08 December 2011

Julie Chon: US lessons for the eurozone - restoring confidence through transparency

Julie Chon argues in a new Atlantic Council - Bertelsmann Foundation issue brief that Europe must learn from the United States' TARP experience, and match a sizeable bazooka with a clear and transparent process for markets to understand how financial mechanisms will work.

She explains how TARP's success was based not so much on the size of the fund, but on clear management, performance oversight, and market transparency--tools that were developed by Congress and effectively implemented starting in January 2009 under the Obama Administration.  Providing transparency and clarity about government intervention in financial markets is just as crucial as the size of the intervention.

---

When it comes to resolving financial crises, size matters, but so does transparency. In both the US and European crises, the drive for size—firing off enough public funds to plug the hole in the financial system—has proven to be self-defeating as markets raise ever higher, unrealistic and inappropriate expectations for government policy. This strategy addresses some of the economics and none of the politics of crisis management. The race to meet the size test distracts policymakers from addressing the real impediment to restoring investor and public confidence: the inherent uncertainty and lack of transparency associated with extraordinary government actions in times of crisis. The absence of transparent decision-making inflicts a costly blow to the credibility of policymakers because markets and citizens cannot see or believe what leaders are doing to stabilise the financial system.

What worked in the United States: A TARP (Troubled Asset Relief Programme) bazooka with safety valves

Although markets have reacted with scepticism to the two options for leveraging the EFSF—credit enhancement for sovereign bond issuance and public-private funds to purchase sovereign bonds—there is still time to build an overarching policy structure that will invite more support for these and other European stabilisation initiatives. A clear decision-making and implementation structure will provide jittery investors better guidance about the direction of future government intervention, and the public with assurances about how and why taxpayer money is being committed to the financial system.

The four safety valves [Management Transparency, Market Transparency, Performance Transparency, Oversight Transparency] from the US TARP experience can offer Europeans building blocks for creating a more enduring  and reliable crisis management structure. In the near-term, they represent vital steps to make crisis response policies more transparent and will go a long way in turning the corner in the European crisis, as they did in the US crisis. These mechanisms can also be built into proposals for achieving longer-term fiscal and political union in Europe.

Conclusion

The United States spent more than a year pursuing expensive, unsatisfactory, ad-hoc financial stabilisation policies. Throughout that period in 2007 through 2008, markets and the public remained on high alert, anxious about the future as the government intervened in markets in unpredictable ways. Nearly two years into the sovereign debt crisis, Europeans are stuck in a similar policymaking rut. Each attempt to add more funds to stabilisation measures has fallen short of market expectations while increasing frustration among a weary public. Part of the problem has been the inability to help shape those market expectations through a defined policy framework with clearly communicated objectives, robust management, consistent criteria for intervention, and strong oversight mechanisms for tracking progress and protecting the public interest. Building these safety valves into European financing facilities should be a priority for the European Commission, European Council, EFSF, and the European Parliament. Taking these steps will be essential to pivoting from confidence-killing to confidence-boosting policy. Adopting some TARP transparency tools will also help overcome persistent roadblocks to financial stabilisation in Europe: parliamentary crises, political backlash, bailout fatigue, and market attacks on European bank shares and sovereign bonds. Transparency is something that markets and political constituents alike can agree on—there should be more of it in future European stabilisation policies.

Full paper

© Julie Chon