Keynes’s genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge.
Martin Wolf, Financial Times
The euro fell again yesterday, by 1.1 percent against the dollar (to $1.2860) and by 1.2 percent against the yen (to 117.52 yen). The change, even if quite large in a short space of time, is hardly dramatic, but what is of more interest is the why. Russian companies announced yesterday that they were thinking of opening negotiations to “restructure” their debt. Bloomberg:
The euro fell after a Russian bank official said the nation’s lenders asked the government to help moderate talks with foreign lenders on $400 billion of loans, adding to speculation financial turmoil in Europe is worsening.
The euro fell versus 13 of the 16 most-active currencies after Anatoly Aksakov, president of the Russian Association of Regional Banks, said in an interview with Bloomberg News that the group has written to the government after talking with foreign banks. He said $135 billion of the loans are due this year and the remainder of the $400 billion within four years.
The “report of rescheduling debt is driving the euro lower because European financial institutions have a bigger exposure to Russia than their counterparts in other countries,†said Takashi Kudo, Tokyo-based director of foreign-exchange sales at NTT SmartTrade Inc., a unit of Nippon Telegraph & Telephone Corp., Japan’s largest fixed-line phone company.
And then there is Kazakhstan to think about:
Kazakhstan’s banks may have their ratings cut as the devaluation of the nation’s currency makes it harder for them to repay foreign debt and “substantially increases†credit risk, Moody’s Investors Service said yesterday.
And Mr Euro, like me, is getting worried:
The widening spreads between the interest rates that different euro-area nations must pay bond investors are “worrying developments,†according to a “speaking note†prepared for Luxembourg Finance Minister Jean-Claude Juncker and obtained by Bloomberg News.
In fact, while there is a growing feeling that the worst phase of the financial-system meltdown may be over in the U.S, unease is mounting that here in Europe the worst may be yet to come. The reason? Europe’s commercial banks have more exposure to distressed emerging markets than their U.S. counterparts. By one estimate, European banks provided three-quarters of the $4.7 trillion in cross-border loans to the Baltic countries, Eastern Europe, Latin America and emerging Asia. Thus it is quite likely that the emerging-markets exposure of European banks exceeds even that of U.S. lenders to Alt-A and subprime loans.
“People expect that part of these debts were from the European banking system,†said Sebastien Barbe, a strategist at Calyon in Hong Kong, the investment banking unit of France’s Credit Agricole SA. “You already have a very weak banking system in Europe. If you have these Russian issues, the next step would be questions about whether similar problems will come out of other Eastern European countries.â€
Dory Wiley, president of Commerce Street Capital, a money-management firm that invests in banking stocks argues that “most of the big banks in Europe are insolvent……..That is what made them great – but unpredictable – shorts. They represent major components in those country funds everyone buys.” The big danger now is that European governments, since they are the prime backstops for their commercial banks, will see their debt liabilities balloon and steadily be forced, in a domino like contagion process onto the slippery path towards downgrade, rising yield spreads and default.
Unicredit Saved Again By Libya
I think it should now go without saying that Unicredit is deeply involved in many of the most problematic countries from this point of view – Russia, Ukraine and Kazakhstan to name but three. So while, as reported here yesterday, the Italian bank seems to have scraped its way over the latest hurdle thanks largely to the timely intervention of the Libyan central bank, this hardly seems to be a stable situation (links to the posts which give some background on all of this can be found here).
Libya’s central bank will fill half of a 500 million euro ($645.5 million) gap in bank UniCredit SpA’s 3 billion euro capital raising measures, newspapers reported on Monday. Shareholders Fondazione Cassa di Risparmio di Torino (CRT) and Carimonte Holding will also take up about 230 million euros of the shortfall, Il Messaggero newspaper said………..La Stampa said Libya’s central bank would hold about 7 percent in UniCredit after the capital increase and become the biggest single shareholder.
Making The Punishment Fit The Crime, Or the Crime Fit The Punishment?
