TABLE OF CONTENT
Introduction………...3
Chapter 1- Overview of the global financial and Eurozone
crises and policy reactions……….6
1.1 Introduction……….6
1.2 Main events of the subprime crisis………...7
1.3 The Euro area Sovereign Debt crisis………18
1.4 Possible causes of the global financial and Eurozone crises………28
1.5 How the crisis affected central banking activity………. 31
Chapter 2 - The optimal monetary policy framework: the rules
versus discretion debate………..36
2.1 Introduction………..36
2.2 Time inconsistency, expectations and reputation……….38
2.3 Central bank independence and inflation targeting………..48
2.4 Rules versus discretion and the global financial crisis……….60
2.5 Unconventional Monetary Policy and Forward Guidance…………...74
2.4 Conclusions………..……85
Chapter 3 - Recent developments in central banking
activity: the experience of four major central banks………...88
3.1 Introduction………...………..88
3.2 The Federal Reserve System………...90
3.3 Bank of England………...…104
3.4 Bank of Japan……….113
3.6 Conclusions………127
Chapter 4 – Empirical evidence on inflation expectations………132
4.1 Introduction………132 4.2 United States………..133 4.3 United Kingdom……….135 4.4 Eurozone………137 4.5 Japan………..138 4.6 Conclusions………139
Conclusions………...142
References……….145
Introduction
The present dissertation investigates central banking activity both from a theoretical and practical point of view. If in the past monetary policy was entrusted to governments, as the theory on central banks independence became widespread, most mature economies shifter the responsibility of conducting monetary policy to independent entities. Independence from governments is one of the features a modern monetary policy authority should possess, however, for various reason, among which there is democratic legitimacy, it is often not a complete independence. In particular, independence is advisable in relation to policy instruments, but not in goal determination. Therefore, usually central banks receives their mandate from and are accountable to governments for the achievement of the goal set by the latters.
The recognition of the value of independence is a consequence of a long lasting debate on rules versus discretion in monetary policy. On one hand rules are simple but impractical, as they cannot encompass all the situations the monetary policy authority has to deal with. On the other hand, from a theoretical point of view, discretion will inevitably result in a suboptimal equilibrium, for the reason that will be explained in Chapter two. The discussion on how limit discretion to achieve a first best result appeared to be concluded in the late 1990s, when a new framework was theorized and implemented by many central banks: inflation-targeting. Inflation-targeting qualifies as constrained discretion, as it prescribes an clearly defined inflation objective to be communicated to private agents, and to be achieved in the medium term, but let the monetary policy authority determine short-term policy that may cause temporary deviation from the target. The most important element of inflation targeting, is that it is a way to gain anti-inflationary credibility, as the target is clearly stated and private agents are able to assess the central bank’s ability to comply with it. In this sense, inflation targeting aims at anchoring inflation expectations to the level defined by the target. Among the central banks taken into consideration in the present dissertation only the Bank of England have officially adopted inflation targeting, however, also the
Federal Reserve, the European Central Bank, and the Bank of Japan, have had a similar approach, despite having avoided the definition of inflation-targeters.
Before the global financial and Eurozone crises, the keeping inflation low was considered the main duty of a central bank. The financial turmoil changed that view, and forced policymakers to focus on financial stability as well. Moreover, the consequent recession was also addressed with monetary policy measures, for example quantitative easing. Among the unconventional monetary policy measures that are currently used to keep markets liquid and attempting at creating economic growth, the most important ones are quantitative easing, and forward guidance. The latter, which is basically a communication policy, is the focus of the present dissertation whose purpose is not to test its effectiveness in smoothing financial markets, but its longer-term influence on inflation expectations. Forward guidance consists in a ‘promise’ of keeping monetary policy accommodative if some conditions are not met, or for a more vague period of time, to create above-target inflation expectation, to foster economic recovery. Given that central banks worked hard to anchor inflation expectations to a given level, and at present they are trying to temporarily increase those expectations, it is interesting to see if they are succeeding in it and if the change in expectations appear to be caused by forward guidance of other economic conditions.
The present dissertation is structured as follow. The first Chapter briefly reviews the main events of the global financial and Eurozone crises. The second Chapter deals with the evolution of the theoretical framework on how monetary policy is to be implemented. The third Chapter shows the actual activities of the Federal Reserve, the Bank of England, the European Central Bank, and the Bank of Japan, including both the usual operations, the monetary policy framework under which they operates, and the most recent unconventional measures. The last Chapter investigated the movement of inflation expectations, inferred from financial markets, through the so-called breakeven inflation, which is a sort of difference in the yield in inflation protected securities and non inflation protected comparable securities.
Chapter 1 - Overview of the global financial and
Eurozone crises and policy reactions.
1.1 Introduction.
As the people familiar with the work of Hyman Minsky know, financial crisis are a regular feature of any capitalist economy that includes a sophisticated financial sector (1984). Whether the process that leads to inflation and debt deflation is a dysfunction of the whole system or just a natural development of such an economic structure, clearly to be kept under control, is an issue that goes beyond the scope of the present dissertation. However, the magnitude of the recession triggered by the subprime meltdown, started in the US back in 2007, constituted a wake up call for many, including academics and professionals, who deluded themselves thinking the bubble economy could last forever and the new complex financial security market would not even suffer liquidity setbacks (Caballero, 2009).
The so-called subprime crisis began with the US housing market bubble. From 2000 to 2005 US house prices skyrocketed, becoming the main driver of the US GDP growth (through both the expansion of the real estate market and the increase of consumer expenditures, made possible by additional cash flows obtained by homeowners by refinancing their mortgages). Such escalation was mainly due to low interest rates and easy access to credit (Morris, 2009). Eventually the bubble burst, causing a rise in foreclosures. Given the huge amount of money invested in subprime mortgages and assed backed securities originated by those, some of the largest and most respected banks, investment houses, and insurance companies have either declared bankruptcy or have had to be rescued financially. Even if the signs of financial distress in the financial sector were already manifest in 2007, it is only in October 2008, after the bankruptcy of
Lehman Brothers, that credit flows froze, lender confidence plunged, and one after another the economies of countries around the world sank into recession.
This financial crisis began in industrialized countries, but then quickly affected also emerging markets and developing economies. Investors pulled capital from countries, disregarding the fact they may have small levels of perceived risk, and caused values of stocks and domestic currencies to tumble. Also, slumping exports and commodity prices pushed economies worldwide either into recession or into a period of slower economic growth.
The crisis exposed fundamental weaknesses in financial systems worldwide, prompting coordinated easing of monetary policy, trillions of dollars in intervention by central banks and governments, and large fiscal stimulus packages (Nanto, 2009). Furthermore, it has been followed by a sovereign debt crisis in Europe, which threatened the solidity of the European Union and put to test its ability to act promptly, and cooperating. This connection is not a coincidence, since the links of these two are tight and strong, if only for the burden of bailing out the financial sector weighting on public finances (Reinhart and Rogoff, 2009).
