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Assessing the reaction of the EU to the Euro-zone crises.

The crisis of the sovereign debt in the periphery of the Euro-area seems to have been the consequence of the combined effect of the global financial crisis and the structural asymmetries affecting the EMU from its establishment. The European Commission was taken completely by surprise by the global financial crisis and the subsequent recession. Moreover, European responses to the financial crisis have been fairly scattered and erratic, and EU authorities have not been capable of initiating coordinated responses to the crisis if not at the very last minute. Equally, macroeconomic responses to the crisis have not been coordinated at the EU level. Stimulus programs were decided at the level of the nation state, had a national scope and produced a number of controversies regarding "financial protectionism" as relating to the support of national industry or national economic players vis-a-vis their European competitors. This might even have a disruptive impact on the EU as a whole, especially in the wake of the sovereign debt crisis affecting the weakest countries in the Euro-zone. Finally, external support for Europe's periphery has been largely delegated to the IMF.

All this must be inserted in the context of the limited potential of the Euro as an international reserve currency. Overall, despite the establishment of the European Stability Mechanism, it seems inevitable that the only real rescue mechanism for any big Euro-area member state in serious financial strain would be the European Central Bank acting as a hidden lender of last resort.

ECB's Response to Euro Crisis

In reality, the European Central Bank is still far from becoming the official "lender of last resort" of the euro-zone area, something that would be more than natural in a currency union. However, in the wake of the collapse of Lehman Brothers in October 2008, the ECB started a novel monetary policy relying not only on conventional measures, such as interest rate cuts, but also on "non standard measures", which included "enhanced credit support" and the "securities markets programs".

This configures a new role for the ECB as "hidden/modern lender of last resort" or, as referred to in some scholarly interventions as "intermediation of last resort". The enhanced credit support relied on (a) increasing the share of liquidity supplied at its long-term refinancing operations (LTROs) relative to its regular main refinancing operations (MROs); and (b) increasing the maturity structure of its LTROs. Most importantly, all the ECB's refinancings would be conducted on a 'fixed-rate full allotment' basis, rather than a variable rate tender format, as used before. In other words, contrary to normal practice, financial institutions were allotted the full amount of liquidity that they wanted at the prevailing interest rate, which was and still is very low.

Moreover, the program allowed the Eurosystem to accept as collateral in its refinancing operations assets that had become illiquid in financial markets (notably mortgage-backed securities). In its operations, the Eurosystem provided cash loans against the security of these assets. Finally, the Eurosystem increased the number of counterparties eligible for Eurosystem operations from 140 to around 2000 and started protecting the counterparties' anonymity to avoid domino effects.

Since 2008, the ECB has successively introduced six-month, 12-month and 36-month terms for LTRO finance. Each of these new issues has been heavily subscribed, with eurozone periphery banks in Ireland, Italy, Spain and Greece taking the majority of the first 36-month issue in late 2011. The second 36-month issue was in February 2012 and also this one was very successful with weaker euro-zone banks. In addition, in May 2009 the ECB announced a first [euro]60 billion Covered Bond Purchase Programme (CBPP) to purchase euro-denominated covered bonds issued in the euro area over the period until June 2010. A CBPP2 started in November 2011.

The Era of Non-Standard Measures

The second non-standard component of the ECB's response to the crisis, together with enhanced credit support measures, was the launch in May 2010 of the Securities Markets Programme (SMP). This allowed the Eurosystem to buy both private and public euro area debt. Given the constraints of the provisions of the Treaty on the Functioning of the European Union, Eurosystem purchases of government bonds were strictly limited to secondary markets and fully sterilized by conducting liquidity-absorbing operations.

On September 6, 2012 the SMP was superseded by the Outright Monetary Transactions (OMT) allowing for unlimited purchase of bonds of struggling countries in secondary markets subject to conditionality. Conditionality implies that member states willing to benefit from the OMT have to agree to the implementation of a full or precautionary ESM macroeconomic adjustment programme. Also the IMF should be involved in the elaboration and monitoring of the country-specific conditionality. The Governing Council of the ECB maintains the right to initiate, continue and terminate OMT in full discretion. In addition to these measures, the Eurosystem continued to provide liquidity in foreign currencies, most notably in US dollars.

Summing up, with the so-called Long Term Refinancing Operations (LTROs) the ECB inaugurated three-year lending programs, which provided virtually cost-free liquidity to banks. Thus, especially in the weakest euro-area, banks were incentivized to acquire the sovereign debt of countries under attack gaining from the interest rate differentials. Moreover, the SMP first, and then the OMT rendered the role of the ECB as a "hidden lender of last resort" more evident and effective, de facto providing for a sterilized monetization of debt. Despite this, the German government has continued to prevent the ECB from transferring risk to its own balance sheet, as the Federal Reserve Bank has done, thus refusing to give the ECB an official role as "lender of last resort". This remains as one of the obstacles before EU's effective reaction to eurozone crisis.

*The Turkish version of this article was first published in the January 2013 issue of USAK's monthly journal, 'Analist'.

Leila Simona TALANI (*)

(*) Dr., Jean Monnet Chair in European Political Economy, Department of European and International Studies, King's College London.
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Author:Talani, Leila Simona
Publication:USAK Yearbook of Politics and International Relations
Article Type:Reprint
Geographic Code:4E
Date:Jan 1, 2013
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