Menace to Solvency

If you thought there was one lesson from the financial crisis of the last 5 years, it would likely be that governments need to have the ability to cut themselves loose from large financial institutions, meaning that they have the power to liquidate or restructure them without incurring massive fiscal obligations. And when people look around for a model of how this process might actually work, they cite the US Federal Deposit Insurance Corporation (FDIC).

It may be worth noting therefore that in the spending cuts bill (H.R. 6684) hastily assembled by US Congressional Republicans on Thursday to drum up votes for their fiscal cliff solution, the FDIC would have lost its expanded 2010 Orderly Liquidation Authority to liquidate or restructure bank holding companies, bank affiliates, or non-bank financial intermediaries (like AIG) — its power prior to then only included banks that it directly insured. It’s not like the bill proposed a better alternative — had it passed, it would have been simply a reversion to the 2008 situation, which worked out so well with Lehmans and AIG. And this was being presented as a solution to the country’s long-term economic problems. Lesson: the fiscal cliff isn’t just about fiscal policy. There are other very damaging agendas being pursued under its cover.

Only a madman could doubt the integrity of…

The French conservatives tearing their party up are weird enough. And they’re still at it, with one important figure trying to get deputies to support having a new election, others picking a fight with Sarkozy’s rightist advisor Patrick Buisson, appeals to Cope to step down and rowdy public meetings, the Socialist in charge of parliamentary financing scheming to offer Fillon a little extra. Tonight’s headline: Discord persists between Cope and Fillon. You could say that.

But it’s as nothing to this German story. So there was this guy who repeatedly claimed that his wife’s division of HypoVereinsBank was smuggling cash into Switzerland for the benefit of its wealthy, tax-evading private clients. He even pressed charges with the Bavarian police but nobody took it at all seriously, although he named 24 of the clients and their advisors at HVB and gave details of the Swiss bank accounts. Eventually, he was arrested for assaulting her.

Well, you can’t condone this kind of behaviour.

Unusually, he was sent to a secure psychiatric hospital, and has been there ever since, while HVB surfed the bubble and sank in the crash. Had he been found guilty, he might not have done time at all. No, stop. Going by the account here, he was held responsible, but acquitted on the grounds of diminished responsibility and sent to the funny farm because he thought HVB was crooked, a belief that only a madman could apparently hold.

And now it turns out he was…right in every detail, even if he accused another figure in the case of being on the side of the bankers because he lived next door to one. HVB’s private clients operation was hugely involved in tax evasion, and yes, carloads of raw cash were driven to Switzerland, to be paid into accounts with codenames like “Monster”. The original file on the case has been shredded. And HVB’s internal audit knew as long ago as 2003.

Now, although the state minister of justice is getting support from the top, this isn’t stopping the taxman from working down the list, reminding those on it that an arrangement could always be made for those who voluntarily choose to settle their outstanding debts.

And if that wasn’t good enough, with its distinct Jimmy Savile flavour, a sinister lobbyist hacks into the Ministry of Health’s e-mail on behalf of one of Germany’s most powerful interest groupsthe pharmacists.

Some French links

Here’s a really interesting piece about French interior minister Manuel Valls and the network of friends around him from his days as a student activist. They include Alain Bauer, Nicolas Sarkozy’s security adviser and the man who got the contract to install Vitrolles’ CCTV surveillance network for its FN mayor.

Hubert Vedrine, former minister, was asked to prepare a report on NATO and France’s return to the integrated command structure. Olivier Kempf blogs it. The recommendations are that NATO stays very much in its classical form, a military alliance with a nuclear dimension centred in Europe and the North Atlantic, that France assert itself in the alliance more, and that the European Defence Agency and NATO Supreme Allied Command-Transformation, which are both headed by French officers, should coordinate more closely on industrial and scientific issues.

He seems to be more suspicious of the UK than of NATO as such, and is very critical of the EU defence initiatives as mostly creating duplication, committees, and complexity.

History is made at night records the moment when “discotheque” became a word in English.

502: French conservatives temporarily unavailable

So, France’s conservative party just blew up. This is surely a major story, as the French Right is one of the most successful political organisations in the democratic world even though it’s not particularly organised most of the time.

It’s common for a party that loses an election to have a bout of feuding. Out of the beating at the polls, two major candidates emerged. Jean-Francois Cope, the party’s secretary general, argued for “getting rid of the Right’s complexes” and moving closer to the FN. Francois Fillon, Sarkozy’s prime minister, argued for moving to the centre and emphasising the Gaullist heritage. This is close to the historic dividing line between the “classical right” and Gaullism, but the division doesn’t map precisely, as it’s complicated by the UMP/FN divide, and the generally loose and personality-driven nature of French rightwing politics. It might be better to think of Fillon’s supporters as conservatives, being pro-business, pro-Euro, mildly authoritarian, and varying between mildly Atlanticist and traditionally Gaullist on foreign policy, and Cope’s as identity rightists*, being much more authoritarian, less pro-Euro, but economically more rightwing, and keen on asserting national identity (e.g. by being nastier to immigrants).

