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

2. From a financial crisis ….
– A systemic crisis of the euro?
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 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 During a two day period in September 2008, $150 billion were withdrawn from US money funds, a key source of credit for banks and nonfinancial firms.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

3. ……. 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 Unemployment sharply increased, reaching in the US its highest level over 15 years. 3

4. 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 Unemployment sharply increased, reaching in the US its highest level over 15 years. 4

5. 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

6. 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

7. The broad ‘geography’ of EMU reform7
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

8. 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.

9. 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

10. 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.

11. 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

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

13. 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

14. 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

15. 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

16. 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

17. 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?

18. 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?

19. Questions?