This interview with Klaus Regling, the head of the European Financial Stability Facility (EFSF), took place on December 17, 2011, and was broadcast on Al Jazeera. The interviewer was Sami Zeidan. A revised and updated version of the interview follows, along with a postscript on the recent downgrading by Standard & Poor’s of credit ratings in the eurozone.
Sami Zeidan: On December 8 and 9, at the European Union summit in Brussels, European leaders tried to solve the debt crisis, and to agree on a long-term solution. The summit discussed a fiscal pact, as they call it, that if eventually enacted would actually make it illegal for a member country to run up budget deficits larger than 3 percent of GDP. Break that law, and the member country will end up in Brussels at the European Court of Justice, where it will face legal proceedings and ultimately sanctions.
But before things reach that point, the current crisis needs to be resolved, and that brings us to the European Financial Stability Facility, based in Luxembourg and set up by the members of the European Union in 2010 to act in an emergency. If a member state can’t pay its bills, this bailout fund may step in. How many people do you have working here?
Klaus Regling: We have been growing rapidly the last twelve months and we now have twenty-five staff, but let me clarify with regard to the EFSF’s mission. Our mandate is to safeguard financial stability in the euro area. The EFSF provides financial assistance to euro-area member states in financial need. Its shareholders are the seventeen euro-area member states. To avoid any confusion: the EFSF has no direct link with the European Central Bank (ECB), which is the independent central bank of the European Monetary Union. The mandate of the ECB is to deliver price stability. This mission is clear and remains unchanged despite the crisis and is anchored in the Maastricht Treaty. The ECB has an undisputed track record. Since the start of the Monetary Union twelve years ago the average inflation of the member states has been close to 2 percent. The ECB is currently buying bonds of certain euro-area member states on the secondary market but this Securities Markets Program is only about ensuring that monetary policies of the member states get the support they need.
The ECB also provides ample liquidity to banks to safeguard financial stability in the eurozone. Recently the ECB provided nearly €500 billion in loans to banks with a maturity of three years. The EFSF provides loans and other financial assistance only to member states of the euro area.
SZ: It’s here, to this office in Luxembourg, that so much hope is now directed. The question is, does Mr. Regling have the money and the credibility it takes to resolve a crisis that so far isn’t letting up? Let’s start with the recent news of that fiscal pact I have described. Will it solve Europe’s problems?
KR: Well, the fiscal pact that was decided by the summit on December 8 and 9 was only the last point in a long process that we have seen in Europe during the last eighteen months.
SZ: Is it the key point?
KR: It was a key point. It will not be the final one. We know that we cannot expect one summit to solve all the problems, but we have to really understand that it was one important step in a long process of decisions that have been made since the crisis broke in early 2010. We have done a lot to improve the governance of the euro area, particularly with regard to fiscal coordination, structural adjustments such as labor market reforms, and tackling macroeconomic imbalances—all things that critics of the Monetary Union have said for some time need to be fixed in order to have, as a complement to the centralized monetary policy and to the euro’s single exchange rate, better-coordinated fiscal and economic policies.
Among these improvements and reforms, I would emphasize the strengthening of the Stability and Growth Pact of 1997 and the introduction of a new European procedure to deal with macroeconomic imbalances. Euro-area member states are also negotiating an international treaty, a “fiscal compact.” This treaty aims to promote conditions for stronger economic growth in Europe and closer coordination of fiscal and economic policies within the euro area.
National governments will remain in charge and accountable, responsible for their fiscal and structural reforms. However, reforms need to be better coordinated and must work better than in the past. And with these decisions, including those on the fiscal compact, I am confident that monetary union will function better in the future than in the past.
SZ: If that’s the case, though, we look at market reaction and it hasn’t been positive, has it?
KR: It has not been positive but it has not been a catastrophe either. We saw yields on bonds issued by some member states rising initially.
SZ: Markets are not convinced. Why? What would you say to them to tell them, “No, we are on the right track”?
KR: Markets focus only on one or two things. And they have a predominantly short-term view. I think the summit on December 8 and 9 focused on longer-term issues. The fiscal compact—that is, an agreement on how to conduct fiscal policies in the countries in monetary union—necessarily is something long-term. It will for instance require that the budgetary position of a member state be balanced or in a surplus. The member state may temporarily incur deficits only to take into account the budgetary impact of the economic cycle. Beyond such impact, it may also incur deficits in case of exceptional economic circumstances, provided that this does not endanger fiscal sustainability in the medium term. It’s not for tomorrow, the fiscal compact, and not for next month only; it’s for the next years and decades.
Markets, on the other hand, as we know, focus mainly on the short term and, therefore, they don’t appreciate the full impact of the decisions that have been made. In the long run, this will be very positive. There is obviously still uncertainty regarding the reform efforts in Europe at the national and community level. But we already see encouraging positive results, in Ireland, in Portugal, in Spain, and in Italy.
