 May). The contrast is stark between the parlous state of Europe’s financial system today and the financial clean-up that occurred in the US, which went beyond banks to include the effective nationalisation (in the US of all places) of the state-dependent home-loan facilitators Fannie Mae and Freddie Mac. Now, in much of the European Union, ‘zombie’ banks are desperately shrinking their balance sheets, while lending to failing ‘zombie’ companies, in part because they cannot afford to take the losses that would come from cleaning up their loan books. This is yet another European vicious circle, comparable to the ‘doom loop’ between banks and governments. In this case, as economists at Deutsche Bank point out (Focus Europe, 17 May), there is an added twist: lending by zombie banks to zombie companies is probably squeezing out lending to healthy companies that are vital to growth. Further evidence of the severity of the funding crisis, particularly in the troubled, peripheral economies of Italy and Spain, which are dominated by small companies, came last week. Confindustria, Italy’s main employer organisation, warned that many small and medium-sized enterprises (SMEs) in the north of Italy, the country’s economic powerhouse, could run out of money before the end of the first quarter of 2014. Almost four years ago, in a seminal paper for Bruegel, an economics thinktank in Brussels, Nicolas Veron and Adam Posen urged a swift, drastic clean-up of Europe’s banking system. Veron told me last week that he believed it was needed more than ever. The opportunity is still there. The European Commission’s (almost enacted) Single Supervisory Mechanism (SSM), coupled with a proposal expected in June for a single resolution mechanism (SRM) for banks in the eurozone, could lay the foundations for a banking clean-up – provided that European leaders can cut a deal on resolution which is more than a tacit bail-out for reform-shy governments. The SRM should not just be seen as yet another step towards stabilising the single currency, adding a vital component to the ECB-based supervisory mechanism, and addressing the threat from banks that are ‘too big to fail’. It is all of these things, but most importantly it can also become the foundation for Europe’s much needed growth strategy. Evidence of the importance of this next step towards banking union is provided by Japan. The failure there, early in the 1990s, to act swiftly to re-capitalise and restructure banks contributed to Japan’s economic stagnation, now nearly two decades-old. Today, a similar failure in Europe could herald a further protracted but worse stagnation. Japan, note well, managed to avoid the mass STEPS FORWARD In their paper on banking union, Deutsche Bank economists argue that the eurozone must embrace what Nicolas Veron and Guntram Wolff of Bruegel have termed (February 2013) a “big bang” leap forward. “It is actually very difficult to ‘stop on route’ and deliver credible single supervision, a single rulebook for bank resolution and no federal backstop,” they write. Graham Bishop, a London-based authority on EU financial markets, argues that if they are correct, then another big step towards deeper political as well as economic integration of the eurozone looms. In a speech last week (20 May), Paul Tucker, deputy governor of the Bank of England, argued that effective, credible resolution regimes are essential. “The crucial next step is for an EU resolution directive,” he said. It is the moment to press ahead, he argued, not least to prevent the world “slipping into a hard-to-reverse Balkanisation of the international financial system”. He did not say so, but that Balkanisation would also throw the fortunes of the City of London into an irreversible downward spiral. British Eurosceptics may not like it but, as Mario Draghi pointed out in a speech in London last week, the City’s prospects are inextricably linked with those of the eurozone. unemployment which is already wracking Europe. As Zsolt Darvas of Breugel writes: “Much of Europe suffers from a mutually reinforcing interaction between limited productivity gains, protracted deleveraging, weak banking sectors and distorted relative prices, [which] threaten to turn into selfperpetuating stagnation.” The awaited SRM proposal is deeply contentious, since, if it is to be credible it must involve a further surrender of national sovereignty by participants. Unsurprisingly, therefore, Sweden and the UK will not participate. There are deep divisions over the underlying principles. In September 2012, Germany, Finland and the Netherlands rejected the idea that bank “legacy assets” could be mutualised. Why, they wondered, should the jointly funded European Stability Mechanism (to which Germany makes the biggest contribution) be a vehicle for helping to recapitalise weak banks whose parlous condition can be attributed to negligent decisions made several years ago by national governments and their bank supervisors? A good question. And what about the coherence of the new banking union structures. With the ECB as a single supervisor, what Deutsche Bank economists describe as “a federal institution” will for the first time have the power on prudential grounds to order the closure of a member state’s bank. But if this is the stick, where, they ask, is the carrot, the “federal backstop” (the equivalent of the Federal Deposit Insurance Corporation in the US), that would facilitate what has to be a swift recovery or resolution process in which shareholders, other creditors and large uninsured depositors should take the first hit? Most immediately, how tough will be the planned ECB-led assessment of the health of eurozone banks, the asset quality review? Yves Mersch, a member of the ECB executive board, said last month (5 April) “Supervisors cannot give objective verdicts on the viability of banks if banks can only be closed in a disorderly way.” Correctly, the ECB sees the SRM and a federal backstop for European-approved assets as vital elements of its new responsibilities to supervise banks. It is easy to see why. Were the ECB to come under pressure to makes its asset review less than rigorous, that would compromise the independence of its monetary policy, undermine its hopes of becoming a credible bank supervisor, relax the pressure to sanitize a sick financial system, and so damage the prospects of economic recovery. The stakes are high in the next stage of the long march towards a genuine economic and monetary union. Stewart Fleming is a freelance journalist based in London.
