Sunday, November 27, 2011

Why euro bonds won't work

Euro bonds won't work without a political authority that backs them up. We have seen over the last week that the EU has no intention of establishing such a government either. The point of bonds is that they are repaid, and without a decisive body to decide who is going to repay those bonds, the message to markets is clear: no one will.

Germany proposed more strongly this last week one way to solve this problem, which is to elaborate in more detail the termination of economic sovereignty for countries that require assistance in exchange for approving euro bonds...a position that attracted the derision of the country's national conscience and premier philosopher, Jurgen Habermas. Habermas rightly points out that the new imposition of central control from Brussels and Berlin contradicts the democracy that the EU is supposed to stand for, and warns that the damage to democracy could last for a century, if not longer.

Germany sees all of this nastiness as necessary to convince the world that it has it's 'problem' under control and that bonds can be issued without placing a higher burden on the German economy. The payers will be located in Greece, Portugal, Italy and Spain.  But without a European government to back the bonds, there is no guarantee. Indeed, these economies are nearly guaranteed under the current rules to contract for at least several more years. They will not be paying anything substantial back.

Which brings us back to why the bonds won't work. Pound for pound, the United States is worse off financially than Europe is, (and has problems governing itself financially, as we saw this last week in the failure of talks to manage the country's finances), but it is still a better financial bet for international investors than Europe. The main reason is that bondholders know not only who is responsible for US debt, but can hope that whoever wins the next elections can make a definitive policy on how to move forward.

As long as Europe's powerful countries hold on to their idea of sovereignty, euro bonds cannot work. And as long as they believe that 'all countries are equal, but some are more equal than others', it positively shouldn't.

Sunday, November 13, 2011

Poland, the new member states and the financial crisis

I am getting seriously tired of referring to countries that entered the EU in 2004 as the new member states. There has to be a better way.

The point of this post, however, is to consider an interview with Lech Walesa on the financial crisis. Desi Anwar interviewed Walesa in 2010 and got to hear two key things from him: that Poland weathered the crisis fairly well because it didn't engage in the same kinds of banking practices as in the West, and that dealing with the crisis requires strong international cooperation.

One could add to the list of reasons why Poland is not the source of speculation: it isn't in the euro, and it has had robust public finances. Part of the consequence, however, was a strong emigration of Poles to other countries during the lean years, due to the lack of economic opportunity at home. Austerity has its costs as well.

Friday, November 11, 2011

Authority, the public and the euro

Within the last 24 hours, Italy and Greece have gotten new heads of government. One is a former central banker. The other a former European Commissioner. Both favour the TINA approach to dealing with the euro zone crisis, that there is no alternative to those countries accepting their obligations, repaying their debts and staying within the euro zone.

There is merit in that approach, but only if the Greeks and Italians are fully on board with the changes that would have to happen. Those who work for the state, receive a pension, or have a contract with the public sector would have to be willing and able to live with far less income, however that is required. Private sector wages would have to decline. All of this would be required to ratchet back the expenses of the state, and to ratchet back the cost of production for export products. These dual measures are required to start reducing borrowing, reducing payouts, and earning more money. 

This means that Greece, Italy and Portugal must accept, if they go down this path, that the next generation is a lost one. Most of them will become poorer. The achievements they have made will be diminished. The lie of their prosperity, built on a bubble paid for by bondholders, will be exposed for the sham it is.

These are harsh words, and there are equally harsh words that can be pointed at the bondholders who lent their money to these countries. They are equally at fault for being so reckless and delusional in investing in countries like these without the recipients using that money as an investment in future productive income. That is the only kind of investment that the private sector should be undertaking. The worst part of all this is that we not only need to ask the pointed question of what kind of crack that asset managers at hedge funds were smoking when they treated these countries as equals of more productive countries, but why the other investment managers we expect to be more prudent were doing precisely the same. Pension fund managers and insurance managers were part of this as well.

If Greece, Portugal and even other countries were required to default on part of their debt, it would finally force creditor countries to start doing more than treating Southern Europe as the evil shadow of irresponsibility, recklessness and demise. It would force them to face questions about why they were the first in line with the money to give these countries.

Those are answers that voters in creditor countries should be demanding. Why is economic decision-making in the financial centres of Europe so irresponsible? A departure of Greece from the euro zone, as painful as it may be to begin with, would ultimately benefit both it and the euro zone. An important impact would be making euro zone membership more compatible with economic objectives again, as would be aligning membership with democratice choice. But the pressure it puts on financial centres will force some hard questions about why Europe's rich countries thought that their own economic welfare depended on speculation in a bubble in financial instruments, even if they were in government debt. What all of this has in common is that a short, sharp downturn could force a return to realistic assessments--of political motivations and political choices, not just in Greece, but everywhere in the EU. 

The new leadership of Italy and Greece is based on the premise that political authority can force a country to embrace low inflation and public borrowing. Chile has done that fairly successfully, but only through a military dictatorship. This will be the first attempt at such authoritarianism inside democracies. I almost wrote functioning democracies, but that is giving the countries too much credit at the present time.

This is a social science experiment of great proportions, the likes of which have not been seen for a very long time. Can you use public power to change who a people are and what they want?

We shall see.

Tuesday, November 1, 2011

Greece and Europe: hardball over default

Europe's creditor and debtor countries are playing hardball over how to handle the Greek crisis. And it matters, because Greece is only the beginning. What is decided here will set precedents. A couple of points are worth underlining from the events of the past week.

First, the EU has made some progress, but it is mostly in agreeing on haircuts on Greek debt. This was something that had to happen, and it is positive, but it only applies to banks, and those banks are being paid with taxpayer money to compensate for the loss, at least in part. If pension funds, hedge funds, or individuals hold Greek bonds, they still can claim 100%. A real solution needs to be more radical.

Second, the increase in the EFSF, the bailout fund, is modest and inadequate unless it is leveraged, and it doesn't look like anyone is biting yet. Neither China nor Brazil seem keen on pouring that kind of money into Europe.

Third, there have been wide-ranging discussions about establishing a European Minister of Finance. It might become a reality, but it is unlikely that this individual would have any real power. The EU has very little tax revenue, nor will it have much. It is only intended to put the screws to Greece. But you don't really need a new Commissioner for that.

Fourth,the very limited deal that has been struck now looks to unravel. The summit itself was delayed, revolved around France and Germany, and now seems to be put in question by a Greek referendum on the deal that is being offered. We will have to wait and see whether Greeks accept the terms of the deal, which would still impose hardship for a long time on the country, but just about be payable, or whether they say Oxi (no).

Greece really does have a choice. Should the people say Oxi, it would be best for Europe to do the dignified thing and deal with the consequences as best they can, rather than doing what they usually do, which is browbeat the country until it votes as it 'was supposed to'.

Wednesday, October 12, 2011

Too little money to save both banks and countries

A twist in Slovakia's politics today: the expansion of the EFSF has been passed with the help of the opposition. New elections are planned to replace the collapsed government.

Also news that the Franco German summit this last week involved France seeking to use the new funds in the EFSF to prop up the Franco-Belgian bank Dexia. Dexia was nationalised this week, and already, the municipalities of northern Belgium, the Dutch-speaking area of Flanders, are getting slammed by the credit rating agencies. Many of them invested their capital in Dexia and are apparently the first victims of the bailout.

Slovakia tumbles, and with it, aid for Greece

Expanding the EFSF: the European Financial Stability Facility, has just hit a wall as the Slovakian parliament refused to support it. The Slovakian government coalition has fallen apart as a result, smashed on political rocks that have nothing to do with Slovakia. You can be sure that Berlin will approach whoever is next in charge and start issuing demands. 

The argument in Slovakia was simple--that there was no reason why a poor member state of the EU should be forced to pay for policies over which it has no control. And they are right in principle. Forcing Slovakia against its will to pay for Greece was not only questionable on the grounds of economic fairness, but on democratic grounds as well. Slovakia has no democratic control over the bills that are being run up in Greece. If it accepted demands that Berlin should dictate its foreign policy and its budget policy, then the German plans to eclipse democracy in Greece would start spreading north. 

What all of this shows is that Germany (and France and the Netherlands) have become terribly attached to saving Greece at any cost. And that is precisely the problem, because the costs are not bearable. Haircuts are needed, i.e. a partial default that will limit the liabilities that taxpayers are expected to bear. This is doubly important because no one in their right minds believes the liabilities will be limited to what we know now, either in Greece or in other countries.

