Miroslav Singer: Sovereign debt crisis in Europe - assessing the current
European instruments - addressing the challenges ahead
Speech by Mr Miroslav Singer, Governor of the Czech National Bank, at the European
Parliament Committee on Economic and Monetary Affairs Public Hearing, Brussels,
23 January 2012.
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Members of the European Parliament,
Thank you for inviting me to this forum and giving me this opportunity to comment on the
European Financial Stability Facility (EFSF). The last few weeks have brought us three new
events that are rightly or wrongly regarded as game changers and I would like to discuss the
EFSF in the context of those events. They are: 1) the ECB's long-term loans to commercial
banks and the widening of the range of guarantees which the ECB accepts from commercial
banks for them, 2) the fiscal pact and 3) the rating downgrades. I would like start by saying
that the provision of liquidity to commercial banks in Europe by the ECB gives us time to
define more precisely the mission, design and operation of the Facility as well its position
among the institutions charged with resolving the debt crisis. If we want to reduce the
probability that some European nations and their banking groups will face liquidity problems
that they cannot solve by obtaining funds from the market, we need to eliminate the following
uncertainties relating to the EFSF:
1. It is not clear what benefits we expect from the EFSF or how it is supposed to
generate them. Many objectives have been hinted at in the more than 18 months
since it was created, but nothing specific has been implemented so far. Yet each of
the objectives is highly important, be it the issuing of protection certificates or the
establishment of the special purpose vehicle or the purchasing of peripheral
countries' bonds in the secondary market.
2. The ambiguity in the definition of the Facility's mission is indicated by the changes
made both to its guarantee structure, even though the structure remains based on
the "per partes" principle, and to its rules of operation during its short lifetime. The
fact that the term EFSF 2 has caught on for the new structure reveals just how
fundamental these changes are seen to be.
3. Uncertainty also exists on the issue of increasing the effective capital strength of the
Facility using concepts such as leverage (via an SPV), protection/insurance, loss
tranches and short-term funds. From the reputational perspective, these are
exceptionally controversial issues, because many market participants interpret them
as a mere attempt to disguise the fact that the euro area countries do not currently
have enough resources for a credible rescue plan for Italy and Spain. If they did
want to create such resources, they would be putting their own debt arithmetic at
risk, because under Eurostat methodology the guarantees for the EFSF's bonds are
included in the guarantors' gross government debt. If the Facility is to provide
effective assistance in stabilising the larger European economies, it will need more
funding. Each of the concepts poses a serious threat to the reputation and credibility
of the Facility.
a. Excessive leverage is now regarded as one of the causes of the financial
crisis.
b. The proposals for protection and a first loss tranche of 20% of the nominal
debt are also laden with problems. The example of Greece demonstrates that
the losses may run to 60%. There is great uncertainty about who would pay
for the difference between the insured loss and the actual loss if the Greek
scenario was to be repeated in other countries. Likewise, it is not clear how
freely tradable protection certificates would be traded, priced, settled and, in
the event of default, enforced if they were to be introduced. Such certificates
would de facto be quasi CDS instruments underwritten by the official institution
of a community of countries that are simultaneously waging a campaign
against credit derivatives because they regard them as one of the causes of
the crisis.
c. The signs of a gradual shift towards short-term funding of the EFSF are a
worrying signal. The risk arising from financing assets that are by definition
long-term and illiquid (primarily rescue loans) through a programme of
shortterm debt instruments (liability rollover risk) is more than clear. This ALM
model proved to be extremely risky during the financial crisis when the
commercial paper market dried up.
4. Another uncertainty is related to the project of purchasing bonds in the secondary
market. To fund these purchases, private capital will be needed (e.g. in the form of
senior tranches of SPV debt). Therefore, this project lacks the firm official
commitment which similar central bank (BoE, Fed) programmes not reliant on
private investor participation have.
