IX EUs Sovereign Debt Crisis*Prof. Dr. Gnter S. Heiduk European Economic Integration - 110451-0992 - 2014 European Recession Slowing Global EconomyOECDAusterity Europeeri Governments across the region are taking action to eliminate unsustainable budget deficits Source: http://www.ft.com/intl/indepth/euro-in-crisisKipper WilliamsGreece and the EURO

Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of economic Perspectives, 26(3), p. 51.

Government EDP debt in the Euro area countries, selected years (percentage GDP)Source: Lojsch et al (2011). The Size and Composition of Government Debt in the Euro Area, Occasional Paper Series, No 132, ECB, p. 17.

Source: EUROSTAT, News Release Euroindicators, No 153-2013, p. 2.

Source: EUROSTAT, News Release Euroindicators, No 153-2013, p. 3.

Eurozone, European and/or Global Debt Crisis?Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 2.

The Share of Foreign Government Bonds in Banks Sovereign Bond Portfolios, 2011Source: Gabor, D. (2012), The Power of Collateral: The ECB and Bank Funding Strategies in Crisis, p. 20.

Financial Imbalances and External Imbalances A key predictor of a banking crisis is the scale of the preceding domestic credit boom.. The European periphery experienced strong credit booms, in part because joining the euro zone meant that their banks could raise funds from international sources in their own currencythe euro rather than their previous situation of borrowing in a currency not their own (say, U.S. dollars or German marks or British pounds) and then hoping that exchange rates would not move against them. In related fashion, lower interest rates and easier availability of credit stimulated consumption-related and property-related borrowing.A related phenomenon was the increase in the dispersion and persistence of current account imbalances across the euro area.. (The) current account imbalances were quite small in the pre-euro 1993 1997 period. But, by the2003 2007 period, Portugal ( 9.2 percent of GDP), Greece ( 9.1 percent), and Spain (7.0 percent) were all running very large external deficits. Conversely, Germany ran very large external surpluses averaging 5.1 percent of GDP, while the overall euro area current account balance was close to zero.Private Credit DynamicsCurrent Account Balances (% GDP)Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of Economic Perspectives, 26(3), p. 52.

*Blundell-Wignall, A. and Slovik, P. (2011). A Market Perspective on the European Sovereign Debt and Banking Crisis,OECD Journal: Financial Market Trends, Vol. 20(2), p. 2.EUs twin crisis

The Risk of Contagion

* 2007 US sub-prime crisis

2008Spillover to Europe- Spain Burst of real estate bubble- Irland Banking crisis

2009- Greek Correction of the budget deficitfrom 6% to 12%

2010- PortugalSpeculative attacks in domesticfinancial markets

2011- ItalyFears of debt spiral

2012- France, Austria, Italy Downgraded by US rating agency

2012/2013 Cyprus Banking crisis exposure to Greek crisis It Started in the U.S.

*The brief characterization of the countries at risk shows that their crisis history differs in origin and course. The outcome is the same, namely a sovereign debt crisis. The common peg between these countries is the Euro. Therefore, it is obvious that the national crises merged into the crisis of the Euro Area, last but not least because the other Euro Area members - under the lead of Germany and France are expected to demonstrate solidarity. The Euro Area members have to fear firstly internal contagion effects and secondly the collapse of the Euro as the symbol of integration of unequal countries. Germanys and (former) Frances leaders set as their common priority a sustainable solution for the continuation of the common currency.

From National Crisis to Crisis of the Euro

*Macroeconomic Imbalances (1)Quarterly GDP, Change over Previous Quarter, in %, Selected Countries, Q3-2007 Q1-2013Q3-07Q2-12Source: Own calculations on OECD National Accounts Statistics.

