EURO Zone EURO Zone CrisisCrisis

Feb 27, 2014

Deshbhratar Sandeep Seungjik YangSung Jin RyuTaro Arakawa

International TradeProf. Vicenzo Quadrini

EURO ZONE CRISIShttp://www.youtube.com/watch?v=I5QwKEwo4Bc http://www.youtube.com/watch?v=I5QwKEwo4Bc http://www.youtube.com/watch?v=I5QwKEwo4Bc

http://www.youtube.com/watch?v=I5QwKEwo4Bc

Incentives of governments to borrow increase both when financial markets become internationally integrated and when inequality rises.

If debt crises are more likely to arise when the stock of public debt is higher, then the growth in government borrowing induced by capital markets liberalization and increased income inequality may contribute to trigger a sovereign debt crisis.

- ???

Contents

1 Euro Formation

2 Causes

3 Measures

4 Challenges/ Future

1 Euro Formation

The EUROZONE

• Officially called Euro Area

• Introduced in 1999

• Single currency shared by 18 of the

European Union's member states

Euro Formation

Early Stage• When it was launched on 1 January 1999, the euro became the

new official currency of 11 Member States

Euro adoption2014: Latvia2011: Estonia2009: Slovakia2008: Cyprus, Malta2007: Slovenia2002: Introduction of euro banknotes and coins2001: Greece1999: Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland

Euro Formation

Enlargement• Ten countries (Bulgaria, Croatia, Czech

Republic, Denmark, Hungary, Lithuania,

Poland, Romania, Sweden, and the United

Kingdom) of the EU do not use the euro

• Lithuania is due to adopt the euro from 1

January 2015

• Denmark and UK are legally exempt from

joining the eurozone

Euro Formation

Comparison of eurozone with other economies

Population GDP % world Exports Imports

Eurozone 317 million €8.4 trillion 14.6% 21.7% GDP 20.9% GDP

EU (27) 494 million €11.9 trillion 21.0% 14.3% GDP 15.0% GDP

United States 300 million €11.2 trillion 19.7% 10.8% GDP 16.6% GDP

Japan 128 million €3.5 trillion 6.3% 16.8% GDP 15.3% GDP

Euro Formation

Comparison of Economies

Euro Formation

2 Causes

• Extension of 2008 global financial crisis

• Starting from Greece in 2010, the financial crisis spread rapidly to

Southern Europe, and finally to whole European countries

Greece Southern Europe

WholeEurope

Causes

PIGS (Portugal – Ireland – Greece - Spain)PIGS (Portugal – Ireland – Greece - Spain)

• Excessive sovereign debt

• Government budget deficit

• High unemployment

IncludingItaly

PIIGS

Causes

Deterioration of Economic GrowthDeterioration of Economic Growth

Why??Why??

Causes

Deterioration of Economic GrowthDeterioration of Economic Growth

Banking Crisis

Loss in securities investment/

collapse in real estate bubble

재정위기

Financial Crisis

Sovereign Debt

Crisis

Bailout on bank / deteriorated current

account / negligence on financial management

Insolvency of financial institutions caused byGlobal Financial crisis and following financialcrisis led to Euro-zone crisis

Causes

Economic recession, drop in tax revenue, deterioration of fiscal sustainability by Global Financial Crisis

Major European banks was placed in bankruptcy by credit crunch

Large scale cash infusion to prevent bankruptcy of banks

Increase in Financial deficit

2007 2009% of GDP 0.7% 6.3%

Causes

The vulnerability of financial management

Some Southern European countries are financially Vulnerable countries (PIIGS)

Tax basis is weak due to the underground economy

Government expenditure and welfare expenditure made things worse

Average ofOECD Greece

Causes

Institutional imbalance by European single currency

European Central Bank(ECB) is responsible for monetary policy

Meanwhile, fiscal policy is carried out by each country

Introduction of single currency without fiscal consolidation made imbalance among European countries worse

Not-working Currency mechanism

Causes

From Global Crisis to Euro-zone CrisisFrom Global Crisis to Euro-zone Crisis

Sub-prime mortgage in 2008 Crisis of European

financial institutionsWorld economic recession transmitted to real economy

Large scale reflation / Deterioration in financial sustainability

Fund collection from in-doubt countries ↑

Countries (PIIGS) with encountered

bankruptcy

Causes

Portugal Italy Greece SpainCountry Major causeGreece High fiscal deficit and high debt/GDP ratioSpain Property and construction sector funded by

foreign flowsPortugal High CAD (Current Account Deficit)Ireland Banking

Causes

Causes

Causes

Causes

3 Measures

How to reach settlement (Assistance to an individual country)

1. Fiscal Austerity

2. Debt Waiver

3. Official Assistance

Measures

1. First Stage (May 2010) *Example of Greece

Fiscal Austerity

• Reduction of fiscal deficit of GDP▲13.6% (2009) ▲ 8.1% (2010) ▲ 3 % (2014)

by raising tax, pension system reform, pay cut for government servant, etc

Debt Waiver • Nothing

Official Support • A €110 billion bailout by EU and IMF

Measures

2. Second Stage (March 2012) *Example of Greece

Fiscal Austerity

• Reduction of debt of GDP 120% (2020)

by pay cut of politicians, raising tax, etc

Debt Waiver• Voluntary 50% Write-off of Greek

debt by private investors (equivalent of €100 billion)