The present Chapter focus exactly on the recent, financial and Euro area sovereign debt crises. The next section highlights the main events pertaining to the subprime crisis in the US and the consequent response from monetary authorities and the Government. The following section continues presenting contagion to certain European countries, along with a timeline of the Eurozone debt crisis and of the position taken on the issue by the ECB and the European Monetary Union. The fourth paragraph consists of a brief explanation of the possible causes of those events. The fifth concludes highlighting the fact that central banks had to make use of new or special policy instruments to address the challenge arisen from the crisis. These new policies are going to be discussed in depth in the third Chapter, also in comparison with the structure and targets of each of the four major central banks, after a review of the theoretical debate on the optimal framework for monetary policy, covered in the next Chapter.
At the onset of 2007, the mortgage lending markets showed some disturbances, causing worries to arise among investors and financial authorities, in particular with reference to the lack of transparency and complexity of valuation of new financial instruments (FT Tett, 2007).
A first indicator of the subprime mortgages market distress condition dates February, 27th, of the same year, when the Federal Home Loan Mortgage Corporation, also known as Freddie Mac1 issued a press release announcing it will no longer buy the most risky
subprime mortgages and mortgage-related securities.2 In the succeeding months, as
house prices started to fall and, consequently, foreclosure soared, some mortgage lender corporations filed for bankruptcy3, reported condition of distress4 or liquidated mortgage backed securities investments, while Standard and Poor’s downgraded some of such securities (FT Scholtes, 2007). On August 9, BNP Paribas suspended three of their funds, stating that they have no way of valuing the complex assets included in them, known as collateralised debt obligations (CDOs), or packages of sub-prime loans.5 It was the first major bank to acknowledge the risk of exposure to subprime mortgage markets. That very day is considered by many the official starting date of the credit crunch: Adam Applegarth, Northern Rock's chief executive at the time, later said that it was ‘the day the world changed’ (Elliott, L., Teather, D. and Treanor, J., 2010).
At same time, the European Central Bank (ECB) responded to shortages of liquidity in money markets around the world caused by the tensions related to US subprime mortgages, injecting €335bn into the euro area banking system (ECB Press Release 070814_1).
1 Freddie Mac is a Government Sponsored Enterprise (GSE) chartered by Congress in 1970 to provide liquidity, stability and affordability to the housing market. Like Fannie Mae, Freddie Mac operates in the secondary mortgage market. The full legal name for Freddie Mac is the Federal Home Loan Mortgage Corporation. (http://www.freddiemac.com)
2 Federal Reserve Bank of St. Louis Website: Financial Crisis Timeline.
3 The Associated Press, "American Home Mortgage files for bankruptcy", Daily News, 06 August 2007; Keoun B. and Church S., "New Century, Biggest Subprime Casualty, Goes Bankrupt (Update4)",
Bloomberg.com, 02 April 2007.
4 Bajaj, V., "More Lenders Feeling Pain From Defaults", The New York Times, 31 July 2007.
5 “The complete evaporation of liquidity in certain market segments of the US securitisation market has made it impossible to value certain assets fairly regardless of their quality or credit rating. The situation is such that it is no longer possible to value fairly the underlying US ABS assets in the three above-mentioned funds. We are therefore unable to calculate a reliable net asset value (“NAV”) for the funds.” (“BNP Paribas Investment Partners temporarily suspends the calculation of the Net Asset Value
of the following funds: Parvest Dynamic ABS, BNP Paribas ABS EURIBOR and BNP Paribas ABS EONIA”, BNP Paribas Press Release, 09 August 2007)
Less than ten days later, the Federal Reserve Board voted to reduce the primary credit rate 50bp to 5.75%, bringing it to only 50bp above the Federal Open Market Committee’s (FOMC) federal funds rate target. Moreover, the Board increased the maximum primary credit borrowing term to 30 days, also renewable by the borrower (FR, 20070817a). The rate cut was accompanied by a statement remarking that ‘the financial market conditions have deteriorated’, and ‘that the downside risks to growth have increased appreciably’ (FR 20070817b).
The United Kingdom was the first non-US country to suffer from the subprime market disruption: the British bank Northern Rock (United Kingdom’s fifth-largest mortgage lender at the time) had borrowed large sums of money to fund mortgages for customers, and needed to pay off its debt by reselling those mortgages in the international capital markets (FT Editorial 2007). When demand for securitised mortgages had fallen, Northern Rock faced a liquidity crisis. A loan, to rescue it, was provided by the Bank of England at a penalty rate, against the security of its book of mortgage loans.6 This sparked fears that the bank will shortly go bankrupt, causing a
bank run, with customers forming queues round the block to withdraw their savings (FT Braithwaite and Tighe, 2007).
During fall, some large financial institutions attempted to enhance their liquidity levels with not great confidence in their plan (that was abandoned before the end the year).7 In the meantime, a first initiative by the US government tried to create a network for helping homeowners with their mortgages.8
From September to December, the Federal Reserve reduced its target for the federal funds rate 100bp to 4.25% and the primary credit rate 100bp to 4.75%, by 3 consecutive cuts(FR 20070918a, FR 20071031a, FR 20071211a).It also announced the creation of a Term Auction Facility (TAF), in which fixed amounts of term funds were to be auctioned to depository institutions against a wide variety of collateral. TAF permitted depository institutions to anonymously bid to receive funds guaranteed by a wide variety of collateral over a period of 28-35 days (Wheelock, 2008). Starting in December 2007, auctions were held every two weeks and involved large sums ranging from $20bn to $50bn, which rose to more than $50bn in May 2008 (FR 20080502a).
6 United Kingdom Treasury Department, Press Release 94/07: Liquidity support facility for Northern
Rock plc, 14 September 2007.
7 Bank of America Newsroom, Consortium Provides Update on Master Liquidity Enhancement
Conduit, 21 December 2007.
8 US Treasury, Press Release HP-599: Announcement of New Private Sector Alliance – HOPE NOW, 10 October 2007.
The first few months saw some success in reducing credit spreads, although such reductions generally lasted only for a few days and had no significant long-lasting impact, especially after March 2008 (Taylor, 2009). On 30 July 2008 the TAF period was extended to 84 days (FR 20080730a). This was part of a coordinated action administered simultaneously across five institutions: the Bank of Canada, the Bank of England, the ECB, the Fed, and the Swiss National Bank. Moreover, they announced measures designed to address elevated pressures in short-term funding markets (Bank of England News Release 2007/158). The FOMC authorized temporary reciprocal currency arrangements (swap lines) with the ECB and the Swiss National Bank (SNB). These swap lines were renewed and expanded several times until they were closed in January 2010 (ECB Press Release pr100127), to be reactivated about four months later, in the wake of the European sovereign debt crisis (ECB Press Release pr100510_1).
