a potential breakdown of the the...

A POTENTIAL BREAKDOWN OF A POTENTIAL BREAKDOWN OF THE THE EUROZONEEUROZONE

Dr. Petr TeplýCharles University in Prague, Czech Republic

University of Economics in Prague, Czech Republic

Massey UniversityPalmerston North, New Zealand

31August 2011

AgendaAgenda

Introduction1.

Origins of the Eurozone and ECB3.

Global consequences of the crisis2.


The Eurozone and ECB during crisis4.

The recent fall of the Eurozone5.

2

Conclusion6.

A potential breakdown of the Eurozone31August 2011

PresenterPresenter –– Dr. Dr. PetrPetr TeplTeplýý

2000 – JKU in Linz, Austria

2006 – University of Otago, New Zealand

2006 – State University of New York, New Paltz, USA

2009 – Ph.D. in Finance, Charles University, Czech Rep.

� Research interests: banking, finance, risk management,

Education

3

� (Co)author of over 60 articles and 10 books

� Guest lectures in New Zealand, Turkey, USA

� Presentations at Harvard University, State University of New York, China, Dubai, India, London, India, Nepal, Singapore etc.

� Research interests: banking, finance, risk management, financial stability, public finance, RIA

Job experience 2001-2005 CSOB Bank, Czech Rep.

2006 Spencer Clarke, New York, USA

2007+ EEIP, a.s., Czech Rep.

IntroductionIntroduction to The to The CzechCzech RepublicRepublic (1/2)(1/2)

4

IntroductionIntroduction to The to The CzechCzech RepublicRepublic (2/2)(2/2)

Three Main Czech Three Main Czech IconIconss

Czech TOP Sports Czech TOP Sports

Czech Beer

5

Czech TOP Sports Czech TOP Sports ((wowo)men)men

PetraKVITOVA

� CUNI = public university founded in 1348

� now 17 faculties, 51,000 students, 7,500 employees, 300 accredited degree programms and 660 study disciplines

� My affiliation: Department of Finance and Capital Markets/Institute of Economic Studies/Faculty of Social Sciences

6

Sciences

Source: Academic Ranking of World Universities – 2011, http://www.shanghairanking.com/ARWU2011.html#

1) To present my view on the global crisis, the ECB and the Eurozone

2) To provide info on origins of the ECB and the Eurozone

1.1. IntroductionIntroduction

ThreeThree aimsaims of the presentationof the presentation

7

and the Eurozone

3) To welcome comments from the opposite side of the globe ☺

GlobalGlobal politicalpolitical governancegovernance1. 1. IntroductionIntroduction

Source: Petr Teply (2010)

PoliticiansPoliticians catchingcatching powerpower oror money?money?BothBoth??

1. Introduction1. Introduction

9

TTaaxxpayerpayers did, do and will always cry!!!s did, do and will always cry!!!1. Introduction1. Introduction

……plus plus ineffectiveineffective regulationregulation ofof financialfinancial marketsmarkets1. Introduction1. Introduction

……andand no no coordinationcoordination on a on a globalglobal levellevel!!

G0

12

G20G21. Introduction1. Introduction

12Source: The Economist

AgendaAgenda

Introduction1.






13

Conclusion6.


2. 2. GlobalGlobal consequencesconsequences of the crisisof the crisis

Déjà vuDéjà vu to to thethe AsianAsian crisiscrisis in in 11997997

14

Source: IMF

2. Global2. Global consequencesconsequences of the crisisof the crisis

Key players during the Key players during the 2007+ 2007+ crisiscrisis

1. Mortgage originators• Lenders• Commercial banks

2. Risk shifters/ transformers• Commercial banks• Investment banks/prime brokers

4. Insurers• Insurance companies• Monoline insurers• Reinsurence companies

5. Rescuers• Central banks• Governmental institutions

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• Investment banks/prime brokers• Government-sponsored

enterprises• SPVs (ABCP/SIV/conduits)

3. Investors• Commercial/investment banks• Hedge/pension funds• Insurance companies• Investment funds• Private investors

• Governmental institutions• Sovereign wealth funds• International Monetary Fund• Private investors

6. Others• Rating agencies• US government• Regulatory bodies

Source: Teply, P., Pecena M. (2010). Credit risk and financial crises

2. 2. GlobalGlobal consequencesconsequences of the crisisof the crisis

FairyFairy taletale aboutabout credit and liquidity riskcredit and liquidity riskss

Central bank

Borrower

Credit risk Liquidity risk

Reinsurer

Insurance

company

$$$

$$$

$$$

Government

institutions$$$

International

Institutions

$$$

US

Government

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CDOST debt

$$$ Mortgage

Lender/Bank GSE SPV

Investors

$$$

$$$

CDO

$$$

$$$

MortgageCommercial

bank

Hedge funds

Insurance

$$$

$$$

$$$

ST debt

$$$

Sovereign

Wealth Funds$$$

$$$

ST debt

Guarantees

Source: Teply, P., Pecena M. (2010). Credit risk and financial crises

2. Global consequences of the crisis2. Global consequences of the crisis

FourFour stagesstages ofof the the pendingpending global global crisiscrisis

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Tsunami Tsunami ofof sovereignsovereign bankruptciesbankruptcies in the EMUin the EMUWhoWho and when and when willwill bebe nextnext??

