In the end at #Haiderbank, everyone who mattered got exactly what they wanted.

So I spent my Christmas reading the Hypo Alpe-Adria crash investigation, in a follow-up to this post . The point that stands out for me is that I don’t think you can blame this one on incompetence. Too many actors involved got what they wanted for that. Instead, they adopted a form of strategic incompetence that has long historical roots in Austria and its former empire, following the creases left by major historical events.

To kick off, the transition of Carinthia’s state-owned mortgage lender to a universal bank was an event conditioned by several massive historical phenomena. One of these was financial globalisation. Another was the relaunch of European integration. A third was the desire of important politicians in Austria to have alternatives to the postwar long coalition. It’s telling that Hypo Alpe-Adria, hereafter HAA, opened its first international office in 1986, about the time the extreme-right FPO was in government for the first time, in a weird alliance with the Social Democrats. Its new name, with its vaguely imperial claim to the “Alps-Adriatic”, actually appeared before the end of communism, and it began to do business in the former Yugoslavia even before it was former.

So the transformation of HAA gave its shareholders, at the time the state of Carinthia, a Steiermark mutual insurer, and some employees, a number of benefits. One of these was an economic strategy – we’re going to create a financial centre and we’re also going to invest in this new region. Another was something like having your own independent foreign policy – after all, the region was being conceptualised at the same time as the bank was being reorganised. Yet another was a source of budget revenue, from taxes and from the annual premium it paid for its state guarantee. Less legitimately, it was also a slush fund that could be used to look after important political constituencies.

And, from a very high level, it also played an important role in integrating the far right back into Austrian and European politics. The regional concept the bank embodied was one rooted in the empire and revived by the Nazis, and much loved by Austrian and German extremists. While Carinthia was an obscure collection of minor ski resorts crammed up against the iron curtain, its political elite didn’t have much to offer in exchange for rehabilitation, which they needed because their key political party had basically been invented as a lobby for old Nazis’ interests in the late 1940s. (The same thing nearly happened with the German FDP, but its liberal core and the allied oversight won out.) With a key lender in the reunification of Europe under their command, they counted for something. Wir sind wieder wer.

The European project was both a precondition of all this and also a threat to it. Without the facts of reunification and integration, it would never have gone anywhere. Without Austrian membership of the EEA and then the EU, it would never have been practical. But joining the union also made the whole deal problematic. The union didn’t, at least in principle, like state aid or special arrangements. It was especially keen to get rid of the state guarantees for German landesbanken and their equivalents. It was also keen on privatising all the things.

The owners of HAA formed a strategy to let them have it all. They would progressively sell down the shareholding, sticking at a blocking minority. They would put off unwinding the guarantee as long as possible, and load up on as much cheap funding as possible before the evil day. In the end they legislated in such a way as to let them keep guaranteeing HAA as long as it paid a market rate, which they didn’t define. The premiums were nice for the state budget and the cheap funding critical for the growth strategy. Influence would take the place of control.

Of course, people now ask “Why did they sign up to all those guarantees?” The investigation wonders why they kept guaranteeing even after they didn’t have majority control. But this is strategic incompetence for you. First of all, they relied on informal influence and personal networks to steer the bank. Second, the actors who mattered didn’t care about the risks because they well knew they weren’t meaningfully on the hook for them. Similarly, the Bavarian landesbank that bought HAA was convinced that the Austrian federal authorities were in charge, while both they and the Carinthians believed (or faked it) that the Germans were in charge.

The structure permitted all parties to get what they wanted. We don’t usually think of getting exactly what you want as being “incompetent”.

In 2006, when the Carinthians began selling down their shareholding, the accounts used for the due-diligence process dated back to 2002/2003 for the crucial South-Eastern European assets. This seems crazy. But it was just what the people who mattered wanted. There is an Austrian word, Schlamperei, which describes a sort of institutional blundering into the best course for one’s own interests. Then again, when Deutsche Telekom was ordered by its regulator to let other operators unbundle its lines, it regularly just failed to know they existed or where they were.

A poorly controlled SEE-focused landesbank was just what Jörg Haider wanted, and you can read the eventual sale to the Austrian feds as a scheme by the Carinthians and Bavarians, presumably with German federal acquiescence, to burn the other Austrians.

In practice, the strategic incompetence worked like this. In 2004, HAA engaged in a variety of transactions in derivatives that boosted its interest margins while taking risk on the absolute base rate. This worked for a while and then didn’t. They hid the losses, until they got caught. The then CEO, Kulterer, had to quit but couldn’t be questioned by financial regulators because the police wanted to talk to him. Because he wasn’t under a regulatory inquiry, that meant he could become chairman of the supervisory board. (In the changed post-crash climate, he went to jail.)