The year 2008 began with two additional rate cuts, resulting in a target for the federal funds rate of 3% and a primary credit rate of 3.5% (FR 20080122b, FR 20080130a). In addition, the government undertook a stimulus plan, signing the Economic Stimulus Act of 2008 into law9. Nevertheless, the financial industry showed increasing distress and
financial institutions kept on defaulting (Adrian et al., 2011) or being bailed out10, as it
happened also to Northern Rock11.
Both the ECB and the Federal Reserve continued injecting liquidity in the system (ECB Press Release pr080328, FR 20080307a), the latter by creating additional policy instruments: the Term Securities Lending Facility (TSLF) (FR 20080311a) and the Primary Dealer Credit Facility (PDCF) (FR 20080316a).
TSLF is a loan facility that promotes liquidity in Treasury and other collateral markets by offering Treasury securities held by the System Open Market Account (SOMA) for loan, over a one-month term and against other eligible collaterals. Securities loans are awarded to primary dealers based on a competitive single-price auction. The TSLF auctioned up to $200bn in Treasury securities in an attempt to increase bank liquidity and to lower spreads on mortgage backed securities (MBSs), which had stopped trading due to their high risk premia. This allowed banks to use a
9 Levine, A., “Bush signs stimulus bill; rebate checks expected in May”, CNN Politics.com, 13 February 2008.
10 Bank of America Newsroom, "Bank of America Agrees to Purchase Countrywide Financial Corp.", 11 January 2008.
broader range of assets, including high-rated bonds and securities as collateral; in May 2008 TSLF expanded to include further asset-backed securities (FR 20080502a).
PDCF accepted a larger range of securities than TSLF and is a ‘cash-for-bond’ form of lending: it is an overnight loan facility that provides funding for up to 120 days to primary dealers in exchange for collateral (DiCecio and Gascon, 2008). Although both schemes did experience some initial success, they failed to effectively bring the MBS risk spreads down in the longer term. In spite of this, the Federal Reserve extended both facilities until January 2009 (FR 20080730a).
These measures were not sufficient to halt the liquidity shortage affecting some of the major banks: Bear Stearns, a large investment bank which engaged heavily in mortgage backed securities was not able to recapitalize itself to cover its losses, its stock collapsed in March, and eventually was purchased by JPMorgan Chase & Co. with the financing support of the Federal Reserve (FT Guerrera, White, and Guha, 2008).12 Another rate cut was necessary, resulting in a target for the federal funds rate of 2.25%, and a primary of 2.50% (FR 20080318a).
Despite the Federal Reserve actions, house and asset prices were rapidly falling, mortgage delinquency and default rates were continuing to rise, and thus also the value of collaterals came to be a problem (Taylor, 2009). Between the third quarter of 2007 and the second quarter of 2008, $1.9tr of mortgage-backed securities received downgrades to reflect the reassessment of their risk.13 On July 11, 2008, IndyMac, the US’s largest mortgage lender, collapsed and its assets were taken into federal ownership.14 Government sponsored mortgage brokers, the Federal National Mortgage Association (Fannie Mae or Fannie) and Freddie Mac (FR 20080713), which owned $5.1tr of US mortgages, about half of the outstanding market15, sought to raise capital as the extent of the problems in the housing market became apparent. However, despite raising $13.9bn in the spring of 2008, benefiting from the ban on naked short-selling issued by the SEC on a variety of financial institutions16 and later having their capital
12 The Federal Reserve Bank of New York agreed to protect JPMorgan Chase against losses exceeding $1bn, in exchange for a fee. (Federal Reserve Bank of New York, Press Release rp080324:
Statement on Financing Arrangement of JPMorgan Chase's Acquisition of Bear Stearns, 24 March 2008).
13 Birger, J., “The woman who called Wall Street’s meltdown”, Fortune, 4 August 2008.
14 Federal Deposit Insurance Corporation, Press Release pr08056: FDIC Establishes IndyMac
Federal Bank, FSB as Successor to IndyMac Bank, 11 July 2008.
15 Federal Reserve Website, Government-Sponsored Enterprises Table L124, 11 December 2008. 16 SEC, Press Release 2008-143: SEC Enhances Investor Protections Against Naked Short Selling, 15 July 2008.
adequacy requirements relaxed17, the Federal Housing Finance Agency (FHFA)18 took both under conservatorship19, on September 7, as their credit, dividend and strength ratings dropped.20
Eventually, the banking industry came up against a colossal hit. On September 15, investment bank Lehman Brothers filed for Chapter 11 bankruptcy (FT Robinson, 2008), having failed to raise the necessary capital to underwrite its downgraded securities. The failure of Lehman demonstrated that the government was not willing to bail out all banks, and this caused an immediate spike in interbank lending rates. On the same day, Bank of America purchased investment bank Merrill Lynch for $50bn.21 The following day, the Federal Reserve authorised the Federal Reserve Bank of New York to lend up to $85bn to the American International Group (AIG), a leading insurer of credit defaults which suffered an acute liquidity crisis following its downgraded credit rating, in exchange for 79.9% equity (FR 20080916a). America’s remaining investment banks, Goldman Sachs and Morgan Stanley, became bank holding companies on September 21 (FR 20080921a), to gain greater access to capital.22 On September 25,
savings and loan giant Washington Mutual was seized by the Federal Deposit Insurance Corporation, and had most of its assets transferred to the bank JPMorgan Chase. Four days later, Citigroup sought to acquire Wachovia, America’s fourth largest bank, although a counter-proposal by Wells Fargo eventually secured the deal in October.23
In response to such news the financial markets became extremely volatile. The Dow Jones Industrial Average (Dow) saw tumultuous shifts almost daily and registered its
17 U.S. Treasury Department, Press Release hp1079: Paulson Announces GSE Initiatives, 13 July 2008.
18 An independent regulatory agency of the executive branch of the US government that regulates the Federal Home Loan Banks, Fannie Mae, and Freddie Mac.
19 US Treasury Department, Press Release hp1128: Statement by Secretary Henry M. Paulson, Jr. on
Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers,07 September 2008.
20Testimony Chairman James B. Lockhart III, US Senate Committee on Banking, Housing and Urban Affairs, Hearing on US Credit Markets: Recent Actions Regarding Government Sponsored Entities,
Investment Banks and Other Financial Institutions, 23 September 2008.
21 Bank of America Newsroom, Bank of America Buys Merrill Lynch Creating Unique Financial
Services Firm, 15 September 2008.
22 The Federal Reserve Board announced on September 19 the creation of the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) to extend non-recourse loans at the primary credit rate to U.S. depository institutions and bank holding companies to finance their purchase of high-quality asset-backed commercial paper from money market mutual funds.
