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Transcript by
Federal News Service
Washington, D.C.

ALEXEI MONSARRAT: It’s nice to see everybody here and thanks for making it to the rescheduled event. I got kudos and hate mail for canceling last week – (laughter) – so we’ll – hopefully on balance, everything goes okay. I’m Alexei Monsarrat. I’m the director of the Global Business and Economics Program here at the Atlantic Council.

And we are very happy today to have another one of our discussions in a series that we do in partnership with Deutsche Bank called “Mapping the Economic and Financial Future.” And as part of this series we’ve had a number of panels as well as high-level speakers, including Bob Zoellick from the World Bank, the CEO of Deutsche Bank, Finance Minister Lagarde from France, and others. And we will be continuing that series this year and we’ll look forward to seeing a number of you there.

Today we’re going to be looking at the European sovereign debt issues. And this is something, as all of you know, that’s been coming for quite some time and really all year I think we’re going to be seeing some interesting developments and so we’ll be planning to keep this discussion going here as we go on.

The goal here and as always with our panels at the Council is to try to be as interactive as possible, so the panelists will have some discussions and some points to raise, but then we really want to make sure that people have a chance to have a discussion with them.

I will turn things over to our moderator, Susan Schadler, who really was the impetus behind putting this discussion together. She is a senior fellow with the Global Business and Economics Program here at the Atlantic Council. I think many of you know her, but just a little introduction: After 20 years at the International Monetary Fund with her final spot as the deputy director of the European department, she is now associated with us and a number of other distinguished organizations around the world, really.

And thank you, Susan, and thanks to our panelists for being here. And I look forward to a great discussion.

SUSAN SCHADLER: Well, thanks very much for that introduction and, as Alexei said, for all of you who came out a second time. I’m going to just say a few words of introduction here to sort of set the parameters, in a sense, for this discussion. We economists like to have characterizations in very succinct terms for things that we – problems that we now say were always inevitable, but we often fail to predict.

And in that vein, what I would say is that this crisis is, in a sense, the new trilemma. There now seems to be widespread agreement that it’s impossible to have a monetary union, multiple fiscal authorities and the absence of some sort of crisis resolution mechanism. Now, there was, of course, what some would call a lucky run for the euro in the first 10 years of its existence, but these inevitable tensions have now surfaced. So Europe is debating the options – the options for institutional reform. And the outcome of this debate is going to obviously have huge implications for Europe, but I would argue also for the United States and for global financial markets more generally.

There are many questions at stake in the European situation right now and many of them involve, as I said, fiscal governance, how fiscal monitoring is going to take place in the future. We’re going to focus here primarily today on the financial market implications and this question of a crisis resolution mechanism. There are a number – a large number of issues, but let me just call attention to five that I consider to be the ones that apparently are at the center of the tensions within Europe on how to move ahead.

First of all, the bailout facility is probably going to need to be larger and more flexible than the current ESFS is.

A second question is: Will this facility – or, must this facility have the power to purchase individual countries’ government bonds.

Third question: Will there be an E-bond? Is it necessary to have a European financial market that has as its anchor the existence of a single Eurobond?

Fourth question: Will the IMF need to be involved in the use of any ESF funds and what kinds of conditionality more generally would need to back up the use by any country of the ESF in the future? And finally, how will the restructuring of debt be included in the final arrangement that Europeans reach? Specifically, what would be the mechanism for – and would it ever be used – involvement of the private sector in future resolutions of debt crises?

The point of this panel is to exchange thoughts on these and any other issues that my colleagues might see as at least or more important than these. But to consider the strengths and weaknesses that the various issues that are under – or solutions that are under debate right now and their implications for Europe and global governance more generally.

Now, we’re going to have each of the panelists speak for just a few minutes raising some of the key issues from each of his or her perspectives. We’ll start with Hung Tran, who is deputy managing director and counselor at the Institute for International Finance, where his responsibilities have included the institute’s emerging market policy work and global capital market analysis.

Prior to joining the IIF, Hung was at the IMF as deputy director of the Monetary and Capital Markets Department, where he was closely involved in the production of the Global Financial Stability Report – the IMF’s twice annual assessment of global financial markets. Before joining the IMF, Hung worked in several private banks, including Rabobank International, Deutsche Bank, Merrill Lynch and Salomon Brothers in various places around the world.

Angel Ubide will speak next. He is the director of global economics at Tudor Investment Corporation and a visiting fellow at the Peterson Institute for International Economics. He is a member of several international economic organizations and this list is rather daunting, but they include, among others, the Euro50 Group, the ECB Shadow Governing Council, Reinventing Bretton Woods Foundation, the Atlantic Council and the Center for European Policy Studies.

He writes a biweekly column on international economics for El País and he contributes to Vox, Telos and Aspenia. He was formerly an economist also at the International Monetary Fund. We have really quite a rollout of the old IMF – (laughter) – and he has been a management consultant at McKinsey.

And Anna Gelpern, who will speak last, is an associate professor at American University’s Washington College of Law and also a visiting professor at the law school of University of Pennsylvania, as well as a visiting fellow at Peterson Institute. She was an international affairs fellow at the Council on Foreign Relations earlier this decade and before that she served in legal and policy positions in the U.S. Department of the Treasury, where she focused on debt issues, international finance and development issues.

She practiced with Cleary Gottlieb Steen & Hamilton in New York and London, advising governments on debt restructuring, investment and other cross-border financial transactions. And she has extensive research exploring the legal and policy implications of international capital flows, including debt, development and financial globalization.

So with that, I’d like to turn first to Hung, who will start off today. Each of our panelists will make a brief comment and then we’ll open the floor to a Q&A.

HUNG TRAN: All right, thank you very much, Susan. It’s my pleasure to be here. And thanks to the Atlantic Council for inviting me to participate in this panel. What I thought I would like to do is to, one, update you on latest development in the effort to deal with the debt/bank – sovereign/bank debt crisis in Europe and while doing so, touch on the issues that Susan laid out for you.

First, let me give you my conclusion: I think that in the past two months or so, we have begun to see the light at the end of the tunnel. And that is because leaders in Europe have finally realized that what they have done in the past year was wrong. They were reacting to events; they were making really a lot of noises in a very uncoordinated way, hurting the market sentiment. And they were not really grasping the key problem facing them.

Now, following a meeting discussion in Brussels with commission staff, with European minister and deputies and so on, I feel that there is a clear resolution, but they really have to come up with a comprehensive game plan to tackle the problem. And deep down, even Germany now realized that for the monetary union to be underpinned, there has to be more progress toward more economic coordination and fiscal integration in whatever form, but it has to be clearly moving forward. And I think because of that, the view of the market about net sustainability will be changed. And I will come back in my final remark to give you some numbers.

Four key points: One, the FSF – the European Financial Stability Fund – it is clear that it will be strengthened, it will be allowed to raise lendable resources up to the 440 billion euro. How to achieve that is still not clear. You do that by either the six AAA member of the euro area increasing their financial guarantees – still difficult to see because German parliament is loathe to increase any further financial commitment, but cannot be ruled out. Or the below AAA countries putting up more cash to give more cash or collateral to underpin the AAA rating of the EFSF. However, the amount of cash needed to achieve that purpose is quite substantial.

For example, the EFSF launched the first bond two weeks ago – 5 billion euro, oversubscribed nine times, but they borrow 5 billion in order to lend to Ireland 3.6 billion. In other words, almost – almost one-third has to be set aside as cash reserve to preserve the AAA rating of the EFSF. So I think there is agreement that resources will have to be increased.

Difficult to see how it can be done. Lengthening the maturity of the program, which is more or less a done deal. Lowering the interest that they would charge. Ireland and then Greece, more or less a done deal. But the key issue is still how to get to the increased reserves. But I think that part is 60, 70 percent more or less advanced.

