Greek debt crisis: risk for the euro, risks for the EU - but how much risk for the creditor banks?

Joschka Fischer, the former German Foreign Minister and former Green Party leader, has long been a hardline "pro-Europe" figure, meaning he very much supported the EU and its development into a more politically integrated union. His profession of dismay at the state of the EU doesn't represent "crocodile tears." He sees it a genuine problem for peace and democracy. And a major failure of German leadership. The Greek debt crisis is currently the Damocles sword hanging over the Union. In Does Europe Have a Death Wish? Project Syndicate 06/27/2011, he writes:

The crisis was always about much more than Greece: a disorderly insolvency there would threaten to pull other economies on the EU's southern periphery, including some very big ones, into the fiscal abyss, along with major European banks and insurers. That could plunge the global economy into another financial crisis, delivering a shock equivalent to the autumn of 2008. It would also mean a eurozone failure that would not leave the Common Market unharmed.

For the first time in its history, the very continuance of the European project is at stake. And yet the behavior of the EU and its most important member states has been irresolute and dithering, owing to national egotism and a breathtaking absence of leadership.

And he makes a central point that should be emphasized in every news article on the topic of the Greek crisis right now, though it isn't (my emphasis):

Everyone knows that Greece will be unable to work its way out of crisis without massive debt relief. The only question is whether the country’s debt restructuring will be orderly and controlled or chaotic and contagious.

And that debt relief will have to include writeoffs of some significant portion of the Greek debt, meaning the creditors will have to recognize that portion as uncollectable.

It's not entirely clear what Fischer is suggesting here:

It is certainly right, in principle, to argue that the banks should participate in financing the resolution of the debt crisis. But it makes little sense to insist on it as long as losses by banks that remain "too big to fail" could trigger a renewed financial crisis. Any chance to make this work would have required overhauling the financial system early in 2009, but that opportunity was largely wasted.

I read this as his saying that recognizing reality and writing off the bad debts from Greece would put some major financial European financial institutions underwater, i.e., bankrupt. And that he doesn't trust the current governments of France and Germany to handle it in a sensible way.

Simon Johnson (Europe's Naked Banks Project Syndicate 06/24/2011) describes the political situation on covering banks' bad debts this way:

Big European banks will not actually default on their debts – the governments of Germany, France, and Italy have made it clear that their banks are too big to fail. And Germany and France – though perhaps not Italy – have enough fiscal firepower to support their banks as needed.

But no European politician would really want to put serious money on the line for the likes of Deutsche Bank or BNP Paribas; governments will not force recapitalization using public funds. Nor do politicians care to order banks to raise more capital from private sources – this would be too embarrassing for all involved, because it would expose the full extent of the folly so far.

But whether the banks are forced to eat their actual bad debts, the governments are going to wind up paying a significant portion of the bill for the cleanup. And in fact what they are doing now to stave off default by Greece is shifting more and more of the downside risk to governments and the European Central Bank, also a governmental institution of the EU, and offering only upside opportunity to private banks. Stefan Kaiser lays this out in more detail in Wen die Griechen-Rettung reich macht Spiegel Online 07.01.2011. This explains the core idea:

Da ist zunächst einmal die schöngerechnete Summe von 3,2 Milliarden Euro. Von wirklich privaten Gläubigern, die man eigentlich rannehmen wollte, kommt davon höchstens die Hälfte. Den Rest steuert der Staat bei.

• 1,2 Milliarden Euro sollen die sogenannten Bad Banks tragen, also Abwicklungsanstalten der WestLB und Hypo Real Estate (HRE) . Beide Institute gehören ohnehin dem Staat, und für die Verluste ihrer Bad Banks kommt der Steuerzahler auf.

• Die restlichen zwei Milliarden Euro teilen sich die deutschen Geschäftsbanken und die Versicherer. Doch auch hier kommt längst nicht alles Geld aus privaten Kassen. Bei den Banken etwa gehören die staatliche Landesbank Baden-Württemberg (LBBW) und die immer noch teilverstaatlichte Commerzbank zu den größten Zahlern.

• Wirklich private Beiträge in relevanter Höhe dürften nur die Deutsche Bank , die DZ Bank sowie die Versicherungskonzerne Allianz und Munich Re leisten.

Without translating it word by word, is that German banks will be contribute €3.2 billion (euros) to the next European rescue package for Greece. But of that amount, €1.2 billion will be from the German government's "bad bank" accounts, consisting of bad loans from WestLB and Hypo Real Estate that the government is resolving. Of the private bank and insurance company participants on the other €2.0 billion, some of that is from banks partly owned by the government, including Landesbank Baden-Württemberg and Commerzbank.

None of the "participation" is in the form of forgiveness of portions of the debt principal. It takes the form of agreeing to roll over the debt on maturity to new debt. But even for the purely private participants, that new debt is a sweetheart deal. The banks are effectively insured by the government from losses. But if the loans pay off at a higher rate than currently expected, the banks get the profit. This is yet another example of how governments regarding banks as too big to fail creates "moral hazard," further encouraging private banks to take bad risks.

