European Central Bank II: Financial Crisis

Dear Delegates,

It is with great pleasure that I introduce you to the 7th annual YMGE conference. My name is Haci Catalbasoglu, and over the course of the next few days I will be directing the European Central Bank. The ECB is a vital component of the economic prosperity of the entire continent and plays a large role in most European’s day-to-day lives, and we all look forward to the deliberation, problem solving, and teamwork that will flourish from such an environment.

Speaking of environments, I was first introduced to the Yale International Relations Association as a junior in high school during one of the Yale Model UN conferences. I still remember how nervous I was during my first conference, but remember that you eventually get the hang of it. At Yale, I am a rising junior in Davenport College. I row for the Varsity Men’s Heavyweight Crew team (Go Dawgs!), compete on Model UN team that travels around the country for conferences similar to this one, and am heavily involved with New Haven politics (let me know if you have any questions!).

Your time in this committee will be very enlightening, constructive and eye-opening. Because the format of this conference is that of a crisis, you will always be on your toes and ready to react at any given moment. Representative of contemporary European politics, you will need to collaborate and think quickly. Much of what you learn and experience at the conference will be directly applicable to your lives when you get back home.

If you have any questions/concerns about the conference, Yale, the committee or just want someone to talk to, email me at Hacibey.catalbasoglu@yale.edu. I look forward to meeting you all in November!

With love,

Haci

Committee History

In 1998, the European Central Bank was established in Frankfurt, Germany to regulate the Euro in the new Eurozone. Its primary roles are to issue bank notes, keep interest rates near or below 2%, and keep liquidity within the market. Another responsibility, of lesser importance, includes serving as the bankers’ bank. In other words, whenever a smaller, private bank needs to borrow capital, it may do so from the ECB. Because the ECB also issues the Euro, its branches are heavily intertwined with that of member states’ governments and banks, giving it amenities and powers that other similar institutions do not equip. For example, the ECB has the unilateral power to print Euros -- though the mints of various countries can print Euro notes at their mints, only the ECB has the jurisdiction to issue the creation of those notes.

Other responsibilities of the ECB include being a lender of credit to other smaller banks as a last resort. By lending capital to these banks, the ECB can deter the instability that would result from the bank's insolvency. Further, the ECB regulates the monetary policy in the Eurozone (e.g., interest rates), while fiscal policies (e.g., taxes) are delegated to their respective member states.

Executive decisions at the ECB are fulfilled by its Governing Council. This council is comprised of governors from other Eurozone national banks and the ECB’s executive board. The second decision making body at the ECB is the Executive Board. The Executive Board is responsible for the implementation of monetary policy and running the bank. Thirdly, there is the General Council, which deals with issues pertaining to the adoption of the Euro in countries that previously utilized its own currency. Finally, the Supervisory Board meets twice a week to ensure the smooth progress of activities on other boards.

Through much of its existence, Europe has continually been at war with itself. The height of Europe’s infighting came during WWII: millions of lives lost, governments collapsed, and economies withered. Following such carnage, France’s Jean Monnet proposed a unified, coalesced Europe where economies would flourish hand-in-hand. Monnet’s persistence is considered by many to be the first domino to fall in the creation of the European Union (EU). This persistence birthed a coalition of European countries (France, Germany, the Netherlands, Italy, Belgium, and Luxembourg) that signed the 1957 Treaty of Rome. The treaty established a universal marketplace (the European Economic Community) and kick-started economic growth in its member states.

Up until the creation of the EU, nearly all European countries employed trade tariffs that hampered the free flowing transfer of goods between the countries. Furthermore, in order to trade goods, the buying country had to convert its currency to that of the selling country. This caused countries with weaker currencies to have to convert their capital in order to purchase goods from other, more powerful countries.