2. Global 2. Global consequences of the crisisconsequences of the crisis

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Magical triangle of exit strategiesMagical triangle of exit strategies aandnd finanfinancialcialstabilitystability

Monetarypolicy

Fiscalpolicy

Financial

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Financialsector

� The magical triangle of exit strategies

� International coordination needed!

� Importance of competitiveness of economies

� Different time schedules of exits

G0 G20

Source: Petr Teplý (2010)


Timing of exit strategies/expansive Timing of exit strategies/expansive monetary policymonetary policy

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� Odysseus’ dilemma: Scylla a Charybdis –higher inflation/asset bubbles or recession?


Expansive monetary policies around the worldExpansive monetary policies around the world

21Source: Petr Teplý (2010)


High engagement of many central banksHigh engagement of many central banks

Monetarypolicy

Fiscalpolicy

Financialsector

22Source: Economist (2011), FITCH (2011)

2. 2. GlobalGlobal consequences of the crisisconsequences of the crisis

Quantitative easing 1,2,3…Quantitative easing 1,2,3…

Monetarypolicy

Fiscalpolicy

Financialsector

� The Federal Reserve announced that it would buy $600 billion in Treasuries over the next eight months in a second round of “quantitative easing”. The decision to pump more liquidity into the American economy to bring down long-term interest rates and spur growth prompted modest rises in stockmarketsaround the world.

23Source: The Economist on 4 November 2010


Deteriorating reputation of central banksDeteriorating reputation of central banks

24Source: The Economist (2011)

AgendaAgenda

Introduction1.






25

Conclusion6.


o European Union (now 27 countries) objective of economic integration.

o Idea of European Monetary Union (EMU) has been around since early 1970s.

o Exchange Rate Mechanism (ERM): system of fixed exchange rates.

3. 3. Origins of the Eurozone and ECBOrigins of the Eurozone and ECB

Origins of the Origins of the EU EU andand the Eurozonethe Eurozone

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rates.

oGerman Unication - ERM collapsed in early 1990s

oThe 1992 Maastricht Treaty set up the EMU with the EURO

o 1 January 1999:

oConversion rates are established

oECB assumes responsibility for a single monetary policy


ECBECB´́s basic s basic capitalcapital distributiondistribution

27Source: www.ecb.int


EurozoneEurozone countriescountries



(In)dependence (In)dependence ofof thethe ECBECB

29Source: www.ecb.int

3. 3. OriginsOrigins of of the Eurozone and ECBthe Eurozone and ECB

PoliticalPolitical pressurepressure on the ECBon the ECB

I know!Sure!

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I amindependant

!

3. Origins of 3. Origins of the Eurozone and ECBthe Eurozone and ECB

HowHow shouldshould the the regulatorregulator reactreact on on underunder//mismispricingpricing risk???risk???

31Source: Mejstřík, Teplý (2011)

3. Origins of the Eurozone and ECB3. Origins of the Eurozone and ECB

Bankruptcies of Ireland and GreeceBankruptcies of Ireland and Greece


……butbut differentdifferent causescauses

Source: Fitch (2010), DB Research (2010)


DDdifferentdifferent macroeconomicmacroeconomic developmentsdevelopments in the EMUin the EMU

Source: DB Research (2010)


……hahass widened gaps in competitivenesswidened gaps in competitiveness



……increasedincreased ppublicublic deficitsdeficits



……andand relatedrelated highhigh ggrossross fiscal financing needsfiscal financing needs

37Source: Fitch (2010)


GreeceGreece –– longlong--termterm fiscalfiscal andand externalexternal imbalancesimbalances



IrishIrish and Greek and Greek public public debtdebt heldheld by by foreignersforeigners!!!!!!

39Source: IMF (2011)


IrelandIreland –– overheatedoverheated financialfinancial sectorsector



……skyrocketingskyrocketing bank bank creditscredits



……financingfinancing realreal estateestate bublebuble


AgendaAgenda

Introduction1.






43

Conclusion6.


