From late 2009 a handful of mainly southern eurozone member states started being unable to repay their national Euro-denominated "government debt or to finance the bail-out of troubled financial sectors under their national supervision without the assistance of third parties. This so-called "European debt crisis began after Greece's new elected government stopped masking its true indebtedness and budget deficit and openly communicated the imminent danger of a Greek sovereign default. Seeing a sovereign default in the eurozone as a shock, the general public, international and European institutions, and the financial community started to intensively reassess the economic situation and creditworthiness of eurozone states. Those eurozone states being assessed as not financially sustainable enough on their current path, faced waves of "credit rating downgrades and rising borrowing costs including increasing interest rate spreads. As a consequence, the ability of these states to borrow new money to further finance their budget deficits or to refinance existing unsustainable debt levels was strongly reduced.
Reforms due to fiscal bailouts
The ECB has pronounced that the EU and its member states are in the main responsible for solving the fiscal crisis of some member states.["citation needed] Until 2009 there had not been sufficient instruments in place on the eurozone level to prevent or solve a debt crisis in a member state.["citation needed]
Several systems have been put into place since then to fill this gap:
- In 2010, two temporary rescue programmes have been started, the "European Financial Stabilisation Mechanism (EFSM) and the "European Financial Stability Facility (EFSF). Together with massive financial support of the "International Monetary Fund (IMF), these facilities have provided funds to Greece, Ireland, and Portugal in 2010 and 2011.
- In 2012 the "European Stability Mechanism (ESM) with a lending capacity of €500 billion, has been established to replace the previous temporary rescue programmes. The ESM is intended as a permanent firewall for the eurozone to safeguard and provide instant access to financial assistance programmes for member states in financial difficulty. Spain and Cyprus have drawn funds from the ESM programme in 2012 and 2013, with a focus on recapitalization (bail-out) of their financial sectors.
- In 2013 the "European Fiscal Compact became valid as a contract that obliges the EU member states to introduce domestic self-correcting mechanisms on member state level to ensure balanced public budgets and sustainable public debt levels.
- In 2014 the "Single Supervisory Mechanism (SSM) was introduced. It grants the European Central Bank (ECB) a supervisory role to monitor the financial stability of banks in the eurozone states (full members) and other EU states. This supervision is intended as a first step to prevent bank bailout needs in EU states that could induce or contribute to a debt crisis in the respective state.
The EU contracts["vague] forbid the financial bailout of other eurozone countries having problems to service their financial obligations. The emergency set-up of the various eurozone rescue funds to help the crisis states to fulfill their obligations was to a certain degree a violation of the non-bailout clause, but it is documented that there were no alternatives that the eurozone states could agree on in this unforeseen debt crisis situation.["citation needed]
There is also a widespread view["vague]["who?] that giving much more financial support to continuously cover the debt crisis or allow even higher budget deficits or debt levels would discourage the crisis states to implement necessary reforms to regain their competitiveness.["citation needed] There has also been a reluctance["citation needed] of financially stable eurozone states like Germany["citation needed] to further circumvent the no-bailout clause in the EU contracts and to generally take on the burden of financing or guaranteeing the debts of financially unstable or defaulting eurozone countries.["citation needed]
This has led to public discussions if Greece, Portugal, and even Italy would be better off leaving the eurozone to regain economical and financial stability if they would not implement reforms to strengthen their competitiveness as part of the eurozone in time. Greece had the greatest need for reforms but also most problems to implement those, so the Greek exit, also called "Grexit", has been widely discussed. Germany, as a large and financially stable state being in the focus to be asked to guarantee or repay other states debt, has never pushed those exits. Their position is to keep Greece within the eurozone, but not at any cost. If the worst comes to the worst, priority should be given to the euro's stability.
There are a variety of possible responses to the problem of bad debts in a banking system. One is to induce debtors to make a greater effort to make good on their debt. With public debt this usually means getting governments to maintain debt payments while cutting back on other forms of expenditure. Such policies often involve cutting back on popular social programmes.
Stringent policies with regard to social expenditures and employment in the state sector have led to riots and political protests in Greece. Another response is to shift losses from the central bank to private investors who are asked to "share the pain" of partial defaults that take the form of rescheduling debt payments.
However, if the debt rescheduling causes losses on loans held by European banks, it weakens the private banking system, which then puts pressure on the central bank to come to the aid of those banks. Private-sector bond holders are an integral part of the public and private banking system. Another possible response is for wealthy member countries to guarantee or purchase the debt of countries that have defaulted or are likely to default. This alternative requires that the tax revenues and credit of the wealthy member countries be used to refinance the previous borrowing of the weaker member countries, and is politically controversial.
