Category Archives: The European Union

Les grandes vacances and the financial crisis

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As the European policy elite prepares for their normal practice of taking August off — because, after all, nothing big ever happens in August or September that you’d need to be ready for — there are conflicting messages about whether this is actually a good idea.  First, a nice quote via a Reuters story arguing that it helped when everyone decamped from their offices last year:

“Last summer, the crisis cooled partly because euro zone politicians went to the beaches and stopped contradicting each other in public every day,” one senior EU official involved in the Greek rescue negotiations said. “That moment can’t come soon enough this year.”

On the other hand, we’re coming up on the 1 year anniversary of the disastrous absence of Official Ireland from its desk (on what was actually a July-September inclusive getaway for the then-government), a problem later noted by outgoing ECB board member Lorenzo Bini Smaghi

Whereas [PM Brian] Cowen and his ministers had responded swiftly during 2009 as fiscal conditions worsened, Bini Smaghi says there was no comparable action to reassure markets when the heat came on last year. Ireland was listing from the summer, its position worsening all the time as investors took fright.

“Markets waited and waited and since they saw no policy reactions they started to lose confidence in the course of the summer. Remember there was a downgrade – in August – but there was no policy reaction, no announcement that a tough budget was in preparation and no announcement of the measures. The loss of confidence also affected the banking system and this created a spiral which led to the crisis and in the end the request for financial assistance.”

Splitting the difference between these positions is currency strategist Stephen Jen –

With signs of anxiety resurfacing late Friday — a rally by Spanish bonds fizzled at the market’s close — the idea that investors would wait patiently for two months for Europe’s leaders to provide the fine print on their grand proposal was met with disbelief in some quarters.  “I would suggest that if the eurocrats want to go on vacation that they bring their cellphones,” added Mr. Jen.

Back when Nicolas Sarkozy was popular, one of his catchy slogans for reaching target voters was “the France that wakes up early.”  Could we get a similar chic in Brussels, Frankfurt, and the national capitals around “the Europe that works during August?”

Debt restructuring in Greece and Dubai

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It’s useful to compare and contrast the terms of the Greece debt restructuring as outlined by the Institute of International Finance and the Dubai World debt restructuring of last year.  In both cases there is a mix of options for the new debt with varying coupon structures and levels of government guarantee.  The Greece case is a little more blunt about the discounted nature of the new debt, but there are enough options so that outright haircuts to principal can be avoided if a creditor so wishes — the impact is being achieved in net present value terms.

Thus there is a sense in which Dubai and its bailout partner Abu Dhabi were ahead of the EU curve.  This is despite considerable differences in circumstances: Dubai was restructuring corporate debt of state owned companies that were perceived as having a government guarantee but in fact did not, whereas Greece is restructuring sovereign debt.  The government of Dubai succeeded in walling off its own sovereign debt burden from its kinda-sorta-maybe legacy guaranteed liabilities — Ireland, take note — and was even able to issue new sovereign debt this year, without a credit rating!

Also in Dubai, the commercial banks grumbled but ultimately took the offer.  Which brings up another issue.  When the government of Dubai needed to restructure debt to commercial banks, it brought in restructuring specialists who came up with the offer to the commercial banks.  When the EU needed to restructure the Greek debt owed to commercial banks, they brought in, er, the commercial banks.  There must be synergy in having poacher and gamekeeper as the same person.

EBA stress tests: sovereign debt is local

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One of the interesting things upon 1st quick read of the European Banking Authority stress tests is the way it downplays the sovereign debt issue:

The data from the sample of 90 banks (Dec. 2010) shows the aggregate exposure-at-default (EAD) Greek sovereign debt outstanding at EUR98.2 bn. Sixty-seven percent of Greek sovereign debt (and 69% of the much smaller Greek interbank position) is in fact held by domestic banks (about 20% refers to loans which are mostly guaranteed by sovereign). The aggregate EAD exposure is EUR52.7 bn for Ireland (61% held domestically) and EUR43.2 bn (63% held domestically) for Portugal. Importantly, EAD exposures are different from similar exposures reported on a gross basis in the disclosure templates …

Given the distribution of the exposures described above, the direct first-order impact, even under harsh scenarios, would primarily be on the home-banks of countries experiencing the most severe widening of credit spreads. In such cases the capital shortfall should be easily covered with credible back stop mechanisms such as the support packages already issued or being defined for Ireland, Portugal and Greece. In this context these countries have announced capital enhancement measures requiring banks to hold capital to a higher level than that used for the EBA’s EU wide stress test. Additional capital strengthening measures have been, and will be, announced to ensure this.