(Federal Reserve, 2008 Banking and Consumer Regulatory Policy Press Release 20080919a, 19 September 2008.)
23 Federal Deposit Insurance Corporation, Press Release pr08088: Citigroup Inc. to Acquire Banking
largest ever single-day point drop in value on September 29, 2008.24 Such was the volatility that between September and December the Dow registered four of the five highest points of gains and losses in its history.25 Consequently, investors’ confidence fell dramatically, which was reflected in the flight to safer assets like gold, oil and the US dollar (FT Mackenzie, and Oakley, 2008).
Contradicting many who thought the crisis would remain confined to the financial markets, it showed serious repercussion to the real economy. The US automobile industry suffered as car sales in October fell 31.9% compared with September 2008. Retail sales were adversely affected, declining by 2.8% between September and October 2008 and 4.1% on the previous year. Only budget companies, like Wal-Mart and MacDonald’s, escaped.26 After a short lag, unemployment rates rose every month from 6.2% September 2008 to 7.6% in January 2009.27
The recession set in Europe as well. The first European country to experience trouble was Ireland, whose banks were heavily investing in mortgage lending and financed themselves by foreign borrowing (Honohan, 2009). Since the collapse of several US financial institutions, Irish banks had difficulties accessing funds, and the house price bubble in the country had burst too. Therefore, Ireland's government promised to underwrite the entire Irish banking system, as a response of its biggest one-day fall in share price for two decades (FT Murray-Brown, 2008).
On October 3, Congress passes and President Bush signs into law the Emergency Economic Stabilization Act (EESA) of 200828, which establishes the $700 billion Troubled Asset Relief Program (TARP). This law authorised the Treasury Secretary to establish vehicles to purchase, hold, and sell troubled assets and acquire equity stakes in any financial institution using market mechanisms. The legislation also required the Treasury Secretary to coordinate efforts with foreign financial authorities and central banks. EESA prevented participants from profiting from the sale of troubled assets to the Treasury, and established a number of oversight provisions, including two oversight boards and an Inspector General to report to Congress. It also included rules on executive compensation for participating institutions, and made a number of other
24 The Time, Lists, Top 10 Dow Jones Drops.
25 “Dow Jones Industrial Average All-Time Largest One Day Gains and Losses”, Wall Street Journal,
Market data center, Last Update: 30 December 2011.
26 Healy, J., “A Record Decline in October’s Retail Sales”, New York Times, 14 November 2008. 27 Bureau of Labor Statistics, United States Department of Labor, Economy at a Glance, 25 February 2009.
28 The Washington Times, “Summary of the Emergency Economic Stabilization Act of 2008”, 28 September 2008.
relevant financial provisions. Federal property managers including Fannie and Freddie were mandated to offer mortgage assistance. Furthermore, Section 128 allowed the Federal Reserve to accelerate its payment of interest on bank deposits, as a means of enhancing immediate capital. The legislation also mandated the SEC to compile a report on the continued use of mark-to-market accounting. Finally, the FDIC insurance limit on deposit and share holdings was increased from $100,000 to $250,000.
On October 14, 2008, the US Treasury announced that $250bn of TARP funds would be made available under a Capital Purchase Program (CPP) for purchasing preferred shares in banking institutions. The non-voting senior preferred shares would count as Tier 1 capital and would not require any board representation. Senior preferred shares were paying a cumulative dividend rate of only 5% per annum for the first five years before yielding annual interest of 9%. Preferred stock might be redeemed with the proceeds of a private rights issue raising Tier 1 capital after less than three years, while the Treasury was free to transfer its shares to a third party. Treasury would also receive entitlements (or warrants) to purchase common stock worth up to 15% of market value at the point of issuance.29
Uptake under the CPP has been very high. Immediately, it was announced that nine large banks (including Citigroup, JPMorgan Chase and Wells Fargo, which all received the maximum $25bn) would collectively receive $125bn (Nelson, 2008). Beginning in late November, the Treasury made weekly purchases of equity stakes in hundreds of public and private financial institutions (Contessi, and Francis, 2011).
Treasury authority under TARP was interpreted broadly to embody a number of schemes. In particular the Treasury launched the Targeted Investment Program (TIP) and Asset Guarantee Program (AGP). TIP provided an additional $20bn in capital investment to both Citigroup in November 2008 and Bank of America in January 2009, albeit on less generous terms than the CPP. In both cases, the banks have provided the Treasury with $20bn in preferred shares paying a cumulative annual dividend of 8% accompanied by warrants for the purchase of common stock.30
AGP was finalised on 16 January 2009 and included Bank of America and Citigroup as participants. The AGP saw the Treasury and FDIC agree to insure the banks against
29 US Treasury, Press Release hp1207: Treasury Announces TARP Capital Purchase Program
Description, 14 October 2008.
30 US Treasury, Press Release hp1287: Joint Statement by Treasury, Federal Reserve and the FDIC
on Citigroup, 23 November 2008; US Treasury, Press Release hp1356: Treasury, Federal Reserve and the FDIC Provide Assistance to Bank of America, 16 January 2009.
potential losses over the coming ten years on a pool of assets backed by mortgages, commercial real estate, corporate debt, and associated derivatives. The Treasury and FDIC agreed to insure $306bn of Citigroup assets in return for $7bn in preferred shares yielding annual 8% dividends. Under the deal Citigroup would be fully liable for the first $29bn of losses, after which the Treasury and FDIC would be liable for 90% of losses. In a similar deal with Bank of America, the Treasury and FDIC agreed to insure $118bn of assets in exchange for $4bn in preferred stock with an 8% dividend; Bank of America has been fully liable for the first $10bn of losses, after which the Treasury and FDIC become liable for 90% of losses. In addition, the Treasury invested $40bn in AIG, under the Systematically Significant Failing Institutions scheme, as well as significant loans for automobile manufacturers General Motors and Chrysler (Contessi, and Francis, 2011). At the end of President Bush’s tenure in office, approximately $350bn of TARP funds had been invested.31
October 2008 was very intense; three major Icelandic banks collapsed over three days triggering a systemic crisis. On September 29, 2008, the Icelandic Government was forced to take a 75% stake in the country's third-largest bank, Glitnir, after it experienced short-term funding problems. At that time the Icelandic banks were reportedly exposed to loans totalling six times the country's GDP. The shock of the collapse of Lehman Brothers had resulted in a lack of liquidity in the world's credit markets, which had left the Icelandic banks unable to refinance loans. Landsbanki Bank suffered difficulties a few weeks later. It operated in the UK as a branch of the Icelandic bank, which raised retail deposits under the Icesave brand. To protect the deposits of their many British customers, Gordon Brown exploited anti-terror legislation to freeze the assets of the banks' UK subsidiaries.32 To avert the collapse of the UK banking sector, the British government bailed out several banks, including the Royal Bank of Scotland, Lloyds TSB, and HBOS.33 Both UK and US governments used the same strategy of capital injections. Many European countries reacted also increasing
31 Herszenhorn, D.M., “At Obama’s Urging, Bush to Seek Rest of Bailout Funds”, The New York
Times, 12 January 2009.