In contrast to the Fed, the ECB normally does not buy bonds outright. The normal procedure used by the ECB for manipulating the "money supply has been via the so-called refinancing facilities. In these facilities, bonds are not purchased but used in reverse transactions: "repurchase agreements, or "collateralised loans. These two transactions are similar, i.e. bonds are used as collaterals for loans, the difference being of legal nature. In the repos the ownership of the collateral changes to the ECB until the loan is repaid.
This changed with the recent "sovereign-debt crisis. The ECB always could, and through the late summer of 2011 did, purchase bonds issued by the weaker states even though it assumes, in doing so, the risk of a deteriorating balance sheet. ECB buying focused primarily on Spanish and Italian debt. Certain techniques can minimise the impact. Purchases of Italian bonds by the central bank, for example, were intended to dampen international speculation and strengthen portfolios in the private sector and also the central bank.
The assumption is that speculative activity will decrease over time and the value of the assets increase. Such a move is similar to what the US federal reserve did in buying subprime mortgages in the crisis of 2008, except in the European crisis, the purchases are of member state debt. The risk of such a move is that it could diminish the value of the currency.
On the other hand, certain financial techniques can reduce the impact of such purchases on the currency. One is "sterilisation, in which highly valued assets are sold at the same time that the weaker assets are purchased, which keeps the money supply neutral. Another technique is simply to accept the bad assets as long-term collateral (as opposed to short-term repo swaps) to be held until their market value stabilises. This would imply, as a quid pro quo, adjustments in taxation and expenditure in the economies of the weaker states to improve the perceived value of the assets.
When the ECB buys bonds from other creditors such as European banks, the ECB does not disclose the transaction prices. Creditors profit of bargains with bonds sold at prices that exceed market's quotes.
As of 18 June 2012, the ECB in total had spent €212.1bn (equal to 2.2% of the Eurozone GDP) for bond purchases covering outright debt, as part of its Securities Markets Programme (SMP) running since May 2010. On 6 September 2012, the ECB announced a new plan for buying bonds from eurozone countries. The duration of the previous SMP was temporary, while the "Outright Monetary Transactions (OMT) programme has no "ex-ante time or size limit. On 4 September 2014, the bank went further by announcing it would buy bonds and other debt instruments primarily from banks in a bid to boost the availability of credit for businesses.
The Emergency Lending Assistance (ELA) programme was designed for financial institutions in a liquidity crisis, such as the Greek banks in the course of the 2015 Greek financial snafu, when the banks experienced massive deposit flight.
On 9 March 2015 the ECB started its "quantitative easing programme, which was designed to ease sovereign stress in its member states. Purchases are initially €60bn per month and subsequently increased to €80bn per month. The program is expected to last until at least end of 2018.
Long-term refinancing operation
Though the ECB's main refinancing operations (MRO) are from repo auctions with a (bi)weekly maturity and monthly maturation, the ECB now conducts long-term refinancing operations (LTROs), maturing after three months, six months, 12 months and 36 months. In 2003, refinancing via LTROs amounted to 45 bln euro which is about 20% of overall liquidity provided by the ECB.
The ECB's first supplementary longer-term refinancing operation (LTRO) with a six-month maturity was announced March 2008. Previously the longest tender offered was three months. It announced two 3-month and one 6-month full allotment of Long Term Refinancing Operations (LTROs). The first tender was settled 3 April, and was more than four times oversubscribed. The €25 billion auction drew bids amounting to €103.1 billion, from 177 banks. Another six-month tender was allotted on 9 July, again to the amount of €25 billion. The first 12-month LTRO in June 2009 had close to 1100 bidders.
On 21 December 2011 the bank instituted a programme of making low-interest loans with a term of three years (36 months) and 1% interest to European banks accepting loans from the portfolio of the banks as collateral. Loans totalling €489.2 bn (US$640 bn) were announced. The loans were not offered to European states, but government securities issued by European states would be acceptable collateral as would "mortgage-backed securities and other "commercial paper that can be demonstrated to be secure. The programme was announced on 8 December 2011 but observers were surprised by the volume of the loans made when it was implemented. Under its LTRO it loaned €489bn to 523 banks for an exceptionally long period of three years at a rate of just one percent. The by far biggest amount of €325bn was tapped by banks in Greece, Ireland, Italy and Spain. This way the ECB tried to make sure that banks have enough cash to pay off €200bn of their own maturing debts in the first three months of 2012, and at the same time keep operating and loaning to businesses so that a credit crunch does not choke off economic growth. It also hoped that banks would use some of the money to buy government bonds, effectively easing the debt crisis.