Diagramm1

0.90.50.7-0.1-0.10.10.80.80.7

0.50.50.60.50.51.40.50.10.3

-0.20.60.40.2-0.1-0.90.71.60.5

0.4-0.100.10.8-2.10.6-0.6-0.4

-0.7-0.7-0.6-0.50.40.50.1-0.3-0.2

-1.4-1.8-1.1-1.70.3-5.6-0.7-2.4-1.5

-1.6-2.5-1.6-20-2.3-0.5-3.5-1.4

-0.2-0.2-10.30.1-0.7-10.30.1

0.40.2-0.30.60.1-0.6-0.60.80.3

0.90.7-0.1-0.1-0.5-1.30.70.70.6

10.40.20.90.51.5-1.90.50.1

0.91.10.30.3-0.6-0.5-1.31.90.5

0.60.70.10.2-0.80.4-1.60.80.4

0.6-0.50.2-0.4-2.1-1.4-2.80.50.4

0.10.40.4-0.6-2.71.80.21.30.9

0.300.2-0.2-0.51.40.3-0.1

0.50.60-0.60.6-1.90.50.3

1-0.4-0.5-1.4-0.70.6-0.10

0.5-0.3-0.3-0.1-0.8-0.70.50

0.3-0.4-0.4-1.2-0.800.30

0.80.7-0.3-0.9-0.30.70.20.1

US

UK

Spain

Portugal

Italy

Ireland

Greece

Germany

France

Tabelle1

USUKSpainPortugalItalyIrelandGreeceGermanyFrance

Q3-070.90.50.7-0.1-0.10.10.80.80.7

Q4-070.50.50.60.50.51.40.50.10.3

Q1-08-0.20.60.40.2-0.1-0.90.71.60.5

Q2-080.4-0.100.10.8-2.10.6-0.6-0.4

Q3-08-0.7-0.7-0.6-0.50.40.50.1-0.3-0.2

Q4-08-1.4-1.8-1.1-1.70.3-5.6-0.7-2.4-1.5

Q1-09-1.6-2.5-1.6-20-2.3-0.5-3.5-1.4

Q2-09-0.2-0.2-10.30.1-0.7-10.30.1

Q3-090.40.2-0.30.60.1-0.6-0.60.80.3

Q4-090.90.7-0.1-0.1-0.5-1.30.70.70.6

Q1-1010.40.20.90.51.5-1.90.50.1

Q2-100.91.10.30.3-0.6-0.5-1.31.90.5

Q3-100.60.70.10.2-0.80.4-1.60.80.4

Q4-100.6-0.50.2-0.4-2.1-1.4-2.80.50.4

Q1-110.10.40.4-0.6-2.71.80.21.30.9

Q2-110.300.2-0.2-0.51.40.3-0.1

Q3-110.50.60-0.60.6-1.90.50.3

Q4-111-0.4-0.5-1.4-0.70.6-0.10

Q1-120.5-0.3-0.3-0.1-0.8-0.70.50

Q2-120.3-0.4-0.4-1.2-0.800.30

Q3-120.80.7-0.3-0.9-0.30.70.20.1

Q4-120.1-0.2-0.8-1.8-0.90.6-0.7-0.2

Q1-130.40.3-0.5-0.4-0.60.7-0.1-0.2

*Macroeconomic Imbalances (2)Unemployment Rate (Number of Unemployed as a Percentage of Total Labor Force), Selected Countries, 2007-2011, 2013Source: Own calculation on European Commission, 2011a; U.S.A.: United States Department of Labor2013XXXXX

*Macroeconomic Imbalances (3)Source: Kam and Shambough (2013), The Evolution of Current Account Deficits in the Euro Area Periphery and the Baltics, WP13/169, IMF,p. 19. Current Account Balance (as Percentage of GDP), Selected Countries, 1999-2012

*Since 2007 the fiscal balance in most EU Member States as well asin the USA has worsened.Primary Deficit-GDP Ratio, Selected Countries, 2007-2011Source: Own calculations on OECD Economic Outlook data.Fiscal Imbalances (1)

*The global recession called in many countries for implementing fiscal stimulus packages. The drastic fiscal slump in Greece, Portugal, Ireland, Spain required external funding which contributed to a significant increase in the government debt. Government Debt-GDP Ratio for Selected Countries, 2007-2011Source: Own calculations on OECD Economic Outlook data. Forecast 2012 (except U.S.A.): European Commission, 2011a. U.S.A: www.usgovernmentspending.com/federal_debt_chart.htmlFiscal Imbalances (2)

Fiscal Imbalances (3)*There are still risks that burden the economies of the debt-ridden countries: increasing interest expenditures, high unemployment rates, current account deficits.Interest Expenditure, General Government (% of GDP), Selected Countries, 20072013Source: Own calculation on European Commission, 2011a. 2011-2013: Forecast.

Policy Options to Deal with the Problem of Explosive Debt ScenariosCutting spending and raising taxes

Causing inflation to riseNo option as long as the monetary policy is in hands of the ECB

3.Carrying out structural reforms- Increasing labor market flexibility- Reform of EU pension systems- Improving competition policy: consistency of regulations and governance

Restructuring the level op outstanding debtPotentially promising, if the primary deficit is small, the need for the governments to return to the capital market is low, the amount of thesovereign debt held by domestic banks is low.

Fiscal Response to the Global Crisis: 2009 Discretionary Stimulus, % GDP, Selected Countries

Government Support Measures to Financial Institutions, October 2008 - May 2010, in % of 2008 GDPSouce: Alter, A. and Schler, Y.S. (2012). Credit Spread Interdependencies of European States and Banks during the Financial Crisis. Draft, 13.01.2012. The downfall of the US investment bank Lehman Brothers on September 15, 2008 changed the latest banking crisis into a global financial crisis. Because of the globally integrated financial markets, banks in Europe and Asia got instantly caught in this downward maelstrom. Central banks, primarily the FED and the European Central Bank (ECB), and governments reacted with money injections into the banking sector, bailouts and fiscal stimulus packages.