When you become too attached to one single outcome, and here it is the all-or-nothing approach to repayment you distort reality and your ability to deal with the real world. You develop, as any armchair crime investigator knows, pathological personality traits that start hurting yourself and everyone around you. In the attempt to preserve a 100% repayment rate, Germany is demanding that we throw good money after bad. The horror of the one scenario looms so great that the even greater horror of the path they're heading down is not acknowledged.

It's like telling the troops at Stalingrad that there will be no retreat, no change in plan, a denial of the realities on the ground. We all know how that worked out. 

The fall of the Slovakian government, but above all, the arguments that were made in refusing to pay further (they had already paid into the pot and said that enough is enough) is a wake-up call to Europe's creditor countries to rethink how they want to deal with the crisis, and whether they really want to start crushing European democracies to ensure that some bonds get repaid.

Sunday, October 9, 2011

Double-dip recession

I hate this expression, because it gives the impression that we actually got out of the recession that started in 2007, but it has become so common, search engines and searchers being what they are, that I decided to use it. The fact is that for many, the economic downturn is a depression, plain and simple. There was never any upturn to pay attention to, certainly not one that generated jobs.

What caught my attention, beyond the constant stream of speculation amongst the investment community about the financial markets taking another nosedive giving up hope of economic recovery, is news from Reuters that private money are now seeking to protect their assets rather than invest in the hope of  profit. The news is a few days old, but is still worth highlighting. Those with the most hope have now lost it. They may come back later on in the hope of a new, self-fulling prophesy of upswing, but it will fall back again unless there is economic substance on which to build a recovery.

What Europe should realise now is that this depression is going to extend for a great deal longer until the boils of debt in European banking are lanced and the wounds dried and healed. Things will have to get worse before they get better. If they don't, they should look to Japan, which never took on its problems and has suffered for decades as a result.

Europe can't want that.

Saturday, October 8, 2011

Surviving a crash with SMEs

Since the financial crisis started, a key issue in keeping the banks upright is whether the money will flow onward to support SMEs--small and medium-sized enterprises. This is where most jobs are created, not in large corporations. A sustainable economic policy therefore has to have a good SME strategy. This is another good reason for public intervention in the banking market, if financial institutions will not do it themselves, and another good reason why the kinds of institutions described in my last post should be promoted.

But as is often the case, there is a spillover effect from one policy area to another, and it is this: the price of rent (or ownership to do business). If SMEs are to survive and flourish, they need space to produce and to sell and service their products. If you go down most city streets, you'll see the same chain stores you see everywhere, because they're the only ones that can pay the rent. City councils have gotten into the habit of permitting rising rents that can only be carried by chain stores because they get more taxes. Those large companies may find themselves in a more difficult bind when it comes to raising capital if banks are allowed to fail. Inevitably, the calls will come that if the banks fail, so will H&M, C&A, Esprit and the myriad of chain stores that people wander through on an average weekend.

A smaller banking system doesn't mean that such companies will disappear, but that they may have to cut back. For SMEs to pick up the slack, rent has to be affordable. And the price of property as well. The propertied classes won't like this one bit, but they can afford to take a haircut. City councils will also suffer initially, as property tax revenue declines, but they will gain the local economies again that they once had--not exactly as it was a century ago--not the SMEs of the coal and steel age--but of the digital age. The challenge will be--what can cities do to promote creativity that pays? We are already asking this at the national level when we construct policies on banks and SMEs. The prospects for that strategy of providing credit will only go so far if it's too expensive to do business where the customer can reach it.

If the opportunity is seized to truly take the economy into the post-industrial era (large chains are industrial enterprises) in which we don't solely rely on large companies for employment, production and consumption, a crash can be a good thing. And perhaps our only hope.

Letting banks fail

This week, there were reports that Dexia, the Franco-Belgian bank, was to be nationalised by the Belgian government. As Joe Weisenthal reported afterward, a big problem with that is that Belgium's capacity to stand up for the balance sheet, which means its capacity to pay for Dexia's mistakes, is that Belgium simply doesn't have the capacity to pay for it. It would be, as Weisenthal reports Lorcan Roche Kelly saying, a reverse takeover of the state by the bank. this is above and beyond the fact that Belgium is no longer a functioning democracy or responsible government any more. It isn't even a country.

There are a couple of reasonable responses to Belgium's inability to pay for such a rescue. One of them is to simply let Dexia fail. Another option would be to let France take it over (see the graph in the link above), since the French have capacity that the Belgians don't. Another option, promoted by Nicolas Veron at Breugel and the Peterson Institute, is to create a truly European framework for managing banks and banking regulation. This would be a truly superior system to the fragmented political and economic framework Europe currently has, and if it can be done, it should. The question is: will it work?

It is possible that member states will overcome their pride of having national champions that they protect and promote, but until now, the established member states have not shown that they will. The consequence is that the banking industry in Europe, Western Europe particularly, is coddled, subsidised and allowed to form effective oligopolies, whilst taxpayers are left holding the bill in the form of ever-rising public deficits.
Cleaning up after Greek failings is nothing in comparison to what is on these balance sheets.

What some are re-discovering in the wake of the financial crisis is that they sleep better at night if they do their financial business with a credit union, with a regional savings and loan institution that doesn't deal with financial derivatives, or with mutual societies. All of these institutions are much safer than the larger banks, as they don't engage in the kind of risky behaviour that their larger cousins do.

Credit unions, savings and loan institutions and mutual societies became endangered species during the last two decades. They are safer for consumers, they are safer for taxpayers, and they function quite well. They became endangered for four main reasons that public policy and citizens should look at as they deal with this new wave of impending bank collapses or bailouts. First, leverage. The financial leverage that other banks had at their disposal due to financial derivatives put them on steroids. It's no wonder they had more resources, looked more attractive, and could offer better deals to lure folks in the door. Second, carpetbaggers. Company law makes it relatively easy for people who want to de-mutualise a company, list it on the stock exchange and start siphoning off the company's money in shareholder dividends (that was replaced by toxic financial derivatives on the balance sheets, making the bank unstable). That needs to  be reviewed to make it harder or impossible for certain kinds of institutions. Third, the European Union. The EU views local savings and loan institutions as a violation of the free market. It has been trying for ages to get Sparkassen in Germany and elsewhere, which have government representatives on the board, and a series of consumer-friendly regulations that reflect that presence, to push the institutions fully into the market. Fourth, consumers themselves. Many have been forcibly pushed out of the credit union/savings&loan/mutual society sector against their will, but many others, more in fact, never woke up to the fact that these small institutions, the financial equivalent of think global, act local, are better for them and their environment, i.e. the global and national economies.

Let the banks fail. And then let the little people bank as they should. If there is public start-up money that will restart banking on a sustainable basis, such as guaranteeing deposits for those who switch over, this is the place to spend it. Not throwing it down a never-ending hole of debt. The European solution will shift around ownership of the debt, but it will not erase it. It will loom over us for decades.

Ironically, if we go down this route, we will all be stronger and stabler as a result.

Wednesday, October 5, 2011

Greek default

Here is a link to an interview I've done on Greece. It lists in more detail why haircuts are a necessary component of keeping the euro together, and why that's unlikely to happen. A deep, downward spiral of the European economy is looking more and more likely as long as the EU's creditors demand full repayment.

When you demand all or nothing, you often get nothing.

Tuesday, September 27, 2011

The archetype of the trader

A video interview of a trader with the BBC has gone viral today. In that interview, Alessio Rastani not only predicts the end of the euro, but reveals that he, and presumably all traders like him, up to and including Goldman Sachs, have been waiting for the opportunity to make money from a crash. If you haven't yet seen it, take a look. You'll see the world as it really is.

This is what Europe is up against, and why, at the end of the day, there are only two choices for Europe if the creditor countries attempt to get 100% of the money back that Greece owes them: A European (Economic) Government, or European Collapse. The interdependencies of the banking system are too extensive to avoid contagion from Southern Europe to the core financial centres of the North. The pattern until now to throw good money after bad in the case of Greece has exacerbated, not reduced the threat.

We see here, in this video, the archetype of the financial market trader--a living representation of all that we associate with the movers and shakers of the financial world--displayed in all its glory. And yet there is no real-life archetype of a European President, of a European Government, that could take authoritative decisions in economic policy Barosso? Van Rompuy?

Exactly. European leaders are selected for their weakness, their capacity to work with the heads of government of the member states, who fear for their prerogatives and only vote for those who are smaller, in a figurative sense.

Barring a turn-around that establishes a European government, we had all better hope that Europe comes down to a negotiated partial default (rather than a complete default), or that Greece leaves the euro or both. Because the alternative is as Mr. Rastani says: governments don't rule the world. Goldman Sachs does.

