memorandum by Mr Omtzigt, rapporteur
1. Many observers, political leaders and individuals
believed that the economic and financial crisis was behind us or
was coming to an end and that recovery was around the corner. That
is not the case, however. The problems encountered by Greece, Ireland,
Portugal and Spain, concerns about public debt management in Belgium
and Italy, and the austerity measures announced in France, the United
Kingdom and many other countries are all bringing home to people
a terrible truth: the worst may yet be to come and the economic difficulties
are only just beginning. From the sub-prime crisis to the crisis
in the international economic system, we have moved from excessive
household and private sector debt to excessive government debt.
In what must now be called a global recession, many European
states faced 2010 in a vulnerable position. Their public debtNote
unprecedented levels and is still growing (see the table in the appendix).
In 2010, public debt was expected to be around 131% of GDP in Italy,
129% in Greece, 125% in Iceland, 105% in Ireland, 103% in Belgium,
93% in Portugal, 92% in France, 81% in the United Kingdom and 80%
debt situation of central and eastern European states is much better,
except for Hungary. Beyond Europe, investor worries accumulate around
the United States, which has received repeated warnings about the
possible downgrading of its credit rating if the national debt (of
about 96% of GDP for 2010) kept growing, and Japan – deemed by some
analysts as “a debt time bomb that is waiting to explode”Note
– with its sovereign debt at 198%
of GDP in 2010. The level of debt deemed sustainable (or not penalising development)
by many economists is 60-70% of GDP.
3. Some economies are now at risk of collapse and are being forced
by excessive debt levels to make painful political, economic and
social choices which affect millions of Europeans and undermine
their fundamental rights. As credit-worthiness of states is eroding,
concerns about shifts of power from nation-states to global financial
markets raise significant challenges to democracy and development
prospects. This distressing reality is the second largest economic
shock in modern history after the Great Depression of the 1930s,
with repercussions reaching wide and deep across society.
This report will therefore look at major policy challenges
that many European governments are currently facing in the light
of the precarious state of public finances. It will, to some extent,
complement this Assembly’s reports on the political consequences
of the economic crisis and on the challenges of the financial crisis
to the world economic institutions.Note
appreciate the valuable input into this report by the participants
of the hearing held by the Committee on the Economic Affairs and
Development on 29 November 2010Note
2 An increasingly
disturbing financial situation in member states, particularly during
a period of economic crisis
5. The current economic crisis, which follows the financial
crisis, has brought to public attention some worrying situations
for numerous states. This second phase provides a little more evidence
of the failures of the policies pursued previously and of the economic
models applied for forty years, especially the one which seems to
think that the market, alone, can regulate the global economy.
6. Public finance difficulties are far from new in Europe – the
creeping indebtedness has been a latent problem – and challenge
– for decades as budget deficits persisted. The private sector’s
debt escalated more recently due to excessive bank leveraging and
cheap credit as a result of over-accommodative public monetary policies
and regulation. In addition, over 2009-2010, we have seen vast private-to-public
debt transfers, with massive liquidity injections by the central
banks into the financial markets to support asset prices and unfreeze credit
channels, as well as stimulus programmes for national economies
amounting to roughly 2% of GDP for most western countries. I wish
to set out in this report the main reasons why European public finances
seem to struggle to strike a balance.
7. The size and recurrent nature of public deficits is to some
extent due to the difficulties being experienced by most European
social systems. As the population ages and the birth rate falls,
the desire to reform retirement pension and health-care systems
have for several years been central to debate in many European countries.
Moreover, as unemployment has been rising across Europe, so did
the payouts of unemployment benefits, whilst tax revenue base was
shrinking. The funding of pay-as-you-go social systems thus has
a significant impact on state budgets, with consequences on the
current and future debt levels of the countries concerned.
What we may today call the crisis of the welfare state determines
the possibilities for European states to implement or not certain
policies. It would in fact seem that states no longer have the means
of keeping their “promises in respect of health and retirement made
to the ageing baby boom generation”. It is in fact my view that
realism will have to be shown from now on in order to reform the
welfare state and make it viable in the long-term. No reference
is made here to the elimination of the state, since this would ignore
the lessons of the crisis. I actually think that it is time to rehabilitate
the state in its regulator’s position and to define “new boundaries
between the state and the private sector”.Note
The fact is that “only the public
authorities can, on the required scale, respond to the problems
thrown up by globalised competition”, so it would be reckless to eliminate
all the obstacles to the free working of the market. Indeed, the
private sector cannot adopt the necessary detachment to enable society
as a whole to function in the best possible way.