Ireland, which requested financial aid from us in November 2010, regained competitiveness and managed a turnaround. Portugal, which began a new macroeconomic program six months after Ireland, implemented many measures such as deep cuts in public expenditures, including substantial salary cuts for civil servants. In Italy, the new government adopted a far-reaching package to shore up the public finances and support economic growth, through measures concerning taxes, pensions, reform of public administration, and liberalization of economic activity. In Spain, the new government is taking measures focusing on fiscal consolidation, repair of the banking system, and labor market reform. These are encouraging signals.
SZ: You talk about the long run, though. Has Europe got the long run? Do we have years, even months or weeks, some would say? The yields on sovereign bonds were rising after the announcement in Brussels [i.e., the countries issuing those bonds had to pay higher rates to bond holders].
KR: True, but those yields also dropped in the weeks before, so let’s not exaggerate. To make it very clear, the euro will be there for decades to come.
SZ: Who’s going to manage it now if yields on bonds are rising?
KR: Markets will understand that there is enough “firepower”—i.e., immediately available financial assistance to any euro-area country—if needed. The support will be provided by the EFSF, the European partners, and the International Monetary Fund. At the moment the countries in need are Greece, Portugal, and Ireland. If other countries think they need assistance—and there’s no other country asking for it at the moment—it would also be available.
SZ: Is there enough firepower?
KR: The firepower is there. The EFSF has a lending capacity of €150 billion to the IMF through bilateral loans, which will be complemented by additional resources from other European member states and international partners. That was also decided at the Brussels euro summit in December. So the situation is not as bad as the markets believed.
SZ: Firepower is rising.
KR: Firepower is increasing, and also, importantly, the summit decided to review the availability of firepower, if that is necessary, by March 2012. By then we will know whether more is needed. At the moment I think we have more than enough.
SZ: The debts of Italy, and if we were to take Spain as well, together, we’re talking around €440 billion, isn’t it? How can you say we’ve got sufficient firepower? How can you send that message out to markets?
KR: I think your comparison is a wrong one. When I look at firepower, and look at what may need to be done, it’s not correct to look at the total outstanding debt of Italy, Spain, and the other countries that you mentioned—somewhere between €1.9 trillion of Italy’s outstanding debt will mature over the next seven years and will be rolled over.
When we look at firepower, the question is what may be needed over the next twelve months, maybe the next twenty-four months, but no more than that. So we have to take account of how much debt is maturing in a year or two, and of the actual fiscal deficit in Italy, which is falling. Italy is moving toward a balanced budget by 2013, so all the financing it needs from markets would really be caused only by maturing old debt that will have to be paid. That’s only a fraction, one seventh on average, of the total debt of €1.9 trillion.
We do know, for instance, that Italy and Spain have about €600 billion in maturing debt over the next two years. So that’s the appropriate figure for the comparison with the firepower of the EFSF.
SZ: But if you look at what’s needed over the next twelve months, can you honestly say that the money that you have now is enough to deal with anything that can come up during that period? I mean, out of the €250 billion available to deal with anything that could come up in the next twelve months with Greece, Italy, Spain, Ireland, Portugal….
KR: No, no, those numbers are not correct. What’s committed from our side, from the EFSF at the moment, is €43 billion for Portugal and Ireland. That is for their financial support programs, which run for the next two years. So everything that they need is already covered.
SZ: So you have about €400 billion?
KR: There might be an additional €300 billion.
And then we know that the IMF stands ready, in principle, to add about 50 percent of what the Europeans do, for whatever country asks for assistance. At the moment there is no country that is asking for assistance. So if, hypothetically, you say what are the countries that may need help, we think about Italy and Spain, but they have not made a request for financial assistance. So far, they are able to refinance themselves. One day they may say they need help; but at the moment we don’t know. With the firepower we have left, plus financing that would be available at the same time from the IMF, there’s more than enough to cover all these possible cases, which are hypothetical, for the next twelve months without any problem.
SZ: If you needed more cash from the member states, how much do you think you could get?
KR: That’s impossible to say because it would depend on the needs at that point in time. And at the moment we don’t know at all whether there’s a need for more. I’m only saying that if there were, then I’m confident it would be made available.
SZ: So after all this discussion about the lending capacity that we have left at this point, it’s more or less €500 billion. The markets aren’t convinced that that is enough even in the short term, as you’ve said, even taking into consideration all the other factors you mentioned about how debts mature over the long term.
The markets are looking to the European Central Bank. Let me put the question this way: Does anybody other than the European Central Bank have the capacity to rapidly increase firepower into the trillions?
KR: I don’t see why trillions are needed at all.
SZ: Okay, rapidly increase beyond what you have?
