Creative accounting is nothing new for the Eurozone

Frances Coppola blogs on the Austrian government’s crash investigation into the failure of Hypo Alpe-Adria (latest detail – the biggest participant in the run on the bank was its garantor), also known as Haiderbank, and on the related topic of the Juncker Commission’s “investment plan”. The link is that the investment plan relies on a succession of heroic accounting assumptions to bulk up the final number without putting in any, you know, actual munn, and the Austrians’ response to the Haiderbank’s failure was based on a lot of funny figures. Frances so:

But what struck me from this report was the sheer naivety of the government officials involved. They were like children playing with fireworks. The instruments they were handling blew up in their faces and they were badly burned. And Juncker wants government officials to do MORE of this sort of thing?

There is a worrying tendency at the moment for public officials worried about deficits and debt/gdp ratios to hide public liabilities off the balance sheet. But the HGAA saga should sound an alarm about this practice. The Carinthian guarantees were all off-balance sheet – but collectively, they were enough to bankrupt Carinthia, which as a sub-sovereign must balance its books. In fact they were sufficient to place the finances of Austria itself under considerable strain, as well as setting up a nasty spat between Austria and Germany with EU-wide implications. And it is painfully evident that government officials lack the expertise to understand the legal and financial implications of the complex financial instruments involved. The ease with which BayernLB’s experts could deceive Austrian government officials is frightening.

I disagree. I would be very surprised if Austrian finance ministry officials were at all naive about the possibilities of structured finance at the edge of the zone of acceptability. Why? Well, way back in the day when Hypo Alpe-Adria was doing its thing funding Jörg Haider’s career and I lived in Vienna, I remember that time Karl-Heinz Grasser, then finance minister before being disgraced in a corruption scandal, got the federal government to sell the lakes of Carinthia to the federal forestry service, for which the government extended its foresters €215m in credit until they could sell other property to meet the bill.

Somehow, because the deal was “Maastrichtkonform” in the jargon of the day, this meant that Grasser could book the money as in-year revenue but not any additional government debt in the EUROSTAT definition (because while the foresters had acquired a liability of €215m, the fisc had a matching receivable of €215m), and as a result, that he (and Haider as junior coalition partner, and prime minister Wolfgang Schlüssel) were lionised for achieving, you guessed it, a “schwarze Null”, although that wasn’t the expression they used.

I’ve no idea how the accounting treatment could possibly work, but of course that wasn’t the point. By the time the matter had gone up to where-ever it needed to go in Brussels, the relevant deadline would have passed, and if the European Commission complained, well, there would be a fine opportunity to indulge in nationalist whining. Hauptsache, the budget was balanced, for an instant, under their preferred definition, on the relevant day. As it turned out, the assets were worth about a quarter of that.

Wonderfully, since then, some of the same property has become the object of another financial scandal.

The point of this bit of dated little-country political gossip is that funny figures aren’t an exception in the eurozone. They’re constitutive of it. The original Stability Pact launched a culture of creative accounting that is still well with us. France got in because France Telecom “voluntarily” loaded up its balance sheet with debt to finance a “voluntary contribution” to the government that just so happened to be enough. The phone company could do this because the government still owned it and guaranteed its debts.

I’m sure every other country in the eurozone has at least one similar story – it was the first great era of financialisation and privatisation, creating all sorts of interesting opportunities just at the same time as there was a huge incentive to cook the books.

That said, you’ll get no disagreement from me about this:

This is no way to do public investment. We should be keeping public investment ON the balance sheet, where the risks can be seen and properly managed, not sweeping it under the carpet and pretending it doesn’t exist. Juncker’s call for EU member states to make greater use of “innovative financial instruments” is madness

It’s Baaack: Looming Greek Elections Threaten To Re-ignite the Euro Crisis

If at first you don’t succeed, try, try again……  aka third time unlucky.

