Prime Minister George Papandreou is correct to put the EU bailout package to a vote.
Without public consent to the tough austerity imposed by the EU aid package, those measures will not be sustained--a future government can balk at its conditions and start spending again.
For their part, the EU, the IMF and leaders in Germany and other wealthy countries are falsely convinced no good solution for the Greek mess exists other than the package now offered Athens. Introduced in 1999, the euro was the last of several sweeping initiatives to more closely bind European economies into a single, integrated unit, as a preface for greater political unity. Others included the elimination of tariffs, a continental antitrust policy, and greater harmonization of tax structures and environmental standards.
However, European leaders never came to terms with the fact that the euro, even if left to float to find a market value against the dollar and other foreign currencies, would be overvalued for some jurisdictions--leaving businesses unable to compete and wages too high to generate adequate exports, as is the case in Spain, Portugal, southern Italy and Greece. Similarly, it would be undervalued for others--creating hypercompetitive enterprises able to offer their workers the very best benefits and short work weeks, as in Germany.
The United States faces similar issues--the dollar is likely undervalued for Manhattan with its robust financial services, advertising and creative arts--and overvalued for mostly rural Mississippi.
Simply, with a single federal tax structure, Washington subsidizes Mississippi with revenues collected in Manhattan, and somewhat equalizes things across the 50 states. Such burden sharing is largely absent in Europe, even though a single market and currency caused voters in Mediterranean jurisdictions to expect the same caliber of health care and other social services enjoyed in Germany and in other northern climes.
Similarly, teachers, doctors and the like, who deliver those services, could demand compensation more comparable to their counterparts in wealthier nations or migrate. Mediterranean governments coped by borrowing too much. Now that string has run out and austerity is not enough to pay off all they owe. The bailout packages simply won't work without draconian consequences.
Government is so intertwined with the private Greek economy, for example, that large cutbacks in government spending are slashing the size of the Greek economy and tax base faster than government obligations can be trimmed and resources freed to pay the interest on outstanding sovereign debt--even with privately held sovereign debt cut in half.
Greeks sense, after successive rounds of austerity, a vicious cycle has emerged, and the EU won't quit in its demands until their economy is reduced to rubble. All to sustain a common currency that is at the center of the problem and really is not necessary for European unity.
Ultimately, Greece must generate a large trade surplus--export considerably more than it imports--to repay its debts, because much so much is held by foreign banks and international agencies like the European Central Bank and IMF. With the euro overvalued for its economy, it can't accomplish that surplus without enduring decades of high unemployment to drive down wages and living standards--likely by 50% or more--to make Greek exports adequately competitive.
If Athens can't pay, private creditors and international agencies can't repossess the Parthenon. In the end, Greek private creditors will be compelled to take additional losses beyond the 50% haircut imposed on them now, and the ECB and IMF will take losses too.
This is simply too draconian compared to the other way out--readopting the drachma, remarking sovereign and private debt to the reinstituted national currency, and letting the value of the drachma fall to levels consistent with a trade surplus that permits Greece to service its debts.
As denominated in euro, foreign creditors would receive payments on Greek debt less than they are currently owed. However, with the Greek economy more fully employed and generating exports, the haircut a reinstituted drachma would impose would be far less than will ultimately occur though the mindless austerity now imposed. In the bargain, Greece would not be pulverized into decades of punishing depression.
Wednesday, November 2, 2011
Friday, August 5, 2011
2007 Revisited?
THERE was a whiff of August 2007 in the air on Thursday and again today as financial markets tumbled around the world. More than a whiff, in fact. The familiar stench of panic was back as shares fell heavily, bond yields in Spain and Italy rose and the search for a haven sent the price of gold to a record level. Banks took an especially severe pummelling amid fears that they were exposed to the two big concerns of investors: a break-up in the euro zone and a double-dip recession in the global economy.
In a week of anniversaries, Thursday was a day that conjured up all the wrong sort of memories. It was 97 years since Britain declared war on Germany, when the resulting financial turmoil meant the stockmarket, which had closed at the end of July, did not reopen for business until early 1915. Yet even in the month or so after the assassination at Sarajevo, when the great powers gave up on diplomacy and prepared for conflict, the movements in financial markets were less violent than they were on Thursday.
