Asset-backed securities: The key to unlocking Europe's credit markets? Bruegel Policy Contribution 2014/07, 24 July 2014

The European market for asset-backed securities (ABS) has all but closed for business since the start of the economic and financial crisis. ABS (see Box 1) were in fact the first financial assets hit at the onset of the crisis in 2008. The subprime mortgage meltdown caused a deterioration in the quality of collateral in the ABS market in the United States, which in turn dried up overall liquidity because ABS AAA notes were popular collateral for inter-bank lending. The lack of demand for these products, together with the Great Recession in 2009, had a considerable negative impact on the European ABS market. The post-crisis regulatory environment has further undermined the market. The practice of slicing and dicing of loans into ABS packages was blamed for starting and spreading the crisis through the global financial system. Regulation in the post-crisis context has thus been relatively unfavourable to these types of instruments, with heightened capital requirements now necessary for the issuance of new ABS products. And yet policymakers have recently underlined the need to revitalise the ABS market as a tool to improve credit market conditions in the euro area and to enhance transmission of monetary policy. In particular, the European Central Bank and the Bank of England have jointly emphasised that: “a market for prudently designed ABS has the potential to improve the efficiency of resource allocation in the economy and to allow for better risk sharing... by transforming relatively illiquid assets into more liquid securities. These can then be sold to investors thereby allowing originators to obtain funding and, potentially, transfer part of the underlying risk, while investors in such securities can diversify their portfolios... . This can lead to lower costs of capital, higher economic growth and a broader distribution of risk” (ECB and Bank of England, 2014a). In addition, consideration has started to be given to the extent to which ABS products could become the target of explicit monetary policy operations, a line of action proposed by Claeys et al (2014). The ECB has officially announced the start of preparatory work related to possible outright purchases of selected ABS1. In this paper we discuss how a revamped market for corporate loans securitised via ABS products, and how use of ABS as a monetary policy instrument, can indeed play a role in revitalising Europe’s credit market. However, before using this instrument a number of issues should be addressed: First, the European ABS market has significantly contracted since the crisis. Hence it needs to be revamped through appropriate regulation if securitisation is to play a role in improving the efficiency of resource allocation in the economy. Second, even assuming that this market can expand again, the European ABS market is heterogeneous: lending criteria are different in different countries and banking institutions and the rating methodologies to assess the quality of the borrowers have to take these differences into account. One further element of differentiation is default law, which is specific to national jurisdictions in the euro area. Therefore, the pool of loans will not only be different in terms of the macro risks related to each country of origination (which is a ‘positive’ idiosyncratic risk, because it enables a portfolio manager to differentiate), but also in terms of the normative side, in case of default. The latter introduces uncertainties and inefficiencies in the ABS market that could create arbitrage opportunities. It is also unclear to what extent a direct purchase of these securities by the ECB might have an impact on the credit market. This will depend on, for example, the type of securities targeted in terms of the underlying assets that would be considered as eligible for inclusion (such as loans to small and medium-sized companies, car loans, leases, residential and commercial mortgages). The timing of a possible move by the ECB is also an issue; immediate action would take place in the context of relatively limited market volumes, while if the ECB waits, it might have access to a larger market, provided steps are taken in the next few months to revamp the market. We start by discussing the first of these issues – the size of the EU ABS market. We estimate how much this market could be worth if some specific measures are implemented. We then discuss the different options available to the ECB should they decide to intervene in the EU ABS market. We include a preliminary list of regulatory steps that could be taken to homogenise asset-backed securities in the euro area. We conclude with our recommended course of action.