With the introduction of the European Union in 1996 and the Euro in 1999 many of these previous barriers were lifted: Countries that were in the Eurozone (used Euro as the national currency) began to freely trade between one another, without having to exchange currencies or pay tariffs

The political, social, and economic standing of a country is always determined by its financial standing, and in order to manage such finances, certain institutions like banks must be put in place. These banks manage the various nuts and bolts of a state's economy such as commercial banks, investment banks, and other financial entities. In short, banks play a key role in the success or demise of their nations and therefore the globe.

European Financial Crisis: History

The ECB and its member states were brought to the forefront of the global community's attention after the 2008 financial crisis that sent shockwaves through the global financial system and brought a handful of countries to its knees: Portugal, Italy, Spain, and Greece (PIGS). Today, the bank’s necessity is beeing brought into question.

Greece

Before 2001, the currency of Greece was the Drachma. During that year, however, Greece, like all of the other 19 countries in the Eurozone, switched from its native currency to the Euro. This meant that that Greece’s monetary policy (e.g., how much money it could print) was controlled by the ECB. Its fiscal policies (e.g., how much money Greece is borrowing), on the other hand, were controlled by Greece itself. Though Greece and other countries in the Eurozone had basic rules they were meant to roughly follow (such as keeping the national deficit at or below 3%), these rules were loosely applied, allowing Greece to misreport budget deficits. In 2009, for example, Greece reported that they would bolster a whopping 13.9% budget deficit. Furthermore, before joining the Eurozone interest rates for loans to Greece were 18%, which kept the government in check. Since joining, however, the interest rates fell to 3%. This in turn allowed Greek officials to borrow excessive amounts of money without considering its repercussions.

After the financial crisis in 2008, Greece's economy tanked, so it ended up borrowing more money from other European countries. This in turn increased the deficit and interest rates. In order to pay for this extra deficit, Greece took out even more money and further increased its debt, which further increased its interest rates, which further increased its debt. In order to remedy this, the ECB imposed austerity measures (stark decreases in public spending) on Greece that worked for a bit, ended up battering the Greek economy. As the economy shrank, the government’s ability to tax its citizens did as well, which forced the country to cut spending on the public. Today, around 1 in 4 people in Greece are unemployed, and 30% of the country's citizens live in poverty.

In most scenarios, when a country is facing such economic hardships, it would just print more money. Though that would cause inflation, the ramifications of not inflating your currency and staying complacent would greatly outweigh that of having nearly 1 in 4 of your citizens not having enough money to meet their daily nutritional needs. There are reports that public buses don old, worn out tires because of lack the of funding, which is a public hazard. Further, some hospitals cannot even afford to hire doctors or buy medicine or syringes because of the crisis. Greece cannot just print more money to fix this problem because that jurisdiction falls only under the ECB. If Greece decides to go forth and print some form of its own currency, then it would effectively be exiting the Eurozone.

Italy

Italy is currently in a similar situation to that of Greece. Instead of the mishandling of capital by the government, enormous, too big to fail, banks have winded the country's economy. Per a study by the the investment bank Mediobanca over a fifth of all the banks in Italy have a Texas Ratio (TR) of over 100%. Simply put, a TR is the value of a bank's bad loans divided by the bank’s appraised value plus capital in reserves. As seasoned investor Steve Eisman puts it, a bank’s TR is "all the bad stuff divided by the money you have to pay for all the bad stuff".

Moreover, recent legislation passed by the ECB dictates that in order for a bank to qualify for financial assistance, banks have to be solvent and not have a TR of 150+, which automatically disqualifies a large division of banks, including Poplare, Vicenza, and Unipol Banca. Further, the EU’s recent mandates state that before a bank can receive relief funds, investors and creditors have to bear the first 8% of the burden thereby incentivizing not going bankrupt. The world’s oldest bank, Monte dei Paschi, was the first be effected by these reforms. The ECB, in the coming months, will determine how much bailout money will be given to the bank.

Today, an unprecedented 18% of Italian loans have been defaulted. Reports show that an injection of 40 billion Euros would be needed to keep Italian banks solvent. To put this in perspective, there are 1/5th of Italy’s GDP worth of loans out there worth of loans out there many of which has, or will, defaulted. This banking crisis is so pertinent that there are currently more Italian banks than there are pizzaries or pharmacies in the entire country.