More recently, it is almost four years since an announcement by French bank BNP Paribas that it was temporarily suspending three hedge funds specialising in United States subprime mortgage debt led to financial paralysis. Banks, it was discovered, had lent unwisely, were loaded up with toxic derivatives that were vulnerable to falling American house prices, and had far too little capital set aside for a rainy day. On August 9, 2007, the heavens opened. On the face of it, the banks are in better shape than they were when British bank Northern Rock became the first major UK high-street lender to suffer a bank run since Overend & Gurney in the 1860s. They have been forced to build up capital reserves and to hold a higher proportion of their assets in liquid form - financial instruments such as government bonds that can be quickly turned into cash.
Financial regulators have spent the past four years crawling all over the banks, making up for the not-so-benign neglect in the days leading up to the crisis, when supervision was far too lax. Britain's Financial Services Authority, the European Banking Authority and America's Federal Reserve know where all the bodies are buried in their respective banks. In theory, at least. One of the parallels between August 2007 and August 2011 is the shiftiness of those running the show, a sense that they are not letting on all they know for fear of creating more panic.
The dwindling band of optimists point to differences with four years ago. Many companies, especially the bigger ones, are in rude financial health after cutting costs aggressively. Parts of the emerging world, such as China and Russia, are growing strongly and may act as the locomotive for the rest of the world. In the West, interest rates are low and budget deficits high: policymakers have pressed the pedal to the floor in an attempt to get their economies moving.
But the ultra-loose state of macro-economic policy cuts both ways. Policymakers were the heroes of Meltdown 1, thumbing through their copies of Keynes's General Theory to come up with the measures deemed necessary to prevent the global banking system from imploding. But if the next few weeks see Meltdown 2, the policy options will be limited. Interest rates are already at rock-bottom levels while the flirtation with Keynesian fiscal policies was brief. As one analyst put it yesterday, the monetary and fiscal guns are not obviously full of bullets. Thursday's mayhem will fan speculation that the Federal Reserve will respond with a third dose of electronic money creation through the process known as quantitative easing.
Not that the $US2 trillion the US central bank has already pumped into the global economy appears to have had much effect, apart from to provide more casino chips for speculators and to push up food and energy bills around the world. There was a colossal stimulus provided in the northern winter of 2008-09 but the results have been profoundly disappointing. Cheap money and big budget deficits certainly averted a second Great Depression, a very real prospect three years ago when no bank looked safe and factories were lying idle, and that is success of a sort. But it has not produced the normal snap back from recession seen during the post-Second World War era. Indeed, the deepest recession since the 1930s has been followed by the feeblest recovery.
The global downturn of 2008 was a different sort of recession - one caused by banks and individuals borrowing far more than was good for them, rather than one caused by central banks raising interest rates in response to higher inflation. It's a different sort of recovery as well - weak, stuttering and at risk of being aborted at any moment.
In one sense, the mood is different from August 2007. Back then, financiers and politicians spent the first six months after the crisis broke in a state of denial, expecting the return of business as usual. They didn't really get it until the collapse of Lehman Brothers in September 2008. Financial markets were taken unawares by Lehmans, but this is a week that has seen the US taken to the brink of debt default, a deal to safeguard the single currency start to unravel within a fortnight of it being agreed, and a steady drip-feed of downbeat economic news. Only a mug would call Thursday's events a ''Lehmans moment''.
Stockmarkets tend to anticipate change. They rise at the bottom of the cycle in anticipation that economic conditions will improve, and they fall when they assume that things are about to take a turn for the worse, which is what they expect now. It is not just that growth appears to be flagging everywhere, even in China. It is the concern, cruelly exposed in Greece, Portugal, Ireland, Italy, Spain and even the US, about the solvency of nation states.
Back in 2007, the one comfort for markets was that a banking crisis never became a sovereign debt crisis. Now it has, and markets are scared witless as a result.
