Ladies and Gentlemen,
It is a pleasure to join you this afternoon.
Around the world, people are waiting for a reply to the question that you put at a forefront of this conference: how can we restore confidence to financial markets and return economic growth to the economy. Indeed, is an extremely pressing one, here in Europe and everywhere.
We are in the midst of the worst crisis we have seen in our lifetime. After nearly one and a half years, the turmoil that has rocked the global financial system since August 2007 has now reached a critical stage.
Some positive signals should help us. Action taken by governments and central banks has managed to diffuse the threat of a global financial collapse, but financial markets are still fragile. On the negative side, the economic outlook has deteriorated severely, and the recession is bound to have feedback effects on financial activity.
The immediate challenge we face today is to prevent a situation where a deepening downturn combines with problems in financial markets and creates a vicious spiral of credit losses and write downs, of negative growth and increasing unemployment.
This is the time for further action: without actions based on the use of all the economic policy instruments available we will not restore confidence and the normal functioning of the financial sector, that are the necessary conditions to put a floor under the deepening recession in Europe.
In other words, we need to draw simultaneously on financial, fiscal and monetary policies.
Today I will outline what we are doing in each of these areas. First however, I will begin by outlining the current situation in financial markets and the initial impact of the emergency rescue measures taken so far in the EU.
Financial market situation and impact of rescue plans
Following the collapse of Lehman Brothers in September last year, the financial turmoil intensified to a global systemic crisis and it became clear that liquidity injections by central banks would need to be complemented with massive government intervention.
Since then, 17 Member States have mobilised bank rescue plans that so far total 300 billion euro in recapitalisation operations and 2.4 trillion euro in different guarantee schemes. Responses have ranged from deposit guarantees, debt guarantees, capital injections and asset purchases.
The objective of this intervention was three fold: To stabilize financial markets, to stimulate inter-bank lending and to ensure that the flow of credit to the real economy does not dry up.
Of course, it is still too early to draw final conclusions on the effectiveness of these measures. But I can already say that on the first two objectives we have seen clear results. We have averted the possibility of a full scale collapse of the banking sector and banks have achieved significant recapitalisation. In the fourth quarter of 2008, the amount of capital raised by EU banks exceeded their asset write downs.
We have also seen an improvement –albeit modest- in quite a number of indicators of financial market stress.
Credit default swap spreads have narrowed, although they still remain well above pre-crisis levels. For example, since the onset of the crisis in July 2007, spreads for non-financial institutions have soared from 20 basis points to 200. However, we have seen a narrowing of spreads for financial institutions since the announcement of national rescue packages from a peak of 200 basis points in September to 150 basis points.
The functioning of interbank markets has also improved since the announcement of the rescue schemes. Euribor, Libor and US Libor lending rates have progressively declined since mid-October and the Euribor yesterday fell to 2.15% - its lowest level since September 2005.
But on the other hand, the reports we are receiving concerning credit markets are worrying. We are hearing widespread reports of businesses being denied access to bank credit. Meanwhile, specific problems have been identified in financing large scale infra-structure projects and for financing international trade.
Of course, we knew that there would be a lag between rescue plans being announced and implemented and seeing the effects on lending to the real economy. Nevertheless, the availability of credit has clearly diminished since October 2008 and it is evident that corporate credit markets are not functioning properly, or are pricing risk at abnormal levels. The reported constraints on the supply side of credit are considered to go beyond those justified by the cyclical downturn in the economy.
And failure to normalize credit flows will have serious implications for the real economy.
Last week I presented new economic forecasts for the European economy which indicate that the intensification of the financial crisis is already having a severe impact on global and European growth. The latest IMF projections are bound to show similar results. The world economy has entered a major downturn with the US, Japan the UK and the euro area all in recession. As a result of the falling investment and exports, we forecast that growth in the EU will contract by a further 1.8% this year and by 1.9% in the euro area.
Anticipating this scenario, the European Commission proposed last November an ambitious recovery plan that was endorsed by all 27 Member States. We established a broad consensus for coordinated action in financial markets and in macroeconomic policies that would stimulate demand and cushion the downturn.
Thanks to this swift response, the combined effect of bank rescue plans, monetary easing and national fiscal stimulus measures should help to stabilize the economy during this year, and we can envisage the start of a recovery from the second half of 2009.
But this scenario depends first and foremost on getting credit flowing to businesses and households. A breakdown in the credit market channel on the other hand could make the current slowdown even deeper.
Returning financial markets to normal functioning
Repairing credit and market channels is therefore an urgent priority. The Commission is constantly monitoring the evolution of markets and financial institutions and will carefully assess the effectiveness of measures and their impact on markets. A first interim report was produced in January and a full report will be prepared for March allowing Ministers to assess their national actions against aggregate action at EU level.