Many readers are, unsurprisingly, outraged by the idea that the EU should create bonds to help a distressed Italian (or Austrian, or Irish) banking sector. Typical of many responses is this from an Italian:
I’d favour a liberal approach, but it’s only my humble opinion, anyway I think bad banks should have to pay for bad policies, households should have to pay for their reckless borrowing, governments should have to pay for communicating the sunstainability of currency pegs and expantion policies. I’d like to see these kind of attitude, negotiating a volunteer currency convesion and a longer repayment time for forex loans, sharing the losses and extra costs among banks borrowers and government. otherwise the ones who acted properly will not see any advantage in acting the right way.
I think this view is being advanced in a very well meaning way, in the sense that the person voicing it simply wants to see some sort of justice, some sort of sense of responsibility. But as I pointed out in my reply to him, the issues here are systemic ones, and the majority of Germany’s citizens are hardly responsible for the bad decisions made by representatives of the Russian subsidiaries of their banks. What I am trying to say is there is no effective mechanism as far as I can see whereby those who took the decisions (many of whom are already bankrupt, and others soon to become so) can be made to pay up and put things right. Meantime innocent parties get trampled on. Being intentionally emotive for a second, think about the one million people who lost their jobs in India in December, and all those millions of other people in poor countries across the globe, what responsibility did they have for the irresponsible lending practices of a limited group of Unicredit managers and employees who caused the financial shock waves they are now receiving?
Take the Latvian case. Looking through the IMF standby loan document, I was amazed to find that as a result of this bailout national debt to GDP will rise from 8% in 2008 to 50% in 2010. The thing is the only “crime” of those Latvian citizens caught up in the Parex problem were those who happened to have their money on deposit there. Now such were the covenants on the syndicated loans contracted by the banks that those who provided them (they certainly knew what they were doing) seem to have first call on any funds the government puts into the bank over and above the needs of the hard pressed depositors. Given the rapid population ageing Latvia now has coming and the serious economic growth problem they face as a result of the boom bust my feeling is that they will be unable to fully recover from the blow and will more than likely have to do some sort of sovereign default at some stage – unless, of course, they are admitted to the eurozone, the debt is “restructured” and some kind of EU institutional support offered. I personally consider the current “sit back and watch” approach to be grossly unfair, especially given that the root of their problem really lies in making it a condition of their EU membership that they join the eurozone, and then withdrawing the possibility when the financial destabilising effects of the original condition send their economy sprialing out of control.
Bad decisions were certainly taken by Latvian politicians, but I have no doubt that the fundamental structural cause of their current problems was the one I have just mentioned. So sending a whole country into bankruptcy because of the decisions and speculation of a few people in a bad bank does not seem to be like using our emotional intelligence, and this is why I think the EU have to help them. We simply cannot continue to perpetuate this kind of injustice in our midst.
I can’t help feeling that inflicting significant economic pain on large numbers of innocent people is not a fitting process of retribution. It is more akin to the unfortunate campaign of intensive bombing carried out by the Allied Powers against Dresden, simply to make the German people “pay” for the crimes of Adolf Hitler. It is amazing to me that we are still having the same kinds of argument 60 odd years later.
We live in an imperfect world and the reality principle suggests we accept it as such. When you get hit by a tragedy in your life the best advice, I think, is that you do a bit of psychological counselling, put the issue behind you, and get on with your life. Don’t go off on a “fatal attraction” kind of obsessive vendetta to try to make the guilty parties pay. Just do what has to be done, stop Europe’s financial system melting down, change the regulations for the future, and let’s all go to work and get on with things. A first step in this direction would be – as I argued on Sunday – for the EU Commission to negotiate a substantial EU Bonds issue with the Swedish, Italian and Austrian governments, and stopping the rot on this whole problem before things get further out of hand.
“The Bottom Line:
European banks face a new round of challenges. Most vulnerable: Credit Suisse, UBS, Barclays, Erste Bank, Nordea, ING, Fortis and Banco Santander.”
Fine, so we rescue the banks, blah, blah, blah. But this means no one in a position of responsibility in the banks gets bonuses and everyone has a salary cap. In fact, probably the upper management of all of these banks should be fired unless they can prove they have any idea what they are doing. We should reinstate strong antitrust protections and strong protections against speculation and risk-taking.
This is a bad situation. It doesn’t have anything to do with morality. It has to do with preventing this from happening again – the best way to do it is control the financial industry and limit pay at the top.