32 UK Parliament Publications, Banking Crisis: The impact of the failure of the Icelandic banks, 4 April 2009.
33 Wearden, G., “British government unveils £37bn banking bail-out plan”, The Guardian, 13 October 2008.
guarantees on bank liabilities, predominantly on deposits, and helping financial institutions to raise capital, also by partially buying their stocks.34
Monetary authorities were still trying to enhance liquidity in the financial markets, with a coordinated effort: eight central banks including the Bank of England, the ECB, and the Federal Reserve cut their interest rates in a coordinated attempt to ease the pressure on borrowers.35 Several rate cuts were carried out, therefore at the beginning of 2009 the target range for the effective federal funds rate was 0 to 0.25% and the primary credit rate was 0.50%;36 while The ECB’s interest rate on the main refinancing operations was reduced to 2%. It also changed the interest rates on the marginal lending facility and deposit facility to 3% and 1% respectively.37 It proceeded on lowering the refinancing rate throughout 2009, while the Federal Reserve has not adjusted it until 2010, when it was increased by 25bp.38
On February, President Obama signed into law the American Recovery and Reinvestment Act of 2009, which includes a variety of spending measures and tax cuts intended to promote economic recovery.39 The Homeowner Affordability and Stability
Plan had also been announced. The plan included a program to permit the refinancing of conforming home mortgages owned or guaranteed by Fannie Mae or Freddie Mac that currently exceed 80% of the value of the underlying home. The plan also creates a $75bn Homeowner Stability Initiative to modify the terms of eligible home loans to reduce monthly loan payments. In addition, the U.S. Treasury Department will increase its preferred stock purchase agreements with Fannie Mae and Freddie Mac to $200bn, and increase the limits on the size of Fannie Mae and Freddie Mac's portfolios to $900bn.40 Fannie Mae and Freddie Mac losses continued for a long time and they still have not repaid their debt to the Treasury: after five years of losses totalling $164bn, Fannie Mae earned a $17bn profit in 2012, its most profitable year ever. Freddie Mac, which racked up $94bn in losses between 2007 and 2011, earned $11bn in 2012. Both agencies have stopped needing state financing, and through the end of 2012 they had
34 Attanasi, M.G., “Euro area fiscal policies: response to the financial crisis”, ECB Occasional paper series no. 109, April 2010, pp. 12-21.
35 ECB, Press Release pr081008: Monetary policy decisions, 8 October 2008; Federal Reserve,
Monetary Policy Press Release 20081008a, 8 October 2008.
36 Federal Reserve, Monetary Policy Press Release 20081216d , 16 December 2008. 37 ECB, Press Release pr090115: Monetary policy decisions, 15 January 2009.
38 Federal Reserve Bank of New York Statistics, Historical Changes of the Target Federal Funds and
Discount Rates; ECB Statistics, Key ECB interest rates.
39 American Recovery and Reinvestment Act of 2009, Recovery.gov.
40 US Treasury, Press Release tg33: Homeowner Affordability and Stability Plan Executive Summary, 18 February 2009.
remitted $55.2bn worth of dividend payments to the Treasury.41 Other measures were put in place to support the automotive industry,42 which has not yet completely repaid its debt.43
On April 2009, G20 leaders, meeting to discuss financial markets and the global economy in London, agreed to establish a new Financial Stability Board, distributing a global stimulus package worth $5tr. It was to collaborate with the IMF to provide early warning of macroeconomic and financial risks and to recommend actions to be taken.44
Market conditions kept improving in the US while Europe was sliding toward its sovereign debt crisis. On October 2009 the Dow Jones Industrial Average closed above 10,000 for the first time since October 3, 2008.45 Many banks that benefited of the TARP funding were repaying their debt to the US Treasury,46 however, the number of the ‘problem banks’ had not ceased to increase.47
The ECB’s Governing Council decided to discontinue the temporary swap lines with the US Federal Reserve System on January 27, 2010, affirming that these lines were no longer needed, as the financial markets were functioning better. The decision was taken in agreement with the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank.48 However, the closing of the swap lines did not last long: they
were reactivated in May, to ease liquidity in the European government bond market.49 On October 3, 2010, the TARP scheme authority to make new financial commitment expired, and the program is winding down its investments since then.50 On January 2011, the Federal Reserve Bank of New York announced the termination of its assistance to American International Group, Inc. (AIG) and the full repayment of its
41 Newman, R., “Surprise: Fannie and Freddie Are Set to Pay Taxpayers Back”, US News, 12 April 2013.
42 US Treasury, Press Release tg64: Treasury Announces Auto Supplier Support Program, 19 March 2009.
43 US Treasury, Auto Industry: Program Overview - Five Year Update, (Last Updated: 1/10/2014 3:08 pm).
44 IMF, G20 London Summit, Final Communique, 2 April 2009.
45 Mackenzie, M., “Dow closes above 10,000”, Financial Times, 14 October 2009.
46 Dealbook, “Bank of America to Repay $45 Billion From TARP”, New York Times, 02 December 2009; Zeleny, J. and Dash, E., “Citigroup Nears Deal to Return Billions in Bailout Funds”, New York
Times, 14 December 2009; Dealbook, “Wells’ TARP Plan Brings End to Bailout Era”, New York Times,
14 December 2009.
47 Federal Deposit Insurance Corporation, Press Release pr10036: FDIC-Insured Institutions Report
Earnings of $914 Million in the Fourth Quarter of 2009, 23 February 2010.
48 ECB, Press Release pr100127: ECB and other central banks decide to discontinue the temporary
swap lines with the Federal Reserve, 27 January 2010.
49 Federal Reserve, Monetary Press Release 20080122b, 22 January 2008; Monetary Press Release
20080130a, 30 January 2008.
loans to AIG.51 At present, more than 98% of the funds spent under the TARP plan has been recovered.52
Eventually, in March, the Federal Reserve released the Comprehensive Capital Analysis and Review (CCAR) of the 19 largest US bank holding companies. As a result of the CCAR stress tests, some firms are expected to increase or restart dividend payments, buy back shares, or repay government capital.53
Starting from 2012, the US economy shows more tangible signs of recovery, in particular growing business investments and profits.54 Employment level picked up as well, with the unemployment rate reaching 7% at the end of 2013, even if long-term unemployment appears to be still an issue, 55 and part of that decline s caused by a diminishing number of people being in the labour force.56 For this reason, the Federal Reserve is willing to slow down the pace of the asset purchases it has been carrying out since 2008,57 while, however, restating the commitment on keeping interest rates very low until 2015, at least.58
1.3 The Euro area Sovereign Debt crisis
While the subprime crisis was finishing to spread out its effect on financial markets, it had already weighted on the public finances of many European countries that had had to rescue financial institutions. Nevertheless, the trigger to the huge sovereign debt crisis that hit the countries in the periphery of Europe was an unexpected statistical
51 Federal Reserve Bank of New York, Press Release: New York Fed Ends AIG Assistance with Full
Repayment, 14 January 2011.