*Bailouts did not solve the crisis situation. The four countries performance regarding the fiscal consolidation did not lead to an easing of tensions. Higher credit default risks increased the interest rates of new government loans especially for Greece, Ireland, Portugal, Spain, and since the end of 2011 also for Italy. Spreads (in Basis Points) of 10-Year Euro Area Government Bond Yields to German Bonds, 2009-2011Source: Arroyo, 2011, p. 15.Interest Rates Spreads Mirror the Differences in Public Debt (1)

Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of economic Perspectives, 26(3), p. 57. Yields on Ten-Year Sovereign Bonds, Oct. 2009 to June 2012 (percent) Interest Rates Spreads Mirror the Differences in Public Debt (2)

Do Markets Believe in Contagion: Who is Next?

The PIGS+1

*The Case of SPAINIn order to enter the Euro Area, Spain had to fulfil the convergence criteria of the Maastricht Treaty. The government reduced the budget deficit and achieved the first surplus in 2005. From 1998-2007 the average deficit ratios had been significantly lower than the average of the Euro Area. The public net debt ratio declined from 57% of GDP in 1998 to 26.5% of GDP in 2007. The Central Bank reduced the long-term interest rates to meet the respective Maastricht criteria. The favourable borrowing conditions motivated more and more young people to take a mortgage to purchase homes. Furthermore, the demand for housing increased because of immigration. In the years 2000-2007, approximately 730,000 people a year immigrated to Spain. Prices of houses increased considerably and demand for loans as well. The average level of household debt tripled since the beginning of this century. The intransparent structure of the Spanish banking system masked up the growing lending to the real estate market even after the beginning of the crisis in 2007. The gap between increasing supply and decreasing demand in the real estate market after 2007 resulted in a sharp decline of housing prices, bankruptcy of unlisted regional saving and loan banks and construction firms, growing unemployment in the construction industry, increasing government expenditures on unemployment benefits, decreasing tax revenue, and finally the reversal of the budget surplus of 2% of GDP in 2006 into a deficit of 8.5% of GDP in 2010. Beginning 2010, the run on the banks forced the government to bail out regional savings and loan banks. Estimations on bad loans range from 40 billion Euros to more than 100 billion Euros. The housing market is estimated to reach balance of supply and demand not before 2017. This negative perspective puts further pressure on housing prices. Banks are forced to offer huge discounts for selling their real estate assets.

*The Case of Ireland

Similar to Spain, Ireland had been one of the above-average performing economies in the EU. From 1998 2006 the pre-crisis public deficits corresponded closely to the respective average ratios of the Euro Area. Similar to Spain, during this period Irelands public debt/GDP ratios declined. But its competitiveness was built on fragile, while wage-sensitive, exports. Funding of infrastructure projectsby EUs Cohesion Policy, increasing wages, tax reductions and a sharp decline of interest rates after joining the Euro Area fuelled the construction and housing sector and resulted in a property and construction bubble. Despite warnings with respect to the sustainability of Irelands growth, banks continued to ease loan conditions due to weak bank regulation. They funded the increasing loan demand by extensive foreign borrowing. The U.S. sub-prime crisis fully struck Irelands banks, especially the Anglo Irish Bank. The government decided to rescue this bank and to introduce a system-wide bank guarantee. The burst of the bubble instantly led to a sharp fall in tax revenue. Spending could not have been reduced at the same speed. Therefore, the budget deficit exploded in 2008.

The Case of Portugal

In December 2009 the IMF stated that Portugals exposure to the global economic crisis is enhanced by its pre-existing, home-grown problems such as low productivity growth, large gap in competitiveness, and high levels of debt (IMF, 2009). In contrast to Spain, Ireland and Greece, Portugals banking sector did not experience similar bank crashes, predominantly because of the absence of a property bubble and stricter bank regulations. The increasing public deficit ratios between 1998 and 2006 raised the susceptibility towards economic shocks. The public debt/GDP ratio also increased but till 2007 remained under the Maastricht criteria threshold of 60%. It has to be noted that the debt burden ratios turned out to be higher than in Spain, Ireland, and even Greece.

The case of Greece

In contrast to Spain and Ireland, the crisis in Greece has its main roots in long-term deficits in its budget and current account. Compared to the aforementioned Euro Area members, Greece experienced by far the highest increase in and the highest ratios of its budget deficit between 1998 and 2006. Since the introduction of the Euro in 2001 the budget deficit averaged 5% of GDP per year until 2008. During the same period of time the Euro Area average amounted to 2% of GDP only. The public debt/GDP ratio climbed between 1998 and 2006 from 72% to 80%. The former government managed to hide the total amount of the budget deficit in order to fulfil the Maastricht convergence criteria for joining the Euro Area. Statistical revisions in the negative direction undermined the confidence of actors in financial markets. The roots of Greeces fiscal calamity lie in prolonged deficit spending, economic mismanagement, government misreporting, and tax evasion (Sandoval et al., 2011, p. 4). According to the former Prime Minister George Papandreou, inefficient allocation of money resulted from corruption, cronyism and clientalistic politics. The current account deficits averaged 9% per year compared to the Euro Area average of 1%.

