Nicolas Véron

The High-Stakes Greek Debt Negotiation

In this just-published interview by Steve Weisman at the Peterson Institute for International Economics, I comment on the current stage of discussion of "private-sector involvement" (PSI) in the issue of Greek sovereign debt, and the prospect for the next phases.  

Europe Must Change Course on Banks

This column was published on Monday by Bruegel and the Peterson Institute, and is forthcoming in various national and international media.

The Eurozone crisis keeps evolving along multiple dimensions. On the sovereign debt front, no deal is yet in sight on Greece’s debt restructuring, and Italy and Spain face major refinancing needs in early 2012. On the institutional reform front, the summit on December 9 fell short of delivering a true fiscal union, and tensions between the Eurozone and the UK have been brought to boiling point. On the growth front, a possible deep and prolonged recession looms.

As during previous episodes, however, the banking system is a crucial piece of the puzzle and epitomizes many of the contradictions of Europe’s experiment in monetary union. Almost continuously since 2007 that system has exhibited worrying gaps in risk management, compounded by massive supervisory failures in some countries. In the past two years, deteriorating sovereign creditworthiness has increased the system’s fragility. The combination of member states’ guarantees on domestic banks, and those banks’ outsized holdings of home-country sovereign debt in periphery countries, has accelerated the feedback loop between sovereign credit and bank funding conditions. The result is fragmentation: whether a euro held in a Greek bank is equivalent to a euro in a German bank is ever more in doubt. This could produce a slow-moving death spiral for a currency union.

Instead of fighting this trend, the recapitalization plan agreed on October 27 has reinforced it. More guarantees on banks are introduced at the national level, none at the European one. Moreover, when raising the minimum capital ratio to 9 percent, leaders decided that its assessment would rest on fair value (or mark-to-market) measurement of each bank’s portfolio of sovereign debt. The fair-value principle is sound for financial disclosure purposes. But it is dangerously pro-cyclical when applied to regulatory capital calculations, especially when extended to debt that is held to maturity – a radical move towards “full fair value” that accounting standard-setters have never dared to embrace. This is a recipe for massive credit rationing and misallocation, for which there is more and more anecdotal evidence.

The situation should be corrected before it runs out of control. The European Central Bank has introduced unprecedented liquidity support, but this step cannot correct the core problem of the sovereign-banking nexus. Both sides of the equation should be tackled. On the one hand, Eurozone-wide financial mechanisms should at least partly replace national backstops, arguably focusing on retail deposits for which the public guarantee is most harmonized and least discretionary or controversial. Such a move would go a long way towards preventing disastrous retail bank runs. On the other hand, leaders should work toward a partial substitution of national debt held by banks with common Eurozone debt, depending on the advancement of discussions on the fiscal front. Doing so would help reduce the current unreasonable home bias in the balance sheets of banks in periphery countries, especially Spain and Italy. These interventions could be overseen by an ad hoc entity dedicated to Eurozone bank restructuring, by delegation of individual member states.

Of course, such actions would require a political commitment that is currently nowhere to be seen. But there can be no sustainable monetary union without an integrated banking system, which would require an integrated policy framework in compliance with the subsidiarity principle. Two conditions add formidable hurdles on the path to a solution. First, as in fiscal matters, the difficult decisions to be made require proper accountability to Eurozone citizens, at least in the medium term. Establishing such accountability may entail reform and empowerment of the European Parliament, or the creation of an ad hoc chamber that would aggregate delegations from national parliaments, or both. Second, action in the Eurozone must be articulated with the existing instruments of the 27-member European Union, including the recently created European Banking Authority (EBA), which is located in London. This is made more difficult by the growing political distance between the UK and the Eurozone, widened after Prime Minister David Cameron’s veto at the December 9 summit. The pragmatic option is a coexistence of Eurozone and EU instruments, at least for some time, but it will add complexity and friction.

The political affirmation of the integrity of the Eurozone banking system does not require new treaties. But beyond the inherent aspect of financial solidarity, it would run against major political resistance, not least from individual banks that fear the loss of national privileges or protections. However, the creation of a “banking union,” parallel to the fiscal union now advocated by German Chancellor Angela Merkel, would not mean the end of all national and local specificities. In the United States, more than a century has separated the creation of a national banking charter (1863) from the achievement of a true national banking market. Interdependences between banking and political structures at the national and local level will remain. But a Eurozone-level banking policy framework that would transcend them is a necessary condition for the survival of the monetary union. 

Market Reactions to the December 9 Euro Summit

In this new podcast interview by Steve Weisman, I expand on the outcome of last Friday's summit in Brussels and why the market reaction has not been overwhelmingly positive.   

Rating Agencies and Sovereign Credit Risk Assessment

Bruegel just published this Policy Contribution co-authored with Guntram Wolff, at the request of the European Parliament. Building on my earlier piece on credit rating agencies, we examine a series of policy questions specifically related to sovereign credit ratings and their role in financial policy. 

