Conference on “The 2007-2008 Global Financial Crisis Revisited, ” Friday, October 5, 2018, Center for International Securities & Derivatives Markets, Isenberg School of Management, University of Massachusetts Amherst
The European Arm of the International Financial Crisis
Gikas A. Hardouvelis www.hardouvelis.gr
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
The European Arm of the International Financial Crisis
Gikas Hardouvelis Isenberg School of Management, October 5, 2018
Introduction: The worldwide Great Recession
10 years ago, in Sept. 2008, the Lehman episode caught everyone by surprise: Economists, central bankers, regulators, rating agencies
It led to a collapse in int/al trade and …
-0,8
3,9
-2
-1
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8
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19
65
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69
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73
19
77
19
81
19
85
19
89
19
93
19
97
20
01
20
05
20
09
%
World real GDP growth
Source: IMF, World Bank
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… 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
I. THE UNHOLY TRINITY: THREE INTERELATED LEGS OF THE EMU CRISIS
Sovereign Debt Crisis
Real Economy under Stress
Austerity measures, rise in interest rates
Sovereign
solvency
questions
Banking Crisis
Large bank failures bankrupt sovereigns as they try to support
banks
A Sovereign default
bankrupts banks
with sizable gov.
bonds
Reduced
supply
of credit
Falling asset prices, reduced
loan demand
Source: Shambaugh, BPEA (2012)
The three legs of a crisis
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
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0
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300
350
400
Jan-07 Aug-08 Mar-10 Oct-11 May-13 Dec-14 Jul-16 Feb-18
itraxx 5-yr CDS spreads of senior European financials
bps
Source: Bloomberg
May 2010 1st Greek bailout program
Mar. 2008 Northern Rock Bear Stearns Incidents
Sep. 2008 Lehman Brothers collapse
Mar. 2009 AIG record quarterly losses
Dec. 2011 ECB announces 3-yr LTROs
May 2012 Greek Elections
Mar. 2013 Monte dei Paschi incident
Jul. 2012 Draghi: “whatever it takes”
58.8 22/2/2018
Europe faces two consecutive crises
5
Diagram shows
the cost of
buying
insurance for
holding a bond
issued by a
European bank
The second phase is more serious: It threatens the existence of the Euro Area Gikas Hardouvelis
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800
1200
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2400
2800
Sep
-92
Oct-
96
No
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Jan
-09
Feb
-13
0
200
400
600
800
1000
1200
140010-yr spreads over bunds (September 1992 – February 2013)
Note: Data are monthly averages Source: Eurostat
Euro Area is formed
bps (GR) bps
Note: Greek spreads are measured on the left axis
Greece
Portugal
Spain
Italy
Ireland
6
Euro Area torn by the bond markets
Gikas Hardouvelis
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
II.
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71.169.3
106.4108.1
170.6
85.0
233.2
103.588.1
0
50
100
150
200
250
USA EA Japan UK Greece Portugal Ireland Spain Cyprus
2007 2011
36.0 21.7
50.2
40.8 12.3
33.081.5
39.7
63.3
%
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
Public Debt (% GDP)
-6.7-5.5
-1.6
-9.5-9.0
-2.2
3.2
-0.2
-4.3
-12
-10
-8
-6
-4
-2
0
2
4
USA EA
Japa
nUK
Gre
ece
Portug
al
Irela
nd
Spai
n
Cyp
rus
Current Account Balance (% of GDP, 1999-2011 avg.)
Source: Eurostat, IMF
Source: Eurostat, IMF
Public & Private Debt (% of GDP, 2011)
Source: Eurostat, IMF, FRB, BoJ, ECB
0
50
100
150
200
250
300
350
400
USA E
Z
Japa
nUK
Gre
ece
Por
tuga
l
Irel
and
Spa
in
Cyp
rus
Households
Non Fin. Corporations
Public
8 Gikas Hardouvelis
Source: European Commission
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
Post-EMU, a competitive North and an uncompetitive South emerged
Politicians interpreted the EMU crisis as a fiscal crisis only
There was no auto-matic 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 price-in those imbalances
Answer: Serious imbalances within EMU
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TWIN DEFICITS
TWIN SURPLUSES
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
Why EMU? A historical background
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During the international crisis 2007-2009 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
The Greek crisis exposed EMU faults
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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
A moral hazard rationale dominated
the response to the Greek crisis
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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
New Institutions are created in EMU
13 Gikas A. Hardouvelis
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
Elke König Daniele Nouy
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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 risk-
sharing 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
Euro Area reform has stalled: Why?