In other words, most of the Greece, Ireland, and Portugal debt is held by domestic banks which is good news for the other EU banks that might otherwise be feared to be sitting on this stuff and thus should be bad news for the domestic banks of these strained sovereigns — but since they are already under official lending programs, these can be tapped to ensure that the domestic banks (and their lenders) don’t lose money.

Leave aside the concern that Exposure at Default is a technical measure that allows some netting of exposures that might not happen as smoothly in practice as on a balance sheet.  Think about the claim that since sovereign debt is domestic, losses can be handled as long as there is an official lending program in place.  Doesn’t that invite attention on countries with lots of domestically held debt, but no program?

We hope to have more when the individual bank results are revealed.  Note also the filename of the EBA document — it includes a “v6″ at the end.  That’s a lot of meetings!

Special Guest Contribution: A simple, repellent plan for Greece

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Ed: At this critical moment for the European project, we have the honour to present a special guest contribution from Norman Strong, who has agreed in the light of the extreme circumstances we are facing to finally resume the occasional series of posts he began here in 2002. Like Duke Nukem Forever and the Stone Roses’ second album, it’s been a while.

The first thing to note is that there is, despite appearances, no urgency. Once one has accepted the fact that a restructuring of Greek debt will be needed, then it is no longer the case that “kicking the can down the road” will “only make things worse in the long run”.

Some simple arithmetic, from the point of view of Greece:

Say that the total sustainable debt burden of Greece is X, while its current debt burden is Y. If we were to reschedule tomorrow, the necessary markdown percentage would be X/Y.

But if we don’t reschedule tomorrow, and instead lend an extra amount Z, then the sustainable burden doesn’t change – the eventual writedown will now just be X/(Y+Z).

In other words, new net lending to Greece, from the EU, IMF and/or EFSF to finance the current deficit, is just pushing down the eventual recovery rate on all debt. The marginal rate of writedown on new credit extended to Greece is one hundred per cent. It is effectively a fiscal transfer, financed by either a tax on all bondholders (if the new debt goes in pari passu), a tax on pre-crisis bondholders (if the new debt were to go in on a senior basis), or a tax on the official sector (if the new debt is wholly or partially financing an exit at par for pre-crisis bondholders as they redeem). The Greek government should be trying to borrow as much as anyone will lend them, since the repayment terms don’t matter if you’re planning to default. It is analogous to the practice of “trading while insolvent” for a company; this is an illegal thing to do for a corporation, but countries aren’t corporations.

With that in mind, we realise we are under no time constraint at all, and we can organise the eventual bailout at our leisure and for our political convenience. Particularly, we can stick it out past 2013, by which time the German Presidential elections will be out of the way, and a raft of new European legislation will be in place with respect to sovereign and bank debt restructuring, allowing the whole business to be carried out on a more civilised basis.

(Academic economists and bond traders alike, by the way, always underestimate the need for legal certainty, while policymakers never do. Much avoidable misunderstanding results from this, and from the fact that I have never seen a “plan to save the world” from either an economist or a bond investor, no matter how otherwise sensible, which didn’t have a giant great lacuna in the middle where anyone with policy experience would immediately say “that’s the bit where a thousand lawyers suddenly pop out of the woodwork and start arguing with each other, resulting in something absolutely critical not getting done”.)

So with time on our side, and no real intention of doing anything until we have as much legal and political certainty as we need, what would be the least painful way to achieve our end? I am assuming that our objective here is to get Greece back to a sustainable fiscal position, without destroying the Eurozone banking system on the way, with as little pain as possible. That is the plan, isn’t it guys? I assume so, but I am often reminded of Enron’s legendary fixer, John Wing and his cry of “Everyone trying to do this deal, that side of the room – everyone trying to screw it up, over there!”. the easy way to do this is by using the equipment provided; a central bank. The ECB currently owns EUR62bn of Greek government bonds outright, via the Securities Market Purchase program. There is also a substantial debit balance on the part of the Bank of Greece at the ECB, reflecting payment imbalances in the Eurosystem. This is not a fiscal exposure (the Greek government has no use of the proceeds and the debt is collateralised). But if need be, it could be converted into one; one would only need the Greek banking system to sell their collateral to the ECB in an extension of the SMPP.

