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I will structure my observations around four points:
This “tale of two debt overhangs”, as some have called this twin crisis of banks and sovereigns, had uneven effects across euro area countries. Some countries were markedly more affected than others, which contributed to increased financial fragmentation in the euro area. This also laid bare further fragilities that had been accumulated in the past, including the fact that some euro area countries had neglected structural reforms and as a result faced competitiveness losses and the built-up of external deficits. While these fragilities had not gone completely unnoticed, and had been pointed out early on by the ECB, they had not received the attention they deserved until the crisis struck.
As a further step to address the banks’ funding problems and financial fragmentation within the euro area, the Eurosystem started intervening directly in securities markets in order to correct severe mal-functioning of certain segments. The first action of this type was the Securities Markets Programme (SMP) launched in May 2010, followed by a purchase programme for bank-issued covered bonds started in October 2011, and finally the Outright Monetary Transactions (OMT) programme announced in September 2012 but so far not activated. Let me now spend a few words on the OMT programme in particular.
It is important to emphasise that the design of the Outright Monetary Transactions programme creates the right incentives for governments to improve their performance with respect to fiscal prudence and structural reforms. In fact, OMTs will only be activated in cases where the beneficiary country has signed up to strict and effective conditionality attached to an appropriate EU/IMF lending programme. They can also be considered for Member States currently under a macroeconomic adjustment programme, but only once they have regained bond market access. Moreover, the design of OMTs entails interventions only in the relatively short end of the government bond market – up to three years’ time to maturity – and they will be fully sterilised, meaning that the Eurosystem would absorb all amounts of liquidity injected by OMTs.
At the beginning of the crisis, it became painfully evident that the euro area was also lacking effective crisis management tools. First, the design of the euro area assumed that stabilisation would take place at the national level and to a large extent automatically. The crisis has shown us, however, that shock absorbers at the national level are insufficient in case of a major financial and economic crisis. Indeed, the scale of the shock after the 2008 financial crisis was unprecedented in a number of countries and it far exceeded their national shock absorption capacity. The euro area had no mechanisms to provide financial support for countries in difficulty, ensure efficient risk sharing and prevent cross-border contagion; notably, there were no area-level institutions to prevent fiscal sustainability from being jeopardised by severe problems in their domestic banking systems. This underscored the pitfalls of a design that relied too much on the national level to fulfil the stabilisation function.
Second, the financial crisis demonstrated that financial contagion is the unintended consequence of financial market integration. The euro area, however, was lacking effective instruments to mitigate contagion. Policy instruments that can act as circuit breaker, limiting thereby negative feedback loops, are an essential crisis management tool in a monetary union.
To summarise, one of the key lessons that we have learned from the crisis is that the design of the euro area was incomplete. Indeed, the euro area lacked certain institutional elements which are associated with federations and which act as crisis prevention mechanisms ex ante as well as shock absorbers ex post. The logical corollary is that we need to compensate for these “missing institutions” by establishing a much stronger financial and economic union. I will now outline the main elements of that endeavour. I will first discuss reforms implemented at the national level – though sometimes also decided in the context of EU-IMF lending programmes – and then move to the reforms at the EU or euro area level.