Flexibility clauses in the Stability and Growth Pact: No need for revision. CEPS Policy Brief No. 319, 24 July 2014

This Policy Brief offers an in-depth review of the Stability and Growth Pact (SGP) and looks at whether the margins of flexibility within existing rules are sufficient in the current climate of low growth, or whether there is a need to broaden them. The issue is especially relevant as the changing economic environment is raising fresh questions about whether the EU’s current common economic policies are able to manage dismal growth and low inflation. The fragile state of confidence in financial markets and the unresolved but inevitable questions of moral hazard linked to lax fiscal policies mean that no large-scale fiscal expansion to support the recovery of economic activity is feasible. The discussion may therefore only concern the scope within the SGP to accommodate an unexpected drop in economic activity and to provide room for the implementation of structural reforms. Here, we analyse the flexibility clauses of the Stability and Growth Pact under three headings; namely “exceptional circumstances”, “structural reforms and other relevant factors”, and the “investment clause”. Recommendation: Our main conclusion is that the SGP contains sufficient flexibility to accommodate an unexpected drop in economic activity and has the margins needed to finance structural reforms during the transition to the new regime. We therefore see no need to change the existing rules of the SGP. We believe that the ongoing debate about a fresh growth strategy for the eurozone and the European Union would greatly benefit from removing from the Council table ill-formulated and unnecessary demands for greater flexibility in the SGP.

The transatlantic growth gap. CEPS Commentary, 5 August 2014

Daniel Gros argues in this commentary that the cause of the transatlantic growth gap following the recovery starting in 2010 from the global financial crisis should not be sought in excessive eurozone austerity or the excessive prudence of the European Central Bank. Rather, compared to the US, he argues that the excess debt created in the EU during the boom years has been much more difficult to work off. He acknowledges that European officials are right to promote structural reforms of EU countries’ labour and product markets, but advises that they should also focus on overhauling and accelerating bankruptcy procedures, so that losses can be recognised more quickly and over-indebted households can start afresh, rather than being shackled for years.

A New Deal for growth and jobs in the Eurozone revisited. EPC Commentary, 27 January 2014

At the EPC breakfast on 28 January, IMF Managing Director Christine Lagarde will launch a book on Jobs and Growth: Supporting the European Recovery, containing detailed policy analysis and recommendations. The book is a further sign that there is now wide-spread recognition that it is high time for Europe to take more action to deliver jobs and growth.

Brexit or not? Time for the EU to move. EPC Commentary, 8 September 2014

The deteriorating relationship between the United Kingdom (UK) and the rest of the EU, including the prospect of a referendum on EU membership, would have dominated the Union’s agenda had it not been for the economic/financial crisis, followed by the external crisis which we are now facing in the East. Precisely because of these crises, it is now time for the incoming European Commission to take the bull by the horns and ensure that the EU can move on from a potential referendum and its possible outcomes. The June European Council noted that “the UK raised some concerns related to the future development of the EU. These concerns will need to be addressed. In this context, the European Council noted that the concept of ever closer union allows for different paths of integration for different countries, allowing those that want to deepen integration to move ahead, while respecting the wish of those who do not want to deepen any further.” While the EU has, arguably, successfully developed at different speeds for decades, to address the UK’s (fundamental) concerns, it is now time to work out whether and how the UK can be accommodated, and what this would mean in practice. UK membership is desirable but not at any price, so the aim should be to keep the UK in, while also ensuring that the principles on which the EU is built are protected. There will need to be a modus operandi which enables the EU and in particular, the Eurozone, to continue to make progress in addressing the shortcomings of European integration and European Monetary Union (EMU) in particular, while at the same time offering a reform package that can satisfy the UK. This does not necessarily mean that all EMU reforms have to be within the EU framework: additional intergovernmental arrangements could also be a possibility. However, this could add to the complexity and inefficiency of the system, as well as sidelining the supranational element of EU governance which will be needed to make EMU function.

A Monetary Union Requires a Banking Union. Bruges European Economic Policy (BEEP) Briefing 33/2014

This paper argues that a monetary union requires a banking union. While the USA developed both during a time span of two centuries, the EMU was created in the course of two decades and remains unfinished as the economic pillar is largely missing. The financial crisis and the Eurocrisis have shown that a genuine banking union is even more needed for the Eurozone than a budget or a fiscal union to let the euro survive.