Sunday, September 25, 2011

War Games and the Euro

In a previous post, I argued that Europe needed people with experience in military affairs to work out strategy and tactics for dealing with speculative attacks against the euro.

And they are here. Breugel is influential. And rightly so.

Things just got a lot more interesting

Saturday, September 24, 2011

Bankers, politicians and honesty about Greek default

The head of the Dutch Central Bank stated yesterday he wouldn't rule out a Greek default. With so many politicians refusing to say the obvious, this is yet another example of central banks acting sensibly when politicians won't. The ECB is warning the the entire common currency is in peril, and it is only the G20 central banks that have moved to ensure liquidity when the Greek case goes critical.

Ironically, out of all the intended reasons for keeping central banks independent of political control, this was not one of them. The failure of democracy in Europe means that the central banks have no choice but to act.

Tuesday, September 20, 2011

France, Italy and the war's fluid front

China has stopped doing business with a number of French banks, and Siemens, for one company, has stopped as well. There is concern that the banks will be hit by a possible Greek default on public debt next month. A good amount of Greek debt will have to be paid or rolled over, the Greeks and the troika of EU, IMF and ECB have been at an impasse, and Germany has just announced that it can't possibly vote on new support until 2012. A default is coming, and the Chinese, who have excellent business acumen in these things, are pulling out.

The silver lining in this cloud is that they will probably be back, purchasing assets and shares at a bargain at a later date, but not before France is significantly weakened, and before the Chinese have strategic positions in French investment banks. Note that will come with political as well as economic influence.

Italy has also been downgraded, and the country is unable to find a replacement for the outgoing Berlusconi.

The war has extended beyond Greece, Portugal and Spain and is now rampaging in France and Italy. The Dutch and the Germans are retrenching budgets all the more to compensate and ringfencing themselves from the carnage. Spain seems to be holding the fort well enough.

This isn't the end of it. Indeed, because the Europeans will not support the economic stimulus plans that the US is proposing, there will be a downward spiral for the next decade in which employment, wages and general economic welfare in Europe will decline. The only people to benefit will be the ones with enough cash to buy in at a discount.

All of this assumes that a default doesn't happen, and/or that Greece remains in the euro. But leaving the common currency may not affect the other countries that are now in the midst of the war.

Assuming Greece stays, invest in emerging markets. Growth will not be happening in Europe for a while.

Thursday, September 15, 2011

Spain gets it right again

Spain has proven once more adept at reading the signs of an attack and going on the offensive. As everyone closes around Greece and France, Spain has passed a balanced budget amendment to its constitution. I expect it will do better than otherwise possible in the turbulence that is coming up this month and next. Indeed, with Spain's lower overall spending profile, the adjustment should hurt less than it does elsewhere.

It's not that budget retrenchment is objectively necessary, especially for Spain, with its low public debt. Nor is it that the current hysteria about deficit reduction is somehow right in treating Spain the same way as Greece or Portugal. Instead, the objectively good reason to move is that markets collectively are sloshing in a huge wave around Europe and don't really care about economic fundamentals any more. They care about political signals like this that identify a country as one of the winners.

Spain has decided it's going to come out of this crisis even stronger than it started. With such a big wave coming, whilst other countries are looking at it and wondering whether they can swim, Spain has just pulled out a surfboard. 

They may just pull it off. Whether it works or not, you've got to admire the balls behind that move.

Tuesday, September 13, 2011

Why are German banks hiding?

French banks are being pounded again today for holding so much Greek debt, but the other story this week (still) is that a number of German banks have decided to withdraw from the stress testing of the European Banking Authority.

To which my response is: are they smoking crack? The banking community has taken a big hit in trust over the last four years, and transparency is the way to restoring it. In order for regulators and the public to know the truth, stress testing has to show what is there. The response of the German banks, that telling the truth about what German banks are holding would exacerbate the euro zone debt crisis only serves to reinforce why German banks and their motives should be distrusted.

Although the UK banks are screaming about new rules on capital adequacy this week, at least they are designed to make the banks safer.

And why in all that is holy would anyone keep their money in such a place. If you're reading this and you're German, the answer is: you shouldn't. Withdraw your cash and put it in an institution that will be honest about what's on its books. Because however ugly it is, what you don't know will hurt you more than what you do.

Thursday, September 8, 2011

Why? Britain and European passport controls.

The UK has always insisted on going its own way within the EU. Okay, we get it, and although I can't think of where that might actually have been a good thing (some Brits reading this will surely look at the euro zone crisis and laugh out loud, despite the fact that their mortgage payments are permanently higher to support the value of sterling), I can respect being eccentric if you aren't just making life difficult just to make a point. To wit:

Insisting on passport controls within the EU makes Britain (and yes, I'm looking at you, Ireland) look like a third-world banana republic with a huge chip on its shoulder. Grow up and let freedom reign already. I've just returned from a trip to Cambridge, a trip in which I spent three times more time in passport control than actually flying. There is a reason I won't be accepting many more invitations to the island anytime soon. It's a complete pain in the ass, even coming back into Schengen. And that's a shame. Because I'm going to tell my UK colleagues next time....let's just meet in Paris.

Switzerland pegs to the euro

Yesterday, the Swiss central bank announced it would intervene to prevent the franc from rising above 1.20 to the euro. What I want to know is how much money the main Swiss banks have planned in as ammunition. Because the markets will surely test it now.

I'd think twice about buying stock in Swiss banks at the moment.

Friday, August 19, 2011

A long roller coaster ride

Financial markets reacting in a manic-depressive manner under times of uncertainty. At the moment, when no one is really sure where the next wave of economic growth and recovery might come from, and where there are serious fears in the background (at least) that we are headed for a double-dip recession (showing the delusion of financial markets--if you were normal, you'd know that we've never gotten out of the one we entered in 2007). That's true of both Europe and America. Three things have been giving financial markets hope over the last year: a new bubble in technology stocks (particularly social media); a new bubble in raw materials (including gold), and taxpayer-financed welfare measure for banks and other financial institutions. 

That is a crappy basis on which to expect a recovery. The first two prospects are built on herd behaviour and inflated valuations which are exceptionally fragile. The last of these prospects not only has natural limits, but is hamstrung by a lack of political capacity. In the United States, the political landscape is so polarized that Americans are stuck with Cliffhanger Government for the foreseeable future, and may very well lurch from one debt crisis to another. In Europe, the EU and the Eurozone are proving equally incapable if not more so, of taking an authoritative decision on any way out of the crisis. 

As a result in Europe, the ECB has resorted once again to emergency purchases of southern European debt. As I've written in my post on the rise of General Trichet, that emergency action is coming with special powers, as witnessed by the humbling of Silvio Berlusconi. That's right. Berlusconi is a very difficult man to humble, in the light of corruption scandals, lawsuits and pressure from Brussels and other European capitals. but now we see where the real power lies. The ECB under Trichet has become very powerful indeed. How that will look in the fall is perhaps another story. The sources of the ECB's power are informal to a great degree, and a willingness to bend or break the rules to secure a greater purpose. That is a great part of Trichet's legacy, and what has kept the EU together over the last few years. What will happen once he passes the torch to his successor remains to be seen.

The roller coaster effect is sure to continue for two reasons: first, the combination of skittish markets, poor economic prospects in both America and Europe and political ungovernability in both areas mean that the world economy is in for a period of enhanced volatility for the next decade at least. To the extent that East and South Asia generate domestic demand that depends little on America and Europe, that volatility will decrease globally and provide America and Europe with new economic perspectives. But that is not going to happen tomorrow.  Until then, without a strong foundation or a government that works, financial markets will continue to freak out on an extended basis. Both positively and negatively. We saw that between the 1870s and the 1890s, when the world never really got out of recession, save for a few manias that collapsed into themselves.

Hold on to your seats.

Wednesday, July 27, 2011

Sovereign Default and Banking Collapse

In a recent stress test of selected European banks, the European Banking Authority made it known that it did not test what would happen if a country defaulted on its debt. Not Greece, not Portugal, not Italy and not the United States.

That means, at the least, that the official outcomes of the stress tests are useless. More seriously, it means that the EBA's official position on the possibility of default (that politicians are talking about amongst themselves very prominently) is that they don't want to talk about it. That is tantamount to reckless endangerment of the European financial system.

Given the obvious possibility of default, and the necessity of factoring it into stability scenarios, the only real question is: who is responsible for ordering the bank regulators to back off from the truth? Possibly, it is the bank regulators themselves who are shielding banks from the light of day. That would be bad enough. But it isn't likely that they could do such a thing without heads of government allowing or insisting that they do so.