In a week of anniversaries, Thursday was a day that conjured up all the wrong sort of memories. It was 97 years since Britain declared war on Germany, when the resulting financial turmoil meant the stockmarket, which had closed at the end of July, did not reopen for business until early 1915. Yet even in the month or so after the assassination at Sarajevo, when the great powers gave up on diplomacy and prepared for conflict, the movements in financial markets were less violent than they were on Thursday.
More recently, it is almost four years since an announcement by French bank BNP Paribas that it was temporarily suspending three hedge funds specialising in United States subprime mortgage debt led to financial paralysis. Banks, it was discovered, had lent unwisely, were loaded up with toxic derivatives that were vulnerable to falling American house prices, and had far too little capital set aside for a rainy day. On August 9, 2007, the heavens opened. On the face of it, the banks are in better shape than they were when British bank Northern Rock became the first major UK high-street lender to suffer a bank run since Overend & Gurney in the 1860s. They have been forced to build up capital reserves and to hold a higher proportion of their assets in liquid form - financial instruments such as government bonds that can be quickly turned into cash.
Financial regulators have spent the past four years crawling all over the banks, making up for the not-so-benign neglect in the days leading up to the crisis, when supervision was far too lax. Britain's Financial Services Authority, the European Banking Authority and America's Federal Reserve know where all the bodies are buried in their respective banks. In theory, at least. One of the parallels between August 2007 and August 2011 is the shiftiness of those running the show, a sense that they are not letting on all they know for fear of creating more panic.
The dwindling band of optimists point to differences with four years ago. Many companies, especially the bigger ones, are in rude financial health after cutting costs aggressively. Parts of the emerging world, such as China and Russia, are growing strongly and may act as the locomotive for the rest of the world. In the West, interest rates are low and budget deficits high: policymakers have pressed the pedal to the floor in an attempt to get their economies moving.
But the ultra-loose state of macro-economic policy cuts both ways. Policymakers were the heroes of Meltdown 1, thumbing through their copies of Keynes's General Theory to come up with the measures deemed necessary to prevent the global banking system from imploding. But if the next few weeks see Meltdown 2, the policy options will be limited. Interest rates are already at rock-bottom levels while the flirtation with Keynesian fiscal policies was brief. As one analyst put it yesterday, the monetary and fiscal guns are not obviously full of bullets. Thursday's mayhem will fan speculation that the Federal Reserve will respond with a third dose of electronic money creation through the process known as quantitative easing.
Not that the $US2 trillion the US central bank has already pumped into the global economy appears to have had much effect, apart from to provide more casino chips for speculators and to push up food and energy bills around the world. There was a colossal stimulus provided in the northern winter of 2008-09 but the results have been profoundly disappointing. Cheap money and big budget deficits certainly averted a second Great Depression, a very real prospect three years ago when no bank looked safe and factories were lying idle, and that is success of a sort. But it has not produced the normal snap back from recession seen during the post-Second World War era. Indeed, the deepest recession since the 1930s has been followed by the feeblest recovery.
The global downturn of 2008 was a different sort of recession - one caused by banks and individuals borrowing far more than was good for them, rather than one caused by central banks raising interest rates in response to higher inflation. It's a different sort of recovery as well - weak, stuttering and at risk of being aborted at any moment.
In one sense, the mood is different from August 2007. Back then, financiers and politicians spent the first six months after the crisis broke in a state of denial, expecting the return of business as usual. They didn't really get it until the collapse of Lehman Brothers in September 2008. Financial markets were taken unawares by Lehmans, but this is a week that has seen the US taken to the brink of debt default, a deal to safeguard the single currency start to unravel within a fortnight of it being agreed, and a steady drip-feed of downbeat economic news. Only a mug would call Thursday's events a ''Lehmans moment''.
Stockmarkets tend to anticipate change. They rise at the bottom of the cycle in anticipation that economic conditions will improve, and they fall when they assume that things are about to take a turn for the worse, which is what they expect now. It is not just that growth appears to be flagging everywhere, even in China. It is the concern, cruelly exposed in Greece, Portugal, Ireland, Italy, Spain and even the US, about the solvency of nation states.