The twenty-first century needs a better G20 and a new G7+. Bruegel Policy Contribution 2014/13, 14 November 2014

During the 2008 financial crisis, the G20 was hastily elevated to ‘global economic steering committee’. In the early stages of the crisis, the G20 was an effective forum for crisis containment. As the crisis has eased, however, the G20 has lost both direction and momentum. Governments and policymakers have felt less need to act in unison and have rather refocused on their national agendas, as is their duty and primary function. However, effective global governance is needed permanently, not just in crisis times. It is desirable to have more representative and effective global governance that, among other things, is equipped to prevent crises rather than just react to them. In an environment of rapid change in global patterns of trade and wealth creation, a new revamped (but highly representative) grouping should be created within the G20, to provide leadership on key economic policy matters. Euro-area members should give up their individual seats in this G7+, allowing room for China and other large emerging economies. Without euro-area countries taking such a step, it would be impossible to reconcile effectiveness and representation in this new G7+, which would take charge of decision making on global economic imbalances, financial and monetary issues. All existing G20 countries, including individual euro-area countries, would however remain in the G20, which could potentially expand and would remain the prime forum for discussion on all remaining matters at global level.

Iceland’s contested European Policy: The Footprint of the Past - A Small and Insular Society. Jean Monnet Occasional Paper 01/2013

Introduction. Iceland’s domestic politics and foreign affairs are undergoing drastic changes. After an economic crash, violent protests on the streets of Reykjavik for the first time in Iceland’s history contributed to the defeat of the government. The party system has been altered. A turn has been taken towards Europe after the United States left the island, first by closing its military base in 2006 and then by its clear stance not to assist the country in its economic difficulties. The former close relations with the superpower are unlikely ever to be restored. The EU membership application is placing severe constraints on political parties which are split on the issue and has put in jeopardy the unity of the first left majority in the Icelandic parliament, the Althingi. Society is in a state of flux after an unprecedented economic downscaling and the collapse of almost its entire financial sector – which had boomed rapidly beginning in the mid-1990s. The credibility of politicians, the parliament and the media is in ruins. Iceland’s smallness and its location on the geographical map – one could also say the geopolitical map – has had a profound influence on its domestic and foreign affairs. Iceland is closely associated with the other Nordic states and has adopted many of their domestic characteristics, with important exceptions. On the other hand, the country has come under American influence – geographically, it straddles the Mid-Atlantic rift – and has limited its participation in the European project. Its geographical location in the middle of the North Atlantic has led to a notion that the country’s culture is unique and should be protected by all available means. Politicians continue to play the ‘nationalistic uniqueness’ card with considerable success even though the country has been swept by globalization. Rapid modernization (which only really began in the Second World War with British and American occupations) and sudden engagement with the outside world (which only extended to the general public in the last quarter of the twentieth century) are still slowly but steadily making their mark on the country’s foreign policy. The country’s political discourse and foreign policy still bear the hallmark of the past, i.e. of a small and insular society This paper will address the political developments in Iceland since the 2008 economic crash and place it in a historical context. The aim is to understand Iceland’s present foreign policy and, in particular, the highly contested decision by its government in 2009 to apply for membership of the European Union. The paper is divided into five sections in addition to this introduction and the concluding remarks. First, it starts by explaining the importance in Iceland of a political discourse based on the concept of independence which dates back to the historical narrative of the settlement period. This section will also examine Iceland’s close relations with the other Nordic states – despite important differences between it and the others. Second, the paper will analyse the importance of the party system, i.e. the dominance of the centre-right in Icelandic politics, and the changed nature of the system. Third, it examines how Iceland further distinguishes itself from the other Nordic states in many important features. Fourthly, the paper analyses the country’s three main foreign policy priorities in the post-war period, i.e. extensions of the Exclusive Economic Zone, firm defence arrangements with the US and membership of NATO, and the drive for better market access for marine products – including a partial engagement in the European project. Fifthly, the paper examines how the country’s smallness, in terms of its central administrative capacity, has affected its domestic and foreign policy-making. The concluding section summarizes the main findings concerning the political and historical obstacles that the Social Democratic Alliance faces in its hard-fought battle to change the country’s European Policy.