Europe and its people deserve better. The EBA without realistic stress testing is, as my grandfather would have said, as useful as tits on a bull.

Tuesday, July 26, 2011

And the War Continues

It has been but a few days since European leaders agreed a new bailout for Greece and financial markets are already tightening the screws as if little had happened. This applies not only to Greece, but to Italy, Spain and Portugal as well. Why?

In a nutshell, the problems are simply to big and the resources are simply too modest to dampen future speculation against southern rim countries in the EU. The first set of problems lies within the affected countries themselves: there is still no sign from Athens or from Lisbon that they have adopted a new way of looking at things and will radically restructure their public finances. We are seeing emergency measures in Greece, but there is no discussion of what sustainable finances look like. As long as Greece and Portugal remain in the euro, and as long as the euro zone resists institutionalised fiscal transfers, sustainable will mean stingy. Tax collections will have to increase, social benefits will have to decrease, and public infrastructure will have to be sold off to private corporations. What little is left will have to go into regulating the private companies providing previously public services, if anyone is capable. The bottom line is: more for less and a loss of public control over the necessities of life. If I were 20 and Greek, and the country continued down this path, I would leave, period.

The second set of problems lies with Europe itself and the way it takes decisions. The response to the Greek crisis in particular has been a series of talks between France and Germany, long periods of German absence from discussions intended to heighten the sense of desperation by others, and German reluctance to spend much of anything. Of all the options available to it, Europe seems incapable of forcing real policy change in targeted countries, incapable of  kicking a country out of the euro, and incapable of agreeing on the fiscal transfers required to keep a country inside. Something has to give, and there will be changes yet to come.

The third set of problems is one that Germany seems intuitively aware of, and if so, is entirely right about: that if they continue throwing money at the countries that are now in trouble, they will themselves be pulled under water. German banks have been worried about the impact that a Greek default would have on their balance books (as have been French and British banks), but the other side of the coin is that ratings agencies have already started to warn that the credit ratings of Europe's more solvent countries would eventually be at risk if the problems in Europe's south are not solved. This is the reason why the European declaration stated time and again that under no circumstances would the arrangements be extended beyond Greece, and that everyone would strictly adhere to the budget and debt criteria. The word 'strictly' was used a lot.

Given all of this, there has been a lot of money spent, but it isn't by far enough to solve the euro zone's problems. The war will continue. Until Europe gets off the pot and does something real.

Wednesday, June 29, 2011

Hemlock, Death and Greece

We are at this moment waiting for yet another delayed vote by the Greek parliament on austerity measures in return for another bailout. The decision has been labelled a suicide vote and a grave mistake by the governor of Greece's central bank, George Provopoulos. The politicians are about to drink the hemlock.

That pronouncement, coupled with the tear gas, batons and full riot gear employed by Greek police to show the authority of the Greek state, shows the stakes in the current vote. Greece stands at the precipice of entering an agreement into long-term servitude and foreign administration to save core banks in Northern Europe, or a period of momentary disgrace, devaluation and a true discussion in Greek politics of what they want to do next. 

One thing is clear: if so much opposition exists to the reforms, in the streets and within the establishment, they will not hold, regardless of what the Greek Parliament votes today.

Friday, June 17, 2011

Unexpected break.

I've cut myself in the finger while working in the kitchen and can't type for very long, but we go into the weekend with three observations: the general strike and riots in Greece stemming from the grassroots, the political chaos at the top (see the Prime Minister's attempted resignation, the inability to make a national unity government), incapable of taking a decision that will stick, and the general chaos in Europe. It is now Germany demanding haircuts, i.e. a partial default, versus the others. But Germany keeps delaying, which is worse than unwise. So good to see that the IMF put Germany in its place this week. None of this has stopped Greece from being downgraded to junk status. The Dutch Central Bank called this week for the emergency fund to be doubled. The Dutch are fairly stingy. If they are calling for more contributions, it means they're really concerned.

And for a good reason.  This is also significant because it shows a break between the traditional allied Netherlands and Germany on funding the stability mechanism.

I will be back to commenting as soon as I don't have to type everything three or four times (the bandage is rather clumsy). Have a good weekend.  

Tuesday, June 14, 2011

The European Systemic Risk Board and Default in Greece

Greece will default on its debt this year, whether Europe helps it or not. The only questions now are: how big will the default be; will the default take Europe down with Greece?

The answer to those questions will look far more positive in relative terms if the European Systemic Risk Board is used to figure out and manage the impact of a Greek default. The ESRB was designed for a different purpose: for preventing financial collapse when a private bank collapses. Now, if its members have any sense at all, it must start making contingency plans for a Greek default. It will have to run through a number of scenarios, from total and unregulated default, with uncontrolled consequences, to a negotiated, managed and partial default. Each will bring its own set of consequences for the rest of Europe, particularly for banks.

For that is the ESRB's job. It exists to plan what will happen when one or more banks collapses. It was not really designed for a country collapsing, but the job is the same, and it is of vital importance that they step up to the plate and do something.

There are reasons, however, due to the ESRB's institutional design, to believe that the ESRB will be a political cripple and not fulfil the role it needs to if it waits for a green light before forging ahead. First, the head of the Board is the European Central Bank, which is refusing to cooperate with anyone on the issue of a managed default. It may have a contingency plan for when Greece can't pay, but if it does, it isn't admitting it. Second, the Board lacks the political clout to make the deals that are required to make a rescue plan work. Its members are the ECB, the central banks of the EU member states and representatives of three European Authorities that regulate or advise the Commission on regulating banks, securities and insurance companies respectively. Unlike the Financial Stability Board in Basel or the Financial Stability Oversight Council in the United States, there are no representatives of national governments at the table.

These are the reasons why we are hearing so much from the European Commission, the European Central Bank and the European Council of Economics and Finance Ministers, but so little from the one institution that was created to ensure the stability of Europe's financial system, at the moment of its greatest peril.

The European Systemic Risk Board needs an explicit mandate to intervene and give much-needed advice on the implications for financial stability of full and partial defaults. It also needs to provide advice on how to manage a Greek exit from the euro. And it needs to start making contingency plans for propping up the European financial system when the Greek default comes. That means it will have to have specific information about bond holdings by banks, and model through who will need what, when and how, once Greek bonds implode and Greek private banks cease to exist. It may also have to consider how great the knock-on effects will be for pension and insurance companies who invest in such bonds, as well as capital requirements for banks. Banks need not set aside reserves for loans to governments, a policy that surely must end.

The Board has this mandate already, even if it is implicit. If it does not get it explicitly from the Commission, the Bank and the Finance Ministers, it should claim it directly for itself without asking permission. That is how the European Court of Justice established its position and the position of EU law in Europe. It claimed it. Right now, national governments are bickering, putting partisan plans forward and kicking the can down the road rather than facing the threat in the eye and dealing with it. That is catastrophic and will become Europe's demise if allowed to continue. If Europe is to be saved, the European Systemic Risk Board will have to assert itself, and others will have to accept a new, larger role for the Board than they originally envisaged. There are two advisory boards within the ESRB that can push for these developments where the key members may not: the Technical Advisory Board (which does the work of modelling the causes and impacts of defaults); and the Academic Advisory Board, which collects experts on a variety of issues related to financial system stability. These are the groups who must start doing some persuading and drawing contingency plans.

Europe's existence is hanging on a thread. Regardless of how long national governments take to agree on strategy, there is both a moral and existential imperative that the ESRB start acting like what it needs to be: Europe's best hope for averting catastrophe once the defaults start rolling. When the politicians look at the tsunami that starts rolling toward them, they will hopefully look at the Board and its plans, and say Yes.

Sunday, June 12, 2011

Helping Greece Default

The EU governments, if they want to avert disaster, need to assist Greece, and other countries as well, in an orderly default of their debt. A default is never easy to propose, but as I indicated in my last post when referring to the assistance of the United States government to Mexico in defaulting through Brady Bonds, this assistance makes all the difference between making the debt load manageable and total collapse.

There will be a lot of bellyaching from Northern Europe. Indeed, the finance minister of the Netherlands' right-wing government, Jan-Kees de Jager, has declared he takes pride in taking the toughest stand of all European countries on the terms that Greece will have to meet. That could be a costly position to maintain.