Second issue is the shape and the modalities of the ESM, which is the European Stability Mechanism of permanent management or crisis management mechanism, which is the successor of the ESF starting in June 2013. One, in that ESM, I think that they will clarify and formalize the role of the IMF in this whole European crisis management procedure.

The fund will be involved in – together with the commission and the ECB, European Central Bank – in determining if the country is facing a liquidity problem or a solvency problem and in assessing whether or not the effort undertaken by the government is enough to restore sustainability of their debt and their fiscal operation – which is a major development. If you recall, at this time last year, everyone and his finance minister or her finance ministers saying that, no, no, no, Europe is civilized enough to take care of our own problem, no thanks to the fund. Now it’s quite different and I think it is a very positive development.

Third thing is PSI, private sector involvement. Forget the fact that when we say PSI in terms of the nonresident holding of the sovereign debt of the countries involved in Greece, Ireland, Spain, Portugal – many of those institutions happened to be state-owned, but Landesbanken in Germany is not really private, but let’s say, PSI, private sector involvement. I have hope that they will clarify the intention of what they want to do. Basically, PSI will be done on a case-by-case basis, on voluntary basis, using collective action clauses.

And what we recommend to them in my meeting with commission staff is basically to make an effort by the authorities to involve private sector creditors in the discussion from the beginning in a good faith negotiation with the creditors because history and experience have shown that if a sovereign debtor do that, then normally they will get fairly positive result in terms of debt restructuring. The outcome would be acceptable to all parties while preserving their continued to capital markets, which is what we all want to see.

Last but not least, a big problem for them is the insistence which is contained in the euro group November 28 statement that ESM lending claims to enjoy preferred creditor status, second only to the IMF but ranking ahead of any other claims, which is very, very problematic. And practically, I don’t see how it can be done because even within the context of Paris Club, the way the EFSF and the ESM is structured, these animals are intergovernmental entities.

They are not multilateral organizations; they are not based on Lisbon Treaty or the European Union, so as such, they cannot have preference over other bilateral claims. In the context of the Paris Club, they are just a government claim pari passu with any other bilateral claims. So even within the Paris Club framework, that insistence in the euro group statement is already problematic. But it’s to be worked out.

Next point, quickly, as a quid pro quo for Germany to accept all of these enhancement of the EFSF and the permanent mechanism, countries have to sign up for a really tighter economic coordination, including reform policy, including fiscal coordination, including automatic penalties and sanctions if a country deviates from the path of righteousness – (laughter) – which is the right thing to advance. But again, between now and March 25th, when is supposed to be announced, I think it is not easy to get that kind of commitment on board.

Last but not least, stress tests. One key concern about the sustainability of the debt situation in Europe is the strain of the balance sheet of the banks – not all banks, but banks in Greece, banks in Ireland, banks in Spain and in Portugal. And therefore, the next route of stress tests going on into spring is very important.

They indicated they have learned the lessons of the previous stress test, so that this time around will be honest – (laughter) – more rigorous based on loss assumption, economic assumption, but I am more realistic. But I think that if they do so, they will be able to scale – or to give key parameters of the scale of capitalization needed for banks. I think that in countries like Spain, the perception today could be worse than the reality. And if they just, you know, fess up and say, here’s the problem, they can easily deal with that.

Quick example: The bank of Spain estimates that the saving banks, the cajas, in Spain have about 490 billion euro exposure to construction loan, development loans which is undergoing stress – 181 of that is the full loan. Let’s assume that they lose all of that, which is a very severe assumption – zero recovery rate, 180 euro loss. Now, all of that loss is covered 30 percent, or one third, by the dynamic provision in the Spanish banking system. That leaves 120 uncovered.

And assuming the cajas will somehow bear 100 billion of that 120 – which is, again, very severe assumption – if the state were to capitalize the cajas to the tune of 100 billion euro, Spain’s debt-to-GDP ratio will increase by 9 percentage points, which will put it by the end of this year at the level of about 69.8 percent of GDP – which is not great, but compared to the average of the European Union at 84 percent of GDP, compared it with the rate here in this country at the end of this year of 99 percent of GDP, compared it with Japan with its 200 percent of GDP – (laughter) – I mean, it’s not great, but it is manageable.

So to make a long story short, basically if leaders in Europe are able to deliver and be ahead of the curve, then we have the quicker way forward. If they can’t bring themselves to agree and be ahead of the curve, they still move forward behind the curve, being pushed by the crisis.

But basically I see movement toward more fiscal integration. And if you have that in mind, then you will view the problem of net sustainability in Europe not from the prism of a single country like Greece, which is clearly unsustainable – 150 percent of GDP – and instead looking at the average of the European area, which is more sustainable.

MS. SCHADLER: Good. Thanks very much. Angel.

ANGEL UBIDE: Thank you. Thank you so I don’t have to be – (inaudible) – myself. (Laughter.) It’s quite convenient, so I don’t have to pretend to be unbiased. But thank you for the invitation and I’ll just basically continue on the last comment that my companion here was making.

And just to start by saying that from the point of view of what has happened in the last year or so, the true problem has been that the European authorities has managed to confuse absolutely everybody about what the rules of the game are, right? Because if you think about what the true parameters and the macro variables that you have out there, basically with the exception of Greece – and one can argue, why is Greece different from Japan if we have to compare countries here – but the numbers are not as bad as the market is saying.

Just to give you an idea, the GDP weighted five-year CDS of the euro area is double that of the U.S. – it’s higher than Japan. Does that make any sense when you realize that the deficit of the euro area is going to be around 5 percent at the end of this year and it will be 10 percent in the U.S.? So what markets are telling the world is that we simply don’t understand how you work, we don’t understand what you mean by private sector involvement, we don’t understand why you are operating this way.

And I think this is very important because the confusion that the European authorities have put in the markets has created a situation where the sovereign market of some of these countries has become a credit market. These are no longer sovereign bonds, what you have in Spain for example – they are credit paper. And that means that markets are pricing probability of default, not the probability of nominal growth when they determine the price of those bonds or when they make a decision about whether to buy a Spanish bond in an auction or not.

And that’s critical, because once you understand that, you understand that the risk manager of the insurance company of country X – call it Germany – probably is telling the portfolio manager of that insurance company, listen, you have many other bonds that you can choose to buy out there; don’t buy Spain, or don’t buy Portugal, or don’t buy Greece, or don’t buy Ireland until I tell you so. And so it becomes a nonlinear process. It’s not a matter of saying, there is a small change in policy and the price of the bond goes up by one or two percent – it simply disappears.

And that is what we have witnessed in the last several months in Europe. And to some extent, this has happened because the European authorities have followed exactly the same mistakes that the IMF made in the ’90s in the whole process of dealing with crisis in emerging markets. If you remember – and some of my colleagues here in the table may remember a lot of these debates – but there was the issue of putting –

MR. TRAN: That was before my time. (Laughter.)

MS. SCHADLER: I was there.

MR. UBIDE: – too much emphasis on moral –

MS. SCHADLER: I retired, but –

MR. UBIDE: – too much emphasis on a small delivery of programs that were small and normally one dollar short and a minute late and that led to the repetition of packages and at the end of the day, if you take the example of Korea where I was involved – or many others – you ended up this policy in a lot of money that you never said you were going to do a few months before. The internal review in the fund about lessons from those years was we need to forget a lot about this moral hazard issue when the tax situation comes and we have to be big and we have to deliver quickly.

And so the IMF move from sort of ex ante conditionality and very strong to the concept of insurance. If you think about how programs are defined now at the IMF, they go very quickly, they will – with very large sizes and they are disposed preemptively. And that is basically the same route that the European authorities intellectually have walked over the last year, because if you remember, at the beginning it was we are not going to bail out anybody, then maybe yes – without the IMF – and now we are ending in a situation where we are talking about increasing the size of the EFSF, lowering the cost and allowing it to buy bonds and then making it permanent.