52 US Treasury Website, Troubled Asset Relief Program (TARP) Tracker. (Last Updated: 27/06/2013 4:22 pm)
53 Federal Reserve, Press Release 20110318a: Federal Reserve completes Comprehensive Capital
Analysis and Review, 18 March 2011.
54 US Treasury Research Center, The U.S. Economy in Charts, April 2012.
55 Politi, J., "Four takeaways from the US jobs report", Financial Times, 06 December 2013. 56 G.I., “America's Job Report - Both better, and worse, than it looks”, The Economist, 10 January 2010.
57 Harding, R., “Fed to ‘proceed cautiously’ with taper”, Financial Times, 08 January 2014. 58 Mackenzie, M. and Massoudi, A., “Fed deftly swaps tools to investor applause”, Financial Times, 19 December 2013.
discrepancy in the national deficit of Greece: the hole in Greece's finances was double that had been previously feared.59
Markets were quivering, being apprehensive that Greece may fail to address the indispensable cuts pledged by the finance minister George Papaconstantinou. The country's sovereign debt credit default swaps stood at 202bp in the end of November 2009, among the highest in the Eurozone. The country's ratio of national debt to GDP was headed for 135%.60 Fitch rating agency cut promptly Greece's long-term debt to BBB+ from A minus, saying the medium-term outlook was gloomy. The downgrade came less than a day after Standard & Poor's put Greece's debt under ‘negative’ watch and warned of a downgrading if the country's government did not tackle overspending quickly.61
Besides the nervousness of financial markets and the Euro fall by 2% against the USD, Greek debt downgrade fuelled investors' fears about the UK's debt and its ability to not fall into recession. Credit rating agency Moody's warned that the UK faced "an inexorable deterioration of debt affordability in the short term" due to a structural public deficit running above 10% of GDP. It confirmed Britain's AAA credit rating, but placed it in the middle of the three categories within the band.62 Great Britain, indeed, have not
experienced a full-scale sovereign debt crisis, however, the Bank of England had to intervene with exceptional policy responses. In comeback to the intensification of the financial crisis and the onset of recession in 2008, the Monetary Policy Committee (MPC) loosened its policy significantly. By March 2009 the bank rate had been cut to 0.5%, but the MPC estimated that further stimulus was required. It was decided that the best way to loosen monetary policy further was to undertake a programme of quantitative easing (QE). Around £200bn of assets, mainly government securities were bought between March 2009 and February 2010. The ultimate aim of the QE was to stimulate demand via a lower cost of external finance and stronger asset prices, and thus to bring about higher output growth and counterbalance deflationary pressures.63
59 Barber, T., “Greece vows action to cut budget deficit”, Financial Times, 20 October 2009. 60 Moya, E., “Investors' fears grow over Greek economy”, The Guardian, 30 November 2009. 61 Smith, H. and Seager, A., “Financial markets tumble after Fitch downgrades Greece's credit rating”, The Guardian, 8 December 2009.
62 Ibid.
63 Bridges, J. and Thomas, R., “The impact of QE on the UK economy — some supportive monetarist
Proposals to restructure Greek finances approved by the end of the year 200964 awakened social unrest, due to rising unemployment and distrust towards rating agencies and EMU membership constraints.65 Anxiety of contagion arose almost immediately, since European banks were very much exposed to Greek debt66, market questioned the state of Spain and Portugal’s sovereign debt67, and EMU member states were failing to reach an agreement on how to approach the crisis68. Two weeks after the socialist government had submitted to international pressure and announced an ambitious austerity programme, finance ministers from the 16 Eurozone countries agreed to assemble financial aid for Greece, if needed, but did not reveal the details of their plan. The indeterminacy of such a programme caused speculation about Greek debt escalation not to come to a halt, though the intervention of the IMF was followed with faint optimism.69 On April 23, 2010, Greece officially requested financial support from the euro area countries and the IMF70, the detail of which had been fixed in the previous week: it would get €30bn in bilateral loans, co-ordinated by the European commission, and paid through the ECB; further €15bn were made available through the IMF.71 The plan had almost no impact on markets, and the rating of Greek debt reached
the junk boundary72, along with the downgrade of Spain and Portugal73 by Standard &
Poor’s, and by Fitch right afterwards. The IMF and Eurozone nations had demanded tough economic reforms in return for the loan, asking an impending deadline on Greece's debt repayment, causing the country to have no choice but to approve additional austerity measures, while shattered by violent protests.74 In the hope that it would give a very clear signal to market speculators to back off, a €110bn EU-IMF
64 Kontogiannis, D., “Greek parliament approves budget cuts”, Financial Times, 24 December 2009. 65 Hope, K., “Union forecasts record turn-out for austerity package protest”, Financial Times, 17 December 2009.
66 Treanor, J., “France and Switzerland most exposed to Greece's debt crisis, say analysts”, The
Guardian, 11 February 2010.
67 Moya, E., “Calls to curb CDS gamblers as Greek crisis continues”, The Guardian, 15 February 2010.
68 Kollewe, J., “Euro continues to fall as EU fails to agree Greece rescue plan”, The Guardian, 12 February 2010.
69 Kollewe, J., “Euro rebounds from 10-month dollar low”, The Guardian, 26 March 2010.
70 European Commission, Press Release: Joint statement by European Commission, European
Central Bank and Presidency of the Eurogroup on Greece, 23 April 2010.
71 Wray, R., “EU ministers agree Greek bailout terms”, The Guardian, 11 April 2010.
72 Wachman, R. and Fletcher, N., “Standard & Poor's downgrade Greek credit rating to junk status”,
The Guardian, 27 April 2010.