The case of Italy

Italys late appearance on the map of severely crisis-stricken European countries is obviously due to the pure size of its economy. Finally, the exposure to the global economic crisis dismantled the long-standing structural weaknesses (IMF, 2010). Low productivity, inefficient and expensive public services to a large extent responsible for the high deficit -, out-dated infrastructure, rigid labour markets are the main shortcomings of Italys economy. Up to now, the banking sector did not need substantial government capital injections. Low confidence in the crisis management forced the former Prime Minister Silvio Berlusconi to resign. At the beginning of December 2011, the new Prime Minister Mario Monti quickly worked out an austerity package of Euro 30 billion that had been accepted by Italys Senate on December 21, 2011.

*The case of Cyprus

After more than a week of messy negotiations, the Troika (made up of the European Union, the International Monetary Fund and the European Central Bank) and the government of Cyprus agreed on a bailout package for Cyprus on 24 March. Cyprus is set to receive a 10 billion loan, on the condition that it shrinks its financial sector and implements austerity policies. Private bank deposits above 100,000 will be taxed at 40% in order to raise the additional 5.8 billion needed to stabilise the countrys de facto bankrupt banks.

Euro banking crisis chapter four Cyprus has become the fourth European nation to fall victim to a banking crisis that was caused by irresponsible lending and lax financial regulation following on the heels of Iceland, Ireland and Spain. Cyprus status as a de facto tax haven also played a role in attracting huge amounts of foreign deposits, mainly from Russia and the UK, which inflated the banking sector to such an extent that lending reached 900% of Gross Domestic Product (GDP) in 2011.

Todoulos, C. and Elmers, B. Cyprus the next chapter of dysfunctional EU debt crisis management, eurodat, 28 March 2013http://eurodad.org/1545029/

Multidimensional crisis?

In Europe, those countries were hit first by the financial crisis where governments since the beginning of the decade have been trapped in budget bottlenecks. But also formerly healthy government budgets came under heavy pressure of the financial burden of the stimulus packages. Public revenues could not cover the additional expenses, firstly because of the huge sudden amount due, and secondly because of the declining tax income. The sovereign debt crisis coupled with a currency crisis emerged in many countries as a new type of twin-crisis. This situation was getting even worse when credit-rating agencies downgraded sovereign bonds, especially in several Euro Area member countries. Downgrading hits its preliminary peak on January 13, 2012 when one credit-rating agency lowered the credit-worthiness of nine Euro Area countries.Shortly afterwards, this agency also downgraded the European Financial Stability Facility (EFSF).

Primary Origins and Developments Toward the Sovereign Debt Crisis

*It immediately catches everbodys eye that the trend of bank liabilities as well as household debt increased stronger than the government debt, especially since 2002.Source: Paul de Grauwe http://www.voxeu.org/index.php?q=node/5062

*Source: Paul de Grauwe http://www.voxeu.org/index.php?q=node/5062

When generalizing the path of the crisis the following sequencing seems to be plausible:

- Pre-crisis phase: Real-estate bubble or optimism bubbleFirst crisis phase:Banking crunch or sudden decline in competitiveness resulting in fast increase of current account deficit or structural budget imbalances Second crisis phase: Unexpected recession, drastic drop of tax income, increasing budget deficit Third crisis phase:Stimulus package, increasing debt, time lag in re-structuring public revenues and expenditures Fourth crisis phase:Sovereign debt leads to solvency at risk, flight of capital, currency crisis

- Sixth crisis phase: Political crisis? See Greece after the latest elections

* Fiscal consolidation/austerity: Increase taxes, cut governmentspending

Debt restructuring:Lower payments for borrower via renegotiating the debt

Inflation:Reducing the real value of the debt

Growth:Structural reforms; investment

Financial repression:Forcing the private sector tobuy government bonds atartificially low interest ratesPolicy Options

*Austerity policy Bailout policy?

Banking union?

Common Fiscal Policy?

ECB bond buyer?

Expansionary policy?

Moving toward social union?

Rule-based sanktions?

Which way is the right one?

*RULESStronger, more effective fiscal rules and greater coordination of economic policiesPROGRAMS Financial assistance for countries in difficulty (but with conditions attached)FIREWALL A permanent mechanism (ESM) to stem the risk of contagion to other countriesBANKSStrengthen the banking system, including stronger supervision at the EU levelEuropean Commissions Proposals Banking Union?Fiscal Union?

