"Line at rationing board, New Orleans, Louisiana"
Ilargi: Even though I was merely a child, it was very clear to me what the problem (or at least one of them) was in the Europe I grew up in. At every border crossing, there'd be a line if trucks often miles long waiting to be allowed through. And then the drivers would often have to wait in line again to change their money for the local currency. Since the countries can be quite small, it would be no exception for trucks to spend days covering a distance they could have covered in mere hours (imagine that in the US!).
So it was no surprise to me that Europe embarked on an economic union, first with the Schengen Agreement in 1985, then the Maastricht Treaty of 1993, and finally the phase-in of the Euro between 1999 and 2002. It all simply makes a lot of sense. There are many people today who insist that the union should have been a political union as well, but that was never going to happen, anymore than a cultural one. But should that have prevented finding a solution for those long lines of trucks? I'm inclined to say no. Nor do I think there's a lot of anger or resentment among Europeans in general about the way the EU has functioned so far. The opaque additional layer of bureaucracy in Brussels is despised, for sure, and many older people will always have problems with using a new currency, but other than that, things seem to run pretty smoothly. Even though I left Europe in the early 1990's, I'm pretty sure I didn't miss out on mass protests in this regard.
In 2002, when the euro became a real currency, Germany was not doing too well economically. The addition of the former East Germany had put a heavy financial toll on the country, and the inclusion of more -mostly poorer- countries into the EU cost a lot of money as well. Germany therefore has no housing boom to speak of in the past decade, it was too busy trying to get on its feet.
Today, Germany is very much back on those feet. So much so, in fact, that in the debate about Greece, French Finance Minister Christine Lagarde told the Germans in so many words that they are too successful. She argued two remarkable things: first, Germany should stop exporting so much, and running its economy so much more efficiently than other EU members, and second, it should boost internal demand, i.e. the German population should buy more stuff, some of which would presumably need to be produced in France and other weaker nations.
The "please stop doing so well" argument has the proverbial snowball in hell chance of being taken seriously in Berlin. And for a country to force its citizens to consume things they apparently don't think they need? Does that even merit an answer?
Germany wants to weaken the euro. Like all main exporters (it was, and may still be, no.1), the country was hit hard by the contraction in trade we’ve lived through over the past 2-3 years. And the Germans had a second problem: the Americans brought down the value of the US dollar by about 20% between March and December 2009 (after an earlier decrease of over 30% between late 2005 and mid 2008). And the Germans have decided they've seen enough of that. Ironically, the low dollar means that even countries within the EU will turn to American products. Germany wants the euro at, or just above, par with the US dollar. And they are using the Greek crisis to achieve this. If that doesn’t do it, they'll find other ways. They have no choice.
All major Anglo news outlets have stories about how the EU is falling apart, how battles are going on left, right and center, and Germany is loving it. Still, you have to wonder what the editorial board at the New York Times, or Wolfgang Münchau at the Financial Times, or all the others, are thinking (or smoking). For all I can tell, they may well be on Berlin's payroll. The stories they write play right into Merkel's hands.
Greece and other weaker European countries and yes, that includes France, are watching with dread as the euro slides further down; when you're weak, a weakening of your currency is frightening. But it's a game now where Germany calls the shots. The rules of that game say that if Germany is going to prop up the union, it will have to be more competitive, not less, as Christine Lagarde -dare we say foolishly- proposes. If only simply because a lower euro makes German products more attractive for those exact same weaker European countries. Lagarde calls for Germany to "do its part", but Chancellor Merkel strongly suggests the "weaklings" -including France- do their part.
And this is why we will see protracted negotiations, confusion, bitter words and battles, until the cows finally come home. Until either the markets attempt to crush Greece entirely, or Athens has so many bills to pay in a short time that it faces default within days. Then Berlin will say: we'll help you. But it'll happen on our terms, not yours. One of those terms, and by far the most important one, is the lower euro.
The European Union is not about to fall apart, and neither is the eurozone. Germany is making sure of that by boosting its own trade position versus the rest of the world. Which may very well be the only plausible way for the union to survive.
Merkel Takes on the EU and Her Own Finance Minister
It was shortly before noon on Friday of last week, as German Chancellor Angela Merkel strolled past the government bench in the German parliament, the Bundestag, distributing signs of her goodwill. Justice Minister Sabine Leutheusser-Schnarrenberger received a friendly greeting and Economics Minister Rainer Brüderle got an encouraging pat on the shoulder.
But her features froze when she saw Finance Minister Wolfgang Schäuble. She shook his hand briefly and nodded without saying a word. A short time later she approached Schäuble, who is in a wheelchair, said something into his ear with a serious expression on her face and, as if to add emphasis to her point, tapped on Schäuble's desk with a pen. Schäuble avoided making eye contact and stared straight ahead.
At the moment, there is little evidence of harmony in the relationship between the two most important members of the German government. In the past, Merkel and Schäuble have represented more than just the central axis of power in the cabinet. The two were also seen as insurance against the ongoing chaos in the coalition government of Merkel's center-right Christian Democratic Union (CDU) and the pro-business Free Democratic Party (FDP), a guarantee that reason would ultimately prevail on the key questions of budgets, taxes and government finances. As long as these two politicians could agree, that is.
