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.