Local view for "http://purl.org/linkedpolitics/eu/plenary/2008-09-24-Speech-3-239"
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"Madam President, the series of events we have witnessed in financial markets during the last year, and in particular during the last few days, are of a magnitude that exceeds anything we have seen in our lifetime. Many believe – and I tend to agree – that this will trigger important changes in the functioning of the international financial system.
I should say that we are talking about a US plan, adapted for the circumstances in the US, where – it should be recalled – the crisis originated and where the financial sector has been most severely affected. But we all have to analyse why this has happened. We all have to cope with the consequences and react to the present situation.
To do this, we first have to understand how we arrived at this point. The origins of the turmoil we see today lie in the persisting global imbalances in the world economy, which created an environment of high availability of liquidity and poor assessment of risks.
The interconnection of global financial markets, the high level of leverage and the use of innovative and complex financial techniques and instruments, which were only poorly understood, caused these risks to spread across the international financial system on an unprecedented scale.
What is clear is that market participants – but also regulators and supervisors – were unable to properly understand the risks of this situation and, therefore, could not prevent the consequences that we see today.
True, in the months leading up to the crisis, the IMF, the European Central Bank and the Commission, among others, all warned of these underlying risks. We knew the situation was unsustainable, but what we could not know, and what no one was able to predict, was how, when and just how violently the crisis would be triggered by rising defaults in the sub-prime mortgage sector.
What we are now seeing is the process of the last few years going into reverse, with the financial system grappling with the consequent need to deleverage. Because of the exceptionally high leverage and the scale of linkages between risks, this process of unwinding is proving particularly painful. The lack of transparency in the system and the inability of supervisors to piece together an accurate and complete picture of the situation, has led to a dramatic fall in confidence.
The financial sector has been most severely affected, as nervousness among banks has caused liquidity to dry up in the interbank lending market.
Several key credit markets remain disrupted, and recently there has been a renewed flight to quality among investors, accompanied by widening spreads between benchmark bond yields and yields on relatively risky investments.
Thanks to the swift and coordinated intervention by central banks – with a relevant role here for the ECB – we have managed to avoid a severe liquidity shortage. Nevertheless, banks remain under pressure. The crisis of confidence has provoked a fall in asset prices, compounding the strain on banks’ balance sheets. Combined with the situation in the interbank market, banks face difficulties to recapitalise.
The situation we face here in Europe is less acute, and Member States do not, at this point, consider that a US-style plan is needed.
Since the outbreak of the crisis in August 2007, disclosed losses have totalled more than USD 500 billion, a sum equivalent to the GDP of a country like Sweden. And, unfortunately, the final figure is considered to be larger still.
Taking a medium-term perspective, it is evident that we need a more comprehensive structural response. The latest events in financial markets have made it clear that the current model of regulation and supervision needs to be revamped.
In the short term, we rapidly need to address the weaknesses in the current framework, and in this respect – and I fully agree with the Council position – the ECOFIN road map of regulatory actions and the recommendations of the Financial Stability Forum contain all the elements necessary. As you know, this includes concrete initiatives on enhanced transparency for investors, markets and regulators; revised capital requirements for banking groups, and clarification of the role of credit-rating agencies.
Work is progressing at the Commission, and the Commission will soon come forward with proposals on a revision to the Capital Requirements Directive – next week – and new legislation on credit-rating agencies, I hope, before the end of October. But given the latest developments, it is likely that we will need to explore additional issues that have come to light.
We will continue to discuss what else should be done to better ensure financial stability and to correct the reasons underlying this crisis, and in this regard I fully share the words of welcome that the Presidency of the Council gave to your contributions.
Finally, let me turn to the impact of the financial sector crisis on the economy – on the real economy. There can be no doubt that events in the financial sector are hurting the real economy. These effects have been compounded by the inflationary pressures of the rising oil and other commodity prices and the severe housing-market corrections in some Member States. This combination of shocks has impacted directly on economic activity through higher costs and negative wealth effects and, indirectly, via a sharp erosion of economic confidence. The result has been a brake on domestic demand at a time when external demand is fading.