There is a difference between rebuilding on terms everyone can figure out, and terms that no one can figure out because the plan won't be kept. Creditors in Europe may look at a 100% repayment plan as only fair, whilst Greek critics will look at it as imposing unrealistic demands. The only part that is important though is: can Greece really pay 100%? If it can't, then an orderly default is better than a European shit storm. 

The Government vs. The People: Greece and the EU

There must be a great deal of irony for Greece's social democrat government (the PASOK party) and the voters who brought them into office, that it is they who will preside over the deepest budget cuts in Greek history, that it is they who will look out over what Pantelis Boukalas of the Greek newspaper Ekathimerini has called the Sea of People protesting in Athens, despite being on the left of the political spectrum. Those cuts were agreed with foreign powers on Thursday and will be brought to the Greek legislature this coming week. We are sure to hear voices that say TINA: There Is No Alternative. Indeed, Barack Obama has joined the TINA chorus, arguing that there will be devastation throughout the global financial system if Greece defaults.

There is no doubt that a Greek default would be costly, but it is an alternative, and regardless of what the parliament chooses, a real democratic debate of the options will be both legitimate and useful for all. Those who have been watching Iceland lately have seen that the country is back in grace already. Mind you, the debts involved were private ones taken on by Icelandic banks, but the country was told many times that it was obligated to take on those debts and service them for decades, lest the international financial community ostracize the country. The investors indeed turned their backs for a while, but they are back.

The real examples to look at, however, are Mexico and Argentina. Mexico is a good example of a country that went through a partial, but relatively orderly default with the assistance of the United States. Loans to Mexico made through the Brady Bond system helped to bring the country back on track after a collapsing bubble in Mexican public debt, that is reminiscent of the Greek situation (with the exception that Mexico's economic situation was in some ways better). Argentina, on the other hand, is a good example of what happens when such compromises are not made, and when such assistance is neither sought nor granted. Riots, fires, food shortages, collapse and chaos.

Those compromises will not come unless the Greeks make it clear there are some things they must insist on. Is there anything they really must have in order to respect themselves as a democracy? And what price are they willing to pay for that?

And given the response, should they remain in the euro? 20 years ago, dollarization was all the rage in Latin America and East Asia. Everyone was doing it, until they realized it was actually bad for them. We have different currencies for a reason. Having a common one has advantages, but disadvantages as well that can outweigh the benefits, as they do in Greece.

Thursday, June 9, 2011

Terror, Greece, and European Collapse

Over the last week, it has become apparent that the Greek tragedy could soon become a European one. If that happens, there is a significant risk of financial collapse in Europe. The good news is that policy makers are trying to avoid it. They may succeed. But it is possible they will fail. If they do, then a cascade of bank failures will reach to the heart of the EU's financial centres. Banks that are not yet under public ownership could find themselves under government stewardship. The threat of that might be the only thing to prevent all of this from happening.

First things first. The European Central Bank has been arguing vehemently for some time now that a default of Greek debt, a partial default, a restructuring, a partial restructuring, call it what you will was completely and totally unacceptable. This has had a number of people scratching their heads.

At first, the ECB offered the explanation that defaults, even partial ones, would result in a lot of credit default swaps becoming payable. That could cause some banks to go bankrupt. A credit default swap is effectively an insurance policy that one bank sells to another in case someone fails to pay a loan back to them. In theory, the swap is a good way of insuring a bank against a loan going bad. It's supposed to be good for stability. In fact, one of the recognized principles of good banking is that banks should use them. And they use a lot. The last I looked, there were more than $62 trillion in credit default swaps out there.  So the ECB is telling us that one of the key tools that was supposed to prevent a massive collapse of the financial system is precisely the thing that could bring it about.

This is not only a point that Europeans should be concerned about. It's one that everyone should worry about, for it continues to be one of the supporting pillars of financial stability on a global scale. I will return to this in another post. The important part here is that even if everything else were in good shape, the ECB is telling us that the safety features that will save our lives should there be a crash will not and cannot work. It illuminates the fact that credit default swaps are really intended to work when only one debtor fails to pay. If several fail to pay, then you suddenly have a problem again. Effectively the swaps simply transfer risk from one bank to another. Someone still has to pay, and then that bank goes under in the second round. Unless the original bank invested in that bank and goes under in the third round, and so on. On top of the losses caused by swaps that undermine the banks who sold them, there will be direct losses for banks that held the loans without the swaps. Bottom line: a lot of money will disappear off bank balance sheets, and the ECB, the Bank of England and so on will be back to the choice of saving banks or not. As will national governments who will have to consider nationalizing more banks. For they have no more money to pump into them.

But there is more. Because the ECB has been buying Greek and Portuguese bonds, a default, even a partial one, will destroy part of the central bank's capital. This is one of the reasons why the ECB isn't technically supposed to buy these bonds from them. The ECB, like any other bank, needs to have assets on its books against which it issues currency into the system. If those assets drain away in significant numbers, you have a problem. You can accept a big dip in the money supply and the economy, or you radically expand the ratio of currency to real output. That means you either print money outright, which the ECB can't do legally, or you provide it for every piece of toxic waste financial paper that a bank waves your way, which is unwise but legal, and what the ECB did during the earliest days of the financial crisis.

All this would mean low interest rates (or at least an end to higher interest rates) at a time when global inflation is running relatively high. That would mean a radically devalued euro, if it continues to exist at all. The alternative is a new, radical wave of nationalizations coupled with an extended economic crash, the likes of which Europe hasn't seen since the 1930s or the 1870s.

That's why there has been so much pressure on the banks to hold onto Greek and Portuguese debt, to not ask for their money back. Technically, that wouldn't be a default, so bank balance sheets will stay clean, swaps will not be paid out, and the problem will 'go away'. For a while.  If they don't, Greece will be bankrupt by October at the latest, and we will see how quickly the contagion spreads to the heart of Europe. That can happen overnight.

The prospect of going bankrupt themselves and being nationalized is the only incentive the banks have left to play along. Roughly 65% of the banks were on board as of today, according to press reports this morning. There will need to be more if the plans are to work.

Terror has a new meaning in the second decade of the 21st century. For 50 years after WWII, it meant the threat of global nuclear holocaust. After 2001, it turned into the threat of terrorist attacks on a smaller scale.

We're back to the threat of global meltdown again. And the epicenter is Greece.

Tuesday, June 7, 2011

Democracy or Europe? Trichet's call for a European Finance Ministry

Jean-Claude Trichet, the sitting President of the ECB, called for a European Ministry of Finance (a European Department of the Treasury) this week. This is an important proposal that needs to be looked at carefully, for there is both opportunity and danger. Even if it is unlikely to happen, by the very act of proposing it, Trichet has put Europe in a do-or-die dilemma.

What Trichet argued for was a Ministry of Finance that could do three things: put the regulation of financial markets in the hands of a politician (rather than a committee of professional technocrats); push the member states to reform their economies to make them more competitive (rather than protecting existing jobs and businesses); and most importantly of all, to control the budget policies of the member states.

No federation on earth allows full control of the second and third goals, because no self-respecting state in the union would allow its powers to be so radically cut and controlled from outside. It would end the democracy on which the federation depends. We're talking about tax policy, budget policy, economic development policy, social policy, welfare policy and regional development. Competitiveness policy sounds harmless, but in Europe, it explicitly extends to unemployment insurance benefits, training, and social welfare generally as disincentives to work in new kinds of industries.

The European Commission, which is something like a federal bureaucracy, but must constantly push to achieve that status, has never dared to make the case for a European Ministry of Finance, because it knew the member states would not support it. It tried for a short time between 2002 and 2004 to take a tough line with the member states and act like one. This was a pretty simple job in theory. Member states had entrenched rules in the treaties on which the EU is based, and had to respect those commitments. All the Commission had to do was insist that the rules be obeyed. Moving a little beyond that, the Commission tried (unsuccessfully) to get the member states to devote more than the 1% of European GDP that it gets in tax revenue.

If you read the Treaties, you'd expect the Commission to succeed. The only problem is that the Treaties only work if the (powerful) member states want them to. Germany, instead of respecting Europe's economic constitution, drove a sword through it. Together with France, it led a revolt against those rules in 2005 that other countries joined until the Commission backed down and negotiated. The only thing that saved Greece and Portugal from being attacked at that moment was that Germany and France, facing the same fate, had told the Commission that hell would freeze over before they accepted punishment and control. European law, effectively, was what it and the other member states in the Council of Ministers (of the member states) said it was. Greece and Portugal simply got lucky. France was never fanatical about forcing national governments to restrain themselves, and Germany was afraid of being exposed for exercizing a naked, all-out power play in which it flouted the rules but insisted they be applied to others. That is no way to drum up support for even a rump Ministry of Finance, a rump that could only tie the hands of the member states but not actually help anyone. And so the idea faded into the background.