Taking its place in Europe – Iceland’s long road to its EU application. Jean Monnet Occasional Paper 03/2013

Iceland applied for EU membership in 2009. Before that it had sought to alleviate pressures on her to fully integrate with Europe firstly by pursuing limited integration through membership of the European Free Trade Association (EFTA) and later by joining the European Economic Area (EEA). This paper traces the steps taken by this peripheral European country from its struggle of independence from Denmark, through World War II, American occupation, the founding of a republic, NATO membership and the Cod Wars with Britain. The paper analyses the various phases of the debate on the ties to the European institutions leading to EEA and Schengen membership, the “miraculous economic success“ which ended in the epic crash of 2008 which precipitated a much contested EU application.

Investment as the key to recovery in the euro area? CEPS Policy Brief No. 326, 18 November 2014

Investment has declined in the euro area since the start of the economic and financial crisis, but this does not mean that there is necessarily an ‘investment gap’, explains Daniel Gros in this CEPS Policy Brief. Investment was probably above a sustainable level due to the credit boom before 2007. Moreover, the fall in the euro area’s potential growth − due to a combination of a sharp demographic slowdown and lower total factor productivity (TFP) growth − should also lead to a permanently lower investment rate. Increasing the investment rate might thus be the wrong target for economic policy. The author advises that the aim of economic policy should be to increase consumption, rather than investment overall. Increasing infrastructure investment might be justified in some member countries, but it is not a ‘free lunch’ when efficiency levels are low, which seems to be the case in some of the financially stressed euro area countries.

Towards a New Industrial Policy for Europe. EPC Issue Paper No. 78, November 2014

An ambitious rhetoric has been adopted both at the European and national level towards industrial policy. Along with rhetoric, sweeping action plans to revive our industrial base and reverse off-shoring trends have been attempted. However, concrete measures undertaken have been inconsistent and weak compared to the magnitude of the challenges faced by European manufacturing as well as the policies implemented by our competitors. At the same time the economic and financial crisis has shed light on the risks of an excessive reliance on the service and financial sector and the necessity to look for new sources of growth. As a response, this Issue Paper, by Claire Dhéret, Senior Policy Analyst and Martina Morosi, Programme Assistant, argues that fostering a more innovative, knowledge-intensive, new technology-oriented and resource-efficient manufacturing industry in Europe is the right way to go. To this end, a new EU strategic vision on industrial policy, based on the operationalisation of European cooperation, is urgently required. The paper presents a toolkit for implementing the vision and a series of policy recommendations.

An economy with unrealistic indicators: an evaluation of the economic situation in Belarus and a forecast for 2013. OSW Commentary No. 103, 2013-02-20

The macroeconomic results achieved by Belarus in 2012 laid bare the weakness and the inefficiency of its economy. Belarus’s GDP and positive trade balance were growing in the first half of last year. However, this trend was reversed when Russia blocked the scheme of extremely lucrative manipulations in the re-export of Russian petroleum products by Belarus and when the demand for potassium fertilisers fell on the global market. It became clear once again that the outdated Belarusian model of a centrally planned economy is unable to generate sustainable growth, and the Belarusian economy needs thorough structural reforms. Nevertheless, President Alyaksandr Lukashenka consistently continues to block any changes in the system and at the same time expects that the economic indicators this year will reach levels far beyond the possibilities of the Belarusian economy. Therefore, there is a risk that the Belarusian government may employ – as they used to do – instruments aimed at artificially stimulating domestic demand, including money creation. This may upset the relative stability of state finances, which the regime managed to achieve last year. The worst case scenario would see a repeat of what happened in 2011, when a serious financial crisis occurred, forcing Minsk to make concessions (including selling the national network of gas pipelines) to Moscow, its only real source of loans. It thus cannot be ruled out that also this time the only way to recover from the slump will be to receive additional loan support and energy subsidies from Russia at the expense of selling further strategic companies to Russian investors.