Back in 2007, the one comfort for markets was that a banking crisis never became a sovereign debt crisis. Now it has, and markets are scared witless as a result.
Friday, June 24, 2011
Why UK Banks Are Not Immune To Eurozone Woes
Will lenders have to accept that they won't get their money back from Greece?
The Bank of England points out that there is an 80% probability that the Greek government won't be able to repay all its debt, based on the current market price for insuring Greek sovereign debt.
For Portugal, investors put the probability of default at some point over the next five years at just under 50% and for Ireland the default probability is a little bit less.
As for the market odds on what eurozone ministers regard as the Armageddon scenario, default by Spain, they're around 40% at any time before 2016 if preceded by Ireland or Portugal going bust, but less than 30% if Greece goes down.
That implies potential contagion from Greece's woes may be less devastating than from Portugal's and Ireland's - which may or may not be a comfort.
Now investors, just like bookies, can be wrong. But a banker or investor who ignores the market odds is probably more foolish than a gambler who bets whatever the price offered in the betting shop.
So if you are a banker or an investor and you have an exposure to these financially overstretched countries, and you don't have a death wish then you would probably be advised to make sure you have sufficient spare capital to absorb 80% of whatever losses would be generated by a Greek default, 50% of Portuguese losses given default, and (perhaps) 45% times 50% of Spain's write-offs from default (keep up!).
Falling dominoes
Here's the thing. It is not at all clear that Europe's banks are making adequate preparation to cope with such potential pain.
In the tests of the stresses they can absorb, being overseen by the newly created European Banking Authority, they have been told - for the first time - to make some provisions for potential losses on the 80% of their sovereign exposure which is held in their so-called banking books.
But it is not at all clear that banks are being asked to protect themselves against either the worst that could happen, in respect of Greece, Ireland, Portugal and Spain - or indeed what may in fact happen.
Which is why Sir Mervyn King, the Governor of the Bank of England, made clear that he doesn't take enormous comfort from big UK banks' relatively limited direct exposure to Greece, Portugal, Ireland and Spain.
According to the Bank of England's analysis, if every single one of those countries went bust and wrote off 50% of their sovereign debt, banking debt and non-bank private-sector debt, that would wipe out around half the capital in the UK banking system - which is another way of saying that, in theory, the majority of our banks would limp on.
What is the probability of all those dominoes falling in that way?
It might be higher than we care to know. But British banks must have done something right that such a catastrophe wouldn't eliminate 100% of their capital.
But it is not only the direct loans to these countries that could do severe damage to our banks.
Sir Mervyn puts it like this: "experience has shown that contagion can spread through financial markets especially when there is uncertainty about the precise location of exposures. A UK bank could have lent to a bank that itself had lent to a bank that in turn was exposed to sovereign risk."
Forgive and forget
So if a British bank has a big exposure to a French bank which is undermined by its exposure to Greece, that could be a problem for said British bank.
And, in the crisis of 2007-8, we learned something else about how modern banks can bring down themselves and the rest of us with them: in an interconnected banking world, it is uncertainty that can be the worst poison.
The point is that those who lend to banks can't be sure where the fatal direct exposures to Greece, or Portugal, or Ireland lie. Which is why in a time of panic they may well stop lending to any bank which may have a direct or indirect exposure.
It is in that way that Greece's solvency crisis can become a liquidity crisis for the banking system - and can even wreak havoc for British banks that have lent relatively little to Greece.
By the way, Sir Mervyn made clear he hasn't got a huge amount of confidence that eurozone ministers have yet come up with a plan to cure the disease that underlies all of this, the excessive amounts that the Greek government has borrowed.
Sir Mervyn said that lending more money to Greece, the eurozone's current strategy, is only useful if it buys time to somehow make those debts affordable.
And there are only two ways that can happen.
Either Greece's relatively weak and small private sector has to be supercharged such that it starts generating current account surpluses that would allow the country to service the enormous debts - which seems unlikely to happen any time soon.