15 Gikas A. Hardouvelis
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
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Euro Area reform: Yes, it can continue
Gikas A. Hardouvelis
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
III.
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65
70
75
80
85
90
95
100
105
110
115
0 1 2 3 4 5 6 7 8 9 10 11 12
Greece
Crisis Stage I
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 110.1 in 1939, but Greece at 74.6 in 2017
Forecast as of Fall 2014: Greece at 82.4 in 2017
Two stages prolong the Greek crisis: Economic imbalances drive the first – Politics the second
Years after recession started
USA
Annual loss 25.4% relative to year 0
82.4
74.6
110.1 Crisis
Stage II
Annual opportunity cost due to Phase II
Int/nal
Crisis
Source: Ameco, EC, BEA
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EC Spring 2018
forecasts
Gikas Hardouvelis
1,5 2,2
5,4
10,1
5,3 3,0
1,5
-0,4 0,0 -0,7
-3,9 -4,2 -3,5 -3,5 -3,5 -3,5 -3,5
4,4 4,5
4,8
5,0
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7,3
5,1
4,0 4,0 6,4 3,3 3,4 3,4 3,3 3,2 3,3 3,3
5,9 6,7
10,2
15,1
11,2 10,3
6,6
3,6 4,0
5,7
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Primary Fiscal Balance
Interest expenditure
Overall Fiscal Balance
% GDP
Fiscal imbalances are corrected by 2014
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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
Source: IMF, ESM, MTFS 2019-2022 Gikas Hardouvelis
Current Account was also balanced
-16,0%
-14,0%
-12,0%
-10,0%
-8,0%
-6,0%
-4,0%
-2,0%
0,0%
2,0% 2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Fore-
casts
%
GDP
20
Peak imbalance in 2007-2008 Complete correction by 2015
Gikas Hardouvelis
Two waves of cash withdraws
Two waves of ELA use
€bn Crisis Phase II
Crisis Phase II
Source: BoG
A second wave of deposit withdrawals
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Source: BoG
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 2011-12 and again in 2015
Gikas Hardouvelis
41.4%
36.6%
3.4%
0,0%
5,0%
10,0%
15,0%
20,0%
25,0%
30,0%
35,0%
40,0%
45,0%
GR PT BG IE HU RO ES LT AT SK DK BE DE CZ FI LU
0
20
40
60
80
100
120
140
160
3/30/12 3/30/13 3/30/14 3/30/15 3/30/16 3/30/17 3/30/18
FTSE/Athex Banks Index Stoxx Europe 600 banks Price Index
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)
Greek Banks
European Banks
Greek banks face difficulties
Politics drove Greek bank stock prices to zero
22 Gikas Hardouvelis
Greece and Cyprus, highest NPEs in Europe
Private sector credit continues to contract
NPEs including restructured loans, EBA definition (% of total loans, Q1:2018)
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
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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
IV.
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Euro Stoxx Banks Index Euro Stoxx ex Banks Index Greek Banks Index S&P 500 Banks Index
Index, September 30, 2004=100
II. ΟΙ ΤΡΑΠΕΖΙΚΕΣ ΜΕΤΟΧΕΣ ΧΤΥΠΗΘΗΚΑΝ ΠΕΡΙΣΣΟΤΕΡΟ ΣΕ ΣΧΕΣΗ ΜΙΣ ΥΠΟΛΟΙΠΕΣ ΜΕΤΟΧΕΣ
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 2011
Note: Indices include Dividends
Source: Bloomberg
Int/nal Crisis begins
Greek crisis begins
Greek Banks
European Banks
European Non-Financial Stocks
US Banks
A summary view from the stock market
Jan 2018
25 Gikas Hardouvelis
Concluding remarks
26
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 2014.
Gikas Hardouvelis
The European Arm of the International Financial Crisis
www.hardouvelis.gr
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THANK YOU FOR YOUR ATTENTION!
Gikas Hardouvelis