73 Mallet, V. et al., “Greek fire turns to Spanish fever”, Financial Times, 28 April 2010; Shellock, D., “Eurozone debt crisis prompts flight to quality”, Financial Times, 28 April 2010.
rescue package for Greece to prevent its debt crisis from spreading was announced in May.75
Besides, a comprehensive combination of measures to preserve financial stability in Europe was established, including a European Financial Stabilisation Mechanism (EFSM) with a total volume of up to €500bn. The IMF pledged an additional €250bn. The document outlining the plan singled out Portugal and Spain as likely beneficiaries of the intervention scheme, but insisted that both countries would need to embark on fiscal cutback, attaining budget consolidation targets in order to qualify for bailouts.76 In coordination with other central banks, it was also decided to reactivate the temporary liquidity swap lines with the Federal Reserve, and resume US dollar liquidity-providing operations at terms of 7 and 84 days, on May 2010.77 The ECB was under pressure to acquiesce in a programme of quantitative easing through a massive bond buyback operation on the secondary markets, and perhaps also by agreeing to accept downgraded bonds as collateral for lending, as it agreed to do for Greece.78
Spanish debt underwent additional rating downgrades. Similarly to Ireland, the country public finances were suffering from supporting the banking sector, which was affected by its exposure to the property industry. The country had experienced its first downgrade in early 2009, as it showed ‘deteriorating public finances’.79 The state-backed bank-restructuring fund (FROB) had been established in late spring, to diminish the number of small banks, merging them together, and thus creating a more efficient system.80
During the summer, the situation escalated. Save for Greece falling deeper into recession81, Hungary and Ireland were expected to follow, sliding down into the sovereign debt turmoil. Hungary was urged by the European Commission to cut its budget deficit faster, after it has been announced the previous government had falsified data82, in order for it to benefit from a rescue package.83 The news set in motion
75 European Commission Economic and Financial Affairs, Press Release: Euro area and IMF
agreement on financial support programme for Greece, 03 May 2010.
76 Council of the European Union, Econfin Press Release 114324, 9/10 May 2010.
77 ECB, Press Release pr100510_1: Reactivation of US dollar liquidity providing operations, 10 May 2010.
78 BIS, Central bankers' speeches: Jean-Claude Trichet: Interview in Der Spiegel, 17 May 2010. 79 Mallet, V., “Spain loses triple A rating”, Financial Times, 19 January 2009.
80 Mallet, V., “Bad loans chill Spain’s summer”, Financial Times, 11 June 2009.
81 Allen, K., “Greece's economy deeper in recession than forecast”, The Guardian, 12 August 2010. 82 Noble, J., "Hungary – not drowning, but wavering", Financial Times, 4 June 2010.
83 Wearden, G., “Hungary to ask for 'precautionary' €10bn–€20bn bailout from EU and IMF”, The
concerns on Ireland, which had a budget deficit of 14% of GDP, the highest in Europe in 2009, due to the cost of bailing out Anglo Irish Bank, estimated to be between €24bn and €40bn.84 Against Irish people discontent, the government negotiated a financial assistance package with the EU and the IMF totalling €85bn (including a contribution of €17.5bn from Ireland’s own resources), as yields on Irish government debt reached an unsustainable 9%85 and another bank had to be bailed out.86
Greek recession deepened and unemployment rose in the second quarter of 2010.87 After a year of struggle, the EU granted new funds to the country88, provided it approved renewed austerity measures89, as it did90.
By October 2010, all the three rating agencies had downgraded Spanish public debt, saying government's efforts to reduce debt are to weigh on the economic growth ahead.91 The banking sector’s losses had been underestimated and particular concerns arose about the cost of rescuing it. As a result, Moody's downgraded Spain to its third highest rating of Aa2.92 The fear that contagion from Greece could spread to Spain (and Italy), which would bring the crisis closer to France and Germany, led the ECB to start buying their bonds.93
In January 2011, investors’ attention moved also to Portugal, the yield on its 10-year bonds rose through 7.1%, raising fresh fears about the health of the country's banks.94 The austerity measures needed caused a political turmoil, forcing the prime minister to resign, while the country was waiting for financial support to be prepared by the European Union.95 Although a plan was put in place in May96, a month after help was
84 Kollewe, J., “Ireland's debt downgraded by credit ratings agency”, The Guardian, 19 July 2010; O’Carroll, L., “Ireland highly rated by Newsweek, but not S&P”, The Guardian, 25 August 2010.
85 European Commission, Ireland's economic crisis: how did it happen and what is being done about
it?, 22 February 2012.
86 Treanor, J., “Ireland nationalises fourth bank with move to take over Allied Irish”, The Guardian, 23 December 2010.
87 Allen, K., “Greece's economy deeper in recession than forecast”, The Guardian, 12 August 2010. 88 ECB, Statement by the European Commission, the ECB and the IMF on the Fourth Review Mission
to Greece, 03 June 2011.
89 Traynor, I., “Greece granted €120bn EU bailout”, The Guardian, 24 June 2011.
90 Wearden, G., “Greek parliament passes bill enabling new package of austerity measures”, The
Guardian, 30 June 2011.
91 Kollewe, J., “Spain loses top credit rating”, The Guardian, 30 September 2010.
92 Inman, P., “New fears for Spain as banks fail stress tests and debt is downgraded”, The Guardian, 10 March 2011.
93 Hooper, J., “European Central Bank mounts rescue for Italy and Spain – but sets its price”, The
Guardian, 08 August 2011.
94 Treanor, J., “Portuguese borrowing costs hit record”, The Guardian, 11 January 2011.
95 Tremlett, J., “Portugal in crisis after prime minister resigns over austerity measures”, The Guardian, 23 March 2011.
officially requested by the country97, markets’ pessimism persisted and Portugal’s debt rating fell to junk.98
In July, EU leaders agreed to reduce the interest rate and to extend the maturity on the EU loans provided to Ireland under the existing programme.99
During summer, the ECB decided to start buying up Italian and Spanish bonds, under the European Financial Stability Facility100 supervision, to avoid both countries to be hit by the crisis, asking for structural reforms to be implemented.101 Anyway, the market turmoil had just started for the country and the European Securities and Markets Authority banned short selling for Italian government bonds (as well as French, Belgian and Spanish ones).102 In response to the requests of the European Union, the Italian parliament approved a €54bn fiscal consolidation plan to eliminate Italy's budget deficit by 2013103, but that did not help to avoid a rating reduction, given the gloomy prospects of growth.104 The interest rate on its 10-year BTP bonds fell below 6.5% only after the Italian prime minister resigned and the new government had promised a tight austerity budget.105
Since the UK was sinking deeper into recession106, further purchases of £75bn worth
of securities under the QE scheme was decided in October 2011107, and, subsequently,
in February 2012 the Committee decided to buy an additional £50bn.108
97 European Commission, Statement by the Eurogroup and ECOFIN Ministers - MEMO/11/227, 08 April 2011.
98 Traynor, J. and Pidd, H., “Portugal's credit rating downgraded to junk status”, The Guardian, 06 July 2011.
99 ECB Press Release, Statement by the European Commission, ECB and IMF on the review mission to Ireland, 14 July 2011.
100 Created in May, 2010, the European Financial Stability Facility is a temporary facility to provide financial support to euro area member states through funds raised by issuing debt securities on capital markets. (http://www.efsf.europa.eu)
101 Hooper, J., “European Central Bank mounts rescue for Italy and Spain – but sets its price”, The
Guardian, 08 August 2011.