Click here to download the piece in case the above link does not work. The European Parliament has also published it on its own website, with the same text in a different format

The European Summit on December 9

In this podcast interview published by the Peterson Institute for International Economics, Steve Weisman interviews me on the outcome of the EU summit of December 9 in Brussels, and the prospects for next steps.

Europe Needs Institutional Creativity

This column was published by Bruegel and PIIE, and also by Vox, the Globe and Mail, Caixin, FT Deutschland, El Economista, La Tribune, Kathimerini, Il Sole 24 Ore, Dziennik Gazeta Prawna, and Radikal, as well as by Bloomberg's Financial Regulation newsletter.

“I guess you guys have to be creative here,” US President Barack Obama was reported as exhorting German Chancellor Angela Merkel at the Cannes Summit on November 4. This is an apt tagline for the current moment in the eurozone crisis. The European Union needs to radically change its ways, or it may not survive.  

Beyond the headlines about Greece and Italy, the central problem is a crisis of decision-making at the European level. At no point since early 2010 has the contagion ever been seriously contained. This is an astounding policy failure, almost universally seen as such from outside Europe. Blaming the individuals would be unfair. Europe’s leaders may not be heroes but, from a historic or international perspective, most are reasonably competent, dedicated and honest. The problem lies not in them, but in the institutions.

At the core of Europe’s predicament is an obvious mismatch: the key decision-makers at the European level are leaders whose accountability derives exclusively from national electorates. Most have no mandate to work for the common European good. The European Commission is mostly powerless, except in specific areas of autonomy such as trade and competition policy. The European Central Bank (ECB) is a truly federal institution but its scope of action is limited, and rightly so. In the areas of fiscal and banking policy that have been made crucial by monetary union, there is no European executive branch.

Awareness of the mismatch leads to partial fixes such as leadership of the “French-German couple” or the more recent “Frankfurt Group” (José Manuel Barroso and Olli Rehn of the European Commission, Mario Draghi of the ECB, Jean-Claude Juncker of the Euro Group, Christine Lagarde of the International Monetary Fund, Angela Merkel of Germany, Nicolas Sarkozy of France, and Herman Van Rompuy of the European Council). But these fixes do not work. Most elements of the latest “comprehensive solution” agreed in the October 27 summit are unworkable.

Leaders must break this mold and empower individuals or entities to make decisions on behalf of European citizens and with adequate accountability to them. Some actions will require treaty change, others only a change of mindset. The latter category includes such vital moves as providing supranational guarantees to national deposit insurance schemes, to forestall the risk of catastrophic retail bank runs in troubled countries. A single European body should provide a consistent assessment of all Europe’s big banks’ capital position as the basis for a credible recapitalization plan. Member states should be prevented from using domestic financial firms as crutches to their own credit problems, to the peril of depositors and borrowers alike. In addition, treaty changes are required to provide proper accountability, starting with a different composition of the European Parliament to ensure that Europe’s citizens are equally represented, irrespective of their country. One recent piece of good news is Ms. Merkel’s explicit endorsement on November 9 of significant treaty change as part of the solution.

If the euro is to survive, a more federal framework for banking and fiscal policy is needed – what Jean-Claude Trichet, then ECB President, in June called a European Finance Ministry. But federations come in many shapes and sizes. The US is an obvious reference point but others may be more relevant. India, for example, shows that a continent-sized federation can be linguistically and religiously diverse, and politically fragmented into myriads of local parties, but still democratic and resilient. Some European countries are more at ease with the federal principle than others – Germany more than France, to name only those two. An additional major difficulty is to provide decision-making for the eurozone in a framework of EU institutions including countries that keep their national currency.

Such a transformation of the nature of European integration can neither be imagined nor delivered by national leaders seeking national reelection, or by exhausted civil servants. An open public debate is part of the answer; for all its parochialism, Germany has gone further in this respect than most other Eurozone countries. But ultimately a mechanism will be needed to propose institutional changes. A traditional intergovernmental conference is unsuited to the task, as diplomats are bound by old solutions and ossified national positions. A more diverse group of national delegates could perhaps do better, even though the convention chaired by former French president Valéry Giscard d’Estaing in 2002-03 failed to escape the traditional diplomatic game and to propose compelling solutions. Given the urgency, maybe a smaller group should be formed, on the model of the one chaired by former central banker Jacques de Larosière in 2008-09, which ushered in Europe’s most promising institutional innovation in this crisis so far, the creation of the European Supervisory Authorities.

A more federal Europe is not a straightforward proposition, but neither is it an impossible one. New ideas on how to shape it are urgently needed.

A Week of Market Turmoil

In this interview by Steve Weisman, I comment on the latest developments in the Eurozone following the chnages of governments in Greece and Italy, and on the monumental challenges leaders need to address.  

