STAR Conference: Financial Crisis: Bend or Break

Toespraak | 31-05-2010

Ladies and gentlemen,

We cannot deny that the financial crisis has made our lives more difficult. Banks have collapsed, unemployment has risen sharply, and public finances have deteriorated rapidly. Now we stand on a crossing and we can decide to postpone solving our current problems or, instead, we can decide to tackle them.

My key message is that there is work to be done. It is to be done urgently and so, to answer the question from the title of today’s conference - Financial Crisis: Bend or Break? - breaking is not an option. Instead we must adapt to the circumstances and work our ways out of the crisis. I’m delighted to see that STAR is organising this conference so that we may discuss ways in which we can cope with the crisis and work to strengthen our economies in the future.

What happened?
Turbulent times
The financial markets are going through troubled times. The credit crisis that started in 2006 is now followed by a sovereign debt crisis concerning some countries in Europe, especially Greece, Ireland, Spain and Portugal. The financial crisis has had a severe impact on the financial sector, public finances and the European economy as a whole.

But I would like to make a positive contribution to this discussion and highlight a specific advantage that has emerged. Because alongside the dramatic events of the past two years, this crisis has also given us a unique opportunity to engage in building a better and more stable financial system. And now is the time to use this momentum.

Or in the words of Machiavelli, ‘Never waste the opportunities offered by a good crisis’.

As a matter of fact, using a crisis as a springboard for action has been an important feature of the history of the European Union. For more than half a century, the deepest crises have given us the best opportunities to take forward the process of European integration. And today, we need to take a similar step forward, to make our financial system and public finances more stable.

Credit crisis
But first, let us get back to what happened since 2006. This story is well known, so I will be brief. It all started with a crisis in the market for sub-prime mortgage products in the US, triggered by falling real estate prices. The crisis then swiftly spread to almost all the international financial markets.

This contagion was possible because banks and other financial institutions had taken to much risks with the money entrusted to them. Governments had to support banks and financial markets in order to preserve financial stability.
The bill for excessive risk taking came to the tax payer. The financial crisis also caused an economic crisis, adding pressure on public finances. As a result, public finances in all developed countries quickly deteriorated.

European sovereign debt crisis
Partly as a result of this, in early 2010 fears of a sovereign debt crisis developed concerning some countries in Europe including: Greece, Ireland, Spain and Portugal. This led to a crisis of confidence as well as the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany. Concern about rising government deficits and debt levels across the globe together with a wave of downgrading of European government debt has created alarm on financial markets.

The debt crisis has been mostly centred on recent events in Greece, where there is concern about the rising cost of financing government debt. On 2 May 2010 the Euro area countries and the International Monetary Fund agreed to a €110 billion loan for Greece, conditional on the implementation of harsh Greek austerity measures.

On 9 May 2010 Europe's Finance Ministers approved a comprehensive European rescue package worth € 500 billion and the IMF added another € 250 billion, all aimed at ensuring financial stability across Europe.

What are the challenges for the future?
The developments over the past two years present us with two major challenges for the future. The first challenge is to prevent the credit crisis from happening again by reforming and developing new regulation for the financial sector. The second challenge is to improve economic policy coordination in Europe, and more specifically the Euro area.

1. Preventing a future credit crisis
One of the main causes for the credit crises was excessive risk taking by banks and other financial institutions, insufficient monitoring of risks and insufficient capital buffers.
It is obvious that we need to make financial regulation stronger and broader. And it’s obvious that countries cannot do this on their own.

Reforms will need to include: (i) stronger capital requirements, (ii) more stringent compensation policies, (iii) better monitoring of systemic risk, (iv) ensuring consistent regulation for similar activities outside the financial sector and (v) creating more harmonised and less pro-cyclical international accounting standards.

Further I want to emphasise that, internationally, we need to work together far more closely on financial supervision.

This crisis has shown us just how interconnected the international financial sector has become – perhaps more so than we thought. Financial instability in one country can spread to other countries almost instantly.