Or lenders to Greece have to accept that they're not going to get all their money back - and Greece's debts would be "forgiven" or reduced to a level it can afford.
Either way, Sir Mervyn noted that Greece has a solvency problem that has not yet been solved.
The Bank of England points out that there is an 80% probability that the Greek government won't be able to repay all its debt, based on the current market price for insuring Greek sovereign debt.
For Portugal, investors put the probability of default at some point over the next five years at just under 50% and for Ireland the default probability is a little bit less.
As for the market odds on what eurozone ministers regard as the Armageddon scenario, default by Spain, they're around 40% at any time before 2016 if preceded by Ireland or Portugal going bust, but less than 30% if Greece goes down.
That implies potential contagion from Greece's woes may be less devastating than from Portugal's and Ireland's - which may or may not be a comfort.
Now investors, just like bookies, can be wrong. But a banker or investor who ignores the market odds is probably more foolish than a gambler who bets whatever the price offered in the betting shop.
So if you are a banker or an investor and you have an exposure to these financially overstretched countries, and you don't have a death wish then you would probably be advised to make sure you have sufficient spare capital to absorb 80% of whatever losses would be generated by a Greek default, 50% of Portuguese losses given default, and (perhaps) 45% times 50% of Spain's write-offs from default (keep up!).
Falling dominoes
Here's the thing. It is not at all clear that Europe's banks are making adequate preparation to cope with such potential pain.
In the tests of the stresses they can absorb, being overseen by the newly created European Banking Authority, they have been told - for the first time - to make some provisions for potential losses on the 80% of their sovereign exposure which is held in their so-called banking books.
But it is not at all clear that banks are being asked to protect themselves against either the worst that could happen, in respect of Greece, Ireland, Portugal and Spain - or indeed what may in fact happen.
Which is why Sir Mervyn King, the Governor of the Bank of England, made clear that he doesn't take enormous comfort from big UK banks' relatively limited direct exposure to Greece, Portugal, Ireland and Spain.
According to the Bank of England's analysis, if every single one of those countries went bust and wrote off 50% of their sovereign debt, banking debt and non-bank private-sector debt, that would wipe out around half the capital in the UK banking system - which is another way of saying that, in theory, the majority of our banks would limp on.
What is the probability of all those dominoes falling in that way?
It might be higher than we care to know. But British banks must have done something right that such a catastrophe wouldn't eliminate 100% of their capital.
But it is not only the direct loans to these countries that could do severe damage to our banks.
Sir Mervyn puts it like this: "experience has shown that contagion can spread through financial markets especially when there is uncertainty about the precise location of exposures. A UK bank could have lent to a bank that itself had lent to a bank that in turn was exposed to sovereign risk."
Forgive and forget
So if a British bank has a big exposure to a French bank which is undermined by its exposure to Greece, that could be a problem for said British bank.
And, in the crisis of 2007-8, we learned something else about how modern banks can bring down themselves and the rest of us with them: in an interconnected banking world, it is uncertainty that can be the worst poison.
The point is that those who lend to banks can't be sure where the fatal direct exposures to Greece, or Portugal, or Ireland lie. Which is why in a time of panic they may well stop lending to any bank which may have a direct or indirect exposure.
It is in that way that Greece's solvency crisis can become a liquidity crisis for the banking system - and can even wreak havoc for British banks that have lent relatively little to Greece.
By the way, Sir Mervyn made clear he hasn't got a huge amount of confidence that eurozone ministers have yet come up with a plan to cure the disease that underlies all of this, the excessive amounts that the Greek government has borrowed.
Sir Mervyn said that lending more money to Greece, the eurozone's current strategy, is only useful if it buys time to somehow make those debts affordable.
And there are only two ways that can happen.
Either Greece's relatively weak and small private sector has to be supercharged such that it starts generating current account surpluses that would allow the country to service the enormous debts - which seems unlikely to happen any time soon.
Or lenders to Greece have to accept that they're not going to get all their money back - and Greece's debts would be "forgiven" or reduced to a level it can afford.
Either way, Sir Mervyn noted that Greece has a solvency problem that has not yet been solved.
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