So essentially, maybe there is something in the political economy of crisis management that requires to work this process. But I think it has been an interesting parallel to see how the same debate that we had at the fund over a period of 10 years, it has happened in Europe over 12 months. And maybe we should congratulate the European authorities that they have been very quick in learning the lesson. And after three or four months of understanding these things, they have moved forward.

So what do I think that needs to be done in terms of fixing the near-term (battles ? ) or making it consistent with the long-term. I think the key concept here – and it also relates a little bit to the experience with the IMF – is that the euro area is a child of the Great Moderation, right? The economic framework for the euro area was designed for small shocks. And because it was designed for small shocks, it was thought that a balanced budget or a small surplus would be enough and there was no need for a centralized fiscal authority to provide transfers (at ? ) those countries.

And we have seen that that’s not necessarily a good hypothesis – that shocks can be very big and that when shocks are very big, a balanced budget or a small surplus is not enough. Let’s not forget Spain had a 2 percent fiscal surplus in 2007 or ’08. So the solution, I think, is very simple. We need to build an insurance – a fiscal insurance mechanism in the euro area. This is something that was debated 10 years ago when the euro area was created. The political decision was there is no need for that.

And this is very important because this breaks the debate that the euro area cannot have a fiscal union without a political union. Well, that’s not true. You can have a fiscal union ex ante, similar to the U.S. where you share taxes and spending and there is a little bit of autonomy in the regions. Or you can have it exposed where it’s mostly independent across countries, but if there is an asymmetric, big shock, then you can have the transfers as a last resort.

And that is essentially, I think, the concept of a Eurobond as an insurance mechanism. The EFSF, at the end of the day, is the beginning of a Eurobond and it’s going to be very difficult to work back because if the process of crisis management that some European thinkers and authorities have in mind that involves a potential debt exchange down the road of the debt of some of these periphery countries and a replacement by European long-term loans.

If that happens, we will have created the Eurobond. And then it’s a question of how we move from there. So for those of you who don’t know some of the details of the different ideas about the Eurobond, there is one proposal out there – what they call the red and blue bonds – which essentially would mean that you issue at the European level the – I don’t remember if it was red or the blue, but let’s call them red – up to, for example, 40 percent of GDP of each country and then the rest would be issued at the national level. So you would have a sort of two-tier – there would be European debt issuance and there will be national debt issuance.

This would be very important for a couple of reasons. One is, the European debt would always be there as the risk-free asset for the country that gets in trouble. So you wouldn’t be in a situation like what happened to Spain, where you cannot solve a banking crisis using the standard tools – that implies you will capitalize your banking system with government money. Spain cannot do it because it’s scared that if they do that, then the market is going to provoke a run on the sovereign debt.

That’s something the U.S. could do because nobody had doubts about treasuries or that the U.K. could do because nobody had doubts about bills. So this is a way of ensuring that even if there is a shock that is very big, you can still have a risk-free asset. And that is critical as a crisis management tool.

This has to be accompanied, obviously, by some strong ex ante, again, conditionality – call it balanced budget rules, which I think are the way to go – and not just because Germany has put it in the constitution. If you remember, Spain had a financial stability law that insured balanced budgets over the cycle already in 2006. So this has been already happening in some of these countries.

But also reporting, right? The problem we had with Greece was essentially that nobody really knew what the true fiscal numbers were. It cannot be too difficult to endow the Eurostat or any other agency to essentially become the fiscal reporting entity for the euro area. And then we will have one part of the problem that is solved – that is, having doubts about the numbers. And that has to be simple unless there is an issue involved in terms of sovereignty of politics or something else.

And finally comes the issue of seniority that was also discussed here. It would be very interesting if this European bond is not senior to the national bonds. And let me tell you why. Imagine this hypothesis whereby what has been reported in some newspapers – that is, the debt has changed at the end of the year and this EFSF or another entity buys all the Greek bonds. So all of a sudden, Greece doesn’t have any debt that is Greek – it’s all a loan from the EFSF. And then the day after, Greece has to go to the market and issue a Greek bond.

It’s very different from a market standpoint whether that Greek bond is senior or junior to the rest of the debt because if it’s not junior, then I’d be the first one buying it. If I have doubts over whether it’s junior or senior, then I may think about it again and the risk manager will tell the portfolio manager, listen, why don’t you buy something else. So I think that is something that needs to be clarified when they come, but it would be very important.

And then the final point is, Germany insists a lot on limited liability as a precondition for this. And I agree that limited liability is very important – that’s why you would want to have a Eurobond that only covers some portion of the debt of each country.

However, limited liability will not be credible unless there is a credible resolution mechanism for pan-European banks because otherwise we will continue to have the problem that some European countries are small but they happen to have big banks – like the Netherlands, just to pick one country.

And so if we don’t have this, either the system will not be credible or we could end up in a situation where we develop a tremendous home bias, whereby countries only buy the debt of their own countries because you fear that there is going to be another cross-country problem like the one we have seen in the last – in the last couple of years.

So I think that is very important that these two processes move in parallel. And I don’t hear much discussion or talk about the second problem and that’s something that worries me. And I’ll leave it there.

MS. SCHADLER: Okay. Thanks, Angel. And Anna?

ANNA GELPERN: Okay, so, thank you very much. It’s a privilege to be here and I look forward to learning from the discussion so I’ll try to be ultra-brief. Another reason to be brief is that my remit is very narrow. I’m a lawyer and not a European lawyer at that. I think one reason I might be here is that the legal rhetoric has been puzzlingly prominent in crisis response. And in a way, that doesn’t strike me as terribly productive.

So I guess I come from more the emerging-market background. And from there, I think we learn that law, be it treaties, legislation or contracts, is never a substitute for political and economic reality, with the one possible caveat: when it is deeply institutionalized.

So Argentine convertability law was pretty institutionalized but clearly not enough; lasted for 10 years. The clauses in the Brady bonds that said we will never restructure proved to be rather an embarrassment. And I might argue that the no-bailout clause has probably not basked in glory over the past year.

The biggest commitment of all to – against restructuring, I guess, is institutionalization – so the interconnectedness that comes from the euro, the links in the banking-and-payment systems, which would make default terribly messy. But when institutionalization and law pull in different directions, it becomes counterproductive.

So I guess one – the first point that – first lesson of the crisis for me is overusing hard rules, especially for signaling, is more likely to destroy than enhance credibility. It might lead to lies or statistics – whichever way you want to call them – (laughter) – and ultimately, breach. (Laughter.)

The second point, which follows from the first, is that Greece – Greece is not – Greece not restructuring until now and Ireland not restructuring its banks until now is not a function of the law or any legal impediments to restructuring, either of Greek debt or Irish banks. If anything, Greek debt is amazingly restructuring-friendly, if you just look at the documentation.

Going from their specific references to tools like collective action clauses or sovereign bankruptcy, particularly linked to very particular iterations of these concepts – like the 2002 G-10 report promoting collective-action clauses – to my mind, are unfortunate because, literally, if you lifted G-10 clauses and put them in Greek debt, you would have a Frankenstein monster. You wouldn’t have a coherent debt instrument.

All right? So putting something that specific in a public announcement, to me, is probably more credibility-destroying than credibility-enhancing. But then again, if it’s only lawyers who can tell the difference, arguably, who cares? (Laughter.) And I’m happy about that much.

Then probably the most important point, to me, is not a law point at all, which is, who is exposed formally and de facto is all-important in designing the policy response and then in checking the legal infrastructure, right? Another way of saying it is that you have to know what will happen the day after you default or restructure.