What remained was the realization that there were very real limits to European integration, limits that still exist today. One of these is the clash between democratic demands and the treaty-based rules that say what goverments are allowed to do. Other limits are national pride, and the very simple fact that Europe is not a country. Europe is not a people. Europe does not share the sense of common destiny that allows citizens in other countries to put up with a government they disagree strongly with, because the majority of their fellow citizens voted for it fair and square. And none of that is likely to happen soon. There is such a thing legally as European citizenship, but there is no common citizenship in the minds of European electorates. On the contrary, Northern Europeans and Southern Europeans, regardless of how much they might like each other personally, are busy demonizing one another as if the apocalypse were already here.

Trichet's proposal is well-meant and should not be demonized. A European Ministry of Finance, if it were a fully-fledged office on par with that of the American Secretary of the Treasury, and the other Finance Ministries of China, India, Brazil, Russia and so on, would indeed be a very good thing. Money could be moved within the EU to where it is needed most. Agreements could be made with other world leaders on all the things we need so badly, from regulating financial markets to averting economic collapse when the next bubble bursts. But Europe's national governments won't allow it, and that is why he didn't propose it. It wasn't an oversight. He explicitly said he didn't want to suggest it.

So what does this mean? A European Ministry of Finance, as Trichet presents it, will do all of the smothering and none of the nurturing. It is pre-destined to say no and rarely to say yes. It will insist on the right to control member state finances without the responsibility of helping to make things better, and without the democratic representation that citizens deserve and expect. And worst of all, the clash between democracy and a European Ministry of Finance will be directed squarely at nearly all of the countries that have been democratic for only a generation. All of these countries will have traded one dictatorship for another.  That is no way to run a union. It would be better to admit that the differing wishes of the member states can't be contained within the same currency.

One day, when Europe's national leaders get over themselves, when they allow European Ministers to be elected, and when they agree that they will bow to the rule of law rather than institutionalising might makes right, and when European voters see themselves as Europeans rather than Prussians and PIIGS, a Finance Ministry would be a fine idea.

But until that day, an EU Ministry of Finance will re-introduce authoritarian rule in Europe, at least for the South, and then surely for the East. That can't be what we want.

Sunday, June 5, 2011

Greece's Rage

More than 500 000 demonstrators are protesting tonight in Athens. They are denouncing both the political and economic establishment for ruining the country. The rage is general, and it is huge, easily outpacing the protests of 100 000 participants each that were seen last year.

When half a million protesters have lost faith in everyone at the top, you know you have a problem. Most of all, there is nowhere left to go for Greece's voters. The Troika of IMF, European Commission and European Central Bank have removed all choice.

There is one choice left. Between the hard road to austerity, which means becoming a new Greece, or another road, which demands change from the country's upper echelons, but insists on a democratic future.

With or without the euro.

Portugal's deceptive shift to the right

It's a clear majority on paper, but messier in reality.

The polls in Portugal have been closed for an hour, and it is already clear that the Socialist Party led by Jose Socrates have been thrown out of office with its worst showing since 1987, and that a centre-right coalition of Social Democrats (PSD) and the People's Party (CDS) will form a majority. It is a sign of Portuguese politics that the social democrats are on the political right. You might wonder who is actually a conservative. That would be the People's Party in this coaltion. They got 10.86% of the vote at the time of writing.

A notable part of this election is that voters, especially young voters, appear to have boycotted the election, while others took an extremely long time to arrive at the polls. By mid-day, when polling stations normally would have already registered a 60% participation, only 20% had voted.  At the end of polling, the number of voters who had stayed away from the ballot box was more than 44%, a 10% rise over the last election. The main reason for people staying home is that there is a sense of despair that voting won't change anything, that whoever is elected will simply do what the foreign powers of the Troika (the trio of IMF, the European Commission and the European Central Bank) tells them to do. The despair amongst left-of-centre supporters is immense.

Another notable part of this election, is that, somewhat like Obama's election in the United States in 2008, that the victors campaigned for change, but apparently with few details, as the CDS made clear in an interview today. As the CDS and the PSD negotiate the terms of their coalition, people will find out kind of program they actually elected.

It is possible that Portugal's new government will turn the ship around, but more likely that the country is in for a period of internal strife over its future. Those on the left who stayed home today are more likely to turn to the streets tomorrow. The voters who want economic austerity the most make up only 10% of the votes cast (for the CDS). They are concentrated in the cities, as the CDS had no luck in the politically important countryside. All of this means that the constituents supporting the incoming government are unlikely to support an iron-fist approach to austerity that one might expect from the CDS. Flip-flopping and backtracking are likely, especially now that Portugal is still shrinking economically. The austerity measures, if agreed and implemented, will drive the collapse of the economy even further.

Portugal has shifted to the right on paper, but there are very few constituents and voters who really support economic austerity. That should give the new government pause for thought, as well as the IMF and the EU. Some will say "Look! We've got a shiny new mandate to cut borrowing and spending. Let's get started!"

But the lower turnout means they speak for fewer Portuguese. There will be foot dragging. There will be backlash. And there will be reminders that this was the election that wasn't.

Tuesday, May 31, 2011

Sometimes you can't have both: democracy and the euro

There is a fundamental tension between democracy and the euro that is playing itself out in the South of Europe today. Daniel Oliveira of the Portuguese newspaper Expresso wrote this week that Portugal is being treated like a colony by the North, where the wishes of the people are being steamrolled, and the democratic and constitutional rule of law is being disregarded.

There is some truth in that statement, now that Portugal's public finances have reached a breaking point. The same is true for Greece. But it isn't the entire truth. The other half is that Portuguese and Greek voters supported joining the euro, which they probably shouldn't have done. They wanted to join, but not pay the price in terms of budget restraint, which means they were not being honest with themselves or the rest of the EU about what they really wanted.  They could have easily joined a different kind of euro with no negative implications for their democracy, one that did not insist so urgently on tough budget criteria. But that is an entirely different universe from the one in which we live, and it is unlikely that a 'soft euro' would have been a success. A euro without Germany or France? Unlikely. They saw it as necessary as a matter of pride and status, of really belonging to Europe. Now, instead of pride and belonging, they have disgrace, humiliation, and relegation to third-rate status within the EU. They are far behind the emerging markets of Eastern Europe and will stay there for a long time.

In theory, what the Portuguese will have to accept is that getting democracy back as quickly as possible means leaving the euro. That is not an easy way out either. The Portuguese government owes a lot of money in euros. Once Portugal re-introduces a national currency that devalues, the value of the national debt compared to the government's ability to pay with debased currency will skyrocket. Portugal will have no choice but to default on its debt. International investors will turn their backs on the country until yet another political leader is elected who wants to satisfy international financiers. And the problem will be back.

The European Commission has always been a strong proponent of countries joining the euro as quickly as possible. In the case of Southern Europe, they encouraged willing governments. In Eastern Europe, which largely was not desperate to join, the Commission resorted to ugly and ill-advised threats to cut EU funding to national governments in April 2004. They, in turn, having just shed Soviet imperial rule, rejected those threats as outrageous, illegal and undemocratic. The Commission's policy toward rapid euro accession needs to be thown out the window re-thought, at least as long as we have the kind of euro we have, which is for the foreseeable future. Without fiscal transfers; without an economic government for Europe, it cannot work. The euro, and the consequences of membership, do not exist in a vacuum.

It isn't the tension between the euro and democracy per se that is playing itself out, but that the colliding wishes, interests and values of certain euro member states make democracy and the euro incompatible. Either everyone adopts the same culture and values, or someone's democracy has to die. Europe has already decided what limits on democracy are compatible with euro zone membership.

So, Portugal and Greece, what will it be? Democracy or the euro?

You can't have both.

Wednesday, May 25, 2011

Declaring Greece Bankrupt

In bankruptcy, putting someone into administration means assigning them a guardian who makes financial decisions on that person's behalf. It's a final step when you admit that the person who is bankrupt is incapable of doing it personally. Assets are sold, income set aside for debt repayment, and in some cases, a portion of the debt is forgiven. That has nothing to do with administration per se, but the heightened sense of trust in the administrator's handling of the bankrupt individual's financial affairs makes such deals possible if they are wanted.