The recent announcement of huge losses by some European banks has shown us that we are not out of the woods yet. Several Member States are now considering how to solve the problem of toxic assets. So long as these remain on bank's balance sheets they will continue to undermine confidence and hamper lending. Among one of the possible solutions that some governments and financial authorities are exploring is the idea of creating a 'bad bank' to buy up the toxic assets, thereby restoring trust and kick starting lending. Needless to say, this solution is not free of problems and it is just one among several possible avenues.
But I believe that before rushing into the 'bad bank' debate we have to coordinate at EU level our views on first, what are the 'bad assets' that we need to deal with, second, what is the best way to value them, and only then to address the issue of what is the best way to manage them.
I want to stress at this point that any further aid to the banking sector must be based on the principle of transparency. If governments are to continue putting taxpayers' money into financial institutions, they must know from the outset the situation of that institution: its exposure to various risks, the quality of its asset portfolio and the sustainability of its business model in the long term.
So far I have talked about immediate actions needed to stabilize the financial sector. But it is clear that the fate of financial markets and the economy are highly interlinked. Macroeconomic measures will play a critical role in preventing a negative feedback loop occurring between the markets and the real economy.
Let me therefore say a few words on the steps we are taking in macroeconomic policy to reverse the economic downturn and put a floor under falling confidence and job cuts.
Macroeconomic policies
The European Central Bank has responded to the financial and economic crisis easing monetary policy by 225 basis points in the last three months to 2%. These low levels of interest rates should provide some relief to businesses and families.
However, the effectiveness of monetary policy has its limits, especially when the transmission channel to the real economy is impaired.
This is why fiscal measures have become increasingly necessary to stimulate the economy. Last year Member States agreed to employ a coordinated budgetary stimulus amounting to 1.5% of GDP.
Progress so far has been encouraging. EU governments have adopted discretionary fiscal measures amounting to around 1% of GDP in 2009. A number of Member States have announced further measures to take effect in 2010. If we take the total of these measures, together with the effect of the automatic stabilizers and extra-budgetary financing facilities, then the overall support to the European economy for 2009 and 2010 is estimated at around 4 points of GDP.
Our task now is to ensure that the packages announced are implemented as quickly and as fully as possible so that they have the necessary impact on investment and private consumption. We will present an assessment of their impact in February.
We will also be paying a great deal of attention to the sustainability and reversibility of these fiscal measures. Should plans harm the long term sustainability of public finances it would only undermine their effectiveness and place an unsupportable strain on government budgets in the medium and long term.
This is why it is crucial that we ensure fiscal stimulus measures are rooted firmly within the Stability and Growth Pact and that Member States devise clear strategies to reverse any deterioration in government deficits once growth returns.
The Commission will adopt its opinion on the latest updates of Member States' Stability and Convergence Programmes on the 18th February - in time for a discussion at the March meeting of EU Finance Ministers. Where appropriate, we will also prepare the first reports on excessive deficit situations based on article 104.3 of the Treaty.
Any recommendations to put an end to an excessive deficit will be taken in the weeks after the March ECOFIN. In setting out the appropriate adjustment path and deadline for consolidation, we will draw on the flexibility built-in to the revised Stability and Growth Pact while putting the emphasis on the long-term sustainability of public finances.
Strengthening the financial system
Even as we strive to tackle immediate urgencies, we are also setting our sights on medium term challenges.
We have a heavy responsibility to ensure that such a crisis cannot occur in the future. No more can we tolerate the 'laissez faire' approach to regulation that has characterised the financial sector over the last 20 years. We must design a new system, one based on transparency, rigorous supervision, and vigilant risk management.
Work is progressing well, both at the European and global level. The G20 meeting last November in Washington set down a strict timetable and various working groups are working hard to meet the established deadlines and prepare for the follow up summit in London, April 2nd.
At EU level, we have already tabled a number of important legislative proposals to tackle some of the failings that contributed to the crisis. We have taken steps to protect bank depositors, adapt accounting rules, regulate the activities of credit rating agencies and strengthen rules on capital requirements.
An urgent priority now is to finally tackle the issue of cross border supervision in Europe. After years of piece meal advances, we can no longer push this issue to the side. At the end of February, the High Level Group chaired by Jacques de Larosière will publish its report. I am hoping for ambitious proposals that – within the limits of the Treaty - will set out concrete actions to strengthen European supervisory arrangements. There is now a real necessity to have a single supervisory agency at EU level.
Conclusion
Ladies and Gentlemen, let me conclude.
The European Commission is working hand in hand with Member States and the financial sector to tackle the enormous challenges that lie ahead of us. We have a sound strategy in place and we are prepared to do all that is necessary to restore confidence to financial markets and reverse the deterioration of the European economy.
But we need to keep in mind that the cure to this crisis must extend far further than short term remedies. The crisis has offered us a rare combination of political will and consensus to eradicate the root causes of this catastrophe. This is an opportunity that must not be wasted.