For some states, poor economic performance insufficient to
meet society’s needs may be blamed. The problem highlighted in this
report stems from many European states’ tendency to live beyond
their means. This tendency leads to “structural deficits in public
finances [for countries such as Greece, which] since it joined the euro,
in 2001, [has] reported only one deficit of less than 3% of GDP”.Note
This is a relatively common
situation in Western countries, which are continuing to increase
the speed of their expenditure despite the slowing down of their
economies over the past few decades. Military spending is also an
important item in some countries that may require additional public
I wish to emphasise here that not every case of use of the
public deficit gives rise to situations of over indebtedness. Each
state’s GDP growth rate is a variable to be taken into account when
analysing the impact of budget deficits. Hence the expectation that
states’ budgets will move in line with their level of economic activity.
Generally speaking, even predictions of low growth levels may cause
investors to take an overcautious approach. “Some analysts in fact
consider that the current level of debt in the eurozone cannot be
offset by expected growth, which is too weak”,Note
this explains the flight of capital to safer investments.
Furthermore, the budgetary situation always tends to worsen
during a crisis through operation of the natural mechanism of economic
stabilisers. As economic activity slows down, tax revenue declines
and expenditure rises, particularly on social protection. In Finland,
for instance, “[D]ue to strong automatic stabilisers and stimulus,
the fiscal position has deteriorated more rapidly than in any other
this notwithstanding a fairly favourable pre-crisis economic situation.
All the aforementioned factors of budgetary imbalance lead
directly to a deterioration in states’ financial situations simply
through the effect of the interest added each year to the debts
incurred. Only rarely do states instinctively balance their budget
during growth periods to prepare to cope with economic crises like
the one currently being experienced in Europe. On this subject,
Latvian Prime Minister Mr Valdis Dombrovskis, has expressed regret
about Latvia’s failure to take advantage of the pre-crisis years
during which annual GDP growth exceeded 10%.Note
Current deficit and public debt predictions are alarming.
The Organisation for Economic Co-operation and Development (OECD)
forecasts gross government debt in 2011 of 97% of GDP for France,
104% for Belgium, 113% for Ireland, 133% for Italy and 137% for
As the economic
crisis is not over, there is a need to think straight and try to
take the necessary policy decisions, bearing in mind the short-
and long-term effect of not only public debt, but also the restrictive
budgetary policies introduced to stabilise public finances.
3 The excessive debts
of states: responsibility shared by rating agencies and states
3.1 Rating agencies’
“The rating agencies, of which there are three,
Standard & Poor’s, Moody’s and
Fitch, are American institutions which rate states, businesses,
authorities and financial transactions so as to give investors an overview
of the solvency risk of economic players”.Note
They award financial ratings to
both businesses and states.
15. These financial ratings are referred to by investors purchasing
shares or government bonds. Thus the rating agencies control the
financial destiny of nations and their millions of citizens. So
when, on 29 April 2010, Spain was downgraded from AAA (the top rating)
to AA, something that had been just a possibility – the threat of
economic collapse – was very close to becoming a reality.
16. Without being the cause of the rise in public debt, the rating
agencies nevertheless bear great responsibility for the worsening
economic conditions of certain European states and for the renewed speculation
which has gripped the trading rooms over recent months. For example,
downgrading of a country’s sovereign debt rating entails a rise
in the interest rates that the country concerned will have to pay
on its debt. It is therefore the states in the greatest economic
difficulty which have to pay higher interest rates to service their
debt, and hence find themselves in even more difficult situations.
This vicious circle in practice brings a worsening of the financial
situation of states already in difficulty, since they are forced
to pay what might be termed a risk premium. It certainly makes economic
sense for there to be a correlation between risk and interest rate,
but speculation gives rise to situations that are not always justified
by a tangible risk of failure to pay.