Portugal

The Portuguese economy, for the last decade, has been in shambles. In fact, the economy has grown less than the U.S. during the Great Depression or Japan during the Lost decade. In the Brookings Papers on Economic Activity "Portugal was one of the fastest growing countries in the world during the 15 years after it joined the Economic Free Trade Area in 1959. The years after joining the then European Community in 1986 were likewise marked by great progress. Yet, joining the European Monetary Union came with a prolonged slump," explains Ricardo Reis.

The Portuguese economic crash can be attributed to two reasons: 1. With the influx of the internet age, jobs started shifting towards more unproductive firms in the non-tradable sector. This caused productivity to fall. 2. Portugal began raising taxes in the turn of the 20th century and continued through 2007. The Euro crisis of 2010 imposed new austerity measures that further increased taxes on the Portuguese. Similar to Italy, Portugal has banks that are too big for the country. It is estimated that these banks house up to two-thirds of the country's GDP in its vaults.

Spain

In 2007, Spain had the Eurozone’s best economy. After 2008, though, that changed. Spain fell victim of any and every kind of crisis imaginable: debt, real estate, downgrading 25% unemployment, etc, Further, the unemployment rate of young Spaniards sits around a whopping 45%, irrespective of the fact that this new generation is the most educated in Spain’s history. Austerity measures hit college students hard, which caused many of them to leave the country in hopes of better opportunity. These people aged from 20-30 can be seen by some as a “lost generation.”

The glaring issue in these cases and the Eurozone as a whole is the lack of unity between the independent members. In the United States, for example, when the state of Kansas needs credit, other states are willing to hand out money, because at the end of the day, all fifty states belong to the same unified country. In Europe, this is slightly different. Yes, the success and demise of one country has an effect on the other, but because the Germans feel no obligation to help the, say, Spanish, and because both countries have their own fiscal policies, Germany will not feel the need to disrupt its own economy to aid that of Spain’s. In 1946, even Winston Churchill famously declared that “We must build a kind of United States of Europe.”

● ECB and Eurozone allowed countries to borrow money from other member countries with little interest rates.

● The ECB regulates the monetary, not fiscal, policies of the Eurozone.

●  Greece obtained credit with low interest rates from counties in the Eurozone.

● When Greece was unable to pay off its debt, it began borrowing more money with higher interest rates.

● After Greece accumulated a crippling debt, many economists began to question the value of the ECB and Eurozone.

● The underlying issue of Eurozone members not feeling accountable to the failure of other Eurozone country continues to be a dilemma many seek to solve

Case Study: Greek Financial Crisis

Failed Attempts at Recovery

Four: the amount of times that Greece will have potentially been bailed out if it agrees to a deal worth 8.5 billion Euros in the coming months. The latest influx of money to Greece will be a drop in the bucket of its 86 billion Euro bailout since its financial crisis began. Because Greece’s monetary policy is controlled by the ECB and the Greek can no longer print money, many economists have questioned whether Greece’s membership in the EU is sustainable for its people. Today, Greece is facing roadblocks from gaining funding to keep its economy crawling from institutions such as the International Monetary Fund (IMF). In order for Greece to continue receiving funding, powerful creditors like Germany must have confidence that Greece can realistically rebound from such a crisis. One way for Germany to regain confidence in Greece’s economy would be a stamp of approval by the IMF. The IMF is worried that Greece will never be able to pay off its debt, which is equivalent to 180 percent of the country’s gross domestic product. If left be, the IMF projects that the country’s debt will engulf more than 250 percent of its GDP.

Many countries have, since Greece’s crisis began, sold their Greek bonds and assets so that they would not be affected by the situation there. In fact, many Greek outlets accuse the IMF and ECB to have lent Greece more money with higher and higher interest rates in order to buy time to sell all Greek assets and distance themselves as far away from the situation as possible. Further, during this time, Europe has taken a number of precautions to ensure that a catastrophe in one country will not bleed into the other countries.

