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11 September 2007

ECON meeting 11 September




In an ad-hoc meeting held before the European Parliaments ECON Committee the Commissioners McCreevy and Almunia as well as ECB President Trichet presented their views on the consequences of the recent financial turmoil.

Commissioner McCreevy reflected on the consequences for Europe of the US sub-prime mortgage crisis and presented the results of the impact assessment on IFRS 8.

McCreevy explained that the European mortgage market is structured very differently from the US so problems on a similar scale are less likely to arise in Europe. Possible contagion effects make regulatory dialogues with the US and with other jurisdictions even more critical.

A key issue is the risk transfer via structured financial instruments, McCreevy said, which needs further attention. However, as regards hedge funds, they cannot be blamed for today's market problems. “The crucial thing is that the EU prudential framework has so far prevented hedge fund failures from triggering wider systemic disruption”, the Commissioner underlined.

On the other hand he views the role of Credit Rating Agencies and their potential conflict of interest is far more critical. “They have been very slow in downgrading their credit ratings; their methodology has been weak and not very well explained”, McCreevy said. “We need to know what rating agencies do and what they don't. What we need are clear, robust methodological rules and principles, rigorously applied.” A number of MEPs criticised the Commissioner for, as they saw it, being slow to act on ratings agencies, despite a call from Parliament in its previous term of office for a report on this issue.

Commissioner McCreevy stressed “transparency is the key to the problem”. and better risk management, but highlighted the Basel II, MIFID and Solvency II projects were designed to achieve this, but were not yet in operation.

Responding to further criticism, notably from Poul Nyrup Rasmussen (PES, DK), over his reluctance to propose regulation for hedge funds, Mr McCreevy argued that is was the regulated banks who held most of the responsibility for lax lending and poor assessment of risk. He warned repeatedly against legislating too quickly in the face of a crisis.

Commissioner Almunia presented the Commissions interim forecast for 2007 estimating 2007 GDP growth of 2.8% for the 27 members of the EU, down 0.1 per cent compared with previous projections.

'The sound economic fundamentals of the European economy will help weather the current financial turmoil', said Almunia. Referring to recent financial turbulence he said that 'no-one could foresee this financial turmoil...but it's too soon to draw conclusions...we don't have to overreact'.

Setting out the ECB's response to money market turmoil sparked by the crisis in the US sub-prime mortgage market, ECB President Trichet explained the series of operations undertaken to inject short term liquidity to the market. “The most important channel for the propagation of the correction turned out to be the maturity mismatch”, he said. “It was the difficulties these vehicles faced in rolling over their short-term funding which created much of the strains we saw in money markets.”

Questioned by Alexander Radwan (EPP-ED, DE), he said that the ECB's primary mandate of maintaining price stability and its responsibility for ensuring the money market functions properly were independent of each other and needed to be kept separate.

Responding to committee chair Pervenche Berès (PES, FR), he said it was not significant that the scale of the ECB's injection of funds was greater than that of the US Federal Reserve. Routine refinancing requirements were always larger in Europe for technical reasons.

Wolf Klinz (ALDE, DE) and Sahra Wagenknecht (GUE/NGL, DE) both asked whether banks which had behaved recklessly were being let off the hook, whether by being rescued or through the ECB's refinancing operations. Mr Trichet stressed that 'Central banks and certainly the ECB will not bail anybody out. We lent at interest, on a 24 hour basis, with collateral. We are not pouring money into bad behaviour. We are permitting the market to function properly so that those who behaved well do not end up being punished by the turbulence. Those who behave improperly will have to pay the price.'

Commenting on the ECB's decision to leave interest rates unchanged last week, Mr Trichet stressed the ECB's view that monetary policy was still 'on the accommodative site' and that 'incoming macroeconomic data confirmed that risks to price stability remain on the upside over the medium term', with the same conclusion to be drawn from money supply data. However, the Bank had decided that, given the high level of uncertainty amid the market volatility, it was 'appropriate to gather additional information and carefully examine all new data, before drawing further monetary policy conclusions.'

Turning to lessons which might be learned from what he characterised as 'a market correction with a significant reappraisal of risk', Mr Trichet said the ECB had repeatedly warned that markets were showing an 'under-appreciation of risks in general.' He said 'the degree of complexity of some products designed for the purposes of repackaging and selling debt instruments has become overwhelming.' He argued that both those selling such products and those buying them had a responsibility to understand and manage the risks involved, and further improvements were needed in regulators' surveillance activity to ensure they did.

The Basel II arrangements would help, but not solve all the problems. 'It is true,' he added 'that the very small number of large global ratings agencies is a real issue for the present functioning of global finance.' He called for potential conflicts of interest to be dealt with and for possible benchmarks of good behaviour to be worked out.

He also argued for rapidly implement the Financial Stability Forum's recommendations for the hedge fund industry to take similar benchmarking initiatives. However, he also noted that “We have to continue reflecting on how to deal with all non-regulated entities. The main channels of propagation of the present turbulences have been the non-regulated constituency of so-called conduits and special investment vehicles and not the highly leveraged non-regulated institutions like hedge funds and private equity funds.”

Finally, he stressed the need for greater transparency to increase trust between financial operators. 'Current sentiment is largely due to the belief that there are obscure facts which are not being communicated,' he said.

Full speech McCreevy






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