On 29 February 2012, the ECB held a second 36-month auction, LTRO2, providing eurozone banks with further €529.5 billion in low-interest loans. This second long term refinancing operation auction saw 800 banks take part. This can be compared with the 523 banks that took part in the first auction on 21 December 2011. Net new borrowing under the February auction was around €313 billion – out of a total of €256bn existing ECB lending €215bn was rolled into LTRO2.
Powers and objectives during the European banking crisis
The European debt crisis has revealed some relative weaknesses in the sovereign debt of such member countries as Portugal, Ireland, Greece and Spain.
Rescue operations involving sovereign debt have included temporarily moving bad or weak assets off the balance sheets of the weak member banks into the balance sheets of the European Central Bank. Such action is viewed as "monetisation and can be seen as an inflationary threat, whereby the strong member countries of the ECB shoulder the burden of monetary expansion (and potential inflation) to save the weak member countries. Most central banks prefer to move weak assets off their balance sheets with some kind of agreement as to how the debt will continue to be serviced. This preference has typically led the ECB to argue that the weaker member countries must:
- Allocate considerable national income to servicing debts.
- Scale back a wide range of national expenditures (such as education, infrastructure, and welfare transfer payments) to make their payments.
The European Central Bank had stepped up the buying of member nations debt. In response to the crisis of 2010, some proposals have surfaced for a collective European bond issue that would allow the central bank to purchase a European version of "US Treasury bills. To make European sovereign debt assets more similar to a US Treasury, a collective guarantee of the member states' solvency would be necessary.[b] But the German government has resisted this proposal, and other analyses indicate that "the sickness of the euro" is due to the linkage between sovereign debt and failing national banking systems. If the European central bank were to deal directly with failing banking systems sovereign debt would not look as leveraged relative to national income in the financially weaker member states.
On 17 December 2010, the ECB announced that it was going to double its capitalisation. (The ECB's most recent balance sheet before the announcement listed capital and reserves at €2.03 trillion.) The 16 central banks of the member states would transfer assets to the ledger of the ECB.
In 2011, the European member states may need to raise as much as US$2 trillion in debt. Some of this will be new debt and some will be previous debt that is "rolled over" as older loans reach maturity. In either case, the ability to raise this money depends on the confidence of investors in the European financial system. The ability of the European Union to guarantee its members' sovereign debt obligations have direct implications for the core assets of the banking system that support the Euro.
The bank must also co-operate within the EU and internationally with third bodies and entities. Finally, it contributes to maintaining a stable financial system and monitoring the banking sector. The latter can be seen, for example, in the bank's intervention during the "subprime mortgage crisis when it loaned billions of euros to banks to stabilise the financial system. In December 2007, the ECB decided in conjunction with the "Federal Reserve System under a programme called "Term auction facility to improve dollar liquidity in the eurozone and to stabilise the money market.
In late May 2012, looking ahead to further challenges with Greece, Bundesbank chief and ECB council member "Jens Weidmann pointed out that the council could veto "emergency liquidity assistance" (ELA) to, for instance, Greece through a two–third majority of the council. If Greece chose to default on its debts yet wanted to stay in the Euro, the ELA would be one of the ways to accommodate the country's and its banks' liquidity needs or, alternatively, to precipitate departure.
On 31 October 2012, the ECB announced it had phased out as planned the Covered Bond Purchase programme, which was one of the crisis measures aimed at supporting the shaky banking system of the 17-country eurozone.
On Wednesday, February 24, 2016, as part of the "Bundesbank's annual news conference, "Bundesbank president and European Central Bank Governing Council member, "Jens Weidmann, dismissed deflation in light of the ECB's current stimulus program, pointing out the healthy condition of the "German economy and that the "euro area isn't that bad off, on the eve of the March 9–10, 2016 meetings.
European financial stability facility
On 9 May 2010, the 27 "member states of the European Union agreed to incorporate the European Financial Stability Facility (EFSF). The EFSF's mandate is to safeguard financial stability in Europe by providing financial assistance to Eurozone Member States.
The EFSF is authorised to use the following instruments linked to appropriate conditionality:
- To provide loans to countries in financial difficulties (e.g. Greek bailout).
- To intervene in the primary and secondary debt markets. Intervention in the secondary debt market will be only on the basis of an ECB analysis recognising the existence of exceptional financial market circumstances and risks to financial stability.
- Act on the basis of a precautionary programme.
- Finance recapitalisations of financial institutions through loans to governments
The EFSF is backed by guarantee commitments from the Eurozone member states for a total of €780bn and has a lending capacity of €440bn. In 2011, it was assigned the best possible credit rating (AAA by "Standard & Poor's and "Fitch Ratings, Aaa by "Moody's)
Monetary policy tools
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The principal monetary policy tool of the European central bank is collateralised borrowing or repo agreements. These tools are also used by the United States "Federal Reserve Bank, but the Fed does more direct purchasing of financial assets than its European counterpart. The collateral used by the ECB is typically high quality public and private sector debt.