5. The latest uncertainty is the adjustment of the entire EFSF project to the loss of
France's (and Austria's) AAA rating from S&P, followed by the downgrading of the
EFSF's own rating from AAA to AA+. In its comments on this change, S&P stated
explicitly that the EFSF's rating has a developing outlook, which means that the
agency foresees the possibility both of returning the rating to AAA (if offsetting credit
enhancements are adopted) and of downgrading it further to below AA+ (if key
guarantor countries are downgraded). A lower EFSF rating would probably be
associated with higher interest costs of refinancing. There might even be a fall in
liquidity in the EFSF bond market owing to the exit of some institutional investors,
who primarily target the AAA segment of issuers.
6. On a more general level, the lack of coordination of resources for supporting
European countries is disturbing. It is resulting in fragmentation of resources and a
lack of transparency in the setting of parameters such as "who", "how much", "to
whom" and "how". Specifically, the European Union, or the euro area, is planning
simultaneously to lend to the International Monetary Fund, to guarantee the EFSF
and to guarantee the ESM, while central banks guarantee the capital of the ECB. If
a non-European country wanted to help Europe, there is the question of whether it
should send the money to the IMF or use it to purchase EFSF bonds, a senior
tranche of the SPV, or the peripheral countries' debt, i.e. with no intermediation.
The many uncertainties associated with the specific operation of the EFSF are giving rise to
general doubts about the appropriateness of the current approaches to overcoming the
ongoing debt crisis in the euro area. I cannot help feeling that many solutions to the problems
have been wrongly chosen in part because the main causes of the financial and debt crisis
have not been correctly identified.
Greece gets too much attention from decision- and policy-makers. It represents a mere
1/50 of the European economy. I believe that without the political will to provide Greece with
massive support from European funds to restore its competitiveness - and I see little such
will at the moment - its exit from the euro area will be inevitable, since depreciation of the
Greek currency will become part of the measures to restore competitiveness. The provision
of loans to Greece has so far primarily bought time. This has enabled wealthier Greeks to
transfer their savings out of the country. The costs of such action have been a reduction in
Europe's credibility and harm to the reputation of the International Monetary Fund and its
ability to raise funds outside Europe. I am therefore very glad that this session is devoted to
the Facility, whose importance to Europe and especially to the euro area is much greater.
I could list other problems, such as the delayed consolidation of the European banking
system and the related recapitalisation of banks, and in particular the fact that the existence
of the euro area has widened the long growing imbalance in the exchange of goods, capital
and savings between euro area countries. The short-term rescue of the euro will not directly
solve the long-term problem of imbalances, and in particular the gradually emerging path
towards a fiscal pact with no significant redistribution of resources at European level will
require the elimination of, or at least a considerable reduction in, the imbalances in the euro
area.
In the context of the three change drivers I mentioned earlier, I would like to say that the time
that the ECB's pre-Christmas actions gave the euro area, the European financial sector and
many European states to solve their problems is useful but not infinite. I believe that the
potential of the fiscal pact to become a true change driver is smaller than generally assumed,
and I expect that the future formulation of the pact in the constitution of each country will
contain (abusable) escape clauses. I base this view in particular on the fact that throughout
its existence the euro area has had a tendency to soften or bend the criteria for its operation.
Be it the not-always-proper manner of fulfilment of the Maastricht criteria by accession
countries or the revision of the Stability and Growth Pact or the purchase of government
bonds by the European Central Bank, we have repeatedly seen how things that are initially
unthinkable become reality over time. I am doubtful that investors, who are well aware of
Europe's relationship to the rules, will change their attitude as a result of the fiscal pact.
My overall view on the current design of the Facility is none too optimistic. To enhance its
ability to face the debt crisis, we need to find a clear consensus on its mission. We need to
precisely identify whom it is supposed to help, under what circumstances and to what extent,
and to derive from that the amount of funding it needs. This will predetermine the solutions to
all the issues surrounding its operation. We have time to solve all these problems, but not
much time.
Thank you for listening.