17. Having already been criticised in our colleague Viktor Pleskachevsky’s
report under preparation (on the underground economy: a threat to
democracy, development and the rule of law) for the positive ratings
that they had assigned to private firms (insurers) or banks which
held toxic assets, the rating agencies are now rightly coming under
fire for their alarmist assessments of the economic health of several
European countries, which seem to become self-fulfilling prophecies.
18. I should like at this point to raise the question of these
agencies’ status and independence. Indeed the United States Senate
did a great deal of work on these matters in the wake of the sub-prime
crisis, without any reaction from the international community. But
the risk of a conflict of interest resulting from the fact that
these agencies are paid by the issuers of the securities which are
to be rated is, in my opinion, one of the main points which needs
to be examined.
It is nevertheless impossible to advocate the elimination
of these agencies, “which should, in theory, be a factor of stability
on stock exchanges”. In absolute terms, the agencies enable private
individuals’ investments to be made safe, and the level of investment
would otherwise be insufficient to finance the functioning of the
economy. The question that I wish to raise here is that of the concentration
of the rating agencies’ market, which can soon lead to misuse of
power. Clearly, the oligopoly within which they operate makes it
possible for them to use their reconnaissance role for profit-making
purposes. No clear link can be established between speculation and
rating, but “the way in which downgradings sometimes coincide with feverish
speculation has some puzzling aspects”.Note
20. In this context, we should recall the resolve of G20 leaders,
at the November 2010 Seoul Summit, to strengthen the regulation
and supervision of credit rating agencies, as well as efforts to
reduce the reliance of various stakeholders (including standard
setters, market participants, supervisors and central banks) on external
3.2 States’ responsibility
European states were lending to national banks at
unbeatable rates, enabling those banks to grant more loans and subsequently
to increase their profits considerably. But when it became necessary
to lend to states, and hence to their people, in order to save public
systems and health services and to avoid pension cuts, the rates
were far higher. So how could “the financial sector […] make a fair
and substantial contribution towards paying for any burdens associated
with government interventions to repair the banking system”?Note
22. The intrinsic difference between an economic player and a
state cannot be ignored: the former endeavours to make its activity
as profitable as possible, while the latter is duty bound to adopt
an approach which covers its whole population. Consequently, subsequent
negotiation based on the rescue of banks by states had little chance
of achieving participation by the financial system.
23. Yet states could have benefited from the rescue of the banks,
and without jeopardising their own finances. In practice, the budgetary
situation was already alarming for many states, and it is my view
that this state of affairs should have encouraged them to demand
more favourable interest rates.
Furthermore, as noted by Henri Sterdyniak,Note
fact that ratings are watched so closely is because states have
been incapable of regulating the financial markets and banning speculation”.
This is why, as the assessment of public finances deteriorated rapidly
on the financial markets of the European countries known as the
“PIIGS” (Portugal, Italy, Ireland, Greece and Spain), speculation
continued thus aggravating further the economic difficulties that
were plunging many citizens into considerable economic and social
hardship in the short and medium term.
25. I regret that the major statements about strengthening the
international system of financial regulation made during the Pittsburgh
G20 in September 2009 were not really followed by practical and
effective action to control the financial markets, regulate their
activities and actually restrict speculation.
3.3 Structural weaknesses
of the eurozone
26. Where the eurozone is concerned, we should note that
in addition to the persisting lack of convergence of national economies
and the absence of effective co-ordination of economic policies
among the states, the Greek crisis revealed, if not a lack of solidarity,
at least a lack of reactivity. The situation required a speedy response,
and some political leaders, fearful of upsetting public opinion
at home during a pre-election period, opted to prevaricate rather
than to come to Greece’s assistance. In the specific case of Germany,
I should like to make clear that its economic policy tradition makes
Germany one of the most virtuous countries within the eurozone when
it comes to fighting inflation and preserving budgetary balance.
As this is not enough to curb its neighbours’ inflationary tendencies
and improvident spending, it is understandable that there was more marked
hesitancy in Germany.