But financial supervision is still organised along national lines. This has been especially evident in the operations to rescue large cross-border financial institutions. The Belgian-Dutch company Fortis was broken up along national lines. All the financial support for ING was provided by the Dutch government, although it is a multinational institution and its problems arose mainly outside the Netherlands.

In our global economy, financial institutions will continue to operate on a global level. Financial supervision has to reflect this economic reality.

In Europe, we have made a breakthrough on international supervision. We have created three European supervisory agencies that will coordinate financial supervision.

And this is only a first step. In the future, we will need to step up international supervision, giving more authority to European agencies and making better rules on crisis prevention and resolution.
We need stronger international supervision on a global basis too.
For the large global financial institutions in particular, we need to continue and to intensify cooperation on international supervision.

2. Improving economic policy coordination in Europe
The recent sovereign debt crisis has taught us several things. It has indicated the pressing need to consolidate public finances in Europe such that financial markets regain trust in our economies. There can be no discussion about the urgency of the matter.

The crisis has also thought us that things cannot go on in this way. That’s why in March the European Council called the President of the Council, Mr. Herman van Rompuy, to set up a taskforce to present before the end of this year the measures needed to strengthen the coordination of economic policies in Europe.

On behalf of the Netherlands I take part in this taskforce. The first meeting of the taskforce was held very recently on Friday 21 May during which we had a first exchange of views on how to improve economic policy coordination in the EU.

The taskforce is looking at three areas in which we can strengthen policy coordination. We need to look into ways to prevent current economic and fiscal problems from arising in the future. At the same time we have to examine the options to better solve problems when things go wrong.

Considering these options we should not only look at improvements that can be made in the short run, but also at more ambitious changes that would complement the EU and Euro area in the long run.

First of all, the taskforce looks into the role of one of the key frameworks for economic and fiscal policy in the EU, the Stability and Growth Pact. The rules of the Stability and Growth Pact are necessary and could be adequate. Yet, looking back, we have to say that the implementation of these rules has at times been insufficient or even wrong.

Member states were not sufficiently pressed to improve their fiscal balances in good times nor did we pay enough attention to debt levels and the sustainability of public finances. The European fiscal rules are also highly geared towards examining plans that member states submit.

Ex ante budgetary coordination in the EU is indeed important. Complementing this, however, we should also pay more attention to ex post evaluation of these plans. To what extent do countries follow their promises?
Finally, smarter sanctions, which are easier to implement in practice, would contribute to making the Stability and Growth Pact more automatic.

A second field which has not received enough attention is related to imbalances within the Euro area.

We have seen large differences between countries of the EMU; some had large surpluses while others had large current account deficits before the financial crisis occurred.

These imbalances are the result of a combination of several problems. Problems such as structurally weak competitiveness in countries like Greece and Portugal, and asset bubbles in the real estate market in countries like Ireland and Spain have contributed to the divergence within the Euro area.

It is important to signal these problems at an early stage and to resolve them before things get out of hand.

So far I have discussed ways in which we can better prevent the problems we have seen in the first 10 years of the Euro area. But what if we failed to solve these issues in time and things go run? This is the third area which needs to be strengthened.

Until recently we had no European framework to deal with the financing difficulties of countries like Greece. When things got really urgent, we had to respond swiftly to calm down financial markets and guard financial stability. That is why we have set up a combined IMF/EU program for Greece and a European Financial Stabilisation mechanism with a total volume of up to € 500 billion with the IMF adding another € 250 billion. These measures are temporary and that’s why within the taskforce it is also important to think about a more permanent crisis resolution framework.

The taskforce will present its ideas to strengthen economic policy coordination in Europe by the end of this year. I’m sure that the proposals of our taskforce will contribute to the Euro area and will help us in preventing and resolving economic and fiscal problems within the monetary union.

As I said at the beginning of my speech, breaking is not an option. We will continue to work on facing challenges in the present and in the future.

Thank you.