Official Support • A €130 billion bailout by EU and IMF

Measures

In addition to individual assistance to countries such as Greece, Ireland, and Portugal, 1. Rescue funding programs

2. Legislative measures

3. Improvement of the health of banks

How to reach settlement (Preparation for a next crisis)

Measures

1. Rescue funding programs

May 2010• European Financial Stabilization Mechanism

(EFSM) €60 billion• European Financial Stability Facility (EFSF)

€440 billion

July 2011 • European Stability Mechanism (ESM) €500 billion

May 2012 • Rise in lending capacity from €500 to €700 billion

Measures

2. Legislative measures (Fiscal Policy Agreement)

Dec. 2011

• “Six-Pack” in effect1) Strengthening of budgetary surveillance2) Enforcement of budgetary surveillance in EURO zone3) Speeding up the implementation of the excessive

deficit4) Requirements for the fiscal framework5) Prevention and correction of macroeconomic

imbalance6) Enforcement to correct excessive macroeconomic

imbalance in EURO zone

Jan. 2013• “Fiscal Compact” in effectIncluding rules such as balanced public finance to national legislative (if possible, constitution)

Measures

3. Improvement of the health of banks

EBA(European Banking Authority)

• Implementation of Stress Test• Set a target of capital ratio (Tier 1 ratio) : 9% by

June 2012

ECB(European Central Bank)

• Bond Purchase• Long-term Refinancing Operation

Measures

3. Improvement of the health of banksBond Purchase by ECB

(Source) ECB

Measures

3. Improvement of the health of banksLending outstanding of ECB to Banks

(Source) ECB

Measures

3. Improvement of the health of banksTrends of Euribor

(Source) ECB

Measures

4 Challenges / Future

Banking-ChallengesBanking-Challenges• The Crisis started in the banking

sector in US and hit the banking sector in Europe

• Use of derivatives rose from 2 ½ times world GDP in 1998 to 12 times world GDP

• Growth of Capital Markets banking led to re-hypothecation of the same collateral multiple times

• Countries with large capital market banks heavily exposed to Sovereign debt of EU economies

Universal/ Global Banking Size

Banking-ChallengesBanking-Challenges

Banking-ChallengesBanking-Challenges

Banking reformsBanking reforms

• Recapitalization of banks based on proper cleaning up of balance sheets where necessary

• Clear distinction between traditional and capital markets banking

• Basel II underestimated the risks that banks were exposed to

• Basel III implementation to help strengthen bank liquidity and reduce bank leverage

• Consistent and transparent accounting by the banks

• Banks should rely more on traditional deposits vs the wholesale funding to improve sustainability

Banking reformsBanking reforms

• Basel III is the global regulatory standard (agreed upon by the members of the Basel Committee on Banking Supervision)  on bank capital adequacy, stress testing and market liquidity risk. 

• Basel I and Basel II are the earlier versions of the same, and were less stringent

• Basel III released in December, 2010  is the third in the series of Basel Accords. 

• Basel III seeks to improve the banking sector's ability to deal with financial and economic stress, improve risk management and strengthen the banks' transparency.

Banking reformsBanking reforms

Requirements Under Basel II Under Basel III

Minimum Ratio of Total Capital To Risk Weighted Assets (RWAs) 8% 10.50%

Minimum Ratio of Common Equity to RWAs 2% 4.50% to 7.00%

Tier I capital to RWAs 4% 6.00%Core Tier I capital to RWAs 2% 5.00%Capital Conservation Buffers to RWAs None 2.50%

Leverage Ratio None 3.00%Countercyclical Buffer None 0% to 2.50%

Minimum Liquidity Coverage Ratio None TBD (2015)

Minimum Net Stable Funding Ratio None TBD (2018)

Leverage Ratio-Systemically important Financial Institutions Charge

None 6%

     

   

Quantitative Easing-TaperQuantitative Easing-Taper

• Increased volatility-falling prices in interest rate sensitive assets

• Government debt service cost could rise substantially by upto 20%

• Household debt service cost could rise significantly

• Corporate profits will be under stress with increasing interest burden

• Capital outflows from the Eurozone to the US with a possible depreciation of Euro

• Investors in bond market could face large losses

Quantitative Easing-Ultra Low RatesQuantitative Easing-Ultra Low Rates• Banks & Insurance

companies to experience continued erosion in profitability with a compression in net interest margins

• Defined benefit-pension schemes would struggle to deliver on their commitment to retirees

• Increasing use of leverage with the return of asset-price bubbles

What Lies Ahead ?What Lies Ahead ?

• Austerity –fiscal consolidation and privatization

• Fiscal Union – allow ECB to float Euro Bonds

• Debt Mutualization- the crisis hit countries transfer debt to the rich countries

• Fracturing of the Eurozone

‘What I object to the current government intervention in so called solving the crisis, they haven’t solved anything. They have just postponed it’

- Marc Faber

‘The bottom line is that unconventional monetary policies that move away from repairing markets or institutions to changing prices and inflationary expectations seem to be a step into the dark.’

- Raghuram Rajan

‘The economic contraction is more severe after a prolonged period of credit expansion.’

-Prof . Vincenzo Quadrini, USC

Thank you!!Thank you!!