Note:This is a Memo entitled \'Systemic Risk in the European Union\' that I had sent out on the 7th of March 2011. Given that we are awaiting yet another \'Comprehensive Deal\' that we may not get and the fact that many of the sources of systemic risk that we had highlighted in March have come to pass, we thought it would be a useful public service to share this. Enjoy (or Feel Depressed) reading this.
The European Union faces three major sources of systemic risk. The first, most likely to manifest itself in the short term is the event based risk linked to an under-delivery on promises by the EU summit scheduled for the end of March. The most significant source of systemic risk in the short to medium term is through the triggering of a downward spiral in the powerful sovereign-bank loop that currently afflicts the Euro area. The most significant source of systemic risk in the medium to long term is the combination of a procyclical squeeze currently underway in many of the peripheral countries with the continuing high levels of stock imbalances and cross-border exposures in the Euro area. Some of the peripheral countries are also vulnerable to a debt-deflation trap. In the longer term, the single biggest source of systemic risk in the Euro area is the emergence of record level of divergences in flow variables combined with the inability of EU policy makers to develop the appropriate policy tools that can help address these divergences.
The Euro area now has a systemic crisis. It is no longer possible to believe that the crisis is limited to the peripheral countries with Spanish and Italian borrowing costs staying high after having breached levels not seen since the birth of the Euro. August also saw questions being raised about the sustainability of French public finances and growth came to a dead halt. September has seen doubts being raised about the soundness of EU banks. Germany can no longer pretend that it does not face a domestic problem now that upheavals in the Euro area have, led to a collapse in German growth.
Unfortunately many sensible things such as reducing the stock of Greek debt, forcing greater and faster recapitalization of EU banks and introducing a bigger and more flexible design for the European Financial Stability Fund and the European Stabilization Mechanism from the outset were rejected by the European Commission, the European Council or the European Central Bank, sometimes all the institutions at once.
This unwillingness and inability to make sensible choices has led us down the wrong fork in the road and is directly responsible for the crisis having morphed from being a containable crisis in the periphery to one which has now infected the core and become systemic. Enormous damage has already been inflicted on large swathes of the EU economy and will cost EU tax payers dearly. Many jobs have now been destroyed, some permanently and the handling of the crisis has done lasting and irreparable damage to the European project. It is now no longer possible to say with certainty that the Euro or even the European Union itself is safe.
Note: This is the english text of an invited Op-Ed that appeared in El-Mundo, one of Spain\'s leading newspapers on Sunday the 11th of September
With Spanish and Italian borrowing costs staying stubbornly high, an increasing possibility of the collapse of the new Greek debt deal agreed just in July and the collapse of growth in Germany and France the Euro area is now in the grip of a serious systemic crisis.
How we got from what started out as a fiscal problem in one of the smaller economies in the Euro area, Greece, to this systemic crisis is a tale of bad politics and bad economics. EU leaders and institutions have failed its citizens repeatedly in the past three years. Sensible policies such as reducing the stock of Greek debt, forcing a greater and faster recapitalization of EU banks and designing a bigger and more flexible European Financial Stability Fund from the outset were rejected by the European Council, Commission or Central Bank, sometimes by all institutions at once.
The EU, in common with other major economies of the world, loses a significant amount of potential tax revenue every year to tax evasion and tax avoidance. Some EU-wide estimates are as high as 500 billion – 1,000 billion Euros annually.
This tax loss takes two major forms 1) domestic and international. Domestic tax losses come about when the taxable funds are not shipped overseas but stay within the country. This form of tax loss is on the decline as the increasingly electronic nature of financial transactions and an economy that is less and less cash oriented make domestic avoidance harder.
At the same time, tax flight, the loss of tax revenues related to cross border flows of funds, has been rising rapidly.
Re-Define Commentary on proposed Private Sector Involvement in Greece The discussion on private sector involvement in Greece has grabbed many headlines over the past few months. Now that a decision has been taken at the Euro area leaders' summit yesterday, let us see what this really means. The first thing to consider is, whether one believes that the Greek debt burden is sustainable or not.