And specific exposure on the part of particularly vulnerable institutions, banks or pension funds, radical uncertainty about who was exposed would make restructuring difficult no matter what the rules are. And I might direct you to the example of Chrysler bankruptcy, where the rules, arguably, were not terribly obscure and yet the outcome was not entirely expected.

To that, I think in the 1990s, we wrote off the banks a bit too quickly, right? So the efforts of the 1990s, from which a lot of the current response appears to be borrowed, are premised on creditors as autonomous, dispersed bondholders, not concentrated, regulated institutions. If you’re trying to solve a collective action problem among autonomous, dispersed bondholders, then you might want to have collective action clauses.

Before you have collective action anything, I might argue you should probably identify a collective action problem. Again, not that solving collective action problems, in the abstract, is a bad thing. But as a matter of policy priorities, I think identifying a problem is probably a good thing.

Contracts matter hugely for how a restructuring is done, not so much whether it is done. So I think I should just, actually, conclude with a couple of thoughts. One is that every crisis exposes a slightly different turn of a familiar problem and gives institutions opportunities to reinvent themselves.

So we’ve seen the IMF retooling; we’ve certainly seen Europe institutionally retooling. And we’re seeing the tools of the – that came to promise in the 1990s, be it the sovereign debt restructuring mechanism or the collective action clauses, and the 1980s-90s – the Brady bonds. And we hear mention of the Brady bonds, which is also kind of puzzling because some of the Brady bonds have nothing to do with actually what the Brady bonds were. But we can talk about that.

So this is an opportunity. We’ve learned from the past. Clearly, the use of the old tools will have to reconsider the new problems. But this illusion has to fix an identified problem. And so far, the problem strikes me as political willingness to address the debt. And restructuring process, contractual or treaty, might help chart the path where the will exists but not overcome the deficit of political will or lack of resources, right?

So we the lawyers are here to help once you decide to do something. (Laughter.) So thank you for that.

MS. SCHADLER: You have to want to lose weight to go to Weight Watchers. (Laughter.)

Well, thanks very much. Those were all – tons of interesting things embedded in all of those comments. I’m going to just throw out one question here and then I’ll turn to questions from all of you.

As I listen to all this – well, at least until I got to Anna – I was thinking, boy, what we don’t have here is a German. We need a German here to sort of pound the table and explain why things are really worse than what Hung and Angel seemed to think.

But so, yeah, so, yeah, I have a German surname – (laughter) – even though I kind of – I mean, I’m very much on board with what Angel said about the IMF and the lessons that were taken away from the ’90s.

And I think there’s no question, if you look, for example – well, at what’s been done – what the IMF did in Greece in particular. Ireland, I’ll leave on the side, at the moment. But look at what the IMF did in Turkey in 2000: I mean, clearly the lesson was learned and there was a very different kind of response from that in the ’90s.

That said, I am left a little bit with the question, after hearing this, that there’s kind of no problem that can’t be solved by just going in with a bold approach and a lot of money. Everything can ultimately get fixed. And you really don’t have to worry about all this legal stuff because we know how to fix these problems, which is – which I think is very consonant with, in a curious way, the great moderation, when we felt we really knew how to keep stability. We definitely had the question of inflation and output gaps – (inaudible).

And so I have a little bit of a sense that there’s the same thing going on here – a little bit of a mention of distinguishing the solvency and illiquidity issue but the truth is that those are very nice terms, but I have yet to meet an economist who, faced with the actual balance sheet of a government, is able to say, this is clearly a solvency versus a liquidity problem.

And then I also hear, looking at the United States – hear people speaking about Europe looking at the United States and saying, well, you know, ultimately, there are ways that these fiscal problems get resolved. And the United States has a good set-up – why can’t Europe look a little bit more like the United States in terms of the transfer mechanisms, in terms of – I mean, fiscal rules, really, because most states do have some sort of balanced budget restriction.

But I hope we can have another session like this in a year – (laughter) – and we can see whether we have a municipal bond problem in the United States and whether, ultimately, the United States is saying, geez, what did Europe do about this when they got into this situation? (Laughter.)

So I just threw out these few words of skepticism on my part, although, quite frankly, I probably could have given the same talk as either Angel or Hung just now. Let me open the floor to comments, questions and you can respond to my points in the context of this or not, as you see fit.

Oh, okay. Go ahead.

Q: Thank you very much.

MS. SCHADLER: I think you have to introduce yourself. Is that your – is that – that’s what we do?

Q: I’m the representative of a small European country with very big banks, the Netherlands – (laughter) – that has a triple A status. And my question to you is, listening to all of you and also looking back at what has happened, Europe actually hasn’t managed that badly, right, for an intergovernmental solution to the problems we had.

In 12 months, the European governments have actually come an awfully long way. And if I understand correctly, from your presentations, the underlying situation in Europe is not as bad as it’s sometimes presented to be or perceived to be.

Why do you think that the perception actually – or that the perception that I have, that the United States or the writers in the United States are very, very negative about the euro? I get asked, wherever I go, when is the euro going to collapse? And when is Europe going to collapse? Why is there so much more negative connotation?

Yes, it has taken some time and yes, we still have some way to go. But if you look where we started and where we are now, it seems to me that Europe actually – that the eurozone has been quite deliberate and active and decisive in where we are now. Thank you.

MR. TRAN: Okay. Susan, if I may put on the hat of a German to address the question that you raise and you raise because my boss at the IMF is a German and I live in Germany for four years. So I kind of know enough – something of the German approach to this thing.

The negative comments and negative view in the marketplace, not only in this country but in London, they are very strong about the euro and the development in Europe. It’s not without an element of truth. And the key – the biggest thing is that since the beginning of the euro area, the European monetary union, Maastricht Treaty and so on, basically, all the leaders for political – domestic political reasons keep saying that no, there won’t be any pooling of sovereign – we are still sovereign country. We are independent; we keep our custom, our country, our tradition – we just put the monetary policy together. So don’t worry – everything else remain in – under domestic sovereignty.

And I probably believe in what they say. But the analysts, being rational, really see that you cannot have monetary union without fairly tight fiscal arrangement. The two cannot go together. It took 10 years to learn that lesson but the crisis of last year, in 2010, basically reveal the fundamental flaw of the European economic and monetary union, the way it was.

And I personally feel that in the last two months or so, particularly in Berlin, there seems to be a dawning that, yeah, if we value the euro – because the Euro, after all, has been hugely beneficial for all of the member countries, not only the Greece and the Spain and Ireland but Germany, benefitting from 10 years of very stable exchange rate, to really support its export. More than half of Germans’ export is to the rest of the euro area.

So the leaders in Europe, particularly in Germany, now realize that we need the euro; we keep the euro; we defend the euro. But if we do that, then we need to make further progress on fiscal integration. And if that point gets through, then the skepticism about the sustainability of the euro will decline over time. And I think that behind the improvement in market sentiment is the realization, finally – that people say, aha, these leaders in Europe finally will make the move in the right direction.

However, having said that, I said, also, in my short presentation, you can have either smooth progression by the leaders being ahead of the curve and come up using their leadership and try to educate their voters and present a game plan, which may or may not happen. Or they are being pushed by another crisis, perhaps in Portugal, perhaps in Spain – who knows?

But my point is that if they are being pushed, they still move forward but in a messier way. Messy or clean, they will make progress. And because of that framework of thinking, I think that the problem is containable.

Q: I have a mic. (Laughter.) Peter Rashish from the U.S. Chamber. My question is for Angel Ubide. You said there was some important value to having an ex ante fiscal anchor. But you also said that in the case of Spain, it was actually in fiscal surplus before the crisis broke. And I think I get a little puzzled because in the case of both Spain and Ireland, it wasn’t a question of fiscal – lack of fiscal discipline but rather private sector imbalances that built up.

