FRANKFURT (MNI) – The following is the third part of the speech
given by European Central Bank Executive Board member Lorenzo Bini
Smaghi at the ECON Committee of the European Parliament in Brussels on
Wednesday. The text was provided by the ECB and is available at

http://www.ecb.int/press/key/date/2010/html/sp100915.en.html:

“2. The Commission ideas currently on the table provide too little
in terms of streamlining the procedures and hence making them more
effective. We have seen many times in the past that procedures are too
lengthy and laborious before effective action can be undertaken to
incentivise or enforce on Member States a correction in their fiscal
developments. So far, procedures have been launched only on the basis of
the notification by the Member States. It could be envisaged to also
launch them on the basis of an assessment or a forward looking
assessment by the Commission. Had this been done in the case of Greece,
many problems could have been avoided or at least reduced. On the second
building block – broader macroeconomic surveillance – we see a strong
need for making a quantum leap, given the large spillovers from the
macroeconomic policies of one country on all other participating
countries in the single currency area. Accordingly, the ECB proposes the
creation of an alert mechanism based on a clear and limited set of
indicators that identifies unsustainable policies at a sufficiently
early stage. We would also like to see put in place a procedure for the
correction of macroeconomic imbalances with a preventive and a
corrective arm which includes graduated enforcement steps to ensure
compliance, including sanctions. Again, the Commission ideas voiced in
its communication of 30 June go in the right direction but are not yet
ambitious enough to meet the long-term requirements of an efficiently
functioning monetary union. We are awaiting for the new proposals in
this field and stand ready to contribute actively. Let me now spend a
few words on the third building block, crisis management. There is a
theory according to which if you have a good prevention system there
will be no crisis. It is a theory, indeed. In practice, crises do occur,
even though the institutional system underlying surveillance and
prevention should be strengthened to avoid such crises. As I mentioned
earlier, it would not only be a mistake but also irresponsible to assume
that crises will never occur again. This would encourage market
participants to speculate on their re-occurrence because of a lack of
proper management framework. As we have experienced, self-fulfilling
expectations could by themselves precipitate a crisis.

The creation of the EFSF ultimately averted the financial collapse
in early May. Without such a system the euro would be vulnerable to any
speculative attack against any of its members, be it justified or not by
economic fundamentals. The question is how to create a management
mechanism that avoids crises without creating moral hazard. This is not
a new issue. It has been dealt with in the context of the IMF and
consists of attaching strong conditions, in terms of structural and
fiscal policies, to any financial support that is provided to a country
in difficulty. Financial support is disbursed only according to precise
milestones, linked to compliance with the conditions contained in the
programme. There is no need for Europe to reinvent the wheel. We can
learn from the experience of the IMF. History shows that countries are
not particularly keen to get financial support from the IMF, precisely
because of its tough conditions.

The proposals put forward by the ECB go very much in that direction
and aim to create a framework that can manage a crisis effectively while
discouraging speculative attacks against the system.

The crisis management framework raises another issue, which is more
complex and deserves some reflection. The issue is known as ‘private
sector involvement’ in crisis resolution. What it means is that public
money should not be used to bail out private sector organisations that
have taken the wrong decisions. This would be the case if the money
provided by the crisis management framework were used to reimburse the
private sector for its losses, eliminating all the risks it was exposed
to.

This issue was considered in the context of the IMF reform after
the Asian crisis. The discussion showed that it is very difficult to
design a simple mechanism which would make restructuring mandatory. The
reason is simple. The solvency of a state is a different concept from
that of a company or a financial institution. It ultimately depends on
the economic and political sustainability of achieving and sustaining a
given level of primary budget surplus to stabilise and reduce the debt.
If a country commits to a certain recovery programme which justifies the
financial support of the other partners, it cannot be considered
insolvent and unable to reimburse its debts. Why should it in such cases
restructure them? On the other hand, if debt restructuring is made too
easy, or too ‘orderly’ – to use a fashionable term – market participants
may consider it the easy way out for countries and might be tempted to
take speculative positions from which they would profit in case of
default. In other words, a restructuring mechanism, if too simple, could
lead to moral hazard. Furthermore, the very nature of the markets would
mean contagion spreading immediately to the other countries, as
participants would start guessing which other country might need to
undergo restructuring.

To sum up, using the words of a recent IMF document, in today’s
advanced economies default is UUU, “Unnecessary, Undesirable and
Unlikely”. It is nave to think that there is such a thing as an orderly
debt restructuring mechanism.

What is the solution then, if we want to avoid moral hazard and
unduly bailing out the private sector? The best way to involve the
private sector is to ensure that a country which experiences financial
difficulties implements a credible adjustment programme, which convinces
markets to invest again in that country. Experience shows that
successful programmes – with ‘success’ being measured by the policies
which have been implemented – have ultimately made it possible to regain
market confidence. It may take some time, and some re-profiling of
official financial support, but in the end access to markets was
regained.

If some form of rescheduling or re-profiling of the debt over time
turns out to be necessary, for the debt to be sustainable, this can be
achieved in an orderly way only through an agreement between creditors
and debtors. Other forms of constrained action, on the creditor or on
the debtor side, are bound to lead to litigations and produce disorderly
effects on financial markets. In this respect, the adoption of
collective action clauses by the euro area member states would make it
easier for creditors and debtors to agree on a fair burden-sharing. This
was the conclusion of the discussions in the context of the IMF and can
be further explored at European level.

Another way to prevent market participants from being bailed out is
to use the funds made available from the official support mechanism to
purchase debt on the secondary market, at the prevailing market
discount, rather than reimbursing the maturing debt at the nominal
value. In this way holders of debt instruments willing to sell would
have to accept the market haircut. This possibility is envisaged in the
ECB’s proposals.

To conclude, the European Union is a community of law, subscribed
to by the Member States in which pacta sunt servanda. This refers to all
the pacts, starting from fiscal discipline in the member states to the
commitment of the Member States to pay their debts. In my view, we have
to be very careful in considering exemptions, such as providing the
possibility for countries to unilaterally modifying the value of their
debt contracts. The euro, and its underlying institutional construction,
is about respect for the law. If any changes are to be made, they should
be to strengthen these principles rather than to provide exemptions –
dangerous exemptions which could undermine the stability and cohesion of
the whole Union.

Thank you for your attention.”

END

[TOPICS: M$$EC$,M$X$$$,M$$CR$,MT$$$$]