27. The European sovereign debt crisis began with anxieties about
Greece’s ability to repay its debt. It then spread to other countries
of the eurozone, particularly Ireland and Portugal, causing the
euro to slide against the dollar and bringing panic on the financial
markets. The aid plan drawn up in May 2010 by the European Union,
with the International Monetary Fund’s (IMF) help, was at first
very well received by the financial markets, but did not enable
the situation to be truly stabilised. This is why the European Union
institutions sought to set up an intervention system – in case a
risk arose of a state defaulting on its payments – with the possibility
of financing by other states.
Yet, the mere launch of the European Financial Stability Fund
(EFSF) endowed with €440 billion (of which €250 billion is available
in loans) will not be enough to stave off this sovereign debt crisis:
posing a threat to the viability of the common currency, the crisis
made states realise that it was impossible to continue integration
without ceding to the Union some powers of budgetary control or
co-ordination. We should note a recent decision by Eurostat that
the funds raised in the framework of the EFSF must be recorded as
the gross public debt of the states participating in a support operation,
in proportion to their share of the guarantee given.Note
This decision will
allow for the greater transparency of public accounts but will also
show higher levels of state debt across the eurozone.
Some economists propose that the eurozone countries consider
issuing Eurobonds, that is to say, a common debt instrument for
the members of the European Monetary Union (EMU). It is argued that
Eurobond issue could serve as a workable tool of fiscal coordination
in those countries and help shield them against capital market uncertainties.
This approach would require the participating states to define an
adjustable fiscal plan and debt issue framework in the long term,
to create a common debt agency (in charge of issuing Eurobonds),
to agree a reimbursement agenda for each participating country,
to select strategic cross-border investment projects (aiming to
reduce economic asymmetries in the EMU), and to progressively replace
all the existing sovereign debt stock with Eurobonds in order to
minimise moral hazard.Note
reject this idea as in these countries not even local municipalities
pool their debt: each one is responsible for its own debt. A Eurobond would
mean far-reaching fiscal and economic integration, way beyond what
is now foreseen in the European Union treaties.
4 The need to strengthen
the democratic legitimacy of the outside bodies which influence
the conduct of public policies
4.1 Financial markets’
growing influence threatens the autonomy of political authority
30. The omnipresence and pressure of the financial markets
in the public conduct of economic policies are symptomatic of the
exhaustion of our economic models. They constitute both a worrying
consequence of governments’ lack of room for manoeuvre when planning
and implementing their economic policies and a reflection of the
extreme dependence of European economies on the international finance
system, unregulated and caring little about the public interest.
31. The emergency press conference convened by Spanish Prime Minister
José Luis Rodriguez Zapatero on 4 May 2010 to deny that Spain had
been granted €280 billion in IMF funding, as had been claimed in
market circles, demonstrates this vulnerability of states to speculation.
The nervousness about intervening and “rescuing” Greece shown by
the states of the eurozone can also be interpreted as confirming
32. In terms of putting an end to the reckless behaviour of the
global finance system, most observers had high hopes of the ambitious
declarations made at G20 meetings, particularly the London meeting
in September 2009, calling for greater financial regulation. However,
it has to be recognised that these ambitious declarations have not
been followed by action.
4.2 Transfers of power
to certain international organisations: the case of the IMF
33. There is no need for any demonstration of the influence
that the International Monetary Fund has on the conduct of public
policies. The question arises of the legitimacy of this influence,
which ranges from simple recommendations to unchallengeable decisions.
This “power-sharing” is called into question simply because the
IMF, as a lender of last resort, is always in a position to ask
for something in return – something that may have detrimental effects
on the population at large.
34. My concerns about the IMF stem from our discussions on the
subject in the Committee on Economic Affairs and Development in
the presence of Mrs Sonia Escudero, Secretary General of the Latin
American Parliament and a member of the Argentine Senate. Those
discussions, partly based on experience of the 2001-2002 Argentinian
crisis, led the members of our committee to wonder “what is left
of democracy if parliaments delegate their powers to the IMF”.
As far as IMF prescriptions to European states are concerned,
examples are legion and clearly illustrate the problem of the shift
in power towards this organisation without sufficient legitimate
justification or accountability, constituting a danger to democracies.
During May 2010, the IMF asked Spain to “do better and act more
quickly to make its labour market more flexible, consolidate its
banking sector and get public finances back under control”.Note
wonder how much room for manoeuvre was left for the Spanish Government,
which represents the Spanish people, to devise a policy appropriate
to its specific national situation.