*?FINANCIAL CRISIS 2008ECONOMIC CRISIS 2009POLICY RESPONSE: STIMULUSSURGE IN GOVERNMENT DEBTSOVEREIGN DEBT CRISISFINANCIAL STRESSES and ECONOMYSLOWINGVicious circle of crisis?EURO

Governing the Sovereign Debt Crisis

In the EU the core activities on the supranational and national level are aiming at rescuing banks from getting bankrupt (mainly in 2008/2009) and financing governments debt (since 2009). Within the Euro Area the rescue of the systemic banks and the maintenance of the public solvency are the top short-term priorities.

Crisis prevention

Stricter bank regulationsIt became evident that stricter global bank regulations are not in the interest of the U.S. and British governments because of the political power and economic importance of the financial centers of New York and London. The new Basel III Accord will introduce tighter requirements for bank capital and liquidity. Furthermore, banks have to pass stress tests. The rules will be put into force in 2013. The controversial discussion in the EU on the role of the ECB in financing of governments concluded that the Lisbon Treaty prohibits the ECB being a lender of last resort to governments.

Stricter budget rulesMaastricht Treaty convergence criteria seem to lack enforcement and sanctions mechanisms.

Fiscal Stability Treaty: intergovernmental treaty which was signed by all of the member state of the EU European Unio except Czech Republic and the United Kingdom on 2 March 2012. The treaty will enter into force on 1 January 2013, if by that time 12 members of the euro areahave ratified it. The treaty requires its parties to introduce a national requirement to have national budgets that are in balance or in surplus. General government budgets shall be balanced or in surplus. The annual structural deficitmust not exceed 0.5% of nominal GDP. Countries with government debt levels significantly below 60% and where risks in terms of long-term sustainability of public finances are low, can reach a structural deficit of at most 1.0% of GDP.The European Court of Justice would fine a country up to 0.1% of GDP if this was not done a year after ratification.Once a country has ratified the Treaty it has another year, until 1 January 2014, to implement a balanced budget rule in their binding legislation.31 Only countries with such rule in their legal code by 1 March 2013 will be eligible to apply for bailout money from the European Stability Mechanism(ESM). The aim is to incorporate it into EU law within five years of its entry into force.30

*2. Crisis control/mitigation: rescue (banks), stimulate (economy), clean-up (governments budget).

European banks were hit much harder by the crisis than the banks in the U.S.A. and in the Pacific. Between July 2007 and March 2009 approximately 3.23 trillion US$ of market value in the global banking sector was destroyed. European banks lost 75% of their market value As long as banks undercapitalization cannot be solved by systemic changes, the fragility and vulnerability will continue. The largest part of commitments and outlays had been allocated to debt and asset guarantees. Purchasing bad assets had not been in the forefront of rescue activities. One of the still unsolved questions is related to the consequences of the restructuring of the banking sector. The crisis has increased the market share of large banks. More banks may reach the size of too-big-to-fail, but at the same time the size of too big to be saved. The discussion on separating universal banks into investment and retail banks may mitigate this problem. Another unsolved question concerns the participation of banks in funding government debt. Despite strong reservations, at the end of 2011 the ECB injected almost 500 billion Euro in loans into the banking sector at a 1% interest rate. More than 500 banks took this money. The sudden increase in liquidity may motivate banks to buy European sovereign bonds.

At the end of 2011 the EC stated that European countries also undertook significant interventions to stabilize their financial sectors. Together, the EU countries injected nearly 300 billion worth of capital into financial institutions and extended 2.5 trillion worth of guarantees. The EU adopted new rules on hedge funds and private equity, and as of January 2011 a new financial supervision system is in place for the 27 Member States.

*In late 2008 the European Commission took the initiative to propose a European Economic Recovery Plan (EERP) adopted on December 08, 2008 - aiming to swiftly stimulate demand and boost consumer confidence as well as to prepare the European economy for the future challenges of tougher competition on the global markets (European Commission, 2008). On the one hand, the plan addresses the current causes of the crisis that result from insufficient competitiveness (Greece, Portugal, Ireland), on the other hand the measures should build-up a protective barrier against future recessions. According to the ECs intention, the plan should guarantee a counter-cyclical macro-economic response to the crisis in the form of an ambitious set of actions to support the real economy (European Commission, 2008, p. 6). The immediate endowment of 200 billion Euro is financed by budgetary expansion of the Member States (170 billion Euro) and the EU (30 billion Euro). Member States are explicitly allowed to break the rules of the Stability and Growth Pact for two to three years. The different crisis histories made it inappropriate to design and implement a one size fits all-strategy. The plan has been criticized by economists because of its Keynesian approach.