That’s an important moral issue in this economic crisis; Who are to blame for this crises and did they take their responsibility?
In my opinion the most responsible for this crises are those people who made and trade the sub-prime loans. And almost non of them were forced to take his/her responsibility. You don’t have to be a banker to understand that it’s madness to provide everyone with a mortgage, who is just capable of placing his signature. And not to look if that persons income is sufficient to pay for it. Yes you always can sell the house to get your money back if that person is not capable of paying for his mortgage, but what is that house worth? In my opinion the value of a house is basically what it cost to build it, everything above this price is an speculative bubble. And exactly by giving an enormous amount of mortgages to people whose income was not sufficient, the bankers were pumping up this bubble sky-high. When the time of the forced selling of this enormous amount of houses begins, the bubble of course explode, and the crisis became a fact. People like my favourite financial radio-commenter Kees de Kort already predict this to happen, at a time when most of the others don’t even did think about a possibility of a big financial crisis. But were the banking managers not aware that this was going to happen? If Kees the Kort was aware of it, then they were probably also aware of it. It is an easy to understand phenomenal and I assume that bankers are intelligent people. But why did they invest in a system that they know it has to collapse sooner or later? The answer in my opinion is greed. The income of those bankers consists largely out of a bonus they received if the profit of the bank was increased over the year. The more the profit increases, the higher the bonus. So, for their personal income this bubble that they had created was very profitable. And it was in their personal interest to let this bubble grow as long as possible. This system of rewarding bankers for the short term results of their company instead of for a stable long term result, has proven to be catastrophically for the banking system. Also to blame are the bankers and managers of other institutes all over the world, who were buying packages of these sub-prime loans. Some of them are claiming now that they did not realized what they bought. But I find it hard to believe that they were spending millions of dollars on something the didn’t know what it was. Again they are intelligent people. And what happened with most of these bankers who made the whole world suffer from this crises? Nothing, because the governments are using enormous amounts of tax money to prevent that their banks will go broke. So you and me must pay for the faults of the bankers, we have to pay so the banks who are responsible for this crises will be saved. In my opinion this is immoral. It would be better to let the banks go broke and dismiss its managements who have caused this crises, and sell the good parts of these banks and bring those parts into a new financial institute headed with a new management. In this case the persons responsible for this crises would al lose their jobs, and it will not be the tax payers, but the share and bond holders of the former banks who have to pay. After all, share and bond holders are the providers of the risky capital for a company. They have taken the risk to invest in those banks and not the ordinary tax-payer. Inevitably, this solution will also bring misery to the common man, think only about the pension funds who will make great financial losses.
But the good thing is that that will speeding up the politically difficult but necessarily decision to increase the age when people may enjoy their pension.
Ron.
It would lighten my mood to make bankers pay. But it doesn’t help. Taking and selling everything they own, down to their underwear, would be a drop in the bucket.
Responsibility doesn’t help. Damage of this magnitude has to be prevented. Finding out who is to blame afterwards is useless.
@ Oliver
“Finding out who is to blame afterwards is uselessâ€
I don’t go along with your fatalism, I think it is really necessarily to find out who is responsible and then to replace these financial “experts†who created this financial chaos. But instead we can see today that the politicians are using an enormous amount of our tax-money to keep these managers and their company’s in their positions. And this is stupid, wrong and bad. We need a chance in the financial policies, and therefore this worlds financial management has to be replaced with trustworthy financial visionaries. Those analytical talents who in an early stage warned us for this crises and have a clear vision of how the financial world have to be chanced, must be made the new financial leaders. This does not mean that every top financial manager has to be replaced, because not all the banks and other financial institutes did trade in sub-prime assets, but a lot of them have.
Ron.
That’s not fatalism. Something can be done. But it doesn’t involve punishment. We now need functional banks. That rules out replacing many people. We can cut their wages. That’s being done. But it doesn’t solve our current problem.
