the euro: fix it or abandon it

The Euro: Fix it or abandon it

Stavros A. Zenios

University of Cyprus

Senior Fellow the Wharton School, USA

Outline

¤ Some of the flaws

¤ Some flawed decisions: Manufactured contagion

¤ Banking Union: is it enough?

Is the quest for banking union urgent and timely?

Manifestations of the flaws

Manifestations of the flaws

Manifestations of the flaws

Why? 2 + 1 mechanisms

¤ Bank-sovereign loop, Brunnermeier et al. 2011 ¤  Governments “pressure” banks to buy government debt

¤  Banks with sovereign concentration need government assistance

¤  No lender of last resort

¤  No mechanism for bank resolution

¤ Capital flight, De Grawue 2012

¤ Manufactured contagion

Leo Tolstoy: Happy families are all alike; every unhappy family is unhappy in its own way.

0 100 200 300 400 500 600 700

Ireland

Greece

Cyprus

Cyprus -post Greek PSI

Mature economies

Households NFC FINANCIAL Govt

Why? Manufactured contagion

October 18, 2010, Deauville. No bailout.

Introduced credit risk in what was considered “safe” government debt.

March 16. Brussels. Bail in.

Introduced credit risk in what were considered “safe” bank deposits.

Who paid the Greek PSI?

!! Cyprus!! Greece! Germany!! Belgium!! France!! Portugal!Losses! 4,14! 24,3! 3,6! 2,1! 5,04! 0,42!%"GDP"" 23,03" 11,65" 0,14" 0,56" 0,25" 0,25"!

The greatest carry trade ever

¤  Acharya and Steffen, May 2013

¤  Investments in periphery countries financed by ECB repos

¤  Sovereign default not in EBA stress tests!

Bank of Cyprus exposure to GGB

¤ OK! But….

¤ Ex post ¤ Arbitrary ¤ Unfair

Bail in

Bail in

•  Bad Politics in the way of Good Policy

•  Haircut money-laundering Russian oligarchs

Basel Institute of Governance AML Index

Cyprus 4.93

Holland 5.03

Germany 5.80

Financial Action Task Force

Who gets a haircut?

68.4 billion in Jan. 2013

26-30 billion Russian money

What does a haircut look like?

Russian “oligarchs” è Eurobankers

Wipe out wealth 30% GDP

Slash business activity 9%-25% GDP

Freeze working capital of SMEs

Massive legal problems

Emergency Liquidity Assistance worth 9.2 billion

Extended to an apparently insolvent bank for 1 year

Passed on improperly to a solvent bank

Where was ECB?

Why was the bail in unfair?

Principles for Stable Capital Flows and Fair Debt Restructuring, 2013, Washington, DC: International Institute of Finance.

1.  Transparency and timely flow of information

2.  Close debtor-creditor dialogue and cooperation to avoid restructuring

3.  Good-faith actions

4.  Fair Treatment

What does a haircut look like?

Whatever it takes! Or…. As much as we can?

What kind of banking Union

¤ Single Supervisory Mechanism -SSM

¤ Single Resolution Mechanism –SRM

¤ Single Resolution Fund -SRF

25

SSM Decision-making

Based on a new procedure known as “non-objection”

•                                                                                                                                                                                                                                                                                                                                            •  The Supervisory Board

will propose draft decisions to the Governing Council of the ECB. If the Governing

SRM – The mother of organizational complexity

SSM Board (24 members)

ECB Governing Council (24 members)

SRM Board (23 members)

Consultation on “specific objections” with

Commission (28 members)

Single Resolution Fund

¤  Too little -- 55 billion

¤  Too late –start 2016 and completed in 2024

¤  No backstop

¤  FDIC could borrow up to USD 30 billion from Treasury

¤  Increased to USD 300 billion during the crisis

Getting out of a debt trap

Charles Wyplosz and Pierre Pâris, 2013.

Politically Acceptable Debt Restructuring in the Eurozone: The PADRE Plan.

Joseph Stiglitz, August 1, 2014.

“a global system is needed for debt restructuring”

Kenneth Rogoff, July 7, 2014.

“it is high time for a conversation on debt relief for the entire eurozone periphery”

Eurozone debt

Conclusions

…can we?

References For the Cyprus crisis:

Zenios, S.A., The Cyprus debt: Perfect crisis and a way forward.http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2233239

Zenios, S.A., Fairness and reflexivity in the Cyprus bail inhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=2409284

For debt restructuring:

Consiglio and Zenios, Risk profiles for reprofiling the sovereign debt of crisis countries,

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2493695

For ECB policies:

Karl Whelan, The ECB and Non-Standard Policies: Too Little Too Late?, report IP/A/ECON/NT/2014-02, June 2014.

Bruegel blog, Fact: T.L.T.R.O. is Too Low To Resuscitate Optimism, Sept. 2014