The Committee on Economic Affairs and Development has already
raised this question of legitimacy in its previous work. Mr Kimmo
Sasi wondered in 2009 about the possible need for greater interaction
between the IMF and national parliaments.Note
I nevertheless note that the
IMF is currently changing, and I welcome the reforms carried out
in recent years to give the Fund greater legitimacy through improved
quota-sharing to remedy the under-representation of some countries,
the rebalancing of the IMF executive board and an increased openness
to dialogue with national parliaments.
It is a fact that we cannot do without an institution like
the IMF, which remains the lender of last resort, and which “deals
with countries to which nobody wants to lend money”.Note
IMF thus effectively finds itself in a monopoly situation, which
may explain why the conditions set for states can be so stringent.
Indeed many countries turn to the IMF for help when they are confronted
with enormous financial imbalances after having delayed adjustments
so long that the need for fiscal austerity is at its peak; in the
absence of IMF funding, such countries would be facing far greater
and much more painful adjustments.Note
I feel that thought needs to be given to the IMF’s decision-making
structures, so as to find out to what extent citizens’ wishes could be
better taken into consideration.
For several years the IMF has been striving to show its commitment
to greater “transparency in its work, to explaining itself, and
to listening to the people whose lives it affects”.Note
this end, the IMF has, since 2004, been developing its relations
with member states’ parliamentarians, in order to improve understanding
of its action. I nevertheless believe that the situation can be
further improved, not least through closer interaction and information
exchange between national parliaments, governments and the IMF whenever
the IMF assistance is sought. The Assembly should therefore encourage
the IMF to continue along this path.
39. Furthermore, Mr Kimmo Sasi’s report stated that IMF interaction
with parliamentarians “should include regular scrutiny of the activities
of the Bretton Woods institutions by the Assembly in accordance
with the terms of reference of the Parliamentary Assembly Committee
on Economic Affairs and Development”. I believe that this observation
is still relevant, and that parliamentarians should continue to
take initiatives to this end.
40. Having said all this, there is at present no credible alternative
to the IMF. Greece, for instance, clearly got into trouble because
its own politicians failed miserably in maintaining a sustainable
budget and deficit. Similarly, Irish politicians seemingly did not
raise the alarm when the government issued large guarantees to the
financial sector. For all this, there is no alternative to IMF intervention.
The IMF itself should be fully aware of its powerful position.
5 Dangers to democracy
5.1 Citizens’ socio-economic
and civil rights under threat
41. The austerity policies applied in response to the
crisis of state over-indebtedness are liable to worsen further the
difficult living conditions of the citizens, already afflicted by
recession. Three options could be envisaged for streamlining public
finances: governments can either increase public resources (revenue), reduce
expenditure, or try to combine the two. In any of these cases, the
measures taken may be to the detriment of many citizens.
42. The possibilities for increasing state resources are manifold
and of varying complexity. That said, governments tend to increase
taxes and dues to achieve this objective. It is therefore difficult
to generalise about the impact of measures of this type, since everything
actually depends on the tax as such and on the public affected by
it. However, a distinction can be drawn between taxes that affect
individuals and those directed at businesses. Increasing corporate
taxation seems inadvisable at a time of recession because it would
have the significant consequence of adding a handicap to the hardships
that already beset economic activity and at the same time prejudicing
employment. In other words, to avoid measures whose direct consequence
would be to delay economic revival, governments would be more inclined
to increase personal taxation. Many governments have chosen to raise
the level of indirect taxation through the value-added tax which
affects all economic actors.
To decrease public spending, the choices are equally limited.
What we usually witness are public service budget cuts and a decrease
in salaries (internal devaluation),Note
of welfare benefits, or freezing of certain large public investment
linked with the modernisation of infrastructures, for instance.
I consider this kind of policy inappropriate at a period of deep
recession. Indeed, these choices would lead to deterioration of
the citizens’ living conditions for one thing, as well as being
unfavourable to economic recovery.
