Dexia's / Belfius' Persistent Problems

Reports this week indicate that the investment and retail bank Dexia needs yet another bailout. That problem is shared by three countries: Belgium, France and Luxembourg. Something needs to be done about Dexia (now officially rebranded Belfius to avoid the stench of failure attached to its previous name) if anyone is to have confidence in the public finances of Belgium and France. Luxembourg has the money.

The Dexia case is particularly vexing because it is strongly responsible for purchasing French municipal bonds, plus Belgian municipals, and bonds for social service bodies. If Dexia imploded, so would an entire tier of government and public services in France and Belgium, which is why those governments won't let it fail.

But will it ever stop? This is another sign that the crisis for Europe is far from over.

Reading on Debt and Rescues

I was reading today on debt crises and rescue packages and thought--most of what we have had written in the past has been about debt crises in developing countries, or as they are more congenially known these days--emerging markets. Two of those I've been reading today are 'The political economy of the Bretton Woods institutions', by C. Randall Henning and another of his works: The Exchange Stabilization Fund: slush fund or war chest?  The first provides a nice history of how the IMF and World Bank developed and changed alongside private finance. As part of that history, you'll get to read how debt crises arose in Mexico particularly, and were dealt with periodically by the American government and the two Bretton Woods institutions. You'll also get to read how, after those crises, the bulk of finance to Latin America shifted from investment in bonds to investment in stock markets, and direct investment. Bond holding shifted elsewhere, particularly Europe, which is why someone ought to write about how those two eras are different.

One obvious difference is the absence of a US Government interest in funding a rescue plan. That's something one can understand, too. The United States has enough problems of its own, and money is funnelled much more easily through the IMF these days from the countries that have it.

The second work looks at the degree of discretion that the President of the United States has to spend money on stabilising the exchange rate and the international monetary system. There are some clues there to constructing a mechanism within Europe to distribute money where its needed, because it looks at the relationship between the executive branch and Congress, of how accountability could be infused into a European mechanism for sorting its internal financial affairs.

The fact that Europe now falls into a literature applied to less prosperous countries underlines a few lessons for international political economy, and comparative politics as well. The first is that advanced and emerging market countries are plagued these days by much the same problems, and should not be treated separately. That's arrogant and presuming and passe.

The second is that it should renew our interest, if it's not already sparked, in long-term decline of advanced economy countries, and the responses to that threat. There is a history of such writing on the United States and the United Kingdom in the 1980s that emphasised strong states as exacerbating decline and strong markets as reversing it. Those messages are already being reversed in contemporary analysis that looks at the crisis generally, but how does the return of the state translate into analysing Europe's choices during the current crisis? How strongly do state intervention, (neo)Keynesian economics and international cooperation factor in giving Europe a chance to deleverage without destroying the economy? Does Europe possess sufficient political coherence and direction to construct a rescue package that compensates for the lack of a European government? Is Europe's economic constitution preventing Europe from recovering?

These are questions that affect us all, and the answers look unfavourable unless Europe changes course.

Banking and the Euro Zone Crisis: the next phase

As an ongoing symptom of the interconnectedness of private finance, public finance, and the lack of infrastructure in the euro zone, the IMF has warned that banks are expected to withdraw 1.2 trillion dollars of credit from the euro zone economy over the next 18 months. That's 10 percent of the EU economy, and even more of the euro zone economy.

The IMF, which views this contraction as the natural consequence of deleveraging (destroying reliance of the financial sector on credit to the same degree as before the crisis started), suggests that the only way to avert an even greater disaster is to accept a milder one--in which banks are closed, merged and restructured across national boundaries to reflect the lower amount of money in the economy.

That, in itself, may make sense. But will national governments in the EU break from their existing pattern of saving national banks to allow such restructuring?

That would indeed be a revolution in thinking, and it's just possible that national governments haven't hit bottom yet. I'm not putting any money it.

INET talks about the crisis

The Institute for New Economic Thinking, INET, is meeting in Berlin today until Sunday to discuss the current crisis, and the state of economics and economic policy: (Paradigm Lost: Rethinking Economics and Politics). This is important and worth watching. Check out the information on the website, and most importantly, comments from folks tweeting at the conference. Just search for #inetberlin  on your twitter feed.