The Euro crisis has all the signs of being back amongst us, and this time it may be here to stay. After two earlier false alerts – one in July around the collapse of the Portuguese Banco Espirito Santo, and another in October over the state of the Greek bailout negotiations – the announcement this week that the Greek presidential decision was being brought forward to December has sent the markets reeling off into a complete tizzy. Continue reading

Three economic history papers you should totally read

The Berkeley Economic History Lab is blogging a lot of its recent working papers, and they’re a goldmine of great stuff. Here’s Richard Sutch writing in October this year, whose The Liquidity Trap, the Great Depression, and Unconventional Policy: Reading Keynes at the Zero Lower Bound basically recovers an important idea from the General Theory and Keynes’ practice during the Depression.

Sutch’s gloss of Keynes is that an important way in which the zero lower bound constraint bites is that there is always a term-structure of interest rates, rather than anything like a single economywide rate of interest. As a result, even if short rates hit the ZLB or even go negative, a large segment of the yield spectrum will still be significantly positive. This of course has some consequences for the debate about when Keynes broke with the Wicksellian idea of a single market interest rate that might deviate from a full-employment natural rate.

He argues that Keynes micro-founded this on differences between the risk profiles of borrowers and lenders. Borrowers and lenders both face the risk that whatever enterprise is being financed will fail and the loan won’t be paid off. Borrowers stand to lose whatever security is put down for the loan, while lenders stand to lose the difference between the security and the principal (i.e. their risk is fundamentally about estimating how much security is enough). In theory, arbitrage should transmit lower rates at the short end along the whole curve, because if you can borrow for a year and roll it over cheaper than you can borrow for 5 years, you will.

But here’s the problem; lenders bring their own idiosyncratic risk to the table. Each event of refinancing brings with it the risk that potential lenders have become illiquid, a so-called sudden stop. This always exists unless the life of the loan matches the life of the asset exactly, and it is an attribute of lenders, not borrowers. Therefore, long-term credit comes at a premium, and in a sense what is “long” is defined in relation to the typical life of capital investments.

Therefore, it’s quite possible for the policy rate to hit zero or even theoretically drive through the ZLB, while a large proportion of the universe of credit still has significantly positive real interest rates. This implies that unconventional policy of some sort – perhaps a combination of QE and an “Operation Twist”-like effort to target long rates, or direct fiscal reflation – would be needed and that’s what the man concluded.

An example of the sudden stop would be another of their papers, Olivier Accominotti and Barry Eichengreen’s The Mother of All Sudden Stops: Capital Flows and Reversals in Europe, 1919-1932. In this one, Accominotti and Eichengreen have literally discovered a trove of historical documents in an archive. It’s a catalogue of major capital-raising exercises in Europe in the 1920s and 1930s, covering the major financial centres and most of the second tier as well. The conclusion is that the rolling financial crisis starting with Creditanstalt in 1931, defined as a sudden stop of international lending followed by capital flight, was driven by volatility in the stock market – it was, in fact, the Great Crash and its lesser crashes that did it. The correlation with volatility in world equities was much higher than with any economic variable in the countries affected.

An example of policy would be Eric Monnet’s Financing a Planned Economy: Institutions and Credit Allocation in the French Golden Age of Growth (1954-1974). This one comes from Paris School of Economics – surely the fac Piketty these days – and you can tell because it’s crunchy with empiricism. Monnet has constructed a database of lending registered with the Banque de France that provides series into very detailed industrial sectors, and another one of firms’ operating results based on tax returns, going through what sounds like epic pain to match the excisemen’s classification up with the central bankers’ and further with the national statistics. The key result is that the change in the state-directed, or as he would put it, state-influenced lending was very strongly correlated with internal rates of return, implying that the system worked well as an allocator of capital.

He’s also done a lot of qualitative work to understand how the French financial sector worked at the time. It was a lot more complicated and subtle than the caricature of being directed by the government, and it evolved over time. To begin with, a lot of lending really was directed by government and issued by the finance ministry, mostly to large capital projects in infrastructure and heavy industry. With time, the heavy lifting moved to a new layer of specialist lenders who faced projects in manufacturing, housing, and tourism. Influence rather than control was very much the point. The key financial product was long-term lending of 5 years plus.

There’s much more stuff in there – the fall of the USSR in a trade perspective, equities and anti-Semitism, Ottoman and Austrian administration and their long-term effects on growth.