DG ECFIN, European Commission Vejen mod en økonomisk union Netværkskonference 2012, Odense Jakob Wegener Friis DG ECFIN, European Commission

From a financial crisis …. 2011-2012 – A systemic crisis of the euro? 2007 - Subprime crisis 2008 – Financial crisis 2009 – Economic crisis 2010 – Sovereign debt crises Assistance programmes + EA financial backstop The sovereign debt crisis is a consequence of the unprecedented financial and economic crisis we went through. Briefly: - The origin of the crisis is to be found in the subprime crisis in the US: the increases in interest rates in the US - from 1% in 2004 to above 5% in 2007 - led to a sharp increases in subprime mortgages cost as a high percentage of these mortgages, over 90% in 2006 for example, were adjustable-rate mortgages. Coupled with the burst of the housing-bubble and the associated decrease in property valuations, this will lead to large losses on these mortgages. - The crisis began to affect the financial sector in February 2007, when HSBC, the world's largest (2008) bank, wrote down its holdings of subprime-related mortgage-backed-securities by more than USD 10.5 bn, the first major subprime related loss to be reported. During 2007, at least 100 mortgage companies either shut down, suspended operations or were sold. - in March 2008, Bearn Sterns as rescued by the Fed and sold to JP Morgan. In November, Fannie Mae and Freddie Mac representing slightly less than half of US mortgages had to be nationalised. Overall capital injections in banks represented 1.5 trillion USD: 700bn from US treasury, 360bn from the Europeans. - As of November 2008, financial firms around the globe had written down their holdings of subprime related securities by $750 billion. These have wiped out much of the capital of the world banking system. When Lehman Brothers and other important financial institutions failed in September 2008, the crisis hit a key point. During a two day period in September 2008, $150 billion were withdrawn from US money funds, a key source of credit for banks and nonfinancial firms. This credit freeze brought the global financial system to the brink of collapse. The response of the Federal Reserve, the European Central Bank, and other central banks was immediate and dramatic: they put in motion the largest liquidity injection into the credit market, and the largest monetary policy action in world history. - The massive reduction in bank capital reduced the credit available to businesses and households. The transmission of financial distress to the real economy evolved at record speed, trough tighter credit conditions, collapsing confidence and sharp contraction in global demand and trade.. It is the most severe financial and economic crisis in several generations. Stimulus packages + automatic stabilizers Bank recapitalizations + guarantees 2 2

……. to an unprecedented economic crisis At the end of 2008, policy makers were confronted with the sharpest downturn since the 30s. GDP growth was in free fall moving from 3% in 2007 to close to zero in 2008 and with a massive further contraction in the offing for 2009. Unemployment sharply increased, reaching in the US its highest level over 15 years. 3

Heartbeat of the crisis At the end of 2008, policy makers were confronted with the sharpest downturn since the 30s. GDP growth was in free fall moving from 3% in 2007 to close to zero in 2008 and with a massive further contraction in the offing for 2009. Unemployment sharply increased, reaching in the US its highest level over 15 years. 4

Legacy of the crisis: 4 key messages A lasting impact on growth and job creation: more than ever a need for comprehensive policy action Recovery in question: uneven and protracted, re-building confidence of paramount importance Fiscal consolidation a necessary but not sufficient condition for sustainable public finances The EU response has been comprehensive, albeit incremental. Stronger EMU governance and commitment to euro area cohesion essentiel

The crisis as an eye opener External shock: the crisis has exposed shortcomings in EMU‘s design and governance system Gaps in original EMU design : monetary and fiscal discipline not enough, no crisis resolution mechanism foreseen Prediction of closing structural reform gap did not materialise fully Weaknesses in enforcement of existing rules The crisis has suddenly and largely unexpectely invalidated the main tenets of the ‘Great moderation paradigm’ The combination of fiscal and monteray discipline turned out not to be the reliable safeguards of overall macro stability. Countries which had scored well in terms of both monetary and fiscal discipline suddenly found themself off track . Lasrgely undetected or ignored by the radar of conventional macro surveillance they had accumulated macroeconmic imbalances , such as large current account deficits and/or housing bubbles, which when they unwound, turned into serious vulnerabilities. 6 6

The broad ‘geography’ of EMU reform 7 The broad ‘geography’ of EMU reform Prevention and correction of macro imbalances Better enforcement: disincentives/ Sanctions National frameworks More effective preventive arm of SGP Focus on debt developments (corrective arm of SGP) Sound fiscal policy Crisis resolution Structural reform strategy (Europe 2020) Sound fiscal policy Balanced growth Regulation and supervision of financial systems Macro-prudential supervision 7 7