As it happened, they appealed to almost precisely equal numbers of party members. That was when the trouble started.

Cope claimed victory. The chairman of the party’s election committee said he couldn’t say who’d won. Cope claimed victory again, by a bigger margin. Fillon claimed victory. Then, it turned out that the election committee had forgotten to count the votes from three French overseas territories. Counting them put Fillon ahead. He appealed to the party’s appeals committee, which is controlled by Cope’s supporters and refuses to hear him.

France watches, fascinated, as half the political spectrum rips itself apart on live TV.

Alain Juppe, elder statesman, former finance minister, current senator and mayor of Bordeaux, still a possible presidential candidate, and convicted criminal, is called in to mediate between the pair. Juppe asks them if they can agree on who is the party leader. No. He suggests they hold a new election. Cope suggests that he should just declare victory again. Fillon insists the votes from Wallis & Futuna be counted. Cope says that he wants to protest the ballots from the Riviera, where former industry minister Christian Estrosi’s influence network delivered the election for Fillon, and suggests just striking out all the “contentious” ballots. Obviously there are more people in Nice and Marseille than Wallis & Futuna. Juppe concludes that there is literally nothing the two men can agree on, and steps aside.

Nicolas Sarkozy, for it is he, returns from making money in Shanghai and gives them a deadline to agree, or he’ll denounce them as unfit to lead. Everyone assumes he’s hoping they’ll both quit and he’ll be party leader.

Fillon sends a bailiff to the UMP HQ to seize ballots. Cope’s supporters physically prevent him from removing the ballots.

Fillon accuses Cope of misappropriating a huge quantity of party funds for his campaign. His supporters join another party, the Rassemblement UMP or RUMP, which turns out to exist in New Caledonia. This is handy because the party immediately achieves the status of a parliamentary group and becomes entitled to state funding. In all, 70 senators and 77 deputies follow Fillon. Cope is left with the rump of the UMP rather than the RUMP and, importantly, all its debts.

Fillon threatens to sue. Cope suggests voting again, but not until after the local elections next year. The Socialist parliamentary group, meanwhile, get on with passing their legislative agenda, because the UMP delegation has stopped turning up to debates. And both men’s poll ratings plummet, although Fillon remains far more popular support than Cope.

What does it all mean? Well, you wouldn’t want to bet on them not finding some way to settle their differences. French conservative politics is dominated by personalities rather than organisation, and they did manage to rule for most of the 20th century. But there is certainly no effective UMP for the time being. That creates political space for Hollande and also Le Pen.

It’s very hard to predict how the crisis will affect the competition between Le Pen and the UMP; it weakens the UMP, but it also discredits the identity-rightist current around Cope and intensifies the distinction between the rightists and the Gaullists. The project of a UMP-FN alliance is only worth having if lots of UMP deputies change sides – if it just scrapes off a few, while solidifying the rest as a centre-right block, it doesn’t change very much.

*Only re-reading this did I notice that I had alluded to the extreme-right student movement, Bloc identitaire, without knowing it. In fact, some of the same people are involved.

Thinking about the austerity trap

In my last post, I alluded to an austerity trap, analogous to the liquidity trap. This reminded me of something. People often associate the liquidity trap with the zero lower bound on interest rates. But as people so often say, Keynes wasn’t as Keynesian as all that. He was very much interested in expectations, uncertainty, and the psychological dimension of economics.

The liquidity trap happens not just because interest rates can’t fall any further – real interest rates, of course, can go negative – but because whatever the interest rate, the demand for liquidity is very high. Firms are operating as if they perceive a level of risk so high that even negative real interest rates wouldn’t motivate them to invest. It’s not that the market price has changed, it’s that the market is closed. Nobody wants anything but cash, and what they mostly want to do with it is to sit on it. Liquidity trap conditions could set in at interest rates quite a bit higher than the zero lower bound.

And we know this could happen, because several key financial markets did indeed just cease functioning in 2007-2008. First, the asset-backed commercial paper market, then the wider mortgage-backed securities market, and finally, the enormous interbank lending market just went dark. Rather than prices moving to unusual levels, there was simply no trade.

