Nicolas Véron, Senior Fellow Bruegel Institute Visiting Fellow, Peterson Institute for International Economics (Washington DC) The Euro Crisis: Where We Stand, and Possible Consequences

1. The Euro Crisis
Where We Stand, Possible Consequences
Nicolas Véron
Senior Fellow, Bruegel (Brussels)
Visiting Fellow, Peterson Institute for International Economics (Washington)
IFAC Conference ‘‘The Sovereign Debt Crisis – From Lessons to Reform’’
Vienna, 19 March 2012
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2. Multiple Layers
 Long-term growth / competitiveness
– Germany since unification
 Banking crisis
– Comparison with US
 Sovereign debt crisis
– A market failure pre-2009?
 Institutional crisis
– The Eurozone-level decisionmaking (or lack thereof) is the
problem itself
– ‘‘repair the ship while on the high seas’’
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3. Governments vs Markets
‘‘In a way, it is a struggle between politics and the markets. We
must re-establish the primacy of politics over the markets’’
Angela Merkel, May 2010
EU financial integration
– Capital markets vs banks
– Consequences for domestic politics
Distorted narratives
– ‘‘speculative attacks’’ vs ‘‘buyers’ strike’’
Communication difficulties
– Underdeveloped European public space / media
– Opaqueness of European politics for investors
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4. National vs European
 ‘‘Politics without policies’’ vs ‘‘policies without politics’’
(Ivan Krastev)
– But only if policies can be carried out without politics
– Fiscal, banking policies a different category
 No European executive
– Not the Commission, nor the presidency of the Council
– Council members have national mandates / no alignment
 Fixes: French-German couple, ‘‘Frankfurt Group’’, ‘‘Gang of Four’’
– Specialized authorities – but limited mandate
 European Central Bank
 Directorate-General Competition (European Commission)
 European Supervisory Authorities??
– Mario Draghi’s ‘‘campaign’’ in Germany 2011
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5. ‘‘The New ECB Chief Is So German!’’
Bild-Zeitung cover picture, 29 April 2011 5

6. Banking Systems
 Regulatory harmonization
 Supervisory autonomy
– European Banking Authority (EBA) 2011
 Resolution authority
– Special resolution regimes introduced in some countries since 2008
– ‘‘cross-border banks international in life but national in death’’
 Financial linkages
– National guarantees on ‘‘domestic’’ banks
 Reinforced by Oct 27 decisions, ongoing discussion
– Home bias in sovereign debt portfolios
 Political linkages
– Different forms in different countries
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7. Banking Systems: ‘‘TBTF’’ Risk Concentration
600
500
400
300
1990
200
2006
100 2009
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Combined assets of Top 3 Banks compared to GDP
Source: BIS; no retreatment of accounting differences 7

8. Banking Systems: Open / Closed
800%
700%
600%
500%
400%
300%
200%
100%
0%
K E R T S L E E K T E U T R I L Z Y U O K I T G V T E
U D F I E N I B D A S L P G F P C C H R S S MB L L E
Domestic Subisdiaries Branches
Assets of credit institutions to GDP, 2009
Source: ECB 8

9. Banking Systems: Home Bias
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
e n l
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e p u t
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l n e m
r r r o b n
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G o e I l m F e A u S e
P G S e h B H D
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L N
Share of home-country sovereign debt in total portfolios of
sovereign debt of EU member states among each country’s
stress-tested banks. Source: 2011 Stress Tests 9

10. Countervailing Factors
 Political commitment
– ‘‘Religion of the euro’’
– Includes Germany
 Downsides of alternative options
– Managed exit of selected countries?
– Possible consequences of Eurozone unraveling
 Financial / economic
 Self-image
 Political stability / security consequences
 Resilience of political systems
– Electoral outcomes since start of crisis
– The German case
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11. Fiscal Union?
 Trichet’s Charlemagne Prize address (Aachen, June 2011)
– ‘‘tomorrow’’: veto on non-compliant national budgets
– ‘‘the day after tomorrow’’: European Finance Ministry
 Surveillance + ability to take control
 Banking / financial sector policy
 External representation
 Fiscal Compact
 Common resources / mutual guaranties
– Eurobonds
– Option of EU tax?
 Information Systems
– Government Accounting
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12. Banking Union?
 Supervision and resolution
– Over large / systemically important institutions
– Or all institutions with devolution to national authorities
 Cf EU competition policy
 Deposit Insurance
 Burden sharing
– Ad hoc, mutualized or both ?
 Governance
– EU vs Eurozone?
 Gradual evolution of financial structures
– Consolidation / privatization
– Cf US until 1990s
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13. Political Union?
 Prerequisite for fiscal / banking federalism
 Executive decision-making capacity / accountability
– Role and reform of European Parliament
 Equal representation
 Control over executive
– Second chamber?
– Geographical subsets?
 Role of European Commission?
 Process of transformation
– Treaty change(s)
– Convention? other groupings?
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14. Transition Measures
 ECB Intervention
 Financial Stability
– Deposit guarantee schemes
– Triage/Recapitalisation/Restructuring?
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15. A Decade of Adjustment
 Structural reform / growth potential
 Europe’s place in the world
 Sequence
– No resolution in one step
– Volatility will remain high
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16. Thank You For Your Attention
Nicolas Véron
+32 473 815 372 (Europe) / +1 202 550 0614 (U.S.)
n.veron@bruegel.org / nveron@piie.com
Bruegel: www.bruegel.org
Peterson Institute: www.piie.com
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