EU must wise up to financial market havoc

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Series Details 22.11.07
Publication Date 22/11/2007
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How is Europe coping with the transatlantic financial crisis?

So far so good, you might say, at least in comparison with the US, where a full-blown recession is now looming as a result of the sub-prime (ie, worthless junk) home loans crisis. But things might have been looking a whole lot better in the EU were it not for a decision its leaders made at the turn of the century.

Alexandre Lamfalussy, the erudite Belgian baron who headed the European Monetary Institute, the pre-cursor of the European Central Bank (ECB), was charged by EU finance ministers on 17 July 2000 with heading a panel of ‘wise men’ (they were always men in those days) to look at the integration of financial markets in the EU. They duly came up with some ground-breaking proposals, including the Lamfalussy Process, to help speed up integration. But Lamfalussy and his fellow sages were instructed not to address the issue of how to promote better financial stability in Europe.

Fast forward to 2007. During the summer two German banks had to be rescued and one of them, IKB Bank, indirectly a state-controlled institution, may now be needing even more support because of its sub-prime related losses. Northern Rock, the UK mortgage bank, is in such trouble that the Financial Times, not noted for its left-wing views, is writing editorials saying that it should be nationalised. Nobody knows how many other medium-sized European banks may be struggling under the weight of their speculation in hyper-sophisticated structured loan markets. What we do know is that the EU’s vital inter-bank money markets are still not functioning properly.

The conclusions from the 9 October meeting of EU finance ministers highlight just how much needs to be done, in the light of the threats thrown up by the US sub-prime crisis, to improve financial market stability in the EU. Indeed, what is genuinely impressive about this document, as Karel Lannoo of the Centre for European Policy Studies points out, is just how quickly Ecofin came up with these policy proposals after the sub-prime crisis began to hit in late July and how tight the deadlines it has set for action really are.

The conclusions also need to be read in the light of the generally positive assessment, in the recently published report from the Inter Institutional Monitoring Committee, of how the so-called Lamfalussy Process has been working, at least as far as its legislative dimension is concerned. This is a subject on the agenda of the 4 December meeting of EU finance ministers (Ecofin).

But the broad judgement has to be made. The EU is still ill-prepared to cope with a serious (especially cross-border) financial crisis and there is no guarantee that the initiatives being proposed by Ecofin will go far enough. This is worrying. Michael Deppler, head of the International Monetary Fund’s European department, was in Brussels last week (14 November) and he remarked that such financial storms usually blow in from the least expected quarter. If you are not well prepared, "they will push you around", he said.

So the good news is that, judging from the Ecofin statement, the EU is serious about trying to prepare for the next financial market hurricane, whether it is another stage of the sub-prime disaster or something new. But the big question remains, can much needed reforms be implemented effectively?

If anyone wants confirmation of just how big the implementation challenge is, look at London. There, the supposed crisis prevention/crisis management co-operation agreement between the UK Treasury, the Financial Services Authority and the Bank of England was blown apart when it faced its first test, Northern Rock. And this was a crisis restricted to one country. Cross-border financial market supervisory and regulatory co-operation in the EU is even more dysfunctional.

There are, for example, no common insolvency procedures for EU banks. In some jurisdictions there are no banking insolvency procedures at all. In others, procedures can only be activated with shareholder approval. Depositor protection schemes are incompatible and, judging from the Northern Rock fiasco, probably inadequate too.

Lannoo argues for the creation of a new panel of wise persons. He cites the Delors Committee, which laid the foundation for the creation of the single currency, as a model. The timing for creating such a panel, namely the middle of a financial crisis, is not great. But this is probably a good idea.

An open public discussion of the issues, rather than the current succession of secretive crisis simulation exercises and closed door policy debates, is needed to build political support for change.

Such a new panel might also allow broader questions to be addressed. How, for example, do you sort out the muddled responsibilities that currently exist between regulators, finance ministries and central banks in EU countries? Without doing this, improving cross-border co-operation will be impossible. And what do you need to do to integrate those micro-economic and regulatory policy issues on which Ecofin has been focusing with macro-economic prudential issues, which overlap with the ECB’s conduct of monetary policy?

  • Stewart Fleming is a freelance journalist based in Brussels.

How is Europe coping with the transatlantic financial crisis?

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