*In spring 2010 the increasing sovereign debt in the Euro Area called for a new response. The EU Member States agreed to establish the European Financial Stability Facility (EFSF) aiming to regain financial stability. In order to achieve this goal the EFSF provides temporary financial assistance to the members of the Euro Area that are in economic difficulties (EFSF, 2012). The guaranteed commitment is fixed at Euro 780 billion and borrowing limit at Euro 440 billion. The EFSF framework came into force on 18th October 2011. The scope of activities includes issuance of bonds or other debt instruments on the market to raise funds, interventions in the debt primary and secondary market, actions based on a precautionary programme, financing the recapitalization of financial institutions through loans to governments. The financial assistance is linked to appropriate conditionality. The EFSF is part of a wider rescue net which also includes the Euro 60 billion European Financial Stabilisation Mechanism (EFSM) and a Euro 250 billion package from the IMF. The EFSM is authorized to raise funds by the European Commission which are guaranteed by the EU budget. The Member States share is in accordance with their share in the paid-up capital of the ECB.In the middle of January 2012 one credit rating agency downgraded the EFSF to AA+. This did not cause a deterioration of the position of the EFSF on the financial market. After June 2013 the EFSF will not be actively present in the financial market, but it will continue in an administrative capacity until all outstanding bonds have been repaid. After controversial discussions the Euro Area member states agreed on leveraging the EFSF in early 2012 by firstly providing a partial protection certificate to a newly issued bond of a member state. After initial issuance, the certificate could be traded separately. Secondly, the creation of one or two Co-Investment Funds would allow the combination of public and private funding.

*IRELAND rescue In November 2010, agreement on the first loan to Ireland could be achieved aiming to safeguard financial stability in the Euro Area and the EU as a whole. The Euro 85 billion program is financed by Euro 17.5 billion from Ireland, Euro 22.5 billion from IMF, Euro 22.5 billion from ESFM, Euro 17.7 billion from EFSF and bilateral loan from UK, Denmark and Sweden. The conditions require an immediate strengthening and comprehensive overhaul of the banking system(Euro 35 billion), an ambitious fiscal adjustment and growth enhancing reforms especially in the labour market. In 2011, the EFSF in total issued Euro 8 billion. The program foresees a 3-year Euro 3 billion issuance in 2012.

PORTUGAL rescue The agreement on Euro 78 billion rescue program for Portugal was achieved in May 2011. The program is equally financed by the IMF, EFSM and EFSF. The three year program is focussing firstly on restoring fiscal sustainability by strengthening budgetary discipline, reforming the health system as well as the public administration, privatizing public assets, secondly on growth and competitiveness enhancing reforms of the labour market, network industries, housing and services sectors, and thirdly on measures to ensure a balanced and orderly deleveraging of the financial sector and to strengthen the capital of banks. In 2011, the ESFS in total issued Euro 8 billion. In 2012, a three years Euro 3 billion issue will be placed.

*GREECE rescueFirst package In May 2010, Greece got a Euro 110 billion loan within the framework of the newly established EFSF. The Euro Area Member States contributed Euro 80 billion and the IMF Euro 30 billion to this first Greek bailout. The financial support was provided under strong policy conditionality. The latter allows the IMF/EU to check Greeks performance each quarter. In 2010, Greece has to reduce the fiscal deficit by 5 percentage points. Measures reducing the deficit include an increase of the VAT, increase in excise taxes on fuel, cigarettes and drinks, a windfall tax, a property tax, near abolition of 13 and 14th month pay in the public sector, cut of Christmas and Easter bonuses, cuts in pensions, reducing early retirement. Second packageMarch 2012, Eurozone Finance Ministers agreed on a Euro 130 billion rescue after Greek government agreed to commit to considerable budget cuts as well as to force privatebondholders to waive part of their claims. The IMF contributes Euro 28billion to the bailout package. Commitments of the main stakeholders are:Buget cuts: Reducing the public debt to 120.5% of GDP by 2020.Permanent surveillance by an increased European presence. Approximately Euro 100 billion debt written off by banks and insurers (swap bonds forlonger-dated securities at lower interest rates). Private sector holders of Greek debt agreed to write-down 50% of the nominal value which makes up around 70% loss on the net present value of the debt.

*3. Crisis resolution

The agreement on the establishment of a permanent crisis resolution mechanism the European Stability Mechanism (ESM) - was achieved in June 2011. The summit on January 31, 2012 clarified legal details. UK did not sign the treaty. Czech Republic did not sign the treaty at that date because of constitutional reasons. The ESM has to execute the same tasks as the EFSF. The ESM was established on 27. Sept. 2012 as an international organisation. The total subscripted capital will be Euro 700 billion with an effective lending capacity of Euro 500 billion. According to the latest information there seems to be discussions aimed at combining the ESFS with the ESM instead of replacing the ESFS by the ESM. If the IMF provides a third Euro 500 billion funding, the total available backstop fund will increase to Euro 1.5 trillion. The adequacy of this ceiling will be reassessed in spring 2012.