Should we still be worried about these building up in the future? And if so, what – how they can be addressed by the eurozone? I don’t seem to see as much emphasis placed on that as on this fiscal anchor.

MR. UBIDE: Let me answer and then I’ll answer also – I’ll just make a comment on what you said.

The answer is, it depends. And it depends in the following way, all right. If the – the assumption we had about the euro area until a year ago was that the Spanish bond and a German bond and an Irish bond were the same; from the point of view of a German insurance company or a Dutch bank or a Portuguese fund manager, they were the same thing, just yielding in 50 basis points, above or below.

If that hypothesis comes back, then there is no problem because the buildup of private-sector imbalances in Ireland or in Spain happened under the assumption that the Spanish bonds and the German bonds were the same thing. Now, if you tell me Spain is no longer a part of the European – of the euro area and therefore those two things are different, then I have to look at that balance sheet – at that national balance sheet in a completely different way.

And so the communication that comes from the European leaders is very important because if European leaders are telling me, financial market participant, you should no longer believe in that because I dare to say in public, I think the euro is not a good idea, then I change completely my hypothesis. So you break a fundamental element of the way these economics have been operating over the last 12 years.

So it’s a question of what the political communication and the political position is. Now, what we see in the last few months is that whatever it takes, we’ll all stay together. Then my hope is that it slowly, you know, over the next 12 months, 24 months, people will come back to the conclusion that, okay, we go back to where we were in 2007: A Spanish bond and a German bond are more or less the same; the spread is no longer 20 – by the way, the Spanish spread was sometimes negative to Germany – but anyway, let’s make it positive 50 or 100 basis points. But they are still the same thing.

If that is the case, then no problem. If not, it’s a completely different thing. And I think that’s – that’s where I think that in the leaders need to understand very well that it’s no longer domestic politics. This is a matter of defending the concept of the euro.

MS. SCHADLER: But I thought, isn’t this partly a problem of there being many different kinds of – a few different kinds of crises in Europe? Because Greece is genuinely a different problem from Spain, Portugal or even Ireland, where, seriously, at some stage, you can get a government that has so completely blown it that indeed, they are going to have to default or restructure or something. That’s not Spain.

But Greece is different. And that’s one thing that makes this whole argument very difficult to channel into the right slots because there are different slots.

Q: I’ll also take the microphone roulette. (Laughter.) My name is – (inaudible) – representing Polish-American Congressus (sic) and member of the Atlantic Council. I just received this morning from Brussels – my good friend sent me some e-mail regarding meeting between Sarkozy and Merkel. And they had a discussion: what to do with this problem in eurozone? And one of them – they say that one currency, with one central bank but 17 governments – there is little way to keep individual countries from undermining the shared currency with overspending, banking disaster or growth-choking policies.

So what I observe, myself, also, is that social and financial engineering – it will not work because there are so many individual countries. Who is going to pay them back the money? You have Greece; you have Spain – they have to tax those. Who’s going to pay for that? With that can be a lot of unrest because they don’t want to pay taxes. They already show us that there’s already enough poor. The people are going to revolt if this keep going (ph).

And I’m afraid that there has to be, somewhere, changes – realistic, materialistic-looking, that there is a problem and 17 different countries with one centralized bank is not easy solution.

MS. SCHADLER: Maybe we’ll take a couple of comments together – (laugher) – so that we can get everybody who wants to talk a chance. Okay, go ahead.

Q: I am Arturo Porzecanski from American University. I wanted to ask you about some of the practical steps of some of the things that you had hoped for. For instance, I thought that some things might require a new treaty or things like that. I gather there’s a lot of treaty fatigue in Europe.

So I’m really wondering whether some of the things that, let’s say, the German side wants to get – the pound of flesh they want to get – actually can be easily gotten, considering the institutional, legal and other practical steps that I understood need to be taken.

MS. SCHADLER: Thanks. And then we’ll let – just have one more and then turn to the –

Q: Nicolas Véron from Bruegel and the Peterson Institute. For the sake of European integration, I’ll ask a slightly German question – (laughter) – following the instructions from the chair. And I guess the question is really to Angel.

You said there was a feeling that you cannot have fiscal union without political union, but then you introduce the difference between ex ante fiscal union and ex post fiscal union. And I understand, from what you’ve said, you certainly cannot have ex ante fiscal union without political union.

I think the question we’re going to face – and I see this as a forward-looking question – is can you really have ex post fiscal union without political union? I’d like to have your views on this.

MS. SCHADLER: Okay. Let’s let some people here have a go. Angel, you can start.

MR. UBIDE: Let me say two things. One is, I think the Spanish countries have done a lot, lot, lot, lot, lot more than anybody thought they were able to be 12 months ago.

So Greece has cut the deficit more than six points of GDP – this by the recession of minus 4 percent of GDP last year – and has done reforms in every single part of the economy. For example, there isn’t a single ministerial decision that is valid until it’s posted on a website. I would like to find a country that does that – (inaudible) – international transparency.

So they did a lot of wrong things in the last few years but to accuse Europe of not having the social fabric to do whatever it takes, I think it’s a little bit – it’s a little bit overlooking the facts. I mean, Spain has had a revolution on the financial sector last week. If you look at the details of what has happened, it’s the end of 150 years of history of a system of savings banks. That’s a very serious reform. Imagine reforming Fannie and Freddie overnight and tell me how you do that and what happens the day after. Okay?

So I think one problem with Europe is that there isn’t a good newspaper to tell the stories unless all of you will do this. (Laughter.) And I believe it – I still believe that. I think there is a lot of things that are not communicated properly there and it’s our own fault and we have to pay for that. But I think it’s important to get the story straight.

Now, on Nicolas, we already have it, right? We are bailing – well, I don’t like the word “bailing out.” We are helping Greece go through a process of adjustment that may take as long as 30 years, from what I read in some newspapers, and we don’t have a political union, as far as I know.

Q: Yes, but then the question, if you allow me, is, is it sustainable?

MR. UBIDE: I think it is because we are doing it. The question is, do we want to repeat the situation again down the road? The answer is, if we can avoid it, no. That’s why we are going to push all of these countries to have a much tighter fiscal infrastructure so really, this only happens in a very exceptional circumstance.

So I think the question is – is like, you know, it’s like buying insurance, right? You really try not to use it. And that is what I think the whole concept of this comprehensive solution goes to. That is, the quid pro quo is, I will build insurance and you will become much more disciplined at the same time. And then we figure out who’s cheating first.

But I think we are there, frankly. I think there is really very little room to track back. But we’ll see, of course.

MS. SCHADLER: “There” in terms of the fiscal?

MR. UBIDE: On the ex post – yes! We have created an insurance mechanism inside the euro area and we are using it.

MS. SCHADLER: No, no, no. But in terms of the fiscal discipline, which was the other side of that –

MR. UBIDE: Well, that’s the part that I hope is going to be announced and eventually legislated in terms of debt breaks or legislated bonds, budget rules or any other things in a month or two.

MR. TRAN: Yeah, I’d like to make two points to respond to the three questions raised. One, Arturo’s question about treaty change: My understanding – and please, colleagues from Europe, correct me if I’m wrong – I think the whole idea of this thing is to avoid major treaty change that is subject to national votes and so on and so on, which nobody has the stomach for. And if you subject it to popular vote, at the moment, it can easily be voted down.

So the whole idea is to do it in a limited treaty change, subject only to national parliament ratification. And because of that, this whole cumbersome process of intergovernmental process has been chosen. I said in my short remark that both the EFSF and the ESM, because of that, real reason is intergovernmental thing. It doesn’t have standing in terms of law, treaty law or anything. It’s just a bunch of government agreeing to do things together.