The only point I’m trying to make here is that, in stage 1 of my plan, I can get the ECB into a position where it is as big or as small a creditor of the Greek state as it needs to be. (Stage zero, helas, involves getting Greece to a position of primary fiscal surplus, and that is going to hurt. Fundamentally, fifteen years ago, Greece faced a choice between being the kind of country that doesn’t collect taxes on the middle and upper class, or the kind of country that pays generous benefits and public sector salaries, and chose both. There is no financial whizzkid trick in the world that will let you get over that one).

But my flexibility in making the ECB the largest creditor in stage 1 is important, because stage 2 involves the EFSF providing a special loan facility for the Hellenic Republic to make an open market tender offer for its outstanding bonds at a discount to face value. My guess is that few private-sector holders would tender into such an offer, but the ECB certainly could, as long as it was given an indemnity for the costs of doing so by its shareholders. The ECB actually holds a substantial proportion of its GGBs at a significant discount to face in any case, as it bought them in the market, while any further transactions would take place at current market price, so the indemnity would not necessarily need to be huge. In actual fact, the ECB could do this solo, without any indemnity – the losses would wipe out its capital, but under the ECB treaty, this would immediately be replaced by its shareholders (the fiscal authorities of Euroland) in proportion to their holdings of the ECB’s initial capital. But that would be an example of the kind of “bright idea with an obvious legal black hole” I was talking about earlier, whereas the provision of fiscal indemnities for central bank rescue operations is very orthodox practice.

What about “private sector participation”? Well, the private sector would have already participated in this one, by crystallising their mark-to-market losses on sale of their bonds to the ECB. It is true that the scale of private sector participation might be less in total than one might wish (as the market price would presumably rally if the ECB were a large buyer), and certain kinds of unpopular players like vulture funds might not bear as much of the burden as policymakers might wish. But if you don’t like this, Euroland, then remember that you have the power to tax. There are all manner of fiscal instruments that can be used to equalise and spread the pain about – the ratings agencies would presumably regard such fiscal rough justice as equivalent to a selective default, but come on – you didn’t really think we were going to get out of this without defaulting, did you?

The idea is so simple (as JK Galbraith said about the creation of money in a fractional reserve banking system) that it repels the mind. To repeat – all we need is the existing Euro, the existing EFSF, and a legal opinion that this would not constitute monetisation of the Greek national debt, which as far as I can see it wouldn’t. But there is no rush.

Highly leveraged

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A quote from a Wall Street Journal article about the standoff over how soon Lorenzo Bini Smaghi should resign from the ECB board:

“Our understanding is that Mr. Bini Smaghi wants to know where he would work next if he were to voluntarily resign from the ECB,” one French official said.

 Mischievous suggestion: Greek trades unions should send a letter to the IMF, ECB, and European Commission saying that “our understanding is that our members want to know where they would work next if they are to voluntarily accept cuts in their current positions.”  Anyway, it’s good to know that the minds of our European Council betters are on the big issues.

How I was wrong about the euro

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This Transitions Online piece is fascinating – as south-eastern Europe has changed, the location of “Europe” or “the West” has swung around all over the place. Once upon a time, Bulgarians and Romanians looked at Yugoslavia as the future, a better version of their own society, and both a reasonable substitute for Germany or Italy and a transit route on the way there. People watched Yugoslav TV illegally. Then, the earthquake, the nightmare. Nobody wanted to be anything like it. People in what had been Yugoslavia looked east, both because there was peace, because that was where the smuggled fuel came from, and also for political support.

Meanwhile, people in the rest of the Balkans looked north at Hungary or south at Greece. Of course, that was because the European Union came to them. Now, well, not so much. If there was ever a time to be eurosceptic, this is the moment. Greeks are quite possibly looking north and wishing they weren’t in the eurozone.

I remember that in the mid-1990s, I was quite sceptical about the single currency for the usual reasons from the left – basically, Keynesian concerns. Having grown up in a succession of recessions, the prospect of joining the Stability & Growth Pact and signing up to the monetarist second pillar of what wasn’t then the ECB didn’t seem great. However, I was (still am) very pro-European on all other issues and eventually I came round to it for not much of a better reason than that it offended the right people. Also, this was the early 2000s and economic policy based on rules seemed to be a pretty good idea. As it happened, of course, when a dose of stimulus was wanted this didn’t keep anyone’s hands out of the medicine chest. Neither did the austerity hold back anyone who was determined to have a monster property boom.