In thinking about how an austerity trap might happen, we need to look at both the “Keynesian” hydraulics and the expectations dimension. Hydraulically, here are three stylised facts. Firstly, the rich tend to spend less of their income than the poor. This is a consequence of diminishing returns. Secondly, investment is the swing item in the national accounts, the one with the greatest variance. Thirdly, budget consolidations very often seem to redistribute in favour of the rich or at least against the poor.

Just like that. It’s also worth noting that construction, the cyclical industry par excellence and one that is very labour intensive, plays a special role in the economy. Not only does it absorb a lot of public investment, public and private investment in construction have become closely integrated in the last 30 years. Private projects are subsidised by the state; state projects are designed to lever-in private investment.

So, here’s a story; budget consolidations tend to be levered-up because the people who lose out tended to spend the income they lost. Further, it’s easier to cut capital investment than current spending, so austerity tends to disproportionately hit the economy’s swing sector and especially construction, the swing item within the swing sector.

Now let’s look at it from an expectations/uncertainty point of view. One thing that baffled a lot of people in the UK was how quickly the trap hit once it was sprung. It is true that much of the spending cuts and the tax rises were planned for the future, and that budgets since 2010 have had the effect of pushing more of them off into the future. But it’s undeniable that the UK economy tanked. The transition was astonishingly swift. This can only be explained by a change in expectations, that is to say, estimates of the future.

The key expectations, I think, were those of earnings in real terms, and of the social wage. It is important that inflation post-crisis has been quite high in the UK, even using the CPI which doesn’t include housing costs. People were credibly informed that their real terms earnings would be reduced, and that the social wage was going to get a hammering. A major effort was made to convince them of this, after all. It should not be surprising that they put off big purchases, put up with poor wage settlements, and paid off debt as fast as possible. Similarly, businesses could also expect this and therefore curtailed investment.

The austerity trap, interestingly, makes sense both in expectations or Lucasian terms and in palaeo-Keynesian terms.

Direction: France. Target: the fiscal consolidation pony

Hear that? Europe’s in recession and the mighty Wurlitzer cranking up for the biggest gig yet. France. Jean Quatremer noted this back on the 12th of November. Apparently, Wolfgang Schauble is briefing-out the idea of sending German experts to help the French implement economic reforms. Of course, Francois Hollande is not actually pursuing an 80s Mitterand strategy of fiscal and monetary reflation in one country, he’s planning to cut the deficit sharply, but it seems that it’s not about the deficit. Cutting it by taxing the rich isn’t really cutting it. The majority must suffer, I guess.

The IMF has capitulated and accepted that the fiscal multiplier is much higher than they thought, to the extent that the austerity trap is real. By austerity trap, I mean the situation where pro-cyclical fiscal policy has such a deflationary impact on the economy that the government budget deficit increases. The analogy to the liquidity trap, where lower interest rates no longer have any stimulative effect because people just want to sit on cash, is deliberate. The liquidity trap is characterised by interest rates near zero; the austerity trap, by a very high fiscal multiplier.

The chart comes from NIESR director Jonathan Portes’ blog post on his organisation’s effort to measure the impact of Eurozone fiscal contraction. He finds the trap – in the right circumstances, scenario 2 on the chart. Izabella Kaminska blogs estimates of the output gap in the UK that are dramatically higher than previously thought. Duncan Weldon, on the UK trade unions’ policy blog, points out the link between estimates of productivity and estimates of the size of the financial crisis. If you think the bubble was smaller, and consequently the crash, you must also think labour productivity has fallen. This will have consequences for your policy judgments. Of course, if you think the problem is productivity, you are probably also inclined politically to minimise the financial crisis.

The shortest comment is from the New Yorker. And, perhaps most crushingly of all, here’s a list of economies ranked by growth since 2010. The UK is 158th and all the countries in troika management are worse that that.

Wiesaussieht points out that the credit rating agencies’ views on France aren’t dominated by “competitiveness” but rather by the weakness of Southern European trading partners and the banks’ exposure to Southern European debt. This is far from a trivial point. You can see it working out in the day-to-day political news. Peugeot is in trouble because its cars sell best around the Mediterranean. Arcelor-Mittal’s Florange site is mostly a supplier to the car industry. Arnaud Montebourg and, more to the point, the old steel executives he’s taking advice from think it can be turned around because it’s well placed to supply the German car industry as well.

Here’s another chart of the week – the German trade surplus is now contributing more to the global imbalances than China’s.

Here’s Krugman. of course. Unfortunately, Art Goldhammer blogs, there is no sign of anything moving. Macrointelligenz offers some hints. Euromoney compares the markets for Italian and French government bonds, and points to another austerity trap: things break when nominal GDP growth falls below the yield on the public debt.

If Hollande allows himself to have a Schauble-esque virtual-troika plan imposed, I expect that this trap will be triggered.