And most definitely, after today’s European Council meeting in Brussels, the leaders –and I know that instead of President Van Rompuy of the European Council, who was, until now, charged with preparing the proposal for limited treaty change at the European Council meeting in March 24-25, it is now Jean-Claude Juncker, who is the head of the Eurogroup, which is just an informal, ad hoc, intergovernmental group. But Juncker is now charged with the leaders who draft the operational modalities of the ESM and present it to the meetings.

So it is a bit awkward because you have the European Commission machinery well oiled, well developed and now you have this kind of ad hoc, intergovernmental process. So that is to answer your question that the leaders are trying to do it in a way that is behind – below the radar screen so that it can get through without major treaty negotiation or treaty change.

On the fiscal union, I don’t think that we need full fiscal union, let alone political union. What we need to sustain the single currency area is a clear fiscal rule which is effective. And that is what they are trying to do to increase the discipline, increase the effectiveness, increase the sanction or what they’re monitoring to make sure that the stability and growth pack going forward will be more abiding and more effective. And a clear rule of a crisis management, which the ESM is intending to do.

So basically, if you have a situation where you have economic policy coordination –which, again, can be done on the intergovernmental basis; governments just agree to introduce into their national law, national constitution, national budget, certain things – then it can be done without treaty. If you have that and you have abiding stability and growth pack and you have the ESM ready with the resources and the conditionality with the help of the IMF to come in and intervene timely, early in any country that need assistant (ph), then I think you can deal with the problem.

And the last point I want to make is the term “bail out.” I think that for journalists to use it is one thing but for serious, serious people to keep using it is really most unfortunate because it is not bail out. It is not free. Imagine the Greeks, who get the 110 billion (euros) package from the EU and the IMF. They really have to do a lot of things – really.

And no government would ever dream of making use of this facility just for fun. So there’s no moral hazard. People who use the term “moral hazard” doesn’t (ph) really understand what they are talking about.

What we are talking about is in any kind of crisis or problem, you always have three key elements: adjustment of policy and then official financing to have the adjustment, which is the fund playing the key role now – the fund with the EU institution. And the third element is private sector involvement so that the private creditors can own some share in the solution. And the fourth element I mentioned is making sure that the banks are healthy and well capitalized.

If you have that, then the official financing should be viewed as part of the overall approach to have a country overcome its crisis. It is not free lunch. It is really very painful and should not be called “bail out.”

MS. SCHADLER: Anna, did you have something to add?

MS. GELPERN: Absolutely. Just a little bit. So, going to Arturo’s question but also answering a little bit the prior question about why does it look so bad when, in fact, it isn’t so bad – I think there’s a tremendous amount that can be done and that should be done, that doesn’t involve treaties at all.

So, for example, harmonizing and making transparent the domestic debt of European governments is a tremendous idea. And the Capital Markets Association, London (ph) put out a very nice document that, you know, goes to that.

Part of the problem is the uncertainty. If I got a penny for every call I got that says, what does this mean? Which are completely unnecessary. Had the debt terms been disclosed and harmonized, a lot of the communication problem might go away.

The other issue, I think, is the bank resolution issue. And so to my mind, the consultation document they came out on bank resolution is much more important than a lot of the noise on sovereign debt. But that may just be my bias. And that goes to, if you know who is taking the hit, you will know a lot of the outcome even if the – you know, laws governing resolution are not as clear as they could be.

And finally, I think it’s quite productive to be having this conversation about seniority ex ante rather than ex post because another problem of the past year is that we woke up to find a lot of debt in the hands of preferred creditors, de facto or de jure – it doesn’t really matter. So talking about it in terms that Angel had talked about earlier, and about senior debt and reserve assets and all of that stuff, I think is very important. And none of it is about treaty change or grandstanding.

MS. SCHADLER: Okay. First here and then there.

Q: I’m Randy Henning at the Peterson Institute and American University. I wanted to pick up on the last point that Anna made and ask about the implications of having the EFSF and the ESM being able to purchase national government bonds in large quantities in the markets – what the implications of that are for the viability of a debt restructuring plan or activation of the collective action clauses. Because if the EFSF or the governments collectively are holding massive amounts of bonds that are then going to be written off, does this make it effectively unusable?

MS. GELPERN: Effectively – sorry?

Q: Effectively unusable.

MS. GELPERN: Unusable.

MS. SCHADLER: Just say yes. (Chuckles.)

MR. TRAN: I had this discussion with Klaus Regling, the head of the EFSF, two weeks ago in Brussels. And my understanding is that I don’t think the intention is for the EFSF as such to go and buy bonds because I don’t think they are set up to really inventory and warehouse whole bunch of government bonds – wonder what they do with the bonds and how they manage them.

The idea is really for them to have a credit line or to lend to governments and the government themselves. Like, Greek government will buy bonds and retire the bonds, basically, taking advantage of the low price trading in secondary markets to do a non-coercive, market-based debt restructuring, so to speak – I mean, to just buy bond at 70 cents on the dollar or 70 cents on the euro; 30 percent haircut, so to speak – but on a non-coercive, market-based approach.

And that the idea is not really to have the EFSF lend enough money to retire a big chunk of bonds because that is a big number – 310 billion euro for outstanding Greek government bonds at this point.

But the idea is to have a bidder in the marketplace. A lot of the problem in the past year is that in the market for sovereign bond for these country, there are absolutely no bidders, no buyers – only sellers. And therefore, price just plunge (ph). And you can see that where there is a big step in and buy just one, two billion of Eurobonds, market improve significantly. So the presence of a bidder with deep pocket, ready to buy, definitely will put a floor under the price of these seven bonds, reduce the volatility. And if they can buy and, you know, retire some bond 1, 5, 6, 10 percent outstanding, by itself, it is not enough. But if it is part of the overall solution, I think it can be helpful.

MS. GELPERN: If I could add to that.


MS. GELPERN: If I could add to that, just briefly.

MS. SCHADLER: Yeah, sure, go ahead.

MS. GELPERN: So the bankruptcy people have a very nice term, which is the pig-to-hog problem. Right? So when a pig becomes a hog, it gets slaughtered. (Laughter.) So senior debt is only senior until it has to be slaughtered. (Laughter.) So in some ways the problem – I didn’t make it up.

MS. GELPERN: But the problem is that you keep moving the same debt until it ends up in a place where it can be quietly reduced. And there’s a transaction cost and a policy political cost in keeping it moving rather than just reducing it where it is.

Now, that cost may well be irreducible political cost, right? So this is the, should we give it to the German banks or should we give it to the Greek government problem, or should we quietly do it at the next acronym? I think earlier is probably better, but I think how many steps it takes before it ends up in a place that can take the right down and how long that takes is an unfortunate political problem.

MS. SCHADLER: Okay, yes. Oh, sorry, no, I promised him first. Then you next. Okay, yeah.

Q: Hi, I’m Marty Weiss with the Congressional Research Service. One of the issues that has come out over the past year is the need for – just picking up on Anna’s – your last comment – the institutions retooling themselves. And one area where we’ve heard a lot of is the effective multilateral surveillance. And this is something the IMF is working on right now.

So I guess a three-part question: One, what does that mean? What would make multilateral surveillance at the IMF effective? Two, can it be done under the existing rules? And three, if the IMF articles would need to be changed, is there political consensus among surplus advanced economies to essentially bind their hands a bit?

MS. SCHADLER: Okay – (inaudible) – sorry, okay, we’ll get two more. Okay, wait one more time.

Q: (Inaudible) – from Lynx Investment Advisory. Thank you for the insight. Can we have one fiscal rule when we have differing levels of productivity – in fact, huge productivity imbalances in favor of Germany?