The plan had been to float HAA, but this was now out of the question. The state of Carinthia had borrowed against the IPO proceeds, which forced someone to do something. Strategic incompetence again. The solution was to do a small rights issue, and get a hedgie called Tilo Berlin to take the other end. The inquiry found that there were no named politicians on his share register but there were some companies whose beneficial owners they couldn’t trace. This was called the Austrian solution, although Berlin’s vehicle was registered as a Luxembourg SARL.

Berlin’s unique selling point was that he was willing to accept a fairness opinion that said HAA was worth what Haider wanted it to be, issued by a local tax adviser in Klagenfurt who got €12m for his trouble, although Haider then demanded half of it back as a “patriotic rebate”. HSBC and Rothschilds were asked, too, but oddly declined to agree with this valuation. HAA’s own auditors thought the due diligence was pathetic, the data room a joke, and the disclosure bordering on the fraudulent, but Berlin and his investors didn’t mind because they almost certainly already knew BayernLB would take it off their hands after a decent interval. After all, they lent them some of the money. Again, everyone with any power got just what they wanted.

Meanwhile, Haider and his circle ran the bank like they wanted. It lent enormously in the Balkans and looked after his people. When an ill-thought out airline venture was close to failure, Haider himself as chairman ordered that it get a €3m equity contribution, plus a €2.5m line of credit that was drawn down and lost within two days. The loan agreement was recorded as a “note on the file”. An Austrian senator with €9.23m in debts as a sole trader got a 50% writeoff, with more of the debt converted to an equity-kicker, permitting him to save the inheritance. Strangely, HAA never tried to collect on the land he put up as security.

Although it couldn’t be said for the man himself, Haider’s machine in Carinthia got out in time. None of the regional shareholders bothered to contribute a cent to the first bailout in 2008. With the crisis, HAA met another group of powerful people who wanted to have it all – the European Commission, which wanted stability as long as it didn’t cost anything. In order to comply with the state aid restrictions, it was necessary for the Austrian central bank, OeNB, to decide whether HAA was “distressed” or “not distressed”, and also whether it was “sound” or “not sound”. The OeNB held that it was “not distressed”, but stated that this did not mean it was “sound”. Helpful!

But then again, everyone who mattered got what they wanted. The state of being not distressed helped on interest rates, while the state of not being sound helped with regulatory clearance. If the situation was absurd, well, that was precisely what strategic incompetence was meant for, and anyway, shouldn’t the people who made the rules take some responsibility?

Then, as J.K. Galbraith said, things became more serious. As 2009 went on, a classic “slow” or “invisible” run on the bank developed, led by big-ticket depositors, often wholesale. Ironically, one of the biggest single names to move out was the state of Carinthia’s treasury.

This is where I disagree with the crash report. Concretely, BayernLB forced their hand by pulling HAA’s lines of credit with the parent company and invoking a mandatory set-off clause that effectively froze much of its cash. The inquiry argues that the Austrian government could have put HAA into insolvency and challenged this in the bankruptcy court, had they only taken more legal advice. Instead, BLB offered to maintain some of HAA’s liquidity and write off €500m of debts if the Austrian feds would buy the bank.

Interestingly, BayernLB had actually done something similar in the past, when they owned a Croatian bank. On that occasion, there was a run on the bank and BayernLB insisted on selling it back to the Croatian fisc. The circumstances of this were such that in 2007, the Croatian central bank tried to block the sale of HAA unless BLB cooperated with their inquiry, dramatically restricted its loan growth, increased its regulatory capital, and made a public apology. However, “high political pressure” was brought to bear – I think this means either the European institutions or Germany or both – and the central bank reversed itself. They didn’t even get the apology.

But I find the criticism wise after the event. It’s true that both the Bavarians (and the German feds) and the Carinthian pols got away with it at the expense of the Austrian federal budget. But nobody knew what would happen if a federal state became insolvent, or what would happen to BayernLB, or to the South-Eastern European banking system, still less what would happen if all of them happened at once. The prospect of perhaps recovering more money in insolvency in the distant future must have seemed a little remote and vague. HAA might not have been systemically important in 2008, but one of the major lessons of the great financial crisis was that it is fear that makes systemic importance.

Similarly, the inquiry rather oddly complains that the feds spent too much time and money combing the crash site for clues. The main evidence of this is that the HAA management complains a lot about how many employees are seconded to help with the special audit. But, as the late Mandy Rice-Davies would say, he would say that, wouldn’t he?

There is a good point here, though. HAA was probably the most directly and egregiously crooked of the bank failures of 2008-2009. But the problem wasn’t that Herr Marolt got let off half his debts, and treating it as if a really big forensic audit would fix it was a mistake. Although the post-crash investigation was meticulous, and quite a few HAA execs went to jail, the Austrian taxpayer is no less on the hook for the money than she was at the beginning of the process, and HAA is still stinking up the shed. It’s even paying premiums to Carinthia.