The EU's Bank Recapitalization Plan

In this piece published by Emerging Markets, the magazine distributed in major international economic gatherings (in this case the Cannes summit of the G20), I take a critical look at the bank recapitalization plan announced by EU leaders last week and suggest that the Eurozone cannot be sustainable without an explicitly federal framework for banking policy. 

Bruegel Policy Contribution on Credit Rating Agencies

Last Monday, Bruegel published this Policy Contribution in which I summarize the European debate on credit rating agencies, the problems they pose and some possible solutions. I warn against the unintended consequences of ill-designed regulation, and suggest that the most important issue in this debate is to improve the quality and scope of issuers' public disclosures about their financial risk factors. 

Global Financial Authorities Must Adapt to a Changed World

This column was published by Bruegel and PIIE as well as De Tijd (Belgium), The Globe and Mail (Canada), La Presse (Canada), Caixin (China), El Economista (Spain), La Tribune (France), Kathimerini (Greece), Il Sole 24 Ore (Italy), Radikal (Turkey), Dziennik Gazeta Prawna (Poland), and RBC Daily (Russia). 

The first G20 summits in 2008 and 2009 were dedicated to overhauling global financial regulation, empowering international financial authorities, and combating the economic downturn. Since then, progress has been uneven and priorities have shifted. The next summit in Cannes is set to be dominated by discussion of the policy chaos in Europe; financial regulatory matters will be little more than an afterthought. The world still needs a functioning international financial regulatory framework, however, if the vision of a globally integrated financial system is to be sustained – and there would be large economic costs from jettisoning that vision. The crisis has demonstrated the perils of unregulated or poorly regulated financial activities. Coordination among different jurisdictions does not happen spontaneously, and the technical nature of financial policy calls for specialized institutions.

This is why global financial authorities are so important. These include the Financial Stability Board (FSB), an umbrella group of national and international organizations, and the ten FSB member organizations not attached to a country or region. These include the Bank for International Settlements (BIS) in Basel; four bodies hosted by the BIS, respectively the Basel Committee on Banking Supervision (BCBS), the Committee on the Global Financial System, the Committee on Payment and Settlement Systems, and the International Association of Insurance Supervisors; the International Accounting Standards Board (IASB) in London; the International Organization of Securities Commissions (IOSCO) in Madrid; the Organization for Economic Co-operation and Development (OECD) in Paris; and the International Monetary Fund (IMF) and World Bank, in Washington DC.

They are not a homogeneous group, and additional international bodies may be needed in the future to tackle specific worldwide financial challenges. But a more immediate challenge is whether the eleven above listed institutions have kept pace with changes in the geography of global finance. All were created in the 20^th century, when Europe and the US (and for a brief period, Japan) dominated the scene. We are in a different financial world now. Based on the Financial Times Global 500 rankings, emerging economies now weigh more than Europe in terms of large listed companies’ aggregate value. Three of the world’s top five banks by market capitalization are Chinese, including the top two. Hong Kong and Singapore get closer to London and New York in financial centers’ league tables. The crisis has accelerated this shift, as the West enters a long cycle of deleveraging and slow growth, while emerging economies continue to catch up. At a less tangible level, the West’s model of financial development has lost much of its aura of superiority.

The new landscape has produced a growing discrepancy between the reality of global finance and the authorities intended to oversee it. True, most of these authorities have expanded their membership to include large emerging economies. But in only one does the chief executive come from the emerging world (OECD Secretary-General Angel Gurria, a Mexican). Among the seven that have a permanent non-executive chair, only at IOSCO is the position is held by a non-Westerner. They are all located in either Europe or the US, making it more difficult for non-Westerners to attend meetings or even conference calls.

As the succession of Dominique Strauss-Kahn at the IMF has illustrated, emerging countries remain unwilling to seize the initiative and force a readjustment. But time is on their side. Westerners should acknowledge that it is in their enlightened self-interest to give up some positions unilaterally, instead of defensively claiming incumbency rights. This requires a monumental change in their mental map, especially for Europeans, who are more overrepresented in this system than Americans, and who still often feel entitled to being at the center of world affairs.

Concrete changes could include the relocation to Asia of, at least, the secretariats of some of the Basel-based committees, including the FSB, and of the IFRS Foundation, which hosts the IASB. This would be logistically easy to achieve. A more ambitious plan could include the move of the headquarters of either the World Bank or the IMF away from the US. At least for some transition time, non-Western candidates should be given priority as heads and chairs of global financial authorities. Certainly, France’s Christine Lagarde and Sweden’s Stefan Ingves, recently appointed at the IMF and BCBS respectively, are highly qualified. But a lot of talent lies elsewhere. The next prominent appointments – at the FSB next month, the IFRS Foundation in the next few weeks, and the World Bank in 2012 – should go to non-Westerners.

Even so, there will be no guarantee of success for global financial authorities. But without some serious such rebalancing, they are assured of fading into irrelevance, even as the world needs them more than ever.