MR. TRAN: It’s difficult, and I think that if we see what the German leaders have been proposing. In this pact for competiveness, they tried to address the question that you raise in trying to have structural reform in countries that have underperformed so far – reform of labor markets, reform of pension, reform of all kind of things. So that basically, hopefully, going from what they will reduce the imbalances and the differentiation in performance of this country.

It is a long-term project, but I think that for Euro-area to stay together, ultimately they have to address that question and they have to be more convergent in term of fundamental economic performances.

Q: Do you think it would be a kind of subsidy? Because IMF (ph) had the same thing and it seems to me that it’s a kind of a subsidy for a different level of performance.

MR. TRAN: No, why is it a subsidy? I mean, if – let’s say right now, the package that has been lent to Greece. One point that the German leaders have not been able to explain enough to the German voters and the German taxpayers is so far, in 2008, they really get a lot of nice interest payment from Greece. So it’s not a free lunch.


(Cross talk.)

MS. SCHADLER: (Inaudible) – in the front.

MR. TRAN: It’s not a trifle.

Q: Antonio de Lecea. I am acting deputy head of delegation at the Youth Delegation here. And my first point is about the curve – being behind or ahead of the curve. What is the curve? And what I usually see here is that the curve is the U.S. model. And if this is the curve –

MS. SCHADLER: Is the what?

Q: The U.S. model. So the fiscal transfers are the fiscal, political system that is prevailing here. And if this is the case, we will always be behind the curve, because this is not our model. And in a country that is the country of innovation – I mean, one should be ready to accept the recent innovation, even political innovation, somewhere else.

So as – (inaudible) – I mean, some of the problems that we in the country now were addressed, or some of the issues, like the big shocks, or big – asymmetric shocks or the resolution mechanism were addressed at some point – were thought about at some point in time. But there were more pressing problems. And the probability that this mechanism would have to be put in – would have to be used was so low that the attention was shifted to some more important things.

So now, okay, the low probability prevailed, and we have the crisis. And we have tried to address the crisis and at the same time fill the institutional gaps, which explains much of the – I mean, of the cacophony that you have seen, besides the fact that there is transparency; we are 27 democratic countries with different institutions and each feels the need to speak, which should not be the case, but it is – (chuckles) – actually the case.

So we have been acting sometimes even hastily. In cases, we have needed to adjust the initial decision to take account of the fact that they were taken too hastily. But we are building, and in this respect, I would take your point, that the crisis is an opportunity for institutions to reinvent themselves. And we are doing that.

So I am less aware of the final details as I’m – at least on what is being decided, but indeed, what I learned from my colleagues is that this time, they want to have a robust package so that – before it is presented. And this is what is being thought of – worked. And I believe that in this respect, it – I mean, the system that will come out will be different from the U.S. but will be as robust in this as the U.S.

On the – another point. On the intergovernmental versus more EU approach, I beg to disagree, and trusting to President Van Rompuy the task of working out the details was in some way heterodox with respect to the usual EU approach. So the Euro group is not an intergovernmental institution. It is very well-enshrined in the treaty, and it is part of the effort, so in this respect, it is going back to the mainstream of EU affairs to bring this into the European Union. Thank you.

MS. SCHADLER: Okay, do we have any other questions?

Q: Hi, my name is Sunjin Choi, Langham Partners. Dr. Tran, could I follow up what – your question about German issues. And as a coalition government, it’s faced with the upcoming full – recent elections. And what is the likely impact on Bundesrat? And you mentioned you’re a boss – a German boss – and – (inaudible) – now runs – I think it’s one of German Landesbank. And former IMF managing director, Mr. de Rato, is now running one of the Spanish saving bank. Are they in good hands? (Laughter.)

MS. SCHADLER: (Chuckles.) I don’t think you can find anyone to answer that question.

MR. TRAN: To answer the second question first, yes, they are in good hands. The Bayern Landesbank last year showed a profit; first time in many years for a German Landesbank to show a profit of 800 million euro. So my former boss is now seen as a hero in Bavaria at the moment.

The Caja Madrid, now run by de Rato, has done also very well with six of other Cajas and now plans to list the commercial banking activities of them on the Stock Exchange. That’s part of this process of reforming the Cajas. So I think that indeed, they are in good hands.

On the German question, you are right and many colleagues are right in the sense that within Germany, particularly among the voters, there are deep frustration and unhappiness, and to some extent resentment, in the sense that they feel that when the country entered the Maastricht Treaty and entered the European Monetary Union, they were promised that the euro is as good as the deutschemark. They were assured that there is no bailout – and in fact, no bailout was one article of the treaty.

And yet they feel that since the crisis last year in Greece, these promises were broken, in the sense that the leaders somehow failed to explain the full background of the move toward monetary union, which not only in Germany, but in many other countries, I don’t think the leadership of the elites have been successful in explaining that to the voters as well.

But anyway, to make the long story short, the popular opinion in Germany today is strongly, deeply, with great majority against any further fiscal arrangement that can help this crisis country. And here, the use of the term bailout is most unfortunate, because as I said, it’s not a bailout. I mean, it’s really, really very bitter medicine with a lot of conditionality, but anyway, that is the popular perception.

In Berlin, the coalition government, I think that the CDU, CSU, if you look at a statement by Finance Minister Schäuble and Chancellor Merkel, they basically came around and understand that to underpin the euro, which is in the interest of all of the member countries and of course of Germany itself, they really have to push forward to have more fiscal integration – not necessarily fiscal union, but more fiscal arrangement to underpin it.

But the Liberal Democratic – the Free Democrats, the liberal – because of the fact that they have really crashed, they are standing with the voters, starting two years ago with more than 15 percent. That’s how they got into the coalition government. Now about 4.5 percent, which will eliminate them from parliament if they have election today – have chosen to make a last-ditch effort to really embrace the popular beliefs in saying, no more fiscal transfer.

And that is a problem, because they have to overcome that so that the coalition government can have a consensus view between now and end of March. So that is one of the open question which is very difficult to say at this point whether or not they will deliver the agreement from Germany or not.

MS. SCHADLER: Let me just say a couple words about – there are a few questions that have been raised here about the fiscal mechanism in Europe – the role of the IMF, the role of the commission, what form it would take, whether it would look like the United States or be a completely new-looking fiscal arrangement.

I have to say, it’s at this point that I do become a little bit pessimistic. (Laughter.) Having lived through the – pretty closely through the IMF surveillance of the SGP in the period 2000-2003, when it was sort of invented, reinvented and ultimately really abused quite badly, there were tensions that were almost impossible to deal with because there were small countries that were violating the SGP, there were big countries that were violating it. There’s inevitably politics when it gets into surveillance. I mean, the IMF encounters it all the time, and the European Union encountered it too. And that’s ultimately really what broke the SGP.

I’d back up and say there was another little issue there, which is, I don’t think the SGP was set up as the best form of a fiscal rule. It had a lot of serious fundamental flaws. So I guess I could express some hope that maybe a new fiscal rule that had fewer flaws would be possible, but let’s be realistic. The UK had a great fiscal rule. (Laughter.) It totally got ignored and totally was behind – a big part of what was behind the UK’s current problems.

So I think fiscal rules are good. I think every country, every transnational organization, whatever, should have them, but let’s be realistic: They don’t work particularly well when push comes to shove and when there are big politics involved. And that’s why I sort of get back to the notion that there needs to be a debt-resolution mechanism. I mean, there’s no question that that’s important.

But I think Anna raised a very important point, which is that the whole way that spreads respond to risk is not linear. They jump around. There’s a huge amount of complacency that gets totally shattered by some trigger that makes everybody become aware of the risks of what’s going on. And suddenly, everyone looks at the rule and says, oh my goodness, nobody’s following the rule. And this has happened so many times that it’s almost like, I can’t believe we’re going to go through this again.