Strengthening the euro area. CHALLENGE EUROPE Issue 22. Challenges and new beginnings: Priorities for the EU's new leadership, September 2014

Since 2007, a series of acute crises have threatened the very existence of the euro area. The financial crisis which spilled into the currency union in 2007 was followed by an unexpectedly strong downturn of the real economy. As of 2010, the euro area was confronted with a severe sovereign debt and banking crisis. Despite these troublesome developments, the euro area has proven to have a considerable degree of resilience. In each phase, governance weaknesses were revealed – and national governments together with the EU institutions have designed an impressive series of policy responses in crisis management and institutional innovation. The euro area today is completed by a banking union with a Single Supervisory and a Single Resolution Mechanism. National budgetary and economic policies are more closely overseen and coordinated. With the European Stability Mechanism, the euro area now has a permanent tool in place to manage sovereign liquidity crises and instabilities in the banking sector. Most importantly, the euro area's only true federal institution, the European Central Bank (ECB), has become its most effective crisis manager: with the announcement of its Outright Monetary Transactions (OMT) programme, the ECB finally managed to calm the self fulfilling crisis in 2012. Meanwhile, the announcement of credit easing and quasi-quantitative easing in September 2014 is a move towards reducing financial fragmentation and countering deflation. The euro area in 2014 is hence a lot different from the one in 2007. And yet, further challenges need to be overcome. Prevailing stagnation, fragmentation and problems of legitimacy require a rethink of policies and further governance reform.

Europe's economic challenges and the importance of ideas and innovation. CHALLENGE EUROPE Issue 22 - Challenges and new beginnings: Priorities for the EU's new leadership, September 2014.

How will we Europeans earn our living in 20 or 30 years' time? And how can it be done, while remaining true to our values of fairness, freedom and solidarity? These fundamental questions predate the financial crisis and will still be with us once we have fully overcome it. Of all the groups in society, business leaders are probably most keenly aware of the challenge posed by globalisation. They have their finger on the pulse of global economic activity and keep alerting me that Europe is losing out. The trade unions, generally more focused on the economy's demand side, regularly call for more (public) investment. Their leadership remains highly committed to Europe but they can sense a rise of Euro-scepticism among their members. We must, and can bring these two narratives together. Yes, global change is relentless and our societies must adapt, but we can also preserve what makes Europe such a special place: a unique combination of relative prosperity, solidarity, individual freedoms, and security. This challenge was always on my mind.

Slovakia: the Eurogroup’s enfant terrible. OSW Commentary No. 63, 2011-10-14

When Slovakia’s parliament rejected the European Financial Stability Facility (EFSF) reform on 11 October it undermined Slovakia’s reputation as a credible partner within the EU. Moreover, Prime Minister Iveta Radicova combined the vote on the strengthening of the EFSF – a key anti-crisis mechanism in the Eurozone – with a vote of confidence for her cabinet. This eventually led to the collapse of the government. Before Slovakia’s decision, the strengthening of the EFSF had been endorsed by the national parliaments of all the eurozone countries. Slovakia, which had opted to be the last one to carry out the ratification procedure, adopted the EFSF reform only in a re-vote on 13 October, due to the support of the opposition left-wing party. However, problems with ratification have cast a shadow over the achievements of Slovakia which as one of the freshest members of the eurozone had been actively seeking to influence the creation of EU mechanisms for dealing with the debt crisis. For the past eighteen months the Slovak government, formed by conservative and liberal parties, has consistently called for the controlled bankruptcy of Greece, a tightening of the rules of the Stability and Growth Pact, and for the private sector’s participation in financing the rescue packages for indebted states. It was in part down to Slovakia that these proposals, previously regarded as extreme, were introduced into the mainstream EU debate. The constructive position presented by Slovakia’s diplomacy in recent months has brought Bratislava tangible results, such as the reduction of its contribution to the permanent anti-crisis fund, the European Stabilisation Mechanism (ESM). Thus Slovakia, which adopted the single currency on 1 January 2009, has become an informal spokesman for the new, poorer members of the eurozone.