The other big concern was the optimal currency-area problem – could the interest rate be right for the whole eurozone? This is about the most conventional critique of the euro there is. In the UK, it used to be quite a commonplace that the country itself wasn’t an optimal currency area, with the corollary that it therefore didn’t matter so much about the euro. I never quite grasped the logic here, although I admit I may have used the argument. Perhaps the underlying thinking was that there is really no such thing as an optimal currency area – a currency system that was sufficiently decentralised to offer an optimal credit environment in its whole territory would have such high transactions costs it wouldn’t be worthwhile, and therefore we would always have to tolerate some inefficiency due to this effect.

So I was very pro-euro and pro-European while it was a live issue in the UK (about 2003, IIRC – I wonder what happened then?).

What I don’t remember anyone discussing much was the Eurosystem as opposed to the Euro or the ECB – the transactional, flow-of-funds financial workings between the member central banks and the ECB. Nor do I remember anyone talking very much about the fact that the ECB doesn’t have an explicit lender-of-last-resort function. And even discussing whether member states should do anything to manage their trade balances with one another – that was so far out of fashion, of course, that even I didn’t give it any thought.

Of course, this was the bit that bit us.

To put it another way, we argued enormously about the fiscal aspects of the Euro, which turned out to be absurdly easy to fudge when it became necessary to do so. We argued quite a bit about interest rate policy. We hardly even mentioned banking or the issue of money. This is quite a cock-up when you remember we were talking about setting up a new central bank. No wonder west is north and east south.

Is this just my fault? Was there serious discussion of how the Eurosystem might work or not in a financial crisis back in the 90s? Working on my own private black swan theory – apparently unlikely events are both predictable and usually predicted, but they tend to be ones it was unrespectable to predict – somebody must have been.

Also, has anyone else in Britain changed their mind, or is it only me?

A political group obituary

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As nobody who hasn’t been living in a Faraday cage on Ellesmere Island for the past four days no longer knows, Dominique Strauss-Kahn, IMF managing director and probable next president of the French Republic, has been charged with attempted rape and has been remanded in custody of the New York police. I’m sure the AFOE Whole Control Inter-Macro Economic Soul Patrol will have some thoughts about the future leadership of the IMF in due course. For mine, I’m tempted to think that rudderless confusion is probably the least harmful condition for this organisation, but I know not every reader will agree.

Anyway. What about French politics? That’s bound to be more fun.

The most important fact here is that DSK was predicted by national polls to beat all the other candidates in the next presidential election. The Socialist leadership has been something between a soap opera and a French movie about self-torturing neurotic dread of action for years, but basically everybody expected that once he decided he was going to run, not only would he win the primary, but he’d also take out the general election. The facts are pretty simple – President Sarkozy has the worst poll rating of any French president ever. The extreme-right leader, Marine Le Pen, is doing better than ever. But DSK was both the top pick out of the Socialists, and also the polls’ pick for the big gig.

In fact, there was widespread speculation that the horrible experience of May, 2002 might be reversed. Rather than the extreme Left splitting the vote and leaving a run-off between the extreme Right and the Gaullist Right, the extreme Right would split the vote and leave a run-off between the extreme Right and the Socialists. This scenario was a little like a nuclear attack on Manchester destroying Old Trafford and Maine Road. A lot of people would think it a terrible disaster. But quite a lot of the people most concerned would have to mourn through gritted teeth to keep from laughing with pure schadenfreude.

Who was DSK? An academic economist and long-time Socialist, from a well-off family, one of those men who always seem to come up lucky. He was an effective minister of Finance, Economics, and Industry in the Jospin government, and he presided over possibly the first time the IMF ever thought wages should go up. I remember him wanting to know why the British let General Electric buy the division of Amersham International plc that at the time made practically all the world’s DNA sequencers. I still haven’t heard anyone answer that.

In French politics, he was very much parallel to his contemporary Peter Mandelson in Britain. Both ran economic ministries with some success, and did likewise as international civil servants. Both were considered dangerously foreign to their own parties for a mixture of reasons to do with ideology and with style – both liked the company of the rich and enjoyed good tailoring and better travel. They were certainly both well to the right of their parties, but it was DSK who was responsible for the 35 hours law in France, and the British Labour Party is now rediscovering how little it likes Conservative government in general. They were also both disliked for appearing clever, visibly enjoying cleverness, and repeatedly winning in micro-political squabbles with the journalists who hated them. As is the way with people who are genuinely clever and effective and look like they enjoy it, they were both hated and indispensable to the leaders of their respective movements.

It is probably worth pointing out that they are both Jewish and – much as everyone involved would deny it – this does look like a role grounded in stereotype.