TO SUM UPIn principle, the EU and the U.S.A. are facing a similar economic situation: fiscal deficit, sovereign debt crisis, economic recession. The governance strategies differ sharply: Whereas in the EU common efforts of the EU, ECB and IMF to finance budget deficits of the four crisis countries are strongly conditioned on fiscal consolidation, the U.S. government turns its primary attention to spur growth by introducing new stimulus measures.

*Distribution of contributions

Germany (27.1464%)France (20.3859%)Italy (17.9137%)Spain (11.9037%)Netherlands (5.7170%)Belgium (3.4771%)Greece (2.8167%)Austria (2.7834%)Portugal (2.5092%)FInland (1.7974%)European Stability MechanismBailout in total since 2008 (Euro billions)Cyprus I + II 12.5Greece 245.6Hungary 15.6Ireland 67.5Latvia 4.5Portugal 78.0Romania 19.6Spain I 41.4 ______

Total 484.6

*Especially the Eurozone needs not only monitoring the government budget debts and deficits, but also monitoring the private sector imbalances, in particular private debt levels. The issue here is how this monitoring can be made effective so as to avoid new crises. One can have doubts whether this can be achieved without a further transfer of sovereignty to European Institutions.Paul de Grauwe

*The Role of the European Central Bank (ECB)In May 2010 it took the following actions:

It began open market operation buying government and private debt securities,reaching 219.5 billion by February of 2012, though it simultaneously absorbed the same amount of liquidity to prevent a rise in inflation.[188] It reactivated the dollar swap lines with Federal Reserve support.[190] It changed its policy regarding the necessary credit rating for loan deposits, accepting as collateral all outstanding and new debt instruments issued or guaranteed by the Greek government, regardless of the nation's credit rating.

The move took some pressure off Greek government bonds, which had just been downgraded to junk status, making it difficult for the government to raise money on capital markets.

*Long-Term Refinancing Operation (LTRO)

The ECB's first supplementary LTRO with a six-month maturity was announced March 2008. The first tender was settled April 3, and was more than four times oversubscribed. The 25 billion auction drew bids amounting to 103.1 billion, from 177 banks. Another six-month tender was allotted on July 9, again to the amount of 25 billion.The first 1y LTRO in June 2009 had close to 1100 bidders.On 22 December 2011, the ECB started the biggest infusion of credit into the European banking system in the euro's 13 year history. Under its LTRO it loaned 489 billion to 523 banks for an exceptionally long period of three years at a rate of just one percent. The by far biggest amount of 325 billion was tapped by banks in Greece, Ireland, Italy and Spain. This way the ECB tried to make sure that banks have enough cash to pay off 200 billion of their own maturing debts in the first three months of 2012, and at the same time keep operating and loaning to businesses so that a credit crunch does not choke off economic growth. It also hoped that banks would use some of the money to buy government bonds, effectively easing the debt crisis.[200] On 29 February 2012, the ECB held a second auction, LTRO2, providing 800 Eurozone banks with further 529.5 billion in cheap loans. Net new borrowing under the 529.5 billion February auction was around 313 billion; out of a total of 256 billion existing ECB lending (MRO + 3m&6m LTROs), 215 billion was rolled into LTRO2.

*Recovery from the crisis

requires increased competitiveness resulting in higher growth rates - short-term measure: lowering wages (down to the level of low-wage countries seems to be impossible) - long-term measure: upgrading the technological and quality level in production processes and prodcuts and may pave the way for a revision of the Treaty of Lisbon aiming to strengthen fiscal disciplin finally resulting in a kind of European Fiscal Union - 9 Dec.2011 agreement (apart from UK) to join a new intergovernmental treaty which will introduce strict caps on government spending and borrowing, including penalties for violations of the limits.

*Hottest controversies

Eurobonds jointly issued by the Eurozone member statesPro: European Commission Contra: Germany

EU Financial Transaction Tax Pro: Germany Contra: UK

European Monetary Fund (similar to the IMF)At the current stage an academic discussion only

Excluding Greece from the EurozonePro: Many economists Contra: Most politicians

Bankers cause the crisis but didnt pay, tax payers are exposed to the damages but didnt get reimbursed

Reducing debt via saving versus increasing debt to create growth

*European Financial Stabilisation Mechanism (EFSM)This mechanism provides financial assistance to EU Member States in financial difficulties.