Early messages:

Classical economists are trying to grapple with the new recognition (new for them anyway), that human behaviour is not as rational and predictable as their theories to date would have us believe. (See @LynnParramore)

Re-working the basics of economic policy to let up on austerity measures.

And my favourite quote so far, tweeted by Megan Greene (@economistmeg)

'Gurria: Markets are like heat-seeking missiles. They go after your weaknesses, not your strengths.' #inetberlin

Externally-Imposed Adjustment and Contraction in Greece

10 days ago, the Greek government successfully arranged a reduction of its outstanding debt with private creditors.This was a requirement of the EU and the IMF approving the next bailout of Greece.

Adjustment means contraction, both for Greeks and for investors. A 20% reduction of the minimum wage and broad budget reductions in advance of the deal followed a 7.5% contraction of the Greek economy in the last quarter of 2011.

In the debt swap deal, private holders of Greek debt, many of them pension funds and other investment funds, were paid 15% of face value in cash and 31% of face value in longer-term, lower-interest bonds. Those that did not accept were forced to accept the terms by collective action clauses that the Greek government recently legislated. Note that Greek pension funds were badly hurt by this restructuring, which means that Greek pension will have to be massively cut. That battle is yet to come.

After that deal was sealed, attention then turned to the private body that decides what happens to credit default swaps when something like this happens. The ISDA, or International Swaps and Derivatives Association, determined that a so-called credit event had occurred, but that it was not that large. Current estimates are that payouts from CDS contracts will cost European banks around 3 billion euros.

This means that for the moment, if you look at it from the perspective of those trying to make the deal, that the cost has been low and catastrophe has been avoided. Catastrophe means a disorderly default, in which investors lose everything and CDS payments become enormous.

Although those who promoted the deal argue that catastrophe has been averted, they are wrong. It has merely been delayed and been made more costly. As the head of the private bank Berenberg says, there is no prospect of growth with which Greece could pay back the rest of the debt it owes. An ever-shrinking economy means ever-growing incapacity to repay. The latest IMF Report on Greece has come up with new figures today on how the current bailout will be insufficient, and how another 21 billion might be required until 2016. Given the recent bailout, and the current trends of the Greek economy, which is deliberately designed by the IMF to focus on 'internal devaluation' (falling prices and wages, despite rising taxes) (see executive summary of the report), which cost the IMF 28 billion euros until 2014, that seems rather hopeful.

What is striking in the IMF report is the clear expectation that Greeks will choose, if given a choice, not to fully implement the deals they've signed on to. Which is why foreign administration is the governance of the future.

Welcome to the new face of the euro.

Greek Default and the Euro Zone Crisis

Standard and Poors downgraded Greece today to Selective Default status. The International Swaps and Derivatives Association is now debating whether this means that credit default swaps are due to be paid as a result. It will decide by the 29th. If it argues that they are due to be paid, then a great many contracts will have to paid out, some banks won't be able to fulfil their obligations.

This is an excellent time for national governments in the EU to consider whether the core business of retail banking ought to be connected to the world of financial derivatives, investment banking and international finance. It still is, and perhaps should not be.

Europe's autocratic politics of debt

Two things have come across the news this week, neither of which bodes well for the EU.

First, the EU Commission and Council, following up on agreements made with the Troika, insisted on written statements by both major political parties in Greece that they would be denied a bailout unless they both declared in writing that they would accept the ultimatum that the Troika had imposed on the current government. Elections are coming up soon, and the EU's creditor states are intent on ensuring that choice is off the table. Of course, Greece could chose to fold and walk away from both the euro and the aid, but neither Commission nor Council are saying that. (Though one politician is now talking openly about Greek exit.)That should again give everyone pause about what the EU stands for.

In the absence of agreement, a Council meeting scheduled for tomorrow has been cancelled.

Second, the Commission is busy preparing to punish Spain, which has been ahead of the curve and the Commission in dealing with the crisis, by charging the government money for not moving any further. I don't know what the responsibles in Brussels are thinking, but whipping the most compliant is not going to further their cause. If anything, it reeks of desperation, to show that the excessive deficit procedure is relevant, somewhere, somehow. That's no way to run the EU.

Once upon a time, the EU stood for democracy. It brought both of these countries into the Union to bolster democratic movements and to prevent a return to dictatorship. And now, it views democracy as the greatest threat to the Union.

Ironic, isn't it?

This is a bad move on the part of the EU