Mandelson collected a lot of fairly horrible abuse from the cheaper end of the British press because (and again, everyone involved will now whine about this) he’s gay. DSK was regularly written up as a stereotypical French ladies’ man, a Latin lover for whom it was all both indivisible from his personality and from the sheer style of politics.

It seems, in the absence of a coup de theatre to blow the theatre roof off, that only one of these statements was true. Women are already turning up who claim that he raped them years ago – most shamefully, one of them was apparently told by her mother to shut up. Her mother is a relatively important official in the PS’s regional organisation for Paris, DSK’s power base throughout his career, and someone who could perhaps have expected favour if and when he was back in power. This week’s Canard Enchainé is likely to be an explosively sordid document.

It would seem that the whole story is the classic one of an abuser protected by his friends, family, and colleagues. The network would say nothing, and indeed would influence others to say nothing, until the day when he pushed his luck outside its zone of influence. At this point, it is usual for a whole lot of people to have sudden and wholly unexpected fits of principle. I would not be surprised if skeletons tumbled from many other French politicians’ cupboards in the next few weeks. If I sound pissed off, well, how many other people were convinced that he was a decent man?

So far, the party and specifically the Ile de France regional federation seems to be…well, check out the list. It is to be expected that a lot of the people named will rapidly forget that the whole thing is a plot against them because Sofitel is a French company. (Surely, had he stayed at the Hilton, that would have been even more suspicious?) I hear that this tone of denial is quite widespread among people who certainly ought to know better.

Upshot? It seems unlikely anyone will be more satisfied with Sarkozy as a result. In fact, only a revolution of opinion would be enough to help much. And Sarkozy’s personal style – all yachts and executive jets and watches and models – is rather like DSK’s. It will probably give Marine Le Pen a little more.

Inside the PS, expect yet more neurosis. DSK’s supporters skew to the right of the party, and he has a particular beef with Laurent Fabius (who in any case isn’t going to win). In the absence of other factors, they’d probably be spread roughly equally between Ségoléne Royal, François Hollande, and Martine Aubry. But there are other factors. Royal and Aubry have defined geographical power bases, Royal from being president of Poitou-Charentes, Aubry from being mayor of Lille. If you had to pick, you’d probably take the second for an intra-party fight. DSK’s support is localised in Paris – it was the only PS federation not to vote for Royal as candidate last time out. Hollande’s base is in the party organisation, from his years as first secretary and therefore chief organiser. It’s fair to say that a lot of his people are also based in the capital, so he might claim more of a bonus than anyone else. He has recently been enjoying an upward trend in the polls.

It is possible that this is an end of an era, or at least a significant moment in moral history. As I said above, I wouldn’t be at all surprised if there were more disgraces in short order, and that the general tolerance-level will have been reduced to a more defensible value.

Also, the style of French politics is changing. Mitterand is dead, Jacques Chirac is gone. Sarkozy is the least popular president on record. DSK, Laurent Fabius, Charles Pasqua, Simone Veil, Edith Cresson, Rachida Dati, a whole series of enormous and often enormously flawed personalities have left the scene in one way or another. Dominique de Villepin and Alain Juppé hang around, but will either make any impact?

The new style is understated and in fact quite dull. On the Right, there are people like François Fillon and Christine Lagarde – a gang of grey managers. On the Left, people like Hollande and Aubry – solid town hall politicians. Marine Le Pen’s unique selling point is that she makes fascism boring. Her party’s thuggish stewards have been ordered by party headquarters to dispense with their shiny boots and paramilitary trappings, and are said to be exploring British football-casual style for the future. So much the better for the Italian textile sector, so much the worse for Leicester. But perhaps dull is good. It’s worth remembering that dull is great news in the long term of European history. They said Clement Attlee was dull.

And now, for the IMF…

A question that will probably not be answered

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Via Nick Pearce at the IPPR, a fascinating chart of where the recovery ended up.

Germany's recovery: fuelled by sunshine

There’s clearly a fair amount of sunshine in the chart for Germany, although it’s very hard to be optimistic about the UK. But will anyone present anything like this chart for the Portuguese economy? And when people like Volker Wissing talk about imposing their adjustment, what is their estimate for the reduction in the German trade surplus? Take it away, Herr Bofinger:

Anyone who sees this as a virtue must ask themselves whether Germany’s export successes would have been possible if other countries had behaved as “virtuously” as we have. It says a lot about the level of the debate that such simple and fundamental insights are apparently difficult to get across in Berlin.

See also J. Random Weblog.

Die Debatte heute ist für mich an Scheinheiligkeit, Zufriedenheit, und schlichte Verlogenheit kaum zu überbieten.