@ Oliver
Punishment and responsibility are two different things. When I was little I asked my mother; “why does my fathers boss earn more money than my father does, is he working harder?†“No“, my mother explained, “he is not paid more because he is working harder, but because he has more responsibilities than your father has“. When you really mashed up the job that your doing, not making a little mistake, but when you and some of your colleague’s are responsible for the worldwide collapse of the branch that you are working in, will you take your responsibility accept it when they ask you to leave? Or do you resist in taking your responsibility, and will you claim to be indispensable? The problem is that the current financial leaders have proven to be not fit for their yob, and therefore we need other people to clean up the financial mess they made. And just don’t believe that these incompetent current leaders are indispensable. Think only about all those good financial experts who did disagree with the current leaders and therefore never were allowed into the world financial top. Punishment is something else, it is to the judge to decide if they deserve it. But even when those financial leaders who are responsible for this mash, are not prosecuted and are allowed to enjoy their million dollar mansions till their dying day, it wont hurt the rest of the world much. But when they are allowed to stay in power, the necessarily change in the financial world would not occur.
Ron.
@Miguel Ruiz
“Most vulnerable: Credit Suisse, UBS, Barclays, Erste Bank, Nordea, ING, Fortis and Banco Santander.”
What, no BNP Paribas?
The financial world has already been altered beyond recognition. Whole markets hyperactive a year ago are gone. For now the immediate problem must be solved.
Still in the long run, responsibility is useless. The scale of possible damage is too large. We need prevention. In this case severely strengthened regulation and supervision.
As the banking system has by necessity an implicit state guarantee, the owners of banks must accept abnormally low returns in exchange. Bright young people must again become engineers, scientists, doctors or programmers, not MBAs or lawyers.
@ Oliver
“The financial world has already been altered beyond recognitionâ€
I am afraid that I again disagree with you. The fundamentals of the economic system are still the same. The good functioning of the current system depends on grow and credit. In order to increase their profit, companies borrow money to invest in the production of new or more products. In order to sell all those products, especially in the USA, consumers were stimulated to buy on credit. But buying on credit means adding future income to your current income. So the same loan that is causing the rise of the amount of money they are able to spend today, is causing the decrease of their future income. Lets pretend that I am an average American citizen that lived two years ago, and I want to go with the flow, so I decide to go to live on credit. Lets say that I make 2000 dollar each month, So I take a loan that enables me to spend 2500 dollar for the next twelve months. But with the passing of the months, I get more and more worried. I think; in a few months I must start paying back this loan including the interest, one year long I have to pay 550 dollar to the bank. So my future income will be 1450 dollar instead of the 2500 I can spend now. I decide to bring a visit to my financial adviser. Don’t worry he said to me, because of you, and all the other Americans who are spending their credits, our economy is booming, so you will most probably have a rise of your salary, and when that’s not enough you can always take another mortgage on your house because the prices of the houses will always keep on rising, it is an endless source of money. And because I am an average American I am reassured, and happily I go back home.
Is this just an crazy story? Yes it is. But it is still the crazy reality on which the fundamentals of our economy still are build, even now. One of the measures of the Bush administration to fight the economic crises was to free billions of dollars to enable the Americans to get credits again. When I heard about this, I realized that they had nothing learned from this crisis. And when you look to the plans of the Obama administration, you cant find any basic difference from those of the Bush administration except from the fact that there is much more money involved (780 billion dollars). Wait a minute…. 780 billion dollar!? Where must this astronomical amount of money come from? The USA don’t have this money, they already have a lot of debts. Basically they have two options; or they barrow it (government bonds) or they going to print it. That last option is not so realistic because printing an extra 780 billion dollars will cause a giant inflation. So what about lending the money? That should be difficult because the countries were the USA is traditionally borrowing from like china and Saudi Arabia, are facing economic difficulties themselves. But if they succeed, how will they ever manage to pay it back? What do you think that they will answer when they are asked. Wouldn’t it be something like; don’t worry the economy will probably grow enough to bring in enough taxes, and if that’s not sufficient, we can always take another loan?
Ron.
I fear when this crisis will have been endured, the money used to soften the blow will have to come out of the printing press with the consequences this entails.
Nevertheless an abrupt fall of consumption a sudden cessation of credit would cause would be worse.
As far as the banking sector is concerned, mortgage backed securities are gone and so are credit default swaps. Things have changed. And the bankers won’t make the same mistake twice. We need to fear the new mistake they’ll make if not tightly regulated.