Learning the lesson: the EMU of tomorrow Growing again: The pre-crisis need for structural reform is reinforced. Releasing Europe’s growth potential is a pressing priority. A well-functioning EMU will help. A choice to be made: the « safe harbour » of Maastricht or further fiscal integration. More intrusive surveillance and forceful enforcement paired with a credible last-resort financial backstop. Beyond fiscal: Broader surveillance to prevent unsustainable imbalances build up. Strengthened financial regulation and supervision in support of the internal market. Hanging together: Realisation of scope and depth of governance required to protect the benefits of common currency. EU rules interacting with increased attention of financial markets Ever closer Union: Political challenge of wide-reaching financial solidarity and « pooling of powers » within the Community method.

Completion of EMU's architecture Banking Union – closer integration in supervisory structures and practices, in cross-border crisis management/resolution and burden sharing Fiscal Union – Moving from coordination towards integration in the surveillance of economic and budgetary policies in the euro area Stability Bonds – Consider joint issuance of euro area debt, once crisis has abated

Why do we need a Banking Union? Necessary for achieving a genuine EMU. Break the negative feedback loop between sovereigns and banks. Prevent bank runs and strengthen overall financial stability. Preserve the single market. Single supervision is the precondition for the introduction of potential direct recapitalisation of banks by ESM.

Banking crisis triggered dangerous feedback loops Higher Government Bond Yields Deeper Recession Higher Government Debt-to-GDP Ratio More Banking / Financial Strains Bank solvency concerns Tighter financial conditions index Bailout costs Higher debt service Default worries Calls for fiscal tightening Lower tax receipts Lower nominal GDP Credit losses Lower corporate profits Reduced loan supply Negative wealth effect Un dels principals problemes que ha sorgit cap a la fi de 2011 és la retroalimentació negativa entre: La feblesa en les balances dels bancs La sostenibilitat de les finances públiques, en concret, la sostenibilitat del deute Les febles previsions de creixement És evident que els problemes en cadascuna creen a la vegada problemes en les altres dues. I es reforcen mútuament. I el que s’està fent per gestionar la crisi vol atacar totes les components a la vegada. L’objectiu és convertir un cercle potencialment viciós en un de virtuós. Aconseguir això és difícil i exigeix disciplina i perseverança. Source: Goldman Sachs, Global Economics Weekly 11/38, 30/11/2011

Key elements of the Banking Union Single Supervisory Mechanism Single Resolution Mechanism Deposit Guarantees Single Rulebook 28/03/2017

Single Rulebook ECB Single Supervisory Mechanism National central banks / supervisors of non-participating Member States Coordination by EBA ECB send preparation and Board Members execution of tasks central banks / supervisors of participating Member States Single Rulebook

A Euro area SSM open to other MS All Euro-area Member States shall participate. Non-Euro area countries may join by establishing a close cooperation between their competent authorities and the ECB. 28/03/2017

The debate about fiscal union Discipline (Austerity) Solidarity (Growth) 6-Pack 2-Pack Fiscal Compact Veto over national budgetary policy Executive tasks at EA-level (e.g. EA Treasury) New enforcement tools Common growth and stabilization instruments Fiscal backstops Financial transactions tax Eurobonds Social pillar ESM

Europe’s Prosperity Triangle "Social market economy" FAIRNESS - participation - generational - territorial GROWTH - single market - catching-up and convergence - investment and innovation STABILITY -monetary/financial -fiscal -environmental

Political "musts" for long-term solutions Political will and leadership for a great leap forward Necessity of Treaty changes  Unanimity Constitional questions in some MS Political and economic cohesion among countries EU27 vs. EU10? Rules vs. discretion: An accepted authority needed Building legitimacy of the EU-level executive - preferences of Member States and citizens Issues: Too little too late? Are we sure about EMU.2? Credible incentives and mutual trust?

Four Presidents' Report Integrated frameworks for: Financial sector: SSM, DGS, RRS, burden sharing? Budgetary policy: EA fiscal capacity? Debt mutualisation? Economic policy: more binding CSRs? Positive financial incentives for reform implementation? Partnership contracts? Ensuring democratic legitimacy and accountability: EA-level accountability structure?

Questions?