44. The inherent risks of these two alternatives for safeguarding
civil and socio-economic rights are of various kinds. At this juncture,
a distinction should be drawn between immediate effects and those
that may become evident some time later. Among the immediate effects,
I consider that these policies, if they delay economic recovery,
will curtail for example the right to earn a living through their
negative impact on employment. Where vulnerable populations are
concerned, these policy choices can have a knock-on effect on the
right to live in decent circumstances, firstly because of a possible
income loss and secondly because of deterioration in infrastructures
and public services (hospitals, prisons, etc.).
The question of freezing public spending, when it comes to
cancelling capital expenditure, is problematic. Situations where
governments seek to rationalise their spending are fully justified,
and this avenue should be favoured over cancelling capital expenditure.
I think that the future loss of advantages that may result from
abandoning modernisation projects is underestimated by European
governments. In this perspective, the OECD advocates gradual, co-ordinated
ways out of recession, favouring reduction of deficits without neglecting
the structural reforms which are indispensable for future growth
and better living.Note
46. Excessive government debt can have harmful political consequences
for a country’s democratic stability. In Argentina in 2001, an unprecedented
economic recession led to a flight of capital, discredited the political classes
and triggered economic and political chaos. Against the background
of the austerity measures recommended by the IMF, in particular
the freezing of bank deposits, 35 people were killed in riots on
19 and 20 December 2001.
It is disturbing to see similar situations emerging in various
European countries with the attendant hazards to Europe’s democratic
stability. In Iceland, after the country’s financial meltdown, rioting
broke out in Reykjavik in January 2009, the like of which had not
been seen since 1949 when Iceland joined NATO. More recently, one
of the general strikes in Greece following the announcement of the
austerity measures ended with three people being killed when a bank
was set on fire in Athens on 6 May 2010. There are many such examples,
and the spate of austerity plans throughout Europe has plainly caused
its share of demonstrations, demands and riots with a sometimes
tragic outcome (see Doc.
on the political consequences of the economic crisis).
5.2 Democracy imperilled
by lack of transparency
48. At the time of the Greek crisis, the falsification
of state accounts was exposed. Greece is thought to have been disguising
the condition of its public budget for some years so as to avoid
European Union sanctions under the excessive deficits procedure
and the Stability and Growth Pact.
49. The following problem is emphasised: the malpractice condemned
on the European and international scene is not new, and was even
the subject of a study by the Council on Foreign Relations (United
States) and the International Securities Market Association (ISMA)
in 2001. However, the absence of change in state practices is perplexing.
States seem to have been using this method for ten years or so without
any ethical qualms about the transparency of public finances or
the considerable impact which these transactions have on the national
At the time, Gustavo Piga, a Doctor of Economics, published
a book as part of this inquiry, Derivatives and
public debt management,Note
highlighting the dubious
practices whereby states could minimise their short-term public
deficit. These practices are typified by their lack of transparency
and have grave repercussions on future and long-term state indebtedness.
For instance, derivatives can be not only a very useful tool for
state debt management but also help hide more public debt if they
51. Some governments have used the derivative transactions to
secure their countries’ entry to the European Monetary Union by
postponing the rising public debt to future years; they continued
such window-dressing strategies once they were in the EMU to avoid
sanctions because of the excess public deficit and the debt-over-GDP
ratio. As disclosure regarding derivative activity by sovereign
borrowers is extremely scarce, monitoring by “government shareholders”
(that is to say, the taxpayers) can only be weak at best. This lack
of disclosure makes governments less accountable as regards the
public debt situation and reduces the transparency of national statistics.
In a way, the financial markets propose the derivative “tricks”
to governments and later bully them when the public debt situation
spins out of control.
52. I stress the importance of transparency in a democracy. Without
transparency, democracy remains incomplete because an uninformed
population is one which cannot vote advisedly. In that respect,
I recall the merit of the media as watchdog of democracy, as they
enable the public to react to potential overspills of political
53. In the situation described above, lack of transparency affects
public financial management, an area that quintessentially requires
faultless transparency. That is why the principle of consent to
taxation, asserted for the first time in habeas
corpus, has ever since been considered one of the sureties
for democracy. Consequently, whether taxes are to be levied or funds
raised, I consider that governments must show proof of good intentions
in order to safeguard democracy.