This morning, the Financial Times reported that Europe is considering a proposal to couple the sale of state assets with an administrative panel that would do two things: ensure that the sales actually take place; and ensure that the proceeds are used to pay down the debt. The sales will take place on state-owned companies, such as utilities and ports. Ironically, the sales will cut further into the revenues of the Greek state looking into the future, but that is a challenge that all European countries face. It is a separate question of whether privatisation of utilities is a good thing to do (indeed its merit is debatable in principle, regardless of the country involved), but Athens has precious few options left.

Somewhere in the last while I came across a proposal from a global institution I will not name until I find the reference which proposed establishing a formalised bankruptcy procedure for countries. Someone within the EU has clearly suggested such a thing on an ad hoc basis for Greece. But Portugal is certainly up next.

If this proposal bears fruit, Greece may be declared bankrupt in some official way soon, setting a pattern for other countries. They will avoid using that name. Going into administration sounds so much more neutral. But the reality is the same.

Tuesday, May 24, 2011

Italy and the euro

Following up on my last post about Greece, and why a Marshall Plan is unlikely to work, I want to share an excellent piece of work by Edward Hugh at Credit Writedowns, who makes a strong case for Italy's bleak future in the euro zone.  His take is that Italy simply lacks the productivity to earn what's required to pay its debt down. The points here can be applied to other countries as well.

In short: structural adjustment programmes that lower unit labour costs are required. That's what living with the euro means.

A Marshall Plan for Greece?

Yes, you heard that right. The idea for a Marshall Plan for Greece comes from Michael Diekmann, head of the Allianz Insurance Group. It would differ from the original Marshall Plan that financed the re-industrialisation of Western Europe in that Greece isn't an industrialised country.

And therefore, Diekmann is not only calling for a Greek Marshall Plan, but for the massive transfer of manufacturing from Western Europe to Greece. That way, he argues, the Greeks would have an economy into which the money could be productively invested.

There is a point in what he's saying from an economic standpoint, but does anyone think that this is going to happen? It could, if protectionism in the EU's more established economies wasn't running rampant. It's better to spend loads of cash to keep Opel German than allow production to close and shift to places like Greece. Then there is also the point that shifting production can also be counterproductive. Volkswagen shifted production outside of Germany during the 1990s and 2000s, drawn by low wage rates, but poor productivity ate up the expected savings.

One part of what made the Marshall Plan so successful in West Germany was the iron determination of the population to work, the sometimes overlooked fact that despite the devastation of World War II that Germany emerged with 50% of its industry (including heavy industry) still intact, that German companies were incredibly well-connected with one another, and that banks had their hands in many of these companies as shareholders or major lenders or both. The result was that the portion of the Marshall Plan funds that were invested in West Germany were invested in a country that had an above-average chances of putting it to good use. The French had the planning capacity of the state, the links between the Ministry of Finance and the country's banks, which then organised what would be produced and what would not. The Brits had a high degree of planning and public ownership well after the war that wasn't really relaxed for quite a while, and which functioned.

But Greece doesn't function, precisely because of the Greeks. Unless it becomes an effective colony of Germany, to the point of changing who the Greeks are, Diekman's Marshall Plan, as noble as it is, won't work.

Character is everything.  Diekmann's suggestion does serve a purpose, for it points to what stands in the way of making it effective: old-style protectionism in the EU's established economies, and a lack of willpower in Greece.

Monday, May 23, 2011

Default, deception and European debt

Europe has economic and political problems that just won't quit. There is a stench of desperation in the air that has gotten so strong that the President of the EU Council, Herman van Rompuy, has effectively told heads of government to STFU, lest they freak out the markets and send investors fleeing unnecessarily. On the contrary, Europe is suffering from a deep psychosis.

It's unlikely to make much difference unless there are real reasons for investors to think that Europe has its act together. And Europe doesn't. Standard and Poors has already downgraded bonds from Greece and Portugal to within a breath of junk bond status earlier this year. Those bonds, as well as those of Spain and Italy, are under renewed pressure as S&P considers a further downgrade of Italy.

The only question that anyone cares about, but that the politicians haven't accepted yet, is which of these countries will default on their debt this year, and by how much. If no default were likely, the problem would take care of itself. Imagine raking in the high interest payments on debt that you just bought for a big discount. The markets aren't buying it. Literally and figuratively.

Europe, with the exception of the ECB, (For its part, the ECB is demanding that the Greeks and everyone else pay in full, and that Europe reject any talk  of default, under whatever deceptive label it might come .) sent a strong message last week that it wants to let Greece default without actually calling it a default. A partial default is called a restructuring and is pretty common. But no one wants to say that. Talk started to circulate of 'soft restructuring', as if this would make an difference to anyone. When it was clear that it wouldn't, European finance ministers started talk of 're-profiling' the debt, which did nothing but slap a new label on an old plan. Last week, realising that someone would have to do something, the EU Council asked banks holding bonds from these countries not to ask for the money back.

Why does Europe think that banks and other institutional financial investors would hold on to such a crappy investment? It's the state equivalent of a sub-prime mortgage. Sooner or later, you want to get rid of it. The less confidence you have in the ability of the borrower, the sooner you want to sell. And if it isn't clear by now, holding on to that debt in the hope that it will be repaid, or at least that markets will re-invest in it at some point out of speculation, is hoping that a new economic bubble will wash the problems away. Or at least onto someone else's balance sheet.

That is a really bad idea. It's like a serious alcoholic who's trying to hide the booze bottles rather than admit having a problem and taking on the pain and responsibility of rehab. But lies and delusion don't make a problem go away. They prolong the disease and the agony. And everyone turns their backs on you.

Under these conditions, when Europe is deliberately trying to mislead the world about the depth of its problems, there are serious reasons to object to Europe insisting on its right to head the IMF. It wants to hold on to its prestige and power by birthright rather than merit, a point that is both legitimate and gaining steam internationally. It's like the town drunk, insisting on running the liquor store. Unless Europe shows a change of heart, that is another really bad idea. Europe hasn't hit bottom yet, and still thinks its in control.

It's time to take away the keys.

Tuesday, May 17, 2011


Draghi is confirmed as the ECB President.

Given what has gone on elsewhere in euroland, that was the easiest decision to make.

A conspiracy theorist's dream

Is Dominique Strauss-Kahn the victim of a sinister, diabolical plot? Is Europe being brought to its knees by dark forces pulling strings in the shadows? Who would have the motive and the means? Can it really be a coincidence that the man responsible for bringing Europe together to rescue the EU's economic basket cases was locked up as a monster just days before Europe's heads of government were to meet to work out a deal for Greece?

Conspiracy theorists have ample material to let their imaginations run wild this week.

If the allegations against DSK are true, then the greatest tragedy of this story will be a personal one: the woman who was apparently attacked in the Sofitel on the weekend. We shouldn't forget that.

But it can be said that two groups stand to gain from this absence of IMF support for Europe. The first are the currency speculators, who stand to make a lot of money if the euro zone fails, or becomes smaller. The second are emerging market countries, who are already questioning the notion that a European should succeed DSK as the head of the IMF. Not only will DSK likely leave, but the second in command as well, American John Lipsky.

A number of names have already been floated, from Turkey, South Africa, Singapore and India. The most important of these emerging markets is China, which has strengthened its influence in Europe by lending the money that others--European creditor countries, American investment companies, and the IMF--are not.

Now, the idea that the euro zone could collapse or could become smaller depends on creditor countries like Germany taking an unrealistically tough line with debtor countries like Greece and Portugal. Until DSK's departure from the scene, it was hoped that he would be able to make a deal possible. The EU's finance ministers are finishing up a two-day meeting, and appear to have reached an impasse.

Monday, May 16, 2011

DSK, the IMF and Europe

This weekend brought a WTF moment from New York that will be bad for Europe, regardless of how the trial turns out.

DSK, Dominique Strauss-Kahn, has been arrested on allegations of attempted rape at the Sofitel in NYC. Since he heads the IMF, folks are now speculating whether it will impair the IMF's ability to play its role in the Euro crisis.

You would think it need not, but the euro zone fund is complex. One-third of the money is provided by the IMF, and Finland reluctantly agreed at the end of last week to support financial aid for Portugal if the IMF is totally happy with the deficit reduction measures that the country's government is implementing.

What DSK's effective departure does is open up a power play for the top role of the fund. With that contest comes an opportunity to upset the existing status quo, and to set new priorities within the fund. You can bet that various camps within the IMF are assessing each other's strengths, thinking of whom they can best work with, securing alliances, hatching plots and so on. 