The European Financial Stabilisation Mechanism (EFSM) essentially reproduces for the EU 27 the basic mechanics of the existing Balance of Payments Regulation for non-euro area Member States. Under EFSM, the Commission is allowed to borrow up to a total of 60 billion in financial markets on behalf of the Union under an implicit EU budget guarantee. The Commission then on-lends the proceeds to the beneficiary Member State. This particular lending arrangement implies that there is no debt-servicing cost for the Union. All interest and loan principal is repaid by the beneficiary Member State via the Commission. The EU budget guarantees the repayment of the bonds through a p.m. line in case of default by the borrower.

The EFSM has been activated for Ireland and Portugal, for a total amount up to 48.5 billion (up to 22.5 billion for Ireland and up to 26 billion for Portugal), to be disbursed over 3 years (2011 2013).

The EFSM is a part of the wider safety net. Alongside the EFSM, the European Financial Stability Facility (EFSF), i.e. funds guaranteed by the euro area Member States, and funding from the International Monetary Fund (IMF) are available for euro area Member States. Non-euro area Member States are also eligible for assistance under the Balance of Payments Regulation. The EFSM and the EFSF can only be activated after a request for financial assistance has been made by the concerned Member State and a macroeconomic adjustment programme, incorporating strict conditionality, has been agreed with the Commission, in liaison with the European Central Bank (ECB). http://ec.europa.eu/economy_finance/eu_borrower/efsm/

*What Does European Financial Stability Facility - EFSF Mean?

An organization created by the European Union to provide assistance to member states with unstable economies. The European Financial Stability

Facility is a special purpose vehicle (SPV) managed by the European Investment Bank, a lending institution. The fund raises money by issuing debt, and distributes the funds to eurozone countries whose lending institutions need to be recapitalized, who need help managing their sovereign debt or who need financial stabilization.

European countries have several options outside of the open market to seek financial help. Other than the European Financial Stability Facility, European countries can seek money from European Financial Stabilization

Mechanism (EFSM), which is guaranteed by the European Union's budget, or the International Monetary Fund (IMF). These funding mechanisms are supported by the EU because, while not all countries have debt problems, the failure of one European economy can have a widespread effect on the health of other economies. Starting in 2013, the EFSF will be replaced by the ESM, or the European Stability Mechanism. http://www.investopedia.com/terms/e/european-financial-stability-facility

The European Financial Stability Facility (EFSF)

*The European Financial Stability Facility (EFSF)The European Financial Stability Facility (EFSF) was created by the euro area Member States following the decisions taken on 9 May 2010 within the framework of the Ecofin Council.The EFSFs mandate is to safeguard financial stability in Europe by providing financial assistance to euro area Member States.EFSF is authorised to use the following instruments linked to appropriate conditionality: Provide loans to countries in financial difficulties Intervene in the debt primary and secondary markets. Intervention in the secondary market will be only on the basis of an ECB analysis recognising the existence of exceptional financial market circumstances and risks to financial stability Act on the basis of a precautionary programmeFinance recapitalisations of financial institutions through loans to governmentsTo fulfill its mission, EFSF issues bonds or other debt instruments on the capital markets.EFSF is backed by guarantee commitments from the euro area Member States for a total of 780 billion and has a lending capacity of 440 billion.www.efsf.europa.eu/

*The European Financial Stability Facility (EFSF)

*The Programme for Ireland

The Programme for Portugal

*The European Stability Mechanism (ESM)The ESM is a permanent international financial institution that assists in preserving the financial stability of the European Union monetary union by providing temporary stability support to euro area Member States. The Treaty Establishing the European Stability Mechanism was signed on 2nd February 2012, establishing the ESM as an intergovernmental organisation under public international law. The ESM was finally inaugurated on 8 October 2012 upon completion of the ratification process by the participating euro area Member States. The ESM will be the primary support mechanism to euro area Member States.

The ESM will issue bonds or other debt instruments on the financial markets to raise capital to provide assistance to Member States. Unlike the EFSF, which was based upon euro area Member State guarantees, the ESM will have total subscribed capital of 700 billion provided by euro area Member States. 80 billion of this will be in the form of paid-in capital with the remaining 620 billion as callable capital. This subscribed capital will provide a lending capacity for the ESM of 500 billion.

Financial assistance from the ESM will in all cases be activated upon a request from a Member State to the Chairperson of the ESM's Board of Governors and will be provided subject to conditionality appropriate to the instrument chosen. The initial instruments available to the ESM have been modeled upon those available to the EFSF: Provide loans to a euro area Member State in financial difficulties; Intervene in the debt primary and secondary markets; Act on the basis of a precautionary programme; Provide loans to governments for the purpose of recapitalisation of financial institutions. http://ec.europa.eu/economy_finance/european_stabilisation_actions/esm/index_en.htm

Euro Crisis: The Worst is Over, Isnt It?Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 4.

Euro Crisis: The Worst is Over, Isnt It?Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 5.

Euro Crisis: The Worst is Over, Isnt It?Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 11.