54. Moreover, having regard to the social consequences of public
debt, the citizens must be properly informed of their state’s funding
strategies. They would thus have all the requisite information for
forming a personal and civic opinion and could thereby exercise
their political rights in full knowledge of the facts. Failing that,
I think our democracies will never be complete, and I would stress
that lack of transparency means domination of the people by the
elite, which is incompatible with their mission of representation
conferred by their election. Leaving aside imperative mandates,
only political ethics and democratic values are at issue here.
55. I am aware that lack of transparency in public financial management
is not the sole cause of the citizens’ growing disinterest in politics.
I nevertheless believe that if the citizens were given greater consideration
in these matters, they might perhaps be more motivated to involve
themselves in public affairs.
6 Interstate debt
and systemic risk
56. Countries transformed state debt into interstate
debt on an unprecedented scale, first via temporary emergency measures
and then in a more permanent way. Iceland became a debtor of the
United Kingdom and the Netherlands when Icesave collapsed. Afterwards,
European Union countries and the IMF scrambled with emergency loans
to Greece when markets were unwilling to issue loans to the country.
57. The European central banks also joined in by buying bonds
from troubled countries. Private market parties, such as weakened
financial institutions, were thus able to offload their risky assets
as the European Central Bank effectively set a floor in bond prices
and capped the maximum interest payable. European governments are
under extreme public pressure not to give more assistance to troubled
banks, but this is an indirect channel through which they do so
on quite a large scale. It is questionable whether this is an efficient practice.
58. The first protocol to the European Convention on Human Rights
severely limits repossession of assets by the state. One clearly
wonders now why it does not limit repossession of debt by states.
Whereas repossession of an individual asset violates the right of
an individual citizen, repossession of debt may violate the rights
of all tax payers.
59. In the current construct, the debtor country may be the stronger
party in negotiations. It knows that if and when it refuses to pay,
its government may increase its popularity at home and harm the
government of the creditor state. Although Iceland is not the best
example, the negotiations on the Icesave deal demonstrate this well:
Iceland is able to negotiate a reduction in the interest due in
every round. Similar developments will take place with the interest
rate countries like Greece and Ireland pay on their debt.
60. Also related to this issue is the behaviour of the financial
sector. The fact that bonuses have returned (like at ING) and that
banks are once again threatening to leave their home country (in
the case of the United Kingdom), is appalling. They have received
direct state support. They now receive indirect state support as states
and the ECB are taking over their bad assets. Moderation on the
part of the banking sector itself is highly warranted.
61. I am worried about the increase in systemic risk due to the
mutualisation of state debt. If one of the states is unable or unwilling
to repay, all the others states in the European Union will share
the burden. Citizens in those countries will be angered to find
out that, at a time of tax increases in their own country, they
are forced to pay for other countries as well, and in particular
for countries that have not behaved responsibly. This could potentially
lead to an enormous backlash against co-operation across Europe
and jeopardise the European project.
7 The way forward
and concluding remarks
My first suggestion is to take the same course as
the G20 of September 2009 concerning financial regulation, by reflecting
on a means of improving the international financial regulation system.Note
the purposes of this reflection, I stress the importance of controlling
financial speculation on sovereign debts. For that to be possible,
the power of the rating agencies with regard to state assets absolutely
must be curbed. Governments are also invited to take measures to
improve the transparency of public financial management policies,
and to do so by increasing the reliability of the statistics on
public finances in order to allay investors’ suspicions and win
back the trust of the citizens. The trustworthiness and transparency
of information on public finances must be restored because the problem
confronting state authorities concerns the citizens first and foremost.
This itself would also take away the power from the rating agencies.
Furthermore, it is necessary to regulate more strictly the
use of derivatives to avert untoward manipulations such as the one
condemned by Gustavo Piga in the case of Italy and replicated by
Greece with Goldman Sachs.Note
better regulation, an international apparatus could be devised in
order to standardise swap transactions at the European level and
thereby permit better containment of the risks run by states. In any
case, citizens and investors should have full insight into derivatives
I realise that in the short term there is no magic solution
for reducing government debt, especially in the present context.