Europe can only lose from this. In a tradition dating back to the original Bretton Woods agreements of the 1940s, America heads the World Bank and Europe heads the IMF. Both institutions have been reformed to  increase the representation of emerging markets within them, but the effects this will have on the institutional leadership have never been tested. Europe can only get weaker from here on in. It would be revolutionary if a non-European were to take the helm of the IMF. It is inevitable, however, that the opinions of the BRIC countries in particular will carry more weight from this morning onward. America should not be too smug either. The new constellation of interests is somewhat more critical of American public borrowing practices than pre-crisis.

For the moment, the immediate impact will certainly be that the IMF, as it deals with Portugal, will be in the process of transforming itself after a long period of pushing for internal reform. This is less likely to be a naked power struggle and more likely to be one that is done in secret. But DSK is politically finished, his parting has sped up something that has been in the works for years.

This means that Portugal will become the first test of what the new IMF is transforming into. What will it demand? Will it be harder? Or will it be lenient, considering that the Chinese have been lending money when other sources dried up, and are now more powerful in the IMF?

This case will not be the last, for it is now clear to all European leaders that Greece will default on its debt this fall. They've been talking about how to deal with this.

It's time to watch both the IMF and national governments very closely indeed.

Tuesday, May 10, 2011

Finland, Portugal and the future of the euro

European Commissioner Olli Rehn warned Finland today that it would cause a 'Portuguese Lehman' if it refused to back emergency funds for Portugal. The term is a bit off, as Lehman was private company, but the message is on target.

Then, as now, an important financial player will go bust without further assistance. If it goes bust, the contagion to other markets will be fast and hard. Portugal can be allowed to fail as a state just as Lehman was allowed to fail as a bank. But does Europe want that?

In concrete terms, if Portugal fails, there may be serious consequences for Spain. It's not the only country that would be hurt, but it is the most vulnerable. And when financial markets smell blood, the sense of weakness can become a self-fulfilling prophesy.

Germany blocks the ECB

Jean-Claude Trichet, the President of the ECB, has a term of office that extends into October and cannot be renewed under the existing rules. And yet, Europe cannot agree on a replacement.

Let me rephrase that. Germany cannot bring itself to support the candidate that everyone else seems to have agreed on. This is despite the fact that the Chancellor herself has praised the candidate, his policies and his credentials. Mario Draghi is the current Chair of the Financial Stability Board, the global body responsible for ensuring that there will not be another financial crisis. In terms of policy, Draghi brings everything to the table the Germans want. He is clear on the question of whether the ECB should continue to purchase bonds from bankrupt eurozone governments as Trichet has reluctantly done. He says the ECB wouldn't do that on his watch. He would be tough on inflation. What more can Germany want?

That is the question. Germany seems to want to teach Europe a lesson. Not just the 'deficit sinners' who will be cast into the fire, but France and Italy as well. The level of hysteria in the German press and in German politics against foreigners is breathtaking. They're not only mad at the so-called PIIGS, they're mad at the ECB as well. And that is run by a Frenchman.  Chancellor Merkel wanted a German candidate, Bundesbank President Axel Weber, to be the next head of the ECB. He withdrew from the running after citing opposition from Europe and from within the Bank itself to his intent to run a tight ship. And it seems in her eyes, the German chanting for European blood could only be appeased by a Teutonic captain at the helm of the ECB.

There is a saying coined by Carl Jung that what you resist persists. In the context of German hysteria, the Weber Affair blew up because it had to. Weber came across outside Germany as arrogant and contemptful of his European colleagues, echoing what Europe hates about Germany most. Only 10 years ago, Germany was an economic basket case. It flouted the rules that it demanded be applied to others. It defied the application of economic penalties in the mid-2000s when it passed one emergency budget after another. Now that it is back on track, it is screaming for obedience and punishment according to terms it would never accept for itself. 

Germany has been rightly criticised for a lack of sensibility in how it deals with its European neighbours. One might argue that there is little the German government could do in the face of such domestic revulsion for Europe. Except for one thing. Merkel forgets that Germany has been here before and chose European cooperation rather than an all-out War of the Roses. In 1991, Merkel's mentor, Chancellor Helmut Kohl, conceded minor points to the hysterical politicians who wanted to torpedo EMU. But he insisted that you had to compromise in Europe, that Germany actually had to get on with its neighbours. Germany's past, he argued, demanded that. 

Germany is at the verge of destroying Europe. It may not in the end, but it is making it weaker every day.

Monday, April 18, 2011

Finland gives the finger to Portugal

Finland's elections yesterday have generated a right-wing government that has promised to block Finish money going into the fund that will be used to help countries like Greece, Ireland and Portugal. Portugal is up for emergency funding now.


There is no immediate clue that Finland will oppose the others moving forward. Nevertheless, it makes it harder to argue that everyone should be involved in the rescue.

Wednesday, April 13, 2011

American investments and European problems

It's possible that America is headed for a patch of economic trouble. If that happens and further American investments are liquidated in Europe to shore up the books on the left side of the Atlantic, that will spell further trouble for the entire EU, not just the euro zone.

The IMF yesterday warned that public finances in the United States are spinning out of control--specifically, that the deficit is growing whilst the economy is not declining. Financial papers and pundits are all over it, from the mildly crazy to the staid and respected. There is therefore a convergence of attention and assessment. Public debt levels are at 100% of GDP. It is not too late to recover. Belgium and Italy both came back from debt levels exceeding 130% of GDP, but that road was hard.

The problem for Europe is this. Once the US government starts reducing borrowing and spending, the economy will shrink, and with it, corporate profits and investment positions. The likely impact will be large enough to incite companies and other investors to sell off some of what they have abroad to make up at least some of the difference. This means redemptions (investors cashing in their positions and repatriating the funds) from investment houses in Europe, reflected in reduced volumes of cash in European financial markets.

We saw what happened last time this occurred in 2008/2009. The dollar started out low in 2008 and then rose in value in 2009 as American redemptions meant selling euros and converting them into dollars. This means that they value of the euro will be pulled in two ways that may cancel each other out initially, but drag Europe down in the medium term. There will be a push upward on the euro for a short time, but those redemptions will lead to stock market declines that may very well spill into the real economy.

Ultimately, Europe will have to start thinking about how it will deal with American decline. When a key global institution joins the chorus of critics who demand you live more modestly, change will eventually happen. What we don't know is what exactly the timing will be or what event will start the rush toward the fire exits. There are no elections this year which serve as a defining moment of political clarity. But the current American showdown between Republicans and Democrats over the national budget will probably play the biggest role of all. 

Monday, April 11, 2011

The Coming Earthquake: Spain and EMU

Spain is already in denial mode: that it won't be the next target in the war to collapse the euro zone. Public finances are suffering due to the general economic downturn. This has to be bitter. It has managed its public finances as well as can be expected, and better than most northern EMU members expected. And as I've said before, Spain has the political wherewithal to make cuts when they're needed. But they also have to be possible.

And yet, none of the political austerity may matter in the end, which would deal a crushing blow to those who argue that public austerity is a public virtue. The problem is Spanish banks. They are enormous, and they are not only exposed to Portugal to the tune of 100 billion euros , but we don't know what toxic assets of their own they have. That makes them (potential) zombie banks. If one or more of them were to fail, the pressure on the Spanish governmment to cover the losses will be enormous. If there is any doubt about that, look toward Iceland, which Britain and the Netherlands are now suing because the Icelandic public rejected a taxpayer-funded bailout of Dutch and British depositors.

It will be interesting to see how the European Banking Authority deals with the stress testing of these banks, in addition to how they deal with stress testing more generally. Will they choose the harsh reality or to assuage public fears about the state the banks are in?

But...if there is some sort of catastrophe, it would be wise for the Spanish government and the Spanish electorate to allow some bank failure if it is required, rather than write a blank check. The government have managed their finances relatively well. If banks fail, it will not be the Spanish government's fault. Other countries (particularly Germany) will say it is, but Madrid should ignore them. The choice between a sharp, deep cut into the economy from which the country can recover quickly and decades of indentured servitude of the Spanish taxpayer to nothern creditors is pretty clear when you look at it in those terms.

When the rage in Spain comes, it should be properly directed at bank practices that have not yet been sufficiently targeted. Yes, the state allowed and encouraged these things and should be critiqued for that, but it is not the same. The corporate governance of banks is still insufficient, and therefore consequences have not been drawn for the causes of the crisis. A good collapse may be just what Europe needs to expose the rot where it really is, in the private sector. Ireland failed to do that. Iceland did do it, but the message hasn't gotten across to the Dutch and the Brits and the Germans. And until it does, the regulatory measures to prevent another crisis won't be forthcoming.