102 Neate, R., Willshare, K. And Garside, J., “Four countries ban short-selling to ease market pressure”, The Guardian, 12 August 2011.
103 Wearden, J. and Hawkes, A., “EU debt crisis: Italy approves €54bn austerity package”, The
Guardian, 14 September 2011.
104 Hawkes, A., “Italy downgrade adds to eurozone contagion fears”, The Guardian, 20 September 2011.
105 Hooper, J., “Markets and Italian MPs applaud arrival of Mario Monti”, The Guardian, 11 November 2011.
106 Elliot, L. and Allen, K., “Britain in grip of worst ever financial crisis, Bank of England governor fears”, The Guardian, 06 October 2011.
107 Bank of England News Release, Bank of England Maintains Bank Rate at 0.5% and Increases Size of Asset Purchase Programme by £75 billion to £275 billion, 06 October 2011.
108 Bank of England News Release, Bank of England maintains Bank Rate at 0.5% and increases size of Asset Purchase Programme by £50 billion to £325 billion, 09 February 2012.
After the election on November 2011, the new Spanish government arranged an austerity plan to address the budget deficit109 that was still at 9.4% of GDP 110. Despite having announced massive supplementary cuts111, given the revelation its debt level would reach a 20-year high Spanish, bond yields soared112, and its credit rating had been downgraded further113 until just above junk level114. The crisis had been exacerbated by the paralyzed position of the ECB and the EU115, which ultimately agreed on funding a bail out of Spanish banks116, as the country’s bond yield spiralled once more117. The scheme was designed to cover financing needs of up to €100bn (plus €30bn to be used in case of urgent unexpected financing needs), to be used for bank recapitalisation. The loans had an average maturity of up to 12.5 years, with any individual disbursement having a maximum maturity of up to 15 years.118 According to the markets, this was not enough: many analysts believed the government needed to apply for further funding, to prevent further ratings downgrades. The European Central Bank has agreed to buy Spanish government bonds to help lower borrowing costs, but the government has not yet to applied for a bailout.119
During July 2012, the Bank of England announced the purchase of a further £50bn to bring total assets purchases to £375bn..120. In addition, a “Funding for Lending Scheme”
has been approved together with the Treasury to provide an £80bn boost to loans to the private sector, through cut-price funds allocated to banks that would guarantee they pass on the benefits to their business customers.121 By the end of the year, growth prospects
109 Burgen, S., “Spain makes €9bn budget cuts to cover rising deficit”, The Guardian, 30 December 2011.
110 CIA Website, The World Factbook.
111 Allen, K., “Spain's debts to hit 20-year high”, The Guardian, 03 April 2012.
112 Tremlett, G., “Eurozone crisis reignites as Spanish bond yields hit four-month high”, The
Guardian, 10 April 2012.
113 Inman, P., “Spain's credit rating downgraded”, The Guardian, 27 April 2012.
114 Elliott, L., Stewart, H. and Moulds, J., “Spain's credit rating downgraded by Fitch as international bailout looms”, The Guardian, 07 June 2012.
115 Tremlett, G., “European Central Bank leaves Spaniards tied into austerity measures”, The
Guardian, 03 May 2012.
116 Traynor, I. and Inman, P., “Eurozone bank bailout deal throws lifeline to Spain and Italy”, The
Guardian, 29 June 2012.
117 Tremlett, G., “Spain's borrowing costs hit 12-year high”, The Guardian, 19 June 2012.
118 Council of the European Union, Statement by the Eurogroup and ECOFIN Ministers, 20 July 2012.
119 Inman, P., “Downgrade raises pressure on Madrid to accept bailout”, The Guardian, 11 October 2012.
120 Bank of England, Quantitative Easing Explained.
121 Bank of England, New Release 067: Bank of England and HM Treasury announce launch of
seemed to be improving122 (even if not as much as it has been hoped123). At present, the UK economy is expanding, unemployment falling124, and the Bank of England rate at 0.5%.125
Portuguese economic conditions deteriorated, arising discontent and protests, to the point that, after a year, a second bail out was inevitable.126 The budget deficit worsened in 2012 as a sharp reduction in domestic consumption wiped out much of value-added tax revenues, while rising unemployment benefits increased expenditures more than anticipated. Poor growth prospects over the following year have reinforced investors’ concerns about the government’s ability to achieve its budget deficit targets and regain full access to bond market financing.127 As a consequence of this, the support granted to Portugal has been extended in April 2013.128 While the economy seems to be currently recovering, there is still some uncertainty on when it will be able to stop relying on international aid.129
Spending cuts and a deeper than anticipated economic recession130 awaken fear of Italy to need a bail out in the wake of summer 2012.131 In spite of that, Italian
borrowing costs kept improving until political instability forced the prime minister, whose government lasted just one year, to resign.132 After inconclusive election results
in February 2013, government bond yields experienced a sharp increase, still remaining under 5%, though.133 When Italy was downgraded by Fitch to BBB+, the yield on Italian five-year bonds rose again in March, getting near the level of Spanish ones.134 Thereafter, borrowing costs have been declining, despite gloomy prospects for the country.135
122 Stewart, H., “UK emerges from double-dip recession”, The Guardian, 25 October 2012.
123 Treanor, J., “Budget 2013: Osborne downgrades UK growth forecasts”, The Guardian, 20 March 2013.
124“ The pros and cons of UK recovery”, Financial Times Editorial, 20 December 2013.
125 Bank of England News Release, Bank of England maintains Bank Rate at 0.5% and the size of the
Asset Purchase Programme at £375 billion, 09 January 2014.
126 Stewart, H., “Portugal gets IMF approval for next bailout payment”, The Guardian, 17 July 2012. 127 CIA, The World Factbook.
128 European Commission, MEMO/13/315: Statement by President José Manuel Durão Barroso on
the situation in Portugal, 08 April 2013.
129 Wigglesworth, R., and Wise, P., "Portugal poised to issue five-year debt", Financial Times, 08 January 2014.
130 Inman, P., “Italy's recession set to be longer and deeper than expected”, The Guardian, 04 May 2012.
131 Hooper, J., “Eurozone crisis: Italy next in line for a bailout?”, The Guardian, 19 June 2012. 132 Traynor, I. and Hooper, J., “Monti resignation announcement causes fears of renewed euro turbulence”, The Guardian, 10 December 2012.
133 Watkins, M., “Poll confusion lifts Italy’s borrowing costs”, Financial Times, 27 February 2013. 134 Watkins, M., “Italy hit by downgrade and weak data”, Financial Times, 11 March 2013. 135 Giugliano, F., “Italian bond yields: the dog that didn’t bark?”, Financial Times, 10 April 2013.