COMMENT 30 May 2013 13 Europe’s troika should grow up Jean Pisani-Ferry considers the record – and the future – of the troika of international creditors that is ministering to the EU’s struggling member states In early 2010, a group of men (and a few women) in dark suits landed in Athens. They belonged to a global institution, the International Monetary Fund (IMF), and to a pair of regional ones, the European Commission and the European Central Bank. Their mission was to negotiate the terms and conditions of a financial bail-out of Greece. A few months later, what became known as the “troika” was dispatched to Ireland, then to Portugal, and later to Cyprus. This endeavour was bound to have wide implications. The troika negotiated what ended up being the largest financial assistance packages ever: loans to Greece from the IMF and European partners are set to reach €240 billion, or 130% of the country’s 2013 GDP – far more in both absolute and relative terms than any country has ever received. Loans to Ireland (€85bn) and Portugal (€78b) are also significantly bigger than those usually provided by the IMF. Moreover, co-operation between the three institutions is unprecedented. Back in 1997-98, during the Asian crisis, the G7 flatly rejected Japan’s proposal for an Asian Monetary Fund. Now the IMF has even accepted a minority-lender role, with the bulk of assistance coming from the European Stability Mechanism (ESM), a new institution often viewed as an embryonic European Monetary Fund. It is frequently argued that the size of the assistance packages is a testament to Europe’s clout within the IMF. Perhaps, but the packages are, first and foremost, a consequence of the constraints to which Europeans were (and still are) subject. Economic adjustment is necessarily slower within a monetary union than it is for countries with their own currency, because, even for very flexible economies, prices change more slowly than the exchange rate. Delivering the same result therefore takes more time, and requires keeping countries in intensive care for longer – and at higher cost. Three years later, the results are mixed at best. Unemployment has increased much more than anticipated and social hardship is unmistakable. There is one bright spot: Ireland, which is set to recover from an exceptionally severe financial crisis. But there is also a dark spot: Greece, where GDP has shrunk by 20% since 2009 and where the public debt/GDP ratio is now higher than anticipated at the launch of the programme, despite the debt reduction negotiated with private creditors in February 2012. This is not because of a lack of fiscal consolidation. On the contrary, the Greek authorities have done more than planned on this front. But the collapse of GDP has necessarily implied a rising debt ratio, driving the country into a recessionary spiral as economic contraction forces further spending cuts. Could the troika have done better? It was not responsible for existing monetary conditions – a currency union with a central bank focused on price stability. But European officials’ REUTERS hesitant response to the crisis added to the difficulty. Prolonged controversies over the terms and conditions of assistance and the absurdly high interest rate initially set on official loans exacted a heavy toll on countries already under stress. Furthermore, the troika made three mistakes. First, Greek debt reduction was postponed for too long. Once it became clear that the burden was unbearable, debt should have been cut expeditiously. Too many creditors were reimbursed at par on their maturing claims. Second, the troika based its programmes on overly optimistic assumptions. It misjudged the consequences of fiscal consolidation and credit constraints, underestimating the contraction of employment and overestimating exports and privatisation receipts. Finally, not unlike what happened during the Asian crisis in the late 1990s, the troika took country cases one by one. As a result, it did not pay enough attention to cross-country spill-overs and deteriorating conditions in the wider eurozone. Should the troika survive? Its three participating institutions have different mandates and different roles. It was perhaps inevitable that initially they worked jointly; but there is reason to question such an approach now. Operationally and financially, the IMF has become much more involved in Europe than its global shareholders deem sustainable. It should become a catalytic lender whose participation in eurozone programmes remains desirable but not indispensable – giving it the possibility to disagree and walk away. The ECB is in an odd position as well, but for different reasons. As the eurozone’s central bank, rather than a lending institution, it does not have a clear role in negotiations on behalf of creditors. If it remains in the troika, its participation should be mostly silent. Finally, Europe should transform the ESM into a European Monetary Fund capable of providing policy assessment and advice, as well as financial assistance – possibly drawing on European Commission staff. Beyond European specifics, the troika experiment answers a question of major importance to other parts of the world: Can the IMF co-operate with regional institutions? The answer is ‘Yes’ – but not easily. The troika has proved functional, and Europe would have been at pains to provide conditional assistance to eurozone countries without the IMF’s participation and support. But co-operation has proved to be difficult, if only because each Clean air plays a key role in keeping people in good health and preserving the environment. Despite good progress in recent years, air quality standards continue to be exceeded throughout the EU, especially from pollutants like particulate matter, ground-level ozone, and nitrogen dioxide. In 2013 the Commission will review its current air policy. The 2013 edition of Green Week, the biggest annual conference on European environment policy, will therefore focus on air quality. The Conference will take place from 4 to 7 June at the Egg Conference Centre in Brussels. Over three days and some 40 sessions, European Commissioners, MEPs, ministers, scientists, national and local authorities, NGOs, businesses and the public will focus on fi nding ways to improve air quality. Green Week offers a unique opportunity for debate and exchanges of experience and best practice on environmental protection issues. It is open to the public and participation is free of charge. Green Week2 2013 Brussels 4-7 June Jean Pisani-Ferry is professor of economics at Université Paris-Dauphine and currently serves as director of economic policy planning for the prime minister of France. This column draws on a Bruegel report co-authored with André Sapir and Guntram Wolff. © Project Syndicate, 2013. http://ec.europa.eu/environment/greenweek/ participating institution has rules and constraints that are not easy to reconcile with the others’.
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Page 23 and 24: 30 May 2013 23 ENTRE NOUS !Jens Fer

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