After the financial crisis in 2008, the European Financial Stability Facility (EFSF) and its successor, the European Stability Mechanism (ESM), provided financing to countries that had lost access to the capital market. At a SAFE Policy Panel on 19 September, Klaus Regling, the ESM´s first Managing Director, reviewed the beginnings and necessity of the European backstop institution, presenting the book “Safeguarding the Euro in times of crisis – The inside story of the ESM”. Further, he discussed the future role of the ESM together with Benoît Cœuré, Member of the Executive Board of the European Central Bank (ECB), and SAFE Director Jan Krahnen.
Regling emphasized that establishing the EFSF and later the ESM had been crucial to stabilizing the European Monetary Union (EMU). “Our crisis response would have been easier and faster if – at the beginning of the crisis – we had already had a backstop like the ESM”, Regling stated. The ESM works like a fiscal pillar of the Monetary Union. While the ECB’s monetary tools stabilized financial institutions after the crisis, the EFSF provided financing to European countries which had lost access to the capital markets.
Regling said that the crisis could not be foreseen and a “lender of last resort” for member states, therefore, did not exist in the Monetary Union. While the International Monetary Fund provides financing to illiquid developing countries, its capacity would not have been sufficient for developed European countries. Regling explained that the borrowing European countries could regain financial stability because of the long planning horizon and the good credit rating of the ESM. For him, there is no risk for moral hazard because the lending is conditional to reforms in the borrowing countries. The five countries which received funding – Ireland, Portugal Spain, Cyprus, and Greece – are now the best-performing countries in the EU, Regling argued.
Prospects of the ESM
The ESM will be extended by 2020 providing a backstop to the Single Resolution Fund (SRF). Further, the ESM will get more involved in designing and monitoring future adjustment programs and will give easier access to precautionary loans. However, Regling said that he sees the need for further reforms: “There are still a few more steps needed to make the euro area crisis-proof in the future”, he argued.
At the discussion, he proposed three additional backstops. First, a backstop is needed to protect deposits which would reduce risks and weaken the link between banks and sovereigns, Regling said. Second, a liquidity resolution backstop would fight potential liquidity shortfalls. According to Regling, this is a difficult issue because the ESM would not have enough resources for this kind of backstop. Third, a backstop for macroeconomic stabilization could complete the architecture of the EMU. Regling suggested a revolving fund that would complement national fiscal buffers. The fund would not rely on permanent transfers between member states. Therefore, it could be created without a new budget if countries repay their loans after recovery. Regling advocated for more fiscal risk-sharing among the member states. National governments have lost both monetary and exchange rate policy as an instrument to respond to macroeconomic shocks, he argued.
Benoît Cœuré agreed that fiscal policy does not play the role it should: “It is high time for fiscal policy to take charge”. While countries that have fiscal space should use it, in countries where government debt is high, rebuilding fiscal buffers is the best contribution to support the single monetary policy. Because of fault lines in the initial architecture of EMU, and a lack of private cross-border risk-sharing, monetary policy had to bear the brunt of economic adjustment, which the ECB did within its mandate, thereby protecting the integrity of the single currency, overcoming financial fragmentation, and putting the economy on a recovery path.
Cœuré sees the ESM as a “resounding success.” The ESM was a start-up at first but graduated into a key European institution in less than ten years, and has turned into a trusted partner of the ECB. Cœuré recommended integrating the ESM into the Community framework to make it formally accountable to the European Parliament. Further, he explained why majority over consensus voting would produce better economic outcomes and that the ESM balance sheet should be leveraged to deliver the full range of backstop functions expected in a crisis from a “stability mechanism”.
Regling agreed with these points. He would favor establishing the ESM in the primary legislation which would result in a change of the EU Treaty. Back in 2010, he said, an intergovernmental institution had been right because it had been the fastest way to develop this institution, he explained. Although the majority decisions would be faster, until now, the decision-making reached always a consensus when needed, he said. However, Regling is skeptical that member states are willing to give up their veto rights at this time.