So I think there really does need to be some credible private-sector involvement which will tend to force spreads to be a little bit more responsive to the risks that are developing that are not able to be fully handled by a fiscal rule.

Does the United States have the system, though? I mean, again, I get back to look at the municipal bond situation in the United States, and let’s think about what’s going to happen when we start really feeling the pinch in several states and localities in the United States. And after we see what the United States system is capable of handling, we can get back and discuss whether that’s really and truly the model that people might think it should be.

More questions? We’ll take a few – yeah, okay. Go ahead.

Q: Maybe to respond to that, I mean, I do think that this crisis was so enormous that countries have really learned a lot of lessons from it. So I mean, speaking from a European perspective – (inaudible) – I really do think there’s a qualitative, quantitative difference. I also – you know, we struggled with – (inaudible) – I know our finance minister at the time was told off when he tried to tell the other countries that they had to stick to the rules.

But I do think new mechanisms will come out what will – (inaudible) – much better than the original pact, plus, the structure of reforms that Mr. – (inaudible) – mentioned. I mean, look at what’s happening with pension systems, with accessibility of neighbor marks – all the underlying changes that have taken place in Europe as well. That won’t happen from one minute to the next, but I do think a lot has been set in motion.

So give us a little bit of the benefit of the doubt. (Laughter.)

MR. UBIDE: If I can just have one – just one – two sentences to that. I mean, take the case of Spain, for example. The regionals governments, starting this year, are going to release the fiscal account on a quarterly frequency basically at the same time as the central government. That’s an historical revolution. They used to be released basically a year later at the – (inaudible) – frequency, and nobody really had any idea of what they were doing in real time.

Or take, for example the U.K. I think – (inaudible) – when you were mentioning the U.K., the rule, the problem with the fiscal rule in the U.K. was that the treasury would define the output cap, and therefore, they would essentially redefine the pool every single time. Now they have surrendered the decision of the forecast of the economic outlook and the output cap to the Office of Budget Responsibility.

This office gives the treasury, this is your assumption, these are the assumptions, now you decide how to spend it. That could be done at the European level easily, and that would be one of the best ways of ensuring that, you know, government – you remove one clear incentive to “cheat”, quote-unquote, in terms of yes, you know, fiddling with the economic assumptions.

MS. SCHADLER: I completely agree with you, and –

MR. TRAN: If I can jump in here to say that another development in the European Union which I just learnt when I was last in Brussels two weeks ago is this European semester, which is the first time that they did it in the sense that all members have to submit their planned budget to be scrutinized by their peers. Before, they submitted to national parliament, which is very interesting and which has really opened up opportunity for meaningful influences by peer in discussing how to get a more coherent budget. So progress has been made.

MS. SCHADLER: And I agree with you. So I’m playing a little bit the devil’s advocate here – (laughter) – but I have to say to you that I think right now, there is a huge amount of seriousness of purpose that is born of the crisis, no question. The real question I have is, 10 years from now, where will we be? And while, establishing these institutions, they take on the momentum of their own and that’s good, but let’s be realistic that there are politics in this.

And no matter how independent the institution, I’ve seen it over and over again that politics just creeps into the process gradually over time. And I feel like one of the insurances – another attack on this problem – the rules and the better institutions are important, but another attack has to be that there really does need to be a little bit more credibility to the private-sector involvement because there is actually a set-up, there is actually a mechanism that people believe could happen that will help ensure the seriousness of purpose in the fiscal realm.

Okay. We have time for really one more question. Go ahead.

Q: Could I just bring up this issue that – (inaudible, background noise)? It seems to me that, leaving Greece aside, really what Europe has faced is a series of financial crises, you know, Iceland, and, again, Ireland. The issue was that the governments were running relatively reasonable fiscal policies but when their banks failed, they tried to bail them out and the banks were simply too big. The balance sheets dwarfed the size of the – (inaudible, cross talk).


Q: What is the solution to this problem? Does it make sense to have the individual governments responsible for – (inaudible, background noise) – financial situation? If not, how do you do it?

MR. UBIDE: That’s what I meant to say when I said that we need – there is a fundamental inconsistency in Europe. You cannot have an integrated European financial system without an integrated – call it not necessarily deposit insurance but bank resolution facility. Otherwise, you need to legislate that countries should not have banks that are too big to fail. And you are not going to do that.

So the question is, we have tried to have the cake and eat it at the same time. For 12 years, I have been having the debate in the fund and outside the fund on burden-sharing on European deposit guarantee. And the question was, do you want to define the burden-sharing ex ante or do you want to do it ex post? And the decision in Europe was always, if you don’t know where the shock is going to come from, we’ll do it ex post.

We had two or three episodes of supranational banks in the Benelux and others. They were resolved over a weekend. We were lucky – or, I don’t know but we were good and it was resolved. There were memorandum of understanding and the thing was done properly. I don’t know if the next one will be resolved the same way.

But what I’m trying to say when I say we need the insurance and therefore we need the European bond is precisely to take this into account. It doesn’t have to be necessarily a banking resolution mechanism. But it has to be something that the governments can use, then, to use the standard rules. That is, my bank is bust; I recapitalize it if it is systemic. And if it is not systemic, I take it apart.

And the problem is, if it’s systemic and I cannot recapitalize and save it because it’s too big, then I really have a problem. That’s basically what I meant by that.

MR. TRAN: I think if I might give some dimension to this very important issue and interesting discussion – one, I think Iceland and Ireland are the outliers in terms of the size of banking system to domestic GDP. Iceland, before the banking went bust in 2008, had about 10 times GDP in terms of banking assets; Ireland, eight times GDP in terms of banking assets. They are the outliers. The rest is about two to four times – big but not huge.

Number two, there are two approaches to dealing with this. One is the Swiss approach. Switzerland has also two big banks but they are very big compared to the Swiss GDP. And the authorities and the regulators in Switzerland deal with that by requiring these two big banks to have very high level of capital – go well beyond the Basel III requirements so it would be up to the 12, 13 percent Tier 1 capital. That is one way to deal with it.

Second way is like you said: effective cross-border resolution regime. And the key to this resolution regime is not to recapitalize banks, but it is to let bank die peacefully without impacting financial stability. When a bank get (ph) into stressful condition and about to collapse, the problem is not that it is collapsing. The problem is that the uncertainty it causes to counterparties and creditors who will suffer what kind of losses, people who are dealing with the bank in over-the-counter contracts – what happens to those transactions?

The uncertainty is the one that really caused a lot of problems. Now, if you have a resolution regime in place, you can have an authority to determine if a bank is nonviable, move in, take over like the FDIC does to a whole host of banks in the U.S. that failed peacefully and under type of bridge financing facility to allow that failing bank to fulfill outstanding contracts. Then that bank can be allowed to die peacefully.

The difficulty, now, comes in the cross-border transaction. You need to have many countries, or at least the key financial centers, to have an agreement to allow the cross-border resolution to happen peacefully or effectively. But I think those are the dimension of the things that need to be done as well to support the fiscal and economic coordination in Europe.

MS. GELPERN: And just to that – one last thing. I would love to see more discussion and analysis of the consultation document that came out in early January which goes to that problem precisely. And there’s some interesting similarities and differences with the U.S. approach. And it’s on a six-month track or something like that and I think now is the time to talk about it. And this is second bite at the apple.

MS. SCHADLER: Good. Well, thank you very much for coming. It would be a little bit of a tough task to sum up – (laughter) – except for, I’m left with the feeling that there was a huge amount of optimism expressed in this room – (laughter) – and I sort of wonder, why are they going to wait until the end of March to figure this whole thing out? (Laughter.) Why don’t they just move things along in the next few weeks, à la this panel? (Laughter.) So we’ll see. Time will tell. And thanks again for coming. (Applause.)