Leading indicators on economic activity point to a marked deceleration in the underlying growth momentum both in the EU and in the euro area. Against this background, GDP growth for this year was revised down significantly in our last interim forecast to 1.4% in the EU and 1.3% in the euro area. At the same time, for this year inflation forecasts have been revised up to 3.8% in the EU and 3.6% in the euro area. Inflation could, however, be at a turning point, as the impact of past increases in energy and food prices gradually fades in the coming months. This could possibly be reinforced by a further downward correction in oil and other commodity prices, although this remains to be seen.
Overall, the economic situation and outlook remain unusually uncertain. Risks to the growth outlook remain on the downside, while risks to the inflation outlook are on the upside. These uncertainties are even higher regarding economic developments next year, but we expect growth in both the EU and the euro area to remain relatively weak next year.
How should we respond to this economic slowdown? The best answer is to make use of all the policy instruments we have at our disposal.
Firstly, in budgetary policy, we must preserve our commitment to fiscal discipline and the rules of the Stability and Growth Pact while letting the automatic stabilisers play their role. In this regard, the reform of the pact in 2005 is proving very helpful.
Secondly, a clear commitment to implement structural reforms, as defined in the framework of the Lisbon Strategy and the national reform programmes, would be crucial to boost consumer and investor confidence in the short term and to improve the resilience and dynamism of our economies in the longer term. Measures to strengthen competition in retail and energy markets and improve the functioning of our labour markets would be particularly valuable at this juncture.
The acceleration of declared losses in the US during the last few weeks, and the subsequent decline in investor confidence, have pushed several major financial institutions to the brink of collapse. In cases where the fall of one of these institutions would have implied a systemic risk – that is to say, put the entire financial system at risk – emergency rescue operations have been required.
Finally, delivering improvements in financial-market regulation and meeting the goals of the ECOFIN road map is, as I have already stressed, more urgent than ever before. An effective and rapid solution to the difficult challenges we are facing could go a long way to restore confidence quicker than expected and limit the damage to our economies.
In each of these policy areas our actions will be more efficient and effective if we coordinate them at the euro area and European Union level.
Inevitably, we will need to overcome some resistance by Member States to agree common action, yet the consensus we reached during the last informal ECOFIN meeting in Nice should be deepened and developed.
European countries face common challenges. We will overcome them most effectively if we work together to find common solutions. In this respect, the Economic and Monetary Union is a formidable asset, and we should exploit the opportunities it provides to strengthen coordination, along the lines we proposed in our EMU@10 report and communication last May.
However, events make clear that internal European action is not sufficient to confront global challenges. We need to reinforce common external action in the Financial Stability Forum, in the Basel Committee, in the G7, as well as devoting more attention to the future role of the International Monetary Fund.
Looking ahead, we need to think about how we can shape the future of our financial systems and global governance, and the role of the European Union in this regard is vital. Europe can be a driving force behind reinforcing global coordination and should take a leading role in international debates in this area, and this first requires European countries to work together and agree on internal solutions.
Some of these rescue operations took the form of public interventions, such as those carried out by the US Treasury and the Federal Reserve to avoid the bankruptcy of the world’s largest insurance company, AIG, or of the mortgage financiers Fannie Mae and Freddie Mac, that together underwrite half of all mortgages in the US.
Others took the form of private takeovers, such as the purchase of the investment bank Merrill Lynch by Bank of America.
For others, like the case of investment banker Lehman Brothers or almost two dozen US regional banks, bankruptcy was the only option possible. In short, we have witnessed an extraordinary transformation in the US banking landscape.
Consequently, we have reached the point where the US financial system is facing a substantial confidence problem. At this juncture, according to the US authorities, a series of bail-outs is not the answer any more. A systemic solution is urgently needed.
In the short term we all need a response that will restore confidence and stabilise markets.
The US plan announced by Secretary Paulson last week is a good initiative. In short, the US Treasury Secretary proposes to set up a federal fund to remove from the banks’ balance sheets the illiquid assets – those mortgage-linked securities that are at the root of the problems we face. Removing these from the system would help to remove uncertainty and refocus the market on fundamentals. However, the details of this proposal need to be properly defined – and quickly – if it is to succeed."@en1
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