KR: As I’ve indicated, over the next twelve to twenty-four months, not that much more is needed. But I have to make one qualification first so that there’s no misunderstanding. The €200 billion mentioned in the conclusions of the summit that will go to the IMF is not earmarked for Europe. That’s an important point. It will go to the general resources of the IMF, usable for whatever program the IMF undertakes.
SZ: So Europe will get even less than that?
KR: But other G20 countries are very likely to also make similar contributions to the IMF so it will get more than the €200 billion, but conceptually it’s important to understand that this is not earmarked for any country. It’s for the general resources of the IMF so it can use it where it’s needed. Of course, it’s true that at the moment, European countries are mainly in need of IMF resources, but this is not so unusual when you look at the IMF history. In the late 1990s it was mainly Asia that needed IMF resources. In the 1980s and the early 1990s it was mainly South America. So it happens from time to time that there’s a concentration of need in one region, and at the moment this is Europe. So that should be understood about the IMF.
Apart from that, again, the firepower of the EFSF is substantial. It will be reviewed in March in case it is not sufficient. I’m sure our governments will take that into account.
SZ: What might make it not sufficient, in your mind, when you say that it’s not sufficient? What are the factors? You must have something in the back of your mind.
KR: I have no expectation here, but markets say one country in need could be Italy; one could be Spain. But again, both countries have been able to refinance their maturing debt at an interest rate that is higher than they wish, and higher than a year ago or two years ago, but still lower than ten years or fifteen years ago, before the Monetary Union, and the important point is that they are able to refinance.
But if that were to change, then our organization would be available, together with the IMF; and the firepower certainly would be enough for a while. And then we have a review clause, so the governments of the euro-area countries would be considering further need. One more point on the available firepower that’s important: we are developing a system where we improve the efficiency of our own resources. Our EFSF resources will be leveraged by attracting private investors, if needed, into buying bonds of euro-area member states.
SZ: But as things stand now, you’re confident that with the help that you could get from the IMF, you could handle even a situation where Italy runs into trouble and isn’t able to raise money in the market…?
KR: Yes, certainly for twelve months or so.
SZ: Do you think the European Central Bank will not be forced into more aggressive buying of sovereign bonds? That scenario: you’ve ruled it out at this point?
KR: It’s very unlikely because, again, I repeat, Italy and Spain and others are able to refinance themselves at interest rates that are on the high side. Those rates should come down again. We have firepower at the EFSF. What the ECB does in the end is its decision. It’s independent. But secondly, there’s a deep conviction in the euro area that monetary financing of governments is not the right way to go. The right way to go, in this view, is rigorous budgetary consolidation complemented by structural reforms to boost competitiveness in order to achieve growth and employment.
These are principles that are enshrined in the EU treaties that gave the ECB a very strong degree of independence. The ECB is the most independent central bank in the world. We are very proud of that and we want to respect that, and nobody wants to jeopardize that status.
I think in the long run it will serve Europe very well to have a strong, independent European Central Bank that decides on its own what is needed, and what is not needed. It would have only one mandate: to guarantee price stability to avoid inflation.
And the division of labor between monetary policy and fiscal policy is much better preserved in the euro area than in the United States, for instance, where the Federal Reserve tries to achieve several objectives at the same time. The ECB doesn’t have that problem and that will serve us well in the long run. Nor, as I note in the separate statement following this interview, will it impede the EFSF’s lending capacity, despite the recent downgrade of the rating of nine euro-area countries and the EFSF….
SZ: Let’s talk a bit about your leveraging vehicles, i.e., your plans to offer financial products that would provide (1) partial protection of risks or (2) the opportunity to take part in a fund in which the EFSF would be coinvestor.
KR: Under the partial risk protection, the EFSF would provide a partial protection certificate to a newly issued bond of a member state. The certificate would give the holder an amount of fixed credit protection of 20–30 percent of the principal amount of the sovereign bond.
Under option two, the creation of one or more Co-Investment Funds (CIF) would allow the combination of public and private funding. A CIF would purchase bonds in the primary and/or secondary markets. The CIF would comprise a “first loss tranche”—i.e., partial protection against loss in the value of those bonds—which would be financed by the EFSF.
SZ: How much money have you been able to secure from outside countries towards those leveraging options?
KR: So far we have not offered those leveraging options to investors. We have had preliminary talks about them. We are still in the final phase of developing them. There are many technical preparations that need to be done, legal preparations that are needed if these instruments are to be sold on stock exchanges. We need discussions with ratings agencies.
SZ: But have you received in your talks any commitment, any pledge?
KR: We cannot really have a pledge before we have the final product available, and also we don’t want money at the moment because we wouldn’t know what to do with the money. First, we would only need the money, this leveraged money, if we see that one or two countries in the euro area make a request for substantial amounts of money. We don’t have any such requests at the moment, so if big creditors would want to buy into our leveraged products, I have to say we don’t need the money at the moment.