The problem, really, is that HAA’s rise and fall followed all sorts of deep features of the EMU and enlargement projects. It was bigger and more interesting than just a fraud. At every turn, you find arrangements that let various privileged groups get what they wanted, usually allowing them to have several contradictory advantages at once by dumping risks on someone else. Even the European Commission was at it – although it repeatedly badgered the Austrians to create a state-owned bad bank, it also pushed the “six pack” balanced budget amendment and insisted that the rest of the budget suffer for it. Similarly, it somehow determined that the €30-odd billion in total that BayernLB got from the Bavarian and German governments wasn’t state aid although the Austrian bailout of its subsidiary HAA kind of was.

In the end, everyone who mattered got exactly what they wanted.

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.

Abenomics 2.0 – Just What Are They Trying To Achieve?

The recent move by the Bank of Japan to take further measures to accelerate the rate at which it ramps up its balance sheet took almost everyone – market watchers included – completely by surprise. The consequence was reasonably predictable – the yen has once more fallen strongly against almost all major currencies – and most notably against the USD – and Japan’s main stock indexes are sharply up. Continue reading

Does The Secular Stagnation Theory Have Any Sort of Validity?

In a number of blog-posts (Paul Krugman’s Bicycling Problem, On Bubble Business Bound, The Expectations Fairy) I have examined some of the implications of the theory of secular stagnation. But I haven’t up to now argued why I think the hypothesis that Japan and some parts of Europe are suffering from some kind of secular stagnation could well be a valid one.

Strangely, while I would suggest the most obviously affected countries are those mentioned above, most of the debate has centered around the US economy. Since it is not at all clear that the US economy is actually suffering from either a liquidity trap or secular stagnation at this point, this has lead many to question whether the idea might not be ill-founded. The Economist, for example, in a revue article (Fad or Fact) of Teulings and Baldwin’s Vox e-book  on the topic conclude the concept “remains a baggy one”, one which is “arguably too capacious for its own good”. Continue reading

Eurocrisis Round Two, Blame the Germans Edition

“What strikes me, also, is the extent of intellectual confusion that remains.” – Paul Krugman, Europanic 2.0

“The problem is that Germany has continued to maintain highly competitive labor costs and run huge surpluses since the bubble burst — and that in a depressed world economy, this makes Germany a significant part of the problem.” – Paul Krugman, German Surpluses: This Time Is Different

According to one fairly widespread (and recently much in vogue) theory about the Euro crisis, Germany bears a large part of the responsibility for the current mess. The view is met with a variety of responses inside the country, ranging from horror to amazement. Naturally, if the argument were simply about the way Angela Merkel has handled the crisis – no Eurobonds, no debt forgiveness, systematic fiscal austerity – then possibly some of it could be understood. But no, things go beyond that, Germany has been too successful, too competitive, and this has presented a big problem for its partners who simply haven’t been able to keep up. Continue reading

Is Japan Back In Recession?

“People should seriously consider that Japan’s economy may have fallen into recession despite the weaker yen and a stock rally from the BOJ’s easing and the flexible fiscal policy by Abe’s administration,” said Maiko Noguchi, senior economist at Daiwa Securities. “Initial expectations that the economy could withstand the negative effects of a sales tax hike through a virtuous circle seem to be collapsing.”

“the risks are rising that the economy will later be determined to be in recession,” said Yuji Shimanaka,  chief economist at Mitsubishi UFJ Morgan Stanley Securities Co.

Worsening Picture

As noted in my post – Does Abenomics Work? -  (published 19 September) the tide of media opinion finally seems to be turning against Shinzo Abe and his economic reform plan for Japan known as “Abenomics”. The degree of skepticism being shown only seems to have grown on the back of a slew of recent data confirming the impression that the recovery of economic activity from the post sales-tax slump isn’t going to be as easy as either the Japanese government or the Bank of Japan initially thought it would be. As the authors of the Bloomberg report from which the above quotes are taken – Oops Japan Did It Again? Sales-Tax Spurs Recession Debate – put it: “Weak industrial production data from Japan today raises concern that the world’s third-largest economy may be back in recession, challenging Prime Minister Shinzo Abe’s growth strategy.” In fact, output which was down 1.5% between July and August (and down 2.9% over August 2013) has fallen in three of the past five months.

Continue reading

The Japanisation Of Europe

By now it should be clear that the monetary experiment currently being carried out in Japan (known as “Abenomics”) is fundamentally different from the kind of quantitative easing which was implemented  in the United States and the United Kingdom during the global financial crisis. In the US and the UK QE was implemented in order to stabilize the financial system, while in Japan, and now the Euro Area (EA) the objective is to end deflationary pressures and reflate economies which are arguably caught in some form of liquidity trap. Continue reading

Does Abenomics Work? – The Doubts Grow

Is something in the air? Do I detect a change in consensus on the way things are going in Japan? Certainly a slew of articles have been published in the financial press over the last month questioning where the Abenomics experiment is headed for. The general conclusion seems to be that wherever it is it is certainly not the originally designated endpoint. Continue reading