This is the opposite of a what a democratic institution like the EU should be doing: imposing brutal cuts on the Greek people and spending the public funds of other EU countries in rescue actions that hold private creditors harmless and saddle the public with their losses. Fischer is right. The handling of the current debt crisis has been a horrible failure of European leadership.

Tags: greece, greece, european union, joschka fischer, simon johnson

More on Simon Johnson and the IMFing of the US economy

Simon Johnson

"No sólo ha fracasado el neoliberalismo, sino una forma de funcionamiento del sistema mundial de los organismos internacionales." (Not only did neoliberalism fail, but also the functioning of the global system of the international mechanisms.) - Argentine President Cristina Fernández, March 2009

Continuing with my reservations about the analysis of former IMF chief economist Simon Johnson, The Quiet Coup The Atlantic May 2009 ...

Criticism of Johnson's article has been coming from a variety of Democratic/liberal sources, including Tim Fernholz at Tappped (Why the IMF approach? 03/30/09; More criticism of Johnson and the IMF 03/31/09) and Dani Rodrick (Simon Johnson's morality tale 03/30/09).

Thinking about Johnson's position some more, the key problem in his approach to the current financial system's crisis is that although nationalization (i.e., recognizing that some major banks are in reality insolvent) is considered a more liberal (left) position at the moment than the Geithner plan, he seems to be clinging to the IMF "neoliberal" faith in deregulation. He doesn't emphasize better regulation at all. He assumes that hedge funds and private equity funds will basically have no new regulations. And he proposes that the largest banks be reduced in size and kept that way through anti-trust legislation and enforcement.

He argues that banks too big to fail shouldn't be allowed to exist in the first place. He generalizes it even more: "Anything that is too big to fail is too big to exist."

I take this to mean that he thinks that through antitrust laws, not only in the financial sector, but in the rest of the economy, that we can adopt a policy of never bailing out failing companies in the future. Presumably, it also means that banks would be simply allowed to go bankrupt and close their doors in the future, rather than be taken over by the FDIC and kept in operation until they can be resold in a healthier form, or their assets and liabilities parceled out to other institutions.

This is very unrealistic, both in his faith in antitrust laws and in the neoliberal assumption that the state can stand on the sidelines and watch companies critical to the economy go down. It's neoliberal utopianism, as far as I can see.

And that's why his definition of the problem sounds so suspicious to me, even though it's clearly partly accurate. He is not only be diagnosing the financial problem. It seems to me that he's even more focused on defending the IMF's Washington Consensus form of neoliberal economics. So while parts of his diagnosis of the corruption of the American financial and political elite could fit comfortably into a left or even radical-democratic analysis, that's not really what he's up to. My reading is that he's presenting the Washington Consensus as being focused on combating elite corruption and crony capitalism, not on slashing social services and public infrastructure projects, which is what happens in reality with countries that become wards of the IMF .

And at least from what appears in the Atlantic article, he's not giving up his IMFish neoliberal faith in the miracles of deregulation of financial companies. He's just packaging it in a Progressive-era wrapping of of antitrust militancy. Dani Rodrick also dings him for his Pollyanna presentation of the IMF approach.

Strong and effective government regulations and honest, consistent enforcement of them are critical. And that is a major area in which the overly cozy relationships between the political and financial elites has been devastating. As Joe Conason argues in No More Refuge for Scoundrels PolitickerNY.com 03/31/09:

Massive fraud has been at the center of this crisis from bottom to top, as everyone paying attention must know. The criminal mind-set extended from the bankers and mortgage agents who made loans to unqualified borrowers and sometimes tricked them into signing agreements they could not fulfill. (Among the most industrious marketers were many with actual criminal records, whose entry into the mortgage industry was not blocked by the state regulators.) They marketed those same bad loans with false assurances of their soundness to convince investors to buy them—and somehow induced rating agencies to offer hollow testaments to their creditworthiness. Investors then resold the toxic packages to other investors both here and abroad. At every step, the inflation of the bubble was hastened by fraud, forgery and deception.

The decisions of the G-20 summit this past week were yet another reminder of the massive failures of the IMF economic dystopia of privatizing everything that can be privatized, slashing government expenses to the bone, radical deregulation, hostility to labor and throwing the doors open to the international "free market" in capital and everything else.

Tags: simon johnson, us economy

That guy used to work where?

Andrew Leonard in his How the World Works blog at Salon points out something that has been bothering me about an increasingly famous article by economist Simon Johnson in Simon Johnson's crusade against the oligarchs of Wall Street 03/31/09. Paul Krugman as well as some of my other favorite bloggers have cited Johnson's article, The Quiet Coup The Atlantic May 2009. Krugman notes that Johnson "served as the chief economist at the I.M.F.".