SZ: How much do you think, then, after the discussions you’ve had with huge creditors and investors, that you would be able to raise through leveraging?
KR: This is very hard to say because first, again, we need a request from a country. If we have no additional program to be financed on top of Greece, Portugal, and Ireland, we don’t need any additional resources from anywhere, and don’t need to use these leverage options. Second, it’s also clear that at the moment, when the general attitude of markets toward the euro area is not very positive, it’s more difficult than if that environment changes, which I think we are hoping for, based on all the good decisions made by the summit in December. So there are several variables that are at play here.
SZ: You’ve already made trips to some of these big creditor nations, haven’t you, like China. What sort of response did you get there?
KR: Well, I talk to important investors around the world and I know those investors who have bought EFSF bonds in the past, on the several occasions that we issued bonds. Some of these big investors are in Asia. And what we have discussed with them is how we need to structure these leverage options so that they are accepted by the markets at the time when we want to offer them. That was the main purpose of my colleagues and me traveling to large investors in the past. We continue to do that. But it was not the moment to ask for concrete pledges.
SZ: Aside from concrete pledges, did you get any indication when you went to China that people there would say yes, we would be interested once you launch this leverage option, we’ll be interested in buying some of it?
KR: Yes. I had a lot of interest from investors, not only in China, but also from investors like insurance companies who very much like the insurance-type leverage options that we are also developing, and there have been statements, public statements, from some of the biggest insurers in the world like Allianz and Generali and Axa that say, “Yes, once you offer that product on the market, we’ll look at it very positively.” So we have had expression of these kinds of interests, general interests, but again, it is too early to have precise pledges.
Let me emphasize again. The summit in December made important decisions, and the euro area is taking major actions to address the crisis. It has strengthened the financial backstops for its debts; member states are making progress on fiscal consolidation and structural reforms to boost potential growth, and they have agreed on a new fiscal compact on binding national rules concerning balanced budgets. The ECB has taken significant additional measures and the EU is following up on decisions to reinforce the banking system. I am convinced markets will appreciate Europe’s efforts to restore financial stability and investors’ confidence in the euro area.
On January 13, the credit-rating agency Standard & Poor’s lowered the credit ratings of nine eurozone countries, including France, which was downgraded from AAA to AA+, and which guarantees some e150 billion of the EFSF’s lending ability. S&P’s decision was based on two main arguments:
The political agreement does not supply sufficient additional re- sources or operational flexibility to bolster European rescue operations…[and] a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating.
The effectiveness, stability, and predictability of European policymaking and political institutions have not been as strong as we believe are called for by the severity of a broadening and deepening financial crisis in the eurozone.
In my opinion, S&P has overlooked many elements and actions taken in Europe during the last eighteen months that will assure that the European Monetary Union will function better after this crisis than before. Many decisions have been made to resolve the crisis. In addition to the progress in Ireland, Portugal, Spain, and Italy that I mentioned in the interview, the entire eurozone will benefit from a new financial supervisory architecture, stronger fiscal coordination, broader macroeconomic surveillance, and a new mechanism for crisis resolution.
I agree with S&P’s second argument—that austerity alone cannot solve the crisis. It has, of course, been necessary for member states to implement spending cuts in order to reduce their debt burden. However, S&P has ignored many measures that have been taken on both the European and national levels to regain competitiveness and promote growth. Austerity measures with dramatic announcements of spending cuts tend to grab the headlines; but it is often the case that little attention is paid to structural measures taken in parallel to improve growth and employment.
To conclude, it is hard for us to understand the decision by S&P to downgrade certain euro-area member states. S&P ignores or underestimates the po- litical will and the many measures that have been implemented by the euro-area member states.
With regard to the EFSF as issuer of financial assistance, there is no need to act in response to S&P’s rating action. The EFSF continues to be assigned the best possible long-term and short-term credit rating by Moody’s (Aaa) and Fitch (AAA). Neither rating agency has indicated any rating action for the EFSF in the immediate future. At the same time, S&P—like the other rating agencies—affirms that the EFSF’s short-term rating remains unchanged at the highest possible level of A-1+.
The downgrade of the EFSF to AA+ on January 16 by only one credit agency, S&P, will not reduce the EFSF’s lending capacity of e440 billion. The EFSF has sufficient means to fulfill its commitments under current and potential future adjustment programs until the new European Stability Mechanism becomes operational in July 2012. Nor does S&P’s rating action affect the EFSF’s plans to increase its leverage using two options: the partial risk protection plan and the Co-Investment Fund I discussed at the end of the interview. These will be in place soon and have already drawn interest from potential investors.
—Klaus Regling, January 26, 2012