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.