Summary: Crisis Management in the European Union by Sylvester

C.W.
Miguel Santana, miguel_santana@me.com

Abstract
This paper summarizes the CEPR Policy Insight No. 27, December 2008, Crisis
management in the European Union, authored by Sylvester C. W. Eijffinger. First, we describe
Eijffingers vision of recent developments, in what concerns both the agents actions and the
regulators reactions. Then, we sum up his policy recommendations and divide them into two
types: particular commands and general rules. Finally, we briefly conclude with a highlight of
his main ideas and hopes for the future.

1. Introduction
The goal of this paper is to summarize the Center for Economic Policy Researchs
Policy Insight No. 27, December 2008, Crisis management in the European Union, authored
by Sylvester C. W. Eijffinger. Published about three months after the collapse of Lehman
Brothers, it intends to provide some regulatory insight for a better handling of financial crises
such as the one witnessed at that moment.
In section 2, we describe Eijffingers vision of recent developments, in what concerns
both the agents actions and the regulators reactions. In section 3, we sum up his policy
recommendations and divide them into two types: particular commands and general rules.
Section 4 briefly concludes, highlighting the special role played by the latter regulatory
category.

2. The making of a crisis

The author starts, in section 1, by providing a picture of the state of the world in what
concerns regulation. Not only the ECB had been providing liquidity and performing
supervisory procedures, but also other EU institutions took action: a Memorandum of
Understanding (MoU) was signed, and it was ascertained what were the financial institutions
with system risk. However, the author notes that several countries took very different
approaches, which had the potential to generate spill-over effects.

Afterwards, in section 2, Eijffinger goes on to divide the development of the crisis in

three periods. First, there was a denial phase, where central and private bankers, and finance
directors alike were refusing to admit liquidity problems and their systemic implications, while
at the same time the cost of capital and inter-bank rates plunged. Then, there was the discovery
phase. This started when banks began to write-off toxic assets from their balance sheets, which
unravelled thereto unacknowledged exposure to the American subprime mortgage market and
catalysed contagion and bank failure. Finally, the disposal phase came: governments
intervened with bailouts, and the Euribor finally decreased.

3. Particular Commands and General Rules

Throughout the paper, the author provides policy recommendations which we broadly
divide into two categories: specific commands and general rules. While the former aims at
directly regulating certain aspects of financial institutions, the latter tries to frame the agents
actions in such a way that they will choose to behave as the regulators wish. When Eijffinger
mentions incentive compatibility, this is what he must have in mind. Another idea to which he
refers is that of constructive ambiguity, which involves avoiding full disclosure of regulatory
commitment (Keller 2012).
Thus, we see that the papers section 3, on the desirable characteristics of bank
nationalisations, belongs to the second type of recommendations. Here, Eijffinger posits that
(1) bailouts should be temporary; (2) posterior privatisation must bring a possibility of positive
returns for the government; (3) posterior privatisation must bring a possibility of negative
returns for the banks. With these rules, he claims, moral hazard would be strongly diminished
and the public would not see its contributions go to waste.
In section 4, on the particular lessons policy makers should learn from the financial
crisis, the first, part of the third and the fourth ones follow this line of thinking. Specifically, in
lesson 1, he claims remuneration for the C-Class had been excessive, and accordingly intends
to change both its the reward structure and corporate governance. In the third lesson, on the
insufficient involvement of financial authorities, Eijffinger claims constructive ambiguity
should be used in bailout rules, and recommends designing incentive mechanisms that force
banks to take into account yield risk. Finally, in the fourth lesson, the author highlights the
necessity of a cross-border European supervisor, stressing at the same time that as long as such
an institution is yet to exist, an emergency fund must not be created in order to avoid freeriding.

Section 5, albeit on the benchmarks that are to pervade new supervision, has a first one,
sustainability, that being about the long-run, also asks for proper incentives to foster that
horizon.
As for specific commands, these can be found mainly in lesson 2 of Section 4. Here,
after claiming that the risk management models based on Basel II have proven to be inadequate,
Eijffinger emphasizes the need to incorporate, on one hand, aspects of the return distribution
other than mean-variance analysis and, on the other, uncertainty and not only risk (Federal
Reserve of St. Louis 2002). Besides, he posits more specific regulations such as stricter capital
and liquidity requirements. In lesson 3, he also talks about enforcing tighter punishments on
lack of transparency on risk.
Finally, in section 5, the last two benchmarks ask for specific commands: integrity is,
in the paper, connected with tighter obligations for banks and rating agencies in what concerns
information on complicated products, and transparency, the author claims, depends on further
standardisation and clarity of the data on financial institutions that is provided to market agents.

4. Conclusion
The broad idea that pervades Eijffingers paper is that of incentive mechanisms design.
Indeed, the following remark is very telling: () these methods of regulation may alleviate
the problem that bankers and traders are always one step ahead of regulators. By creating the
proper incentives, activist regulation may not be as necessary anymore and liberalisation can
do its much needed work (Eijffinger 2008, p. 4) Therefore, more than directly influencing
agents decisions through commands, we see that the author wishes to accomplish his aims
with appropriate incentives, thereby creating a self-sustaining regulatory apparatus.

Bibliography:
Eijffinger, C., W. Sylvester (2008): Crisis management in the European Union, Center for
Economic Policy Researchs Policy Insight No. 27, December 2008.
Federal Reserve of St Louis (2002): The Stock Market: Risk Versus Uncertainty,
https://www.stlouisfed.org/publications/inside-the-vault/fall-2002/the-stock-market-risk-vsuncertainty (last visited 05.10.2016).
Keller,

Peter

(2012):

Mitt

and

Bibi:

Diplomacy

as

Demolition

Derby,

http://keller.blogs.nytimes.com/2012/09/12/mitt-and-bibi-diplomacy-as-demolitionderby/?hp&_r=1, (last visited 05.10.2009).