That's what Leonard focuses on with some highly relevant observations:

The central narrative gambit of "The Quiet Coup" is simple: The United States is unwilling to take the same harsh medicine it would prescribe to a developing nation that exhibited the same critical problem: domination of the political process by self-interested economic elites. But there is more than a little irony involved with the fact that this advice is coming from a former IMF chief economist. A great many people on the left who are applauding Johnson seem to have forgotten just how critical the IMF was in spreading exactly the kind of economic policies that helped secure Wall Street's absolute sway over global markets. Doesn't anyone remember "the Washington Consensus" -- the belief that deregulation, privatization and trade liberalization were the holy writ for all developing nations? The IMF was one of the primary proseletyzers and implementers of this vision. If your economy got into trouble, the IMF would help you out, but only after requiring "structural adjustments" that often caused significant hardship.

The result, particularly after the Asian financial crisis of the late '90s, was a massive rejection of IMF help by developing nations, particularly in East Asia and South America. If you're looking for reasons why so many countries in South America have turned sharply to the left, it is partially due to the pain caused by following IMF advice. If you want to know why China and other East Asian nations have built up huge reserves of foreign dollars, creating global imbalances that contributed to the creation of today's economic crisis, it is precisely because they wanted to avoid ever again being forced to come, hat in hand, to the IMF. As the Wall Street Journal notes on Tuesday, in "An Empowered IMF Faces Pivotal Test," "where once the IMF demanded that borrowers dramatically remake their economies, the IMF is now taking a softer stance, and attaching few restrictions to its massive loans." This is not out of the goodness of its heart, but because few developing nations are willing to accept the conditions that the IMF once required.

Now, I'm all for repentance and redemption and so on. But I'm not sure he's changed his Washington Consensus perspective all that much.

One bad sign is when he says early on in the Atlantic piece, referring to various crisis over the last two decades in Asia, eastern Europe and Latin America, "But I must tell you, to IMF officials, all of these crises looked depressingly similar."

If you take things to a high enough level of generalization, anything can be made to look similar to anything else, e.g., Earth and Mars are planets so they are basically similar. Given the record of the IMF, though, I have to wonder if all those crises looked so depressingly similar to the IMF and/or Simon Johnson because they were applying cookie-cutter assumptions to them.

The IMF's prescription for financial crises were depressingly similar: "deregulation, privatization and trade liberalization", as Leonard puts it, and I would add slashing public services to the bone. In Argentina's case, President Carlos Menem pretty much governed according to the Washington Consensus playbook, and it led to a new economic and political crisis at the end of 2001. The Washington Consensus gospel of free trade was actually a major cause of many problems. As Jamie Galbraith pointed out a couple of years ago, Rich World, Poor World The American Prospect 03/20/06:

China has adopted markets without capitalism; it has not had broadly open, speculative markets for capital assets and land. The result is that you usually have to make something in order to get rich. So companies produce and produce, flood the markets with goods, accept low profit margins, improve quality, and hope to strike gold by exporting to the West. If they have losses, as they often do, these may be covered by borrowing from China's rotten, state-owned banks, protected by capital control. Workers thrive on the glutted market for goods. Meanwhile, the richer local governments finance themselves with land rent and spend the proceeds on infrastructure at an incredible pace. [my emphasis in bold]

The point to which I wanted to call attention in that quote is the part about open capital markets. China has national capital controls, so that international speculators can't create a run on its currency the way they could in Indonesia or Argentina. (And, no, trolls, he isn't arguing there that only a Chinese-style economy can deal with that problem.)

The Washington Consensus at the moment is considered widely discredited because of its results. And because the results are so bad, it's worth asking how good the diagnosis has been.

In Johnson's case, his cookie-cutter diagnosis is, "the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis." Now, he defines the problem in a way that has its particular attraction at the moment, and one to which Krugman refers in the link above:

Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise. ...

In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there’s a deeper and more disturbing similarity: elite business interests —financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them. [my emphasis]

It makes for great snark: the Republicans have made us into Argentina or Russia in their worst crises, har, har!

It's pretty obvious that excessive deference by the government to major financial interests has been a major contributor to the current mess. And there may well be important resemblances between this crisis and those of the other countries he names.

But I find Johnson's analysis problematic in several ways. I can see I'm going to be doing more than one post on this. But I see at least two key problems. One is that he focuses a lot on the problem of debt in the abstract. I can't help but wonder if there's not some notion that the federal budget deficit is our biggest problem lurking behind that. That's one place where those comparisons to other countries can be very misleading. The dollar is currently the world's reserve country and we have floating exchange rates. In those conditions, the combined public and private deficits are going to equal the external trade deficit. And as long as the dollar is the world's reserve currency, we'll have a trade deficit. In those conditions, balancing the federal budget as an economic goal is worse than meaningless, it's destructive.

The other problem is he conspicuously spares the Republican Party any particular blame for the current problem. This has a certain appeal for many Democrats because a lot of us are more than suspicious of our Party leaders' attachment to the some of the more reality-challenged pieces of corporate ideology. And he does so in a weird kind of blending of 60s hippie notions of false consciousness and Herbert-Hooverish pep talk about how "confidence" is all that really matters in economics.

Tags: simon johnson, us economy