The criteria for determining "high quality" for public debt have been preconditions for membership in the European Union: total debt must not be too large in relation to gross domestic product, for example, and deficits in any given year must not become too large. Though these criteria are fairly simple, a number of accounting techniques may hide the underlying reality of fiscal solvency—or the lack of same.
In "central banking, the privileged status of the central bank is that it can make as much money as it deems needed. In the "United States Federal Reserve Bank, the Federal Reserve buys assets: typically, bonds issued by the Federal government. There is no limit on the bonds that it can buy and one of the tools at its disposal in a financial crisis is to take such extraordinary measures as the purchase of large amounts of assets such as "commercial paper. The purpose of such operations is to ensure that adequate liquidity is available for functioning of the financial system.
Regulatory reliance on credit ratings
Think-tanks such as the World Pensions Council have also argued that European legislators have pushed somewhat dogmatically for the adoption of the "Basel II recommendations, adopted in 2005, transposed in European Union law through the "Capital Requirements Directive (CRD), effective since 2008. In essence, they forced European banks, and, more importantly, the European Central Bank itself e.g. when gauging the "solvency of financial institutions, to rely more than ever on standardised assessments of "credit risk marketed by two non-European private agencies: Moody's and S&P.
The bank is based in "Frankfurt, the largest financial centre in the "Eurozone. Its location in the city is fixed by the "Amsterdam Treaty. The bank moved to new purpose-built headquarters in 2014 which were designed a Vienna-based architectural office named "Coop Himmelbau. The building is approximately 180 metres (591 ft) tall and will be accompanied with other secondary buildings on a landscaped site on the site of the "former wholesale market in the eastern part of Frankfurt am Main. The main construction began in October 2008, and it was expected that the building will become an architectural symbol for Europe. While it was designed to accommodate double the number of staff who operate in the former "Eurotower, that building has been retained since the ECB took responsibility for banking supervision and more space was hence required.
- The process is similar, though on a grand scale, to an individual who every month charges $10,000 on his or her credit card, pays it off every month, but also withdraws (and pays off) an additional $10,000 each succeeding month for transaction purposes. Such a person is operating "net borrowed" on a continual basis, and even though the borrowing from the credit card is short term, the effect is a stable increase in the money supply. If the person borrows less, less money circulates in the economy. If he or she borrows more, the money supply increases. An individual's ability to borrow from his or her credit card company is determined by the credit card company: it reflects the company's overall judgment of its ability to lend to all borrowers, and also its appraisal of the financial condition of that one particular borrower. The ability of member banks to borrow from the central bank is fundamentally similar.["citation needed]
- The European dilemma may be imagined as follows. In the US, if tax collections from California are weak, the total federal debt is financed through tax collections in other states, through federal taxes. California may default on its state debt, but the federal government bypasses California in directly taxing California citizens to finance the federal debt. There is only one legal authority taxing, paying for, and backing the federal debt. Federal expenditures are determined by the federal government. Therefore California cannot leverage more money out of the federal system other than by means of the normal constitutional procedures in the House and Senate. If the federal government transfers additional money to California it is because of federal policy, not because California's state debt is threatening the backing of the US dollar. Consider this hypothetical: If the US federal reserve carried state debts on its balance sheets the system would be more similar to the ECB. If California stated to default on its debt a hole would appear on the Fed's balance sheets where it carried California bonds. To make good this loss, the Fed would have to raise capital from the more solvent states, giving rise to the political issue that California's "lack of responsibility" was forcing other states to jump in and save California's public debt. This, one might worry, could turn into a license to California to ignore fiscal restraints and in effect transfer money from the "more responsible states" to the "least responsible states." Even though California's state finances are faltering in 2010, this is not an issue for the Federal Reserve, because of the federal system of taxation and unified backing of the federal debt. In Europe, the ECB could push for greater political and fiscal integration, which would make the member states more explicitly responsible for backing each other's debts and potentially lead to greater political integration. Speculative attacks on the sovereign debt that backs the euro have in effect revealed the weaknesses in the EU's political and fiscal structure.["citation needed]
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To ensure that adequate liquidity is available, consistent with the central bank's traditional role as the liquidity provider of last resort, the Federal Reserve has taken a number of extraordinary steps.
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- European Central Bank, official website.
- The origins and development of the European organisations: The European Central Bank, CVCE.eu website.
- European Central Bank: history, role and functions, ECB website.
- Statute of the European Central Bank (2012)