4. The Eurozone 4. The Eurozone and and ECB during crisisECB during crisis

…ECB…ECB´́s help to PIGSs help to PIGS

4444Source: FITCH (2011)

4. The Eurozone and ECB during crisis4. The Eurozone and ECB during crisis

Future expected Future expected probprobllems ems in Europein Europe

45Source: Petr Teplý (2011)

� The dark future of Greece: bank runs, demonstration, riots,…followed by anarchy/revolution/dictatorship like in the past.... And what about other PIGS?

4. The Eurozone and ECB during crisis4. The Eurozone and ECB during crisis

……differentiated differentiated govgov’ t bond yields’ t bond yields

46Zdroj: Bloomberg, IMF, MARKIT

� 10-year bond yields in the EMU and the CR (%)

� 10-year bond yields of developed countries (%)

4. The Eurozone and ECB during crisis4. The Eurozone and ECB during crisis…CDS …CDS spreadspreads imply different credit risk of s imply different credit risk of CEE countries and PIGSCEE countries and PIGS

47Source: MMF (2011), RB Research (2011)

� Credit Default Swap (CDS) spreads (bps)

� Sovereign CDS (bps), change in April 2011 and April 2010

AgendaAgenda

Introduction1.






48

Conclusion6.


5. The recent fall of the Eurozone5. The recent fall of the Eurozone

GreeceGreece´́s s bankruptcybankruptcy in May 2010in May 2010

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� …financial markets stopped believingGreek myths and numbers!


……andand EuropeanEuropean support support startedstarted

oEUR 500 billion emergency fund with two facilities

1) An existing EU balance‐of‐payments facility, previously only available to non‐‐‐‐euro area members of the EU: this has now been expanded by EUR60bn, funded out of the existing EU budget and made accessible to euro area member states (European Financial Stabilisation Mechanism (EFSM)

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member states (European Financial Stabilisation Mechanism (EFSM)

2) The second component is a new European Financial Stabilisation Facility (EFSF). The EFSF will access capital markets for up to EUR440bn through a specially created funding facility on the back of sovereign guarantees from euro zone member states, much of which will be available for on‐lending to those countries facing financing distress. This funding could be supplemented by as much as EUR220bn from the IMF, in addition to the EUR30bn already committed to Greece. Source: Fitch (2010)


The EFSThe EFSMM –– structure of fundingstructure of funding

51Source: ECB (2010)


The The EFSEFSFF –– structure of funding structure of funding

52Source: ECB (2010)


Financial needs and support of the EFSFinancial needs and support of the EFSFF



The ESFS The ESFS –– structure of fundingstructure of funding



EuropeanEuropean Stability Stability MechanismMechanism ((MarchMarch 2011)2011)

55Source: Financial Times (2011)


Main Features of the EFSM, EFSF and ESM (1/2)Main Features of the EFSM, EFSF and ESM (1/2)



Main Features of the EFSM, EFSF and ESM (2/2)Main Features of the EFSM, EFSF and ESM (2/2)



But fBut futureuture financialfinancial needsneeds ofof PIGSPIGS



....including including a a roadroad to to hellhell ofof SpainSpain ((cajascajas!)!)



.....lack of capacity of the EFSF.lack of capacity of the EFSF

� Why not Eurobonds?

� Because of higher financing


financing costs for Germany (IFO: EUR 47bn costs annualy!)


Strong connection between Germany andStrong connection between Germany and PIGS PIGS

61Zdroj: Wolf: Intolerable choices for the eurozone, Financial Times on 31 May 2011


Exposures to Greek debt (2010)Exposures to Greek debt (2010)

62


……restructuralizationrestructuralization ofof PIGS PIGS debtdebt neededneeded!!

63Source: DB Research (2011)

� …the need to fix a situation after 2013 -> European Stability Mechanism (ESM), but ONLY a partial agreement (due to elections in Finland and Germany)


5 options on Greek debt restructuring5 options on Greek debt restructuring

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� Politicians are just buying time (until their elections) but “hard restructuring” is inevitable

� Greeks will never repaid all their debts!

5. Euro a kurzové riziko5. Euro a kurzové riziko

And what about GermansAnd what about Germans??

� In case of Greek debt restructuring German taxpayers will cry, but in different time and different amount

1) Bankruptcy of Ger. banks (bail-out)

2) Recapitalization of the ECB

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2) Recapitalization of the ECB

3) Guarantee mechanisms (EFSF, ESM)

4) International Monetary Funds

� Optimum for Germans: To keep Greece/PIGS alive until the lections in 2013 and then let them go down (kick-off out of the Eurozone)

AgendaAgenda

Introduction1.






66

Conclusion6.


6. 6. ConclusionConclusion

The Eurozone in its current form will not survive the

year of 2013!

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year of 2013!

DiscussionDiscussion

Many thanks for your kind attention!Many thanks for your kind attention!Any questions?Any questions?

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UsefulUseful sourcessources

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