● Greece has inherited 86 billion Euros of bailout money since its financial crisis began.

● The IMF projects that the country's debt will engulf more than 250 percent of its GDP.

● The lack of control over its fiscal policy inhibits Greece from being able to print more money.

● Many Greek economists believe that bailout packages were given to Greece in order to buy time for investors to cut their loses and sell their Greek bonds

With that in mind, many economists argue that Greece leaving the EU would not be so detrimental after all. Greece's economy is miniscule compared to the rest of the EU member states. Further, Greece would now be able to default, set its own monetary policy, and print its new currency. One factor to keep in mind is Greece’s geographic leverage over other the EU. With a rise in nationalism and fear of foreigners, many European countries have begun to close their borders to refugees around the world, especially those from the war-torn Syria. Greece is seen as a bridge between the Middle East and Europe, so had Greece allowed it, it could have let refugees freely enter its continent and travel to countries that otherwise would have not been welcoming to them.

● By leaving the EU, Greece would finally be able to pay off its debt by printing its own money.

● Greece has leverage over the EU by essentially being the gatekeeper to a significant influx of Middle Eastern refugees into Europe.

Debt Repayment

Now, the question at hand is where to go moving forward. Should Greece accept another stimulus package or should it tighten austerity measures? One method by which to address the issue would be by once and for all declaring bankruptcy. This way, instead of continually paying back the absurd interest rates imposed on them, Greece can freeze the rest of the debt it owed and come to the negotiation table with a timeline of payments to the most senior loans and work its way down the list. Though this avenue seems tough, it is possible. A handful of Latin American countries have been through the same process in the 1980s and 1990s. A second suggestion would be to cut ties with the Euro once and for all. If one borrows money from a bank, inflation will devalue the money in that person's pocket but not have an effect on the amount of money actually borrowed. In other words, by printing more money, the Greek government can quickly pay off its debt. This would undoubtable lead to inflation, but with the proper regulations and negotiations in place, inflation with any sort of economic growth would be a godsend for the Greeks. A third, more unconventional, suggestion would be to sell off parts of Greek land to investors. Greece has some of the most attractive beaches and island on the globe; selling those would undoubtedly make a dent into the billions of Euros deficit Greece is in. More importantly, it would force Greek citizens to take moderate proposals more seriously.

● In order stand back on its feet, Greece should officially declare bankruptcy. This would freeze Greek debt and buy time to construct a clear, thought out scheme to repay its loans.

● Greece should leave the EU and begin printing its own money. This will cause inflation and will take years to recover from, but there is precedent, and Greece may have no other option.

● A radical idea to make the aforementioned ideas seem more reasonable would be to sell off some coastal islands of Greece that investors would jump at buying.

Questions to Consider:

Should EU member states continue to accebe givenpt bailouts?

How can/should Greece use the refugee crisis to its advantage?

How could Italy's exit from the Eurozone backfire?

Should there be an economic (e.g., GDP) cutoff for membership in the EU?

Further Research

Greece was recently approved for an 8.5 million euro bailout. Make sure you follow advancements in the allocation of that capital.

You should read up on the ECB, and understand its highly bureaucratic structure. This is important as every decision made by the ECB is done so with extensive deliberation. Such deliberation has been reason for many to believe that the ECB, an entity that is supposed to be above politics, has become swamped in politics and public opinion.

Research the current international political climate, for example whether the UK-EU compromises indicate that leaving the EU is more beneficial than staying. Further, you should keep in mind how changing global ideologies affect affect the international economy (e.g., the election of Donald Trump in the U.S.).

While writing a position paper is not required, you are more than welcome to send me your thoughts on the topic and/or any questions you have before the conference. The more you prepare before the conference, the better position you'll be in to tackle problems as they arise during YMGE. Again, good luck, and see you in November!