Saturday, October 26, 2013

Europe's debt troubles, including Germany's

"Mrs Merkel has been far tougher on Greece than on the German banks that lent the Greeks so much."

That from The Economist is a good one-sentence summary of the political and economic perspective of Angie the Great, German Chancellor Angela "Frau Fritz" Merkel. (Europe's other debt crisis 10/26/2013)

The European Central Bank (ECB) is doing a review of the health of European banks. And what it finds is likely to be not very pretty:

As part of its "asset-quality review", ECB officials, along with outside experts, will start peering into the banks’ balance-sheets and impose common standards for loan quality (see article). This process is supposed to find out which banks are viable now, which will need more capital and which should just be closed down.

... The euro zone's politicians, even in supposedly prudent Germany, have been reluctant to look too deeply into banks' balance-sheets, let alone to force them to clean themselves up. There are certainly questions to be asked about all the government bonds that the banks have bought in recent years. But the main dodgy assets that have been swept under the European carpet are private: bad loans made to households and companies.

Europe is always thought of as having a sovereign-debt crisis, and it has. But the origins of the euro disaster lay less with government profligacy than with excessive private borrowing. True, Greece got into trouble because its government spent too much and collected too little in taxes. But elsewhere the bust followed a private-sector binge: mortgage debt in Ireland and Spain; corporate borrowing in Portugal and again in Spain. In all three countries household and corporate debt combined were way over 200% of GDP before the crisis, much higher than in America (175%) or even Britain (205%). [my emphasis]
These bubbles were also very much related to the flaws in the construction of the euro currency, in which capital could move freely across national borders but the political and regulatory structures were not equipped to deal with the economic consequences.

Alexis Tsirpras, leader of the Greek left alliance SYRIZA, recently explained how this works (Alexis Tsipras at the Kreisky Forum, Vienna (the complete speech/address to Austrian social democrats) Yanis Varoufakis Blog 09/24/2013):

The Eurozone resembles the Gold Standard with a difference that makes things worse: instead of fixed exchange rates among currencies, there is a single currency from which it is impossible to escape at a time of severe crisis.

But, because it is so badly designed, that common currency did two terrible things to us. Two things that make the analogy with the Gold Standard very, very apt:

First, it caused massive capital movements during the first years of its existence from the surplus developed Eurozone countries toward the Periphery.

Surplus countries have capital intensive oligopolistic industries that produce capital goods and consumer goods which the Periphery cannot produce at all – or at a price that is competitive.

By its very nature, a monetary union between such advanced economies and a less advanced and less capitalized Periphery will generate increasing trade surpluses.

But these trade surpluses immediately create mountains of profits in the surplus countries that far exceed their investment needs.

The result is that the interest rates collapse in the surplus countries and, for this reason, the northern bankers have an incentive to divert their capital to the Periphery, where interest rates are higher. This is why capital flows to the Periphery in large quantities.

And why is this capital flow a problem?

Because the money that flows into the Periphery creates bubbles.

In Greece, it caused a bubble of public debt as the state borrowed on behalf of the developer-cleptocrats who then used the money to create all sorts of bubbles indirectly.

Then, all of a sudden, but very predictably, Wall Street collapsed in 2008. All this capital that had flooded the Periphery left instantly. And those who had never benefitted from any of these bubbles ended up owing all the money.

Just like Hoover, in the late 20´s and 30´s, European conservative and social democratic governments insisted that un-payable debts must be still be paid.

But how?

With new debts that were taken from the surplus countries.

It was in this way that bankrupt Greece ended up, in May 2010, accepting the largest loan in human history which accelerated national income loss.
One of the contradictions of the bizarre euro crisis management of Frau Fritz' governments is that they were aimed at covering up the vulnerability of the German banks that would have been hard hit by an honest recognition of the value of the crisis country bonds held by those banks, which would have then required Merkel's government to recognize the deep-seated problems of the German financial industry.

Chase Gummer has a somewhat superficial but nevertheless informative piece on this, The Other Default? 10/25/2013 The American Prospect:

In no area of crisis management have the Europeans differed more from Americans than the way in which they dealt with the banks. Or didn't deal with them. After the meltdown of 2008, the United States instituted a massive relief program, the controversial TARP, which, despite its flaws, helped shore up banks' balance sheets and get them lending again. In Europe the reckoning never really came. Toxic assets like real estate weren't the main problem, rather the general over-extension of the banking sector and the mounds of bonds that European banks had accumulated from the governments of Greece, Spain, Portugal, and Ireland.
He probably gives the Americans too much credit as a way of making a contrast to European neglect. But Gummer's description is also accurate as far as it goes:

Amid the overall global belt-tightening after 2008, countries like Greece attracted greater scrutiny. It turned out the entire country had been one great Ponzi scheme—officials had lied about everything: debt levels, tax revenues, growth rate, the whole shebang. Spain’s booming real estate economy went bust at roughly the same time, putting enormous strain on the country’s public finances. Suddenly all of the supposedly risk-free investments in government bonds (after all, these countries were all in the eurozone, what could go wrong?) seemed very risky indeed. Capital flight and fears of contagion ensued, bond buying stopped, and all of the assets in the balance sheets of European banks looked to be every bit as toxic as American mortgages did back in 2008-2009.

Yet instead of a TARP-like program and finding ways to recapitalize the banking system, European leaders blamed the southern European governments for “fiscal indiscipline”. Greece got a bailout, then Ireland and Portugal got one too, while Spain and Italy were told to save their way to prosperity and promised financial assistance if things got really bad. The bond-holding banks continued to get paid for their mistakes, while taxpayers in the wealthy North—Germany, the Netherlands, and Finland—were told they had to help insolvent governments in the South, not their own teetering banks, who had leant them the money in the first place and needed to get repaid to remain solvent[.]
We'll see what the EU's review comes up with. According to The Economist, Germany's banks may not even be the most vulnerable:

The corporate-debt problem is worst in Portugal, Spain and Italy, where the IMF says that 50%, 40% and 30% of debt, respectively, is owed by firms which cannot cover their interest payments out of pre-tax earnings. These firms are unable to invest or grow. They are zombie companies, much like those wafting through Japan in the 1990s.

The household-debt burden is especially heavy in Ireland and, surprisingly, the Netherlands—exceeding 100% of GDP in both places. Paying the mortgage strains household finances and crimps consumer spending. Whereas in America the share of income that the average household spends on servicing debt is now the lowest in decades, in Spain it is higher than during the boom years.
The vulnerability of the financial systems in crisis countries like Italy, Portugal and Spain could wind up causing Merkel's precarious balancing act in the euro crisis to unravel quickly. Italy and Spain are, respectively, the third and fourth largest economies in the eurozone.

Jamie Galbraith's characterization of the crisis from two years ago (The crisis in the eurozone Salon 11/10/2011) still holds true: "The eurozone crisis is a bank crisis posing as a series of national debt crises and complicated by reactionary economic ideas, a defective financial architecture and a toxic political environment, especially in Germany, in France, in Italy and in Greece."

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