The pressing question is therefore how to react to this economic
crisis without sacrificing human rights. The Parliamentary Assembly
is not the only institution addressing this question; in the United Nations
for instance, a high-level round table to discuss the impact of
economic and financial crises on the realisation of human rights
was organised on 1 March 2010. One of the keypoints of the conclusions
is to regard human rights as the “ethical reference”Note
“moral compass” for guiding official policies, even austerity policies.
A report jointly drafted by several organisations of civil
some useful answers to the present enquiry. Firstly, states cannot
avail themselves of the crisis to justify encroachments on human
rights or a more permissive stance in their protection. It is proposed
to devise fiscal policy instruments to avert erosion of rights and
aggravation of funding needs concerning education, housing or health
care, in particular for the vulnerable segments of the population.
They say that a set of economic recovery measures ensuring equal access
to these rights for all could boost employment and income-generating
States should accordingly take care
not to implement measures that would have the effect of penalising
society’s most vulnerable members such as women, children and the
66. Here attention is drawn to the broad construction which the
United Nations Human Rights Council places on human rights issues,
more so than the Council of Europe, since the participants in the
aforementioned high-level round table also addressed the question
of economic and social rights. Indeed, in a situation of economic recession
and having considered the consequences of state over-indebtedness,
plainly the protection of these rights comes to the fore.
67. I stress the need to rationalise public finances to avert
still more severe consequences for the future generations, but consider
that the European states should take no radical steps without first
analysing their short-term and long-term effects. The interests
at stake here are too momentous to risk negative repercussions in
the long term. That is why financial rationalisation must be properly
thought out and European citizens’ fundamental – civil, economic
and social – rights safeguarded.
68. As the creditworthiness and finances of many European states
have dwindled, challenges for the eurozone economies are particularly
daunting. The euro promise of greater stability and shared prosperity
has turned into the “euro-mess” in the absence of credible economic
governance, or at least co-ordination of policies. A mountain of
debt that many European economies are facing will not melt away
without concerted and orderly action. The immediate challenge is
to at least to stop the public debt from growing, to devise credible
strategies for debt reduction over the medium to long term and to
rebuild trust in the economic system by repairing past failures
in governance and regulation.
The creation of the European Financial Stability Fund in May
2010 was a welcome development that helped appease the financial
markets for some time. In addition, the newly created watchdogs
– the European Systemic Risk Board and three European supervisory
authorities for the banking, insurance and securities sectors –
became operational from January 2011. They have exclusive centralised
supervision powers that should help detect and correct early any
emerging macroeconomic imbalances. The European Securities and Market
Authority has also been tasked with overseeing the activities of
credit-rating agencies registered in the European Union. Moreover,
we should note the intention of the European Commission to propose,
in summer 2011, a comprehensive legislative framework for dealing
with ailing banks (that are too big, complex and interconnected
to be allowed to fail) so that these could be restructured or resolved
without making taxpayers carry the burden.Note
70. Further to these European governance measures, I feel it is
worth examining options for the gradual de-escalation of sovereign
debt problems, including by considering early partial restructuring
of state liabilities (to share the state debt burden with private
investors and preserve growth prospects), some monetary easing, continued
fiscal consolidation combined with structural reforms and sustained
stimulus for growth sectors. And finally, states should be extremely
aware of the moral hazard issues in underwriting each other’s debt.
In case of a default, such underwriting will come at a heavy economic
and political price.
71. Banks themselves will have to take a closer look at their
public support. They are no longer private sector institutions as
they once were and are now able to offload losses to the public.
This means that they must be publicly accountable and show moderation
to themselves. Repossession on failing mortgages will also occur in
Europe and will look particularly ugly when it goes hand-in-hand
with unexplainable and inexcusable behaviour of the management whose
jobs and banks were often rescued by the public at large.
72. We also need to have a closer look at the integrity of economists
whose advice to policymakers is as indispensable as it is dubious,
or even manipulative, at times. Of course, economics is not an exact
science but the ethics and responsibility of this profession could
be strengthened, such as by devising a global code of conduct.
73. This report therefore comes at a crucial time when key economic
decisions are being taken which will determine the health and growth
of Europe’s nations in the years ahead, as well as the development
of our societies, living conditions and respect for Europeans’ fundamental
rights. The decisions which our governments must now take will have
an irreversible impact on the building of 21st century Europe and
on the quality of the lives of future generations.