Clash Over German Leadership in Europe
But doubts have now been raised over that very consensus between Merkel and Schäuble, specifically when it comes to one of the central questions of German politics: the future of the European Monetary Union, in the light of the growing economic tensions in the euro zone and a possible bailout for debt-plagued Greece.
The finance minister sees the euro as proof of Europe's integration ability, and he is willing to use German government aid to rescue Greece, if necessary. This is precisely what Merkel wants to avoid at all costs, which is why she favors intervention by the International Monetary Fund (IMF).
The conflict is about more than how best to handle a European country that is deeply in debt. It is also a question of power, as Schäuble and Merkel clash over the German leadership role in European politics.
Officially, the chancellor insists that she is "completely in agreement" with her finance minister. But close associates of both politicians say this is not the case. Senior officials in the Berlin government and at the European Commission in Brussels report deep alienation, contradictory directives and "trickery" on both sides.
The behind-the-scenes dispute recently reached its first bizarre climax. To prevent Merkel and her staff from discovering what he was thinking about before he was ready to announce it, Schäuble ordered his staff not to speak to anyone at the Chancellery. From now on, all contacts and information are to be channeled through top ministry officials. Telephone conversations and the exchange of documents now require prior approval by department heads. A ban on communication with government headquarters -- even veteran Finance Ministry officials cannot recall anything like it. Officials at the ministry say that it is "a measure to safeguard departmental authority."
The behind-the-scenes power struggle isn't just a source of irritation in the Berlin government. It also weakens Merkel's position in Brussels.
Recovered 'Sick Man of Europe'
The chancellor has been under fire from partner countries for weeks. Some are urging her to finally agree to an emergency plan for Greece, while others are complaining about Germany's export successes, which they say triggered the euro dilemma in the first place. Last week, French Finance Minister Christine Lagarde criticized the German trade surplus for being "unsustainable."
The irony is that Germany was once seen as "the sick man of Europe." Now, after painful reforms, the country is in a relatively strong position -- and yet it is forced to listen to criticism at home and abroad. Germany's European Union partners feel overrun by the Germans'. On the other hand, there is growing insecurity in Germany over the downsides of labor market reforms.
Merkel is determined to stand up to the pressure from her EU counterparts. No hasty aid for debt-ridden countries, and no curtailment of Germany's export strategy -- these are the positions Merkel is championing in Brussels, with a determination not unlike that of former British Prime Minister Margaret Thatcher when she demanded a rebate of British contributions to the EU.
The chancellor is taking a cool, calculating approach. Although the role of the Iron Lady doesn't necessarily make her more popular in Brussels, it does at home. A majority of Germans support Merkel's opposition to billions in new financial payments to cash-strapped southern European countries. For weeks, the mass-circulation newspaper Bild has echoed these sentiments with headlines like: "Why don't you sell your islands, you bankrupt Greeks?"
Fears of IMF Influence
It is, therefore, all the more annoying that her most important cabinet minister is only half-heartedly supporting her course of action. The conflict has become increasingly public in recent weeks, after the chancellor distanced herself from Schäuble in the plenary assembly of the Bundestag. Using the usual guarded approach she adopts for her parliamentary appearances, Merkel brought up the possibility of IMF aid for Greece. IMF intervention, she said, is "perhaps the thing that ought to be the solution now, if one were to do anything." Translation? "My finance minister is wrong."
Schäuble had already categorically rejected the idea of IMF aid, saying that he felt it would be shameful if the Europeans couldn't solve their own problems within the monetary union.
The minister is worried about political union in the EU. When the IMF provides bailout funds, its representatives typically become deeply involved in the affairs of the troubled countries in question, dictating how they should structure their financial and monetary policy. Schäuble fears that such requirements, directed at a member of a monetary union, would have an affect on other euro zone countries. But his biggest concern is that the independence of the European Central Bank (ECB) could be compromised.
Besides, the US-dominated IMF is regarded as an extension of US foreign policy, which, says Schäuble, has no place in the euro zone. For these reasons, he is willing to incur even more debt than the 80.2 billion ($110 billion) already budgeted for this year -- and to transfer more money to Greece.
The chancellor's support has been muted. Merkel wants to make it clear to the Greeks that, most of all, they need to help themselves. And she finds the willingness with which Schäuble wants to incur new debts to help Greece increasingly irritating.
She also has significantly fewer scruples than Schäuble about asking the IMF for help. "We don't have the expertise, but the IMF does," she said recently to a small group of intimates. If the IMF intervened in Greece, it would "not be an embarrassment for Europe." The opinions of the chancellor and the finance minister couldn't be more diametrically opposed.
Merkel fears, most of all, an internal political debate. Something that would inevitably flare up if German taxpayer money or borrowed funds were used in Greece.
The IMF's possible involvement is only one of the bones of contention between Merkel and Schäuble. The finance minister had already irritated the chancellor with his proposal to create a Europe-wide monetary fund, based on the IMF model, which would distribute bailout funds to distressed partner countries.
The plan was ill-fated from the start. Schäuble first mentioned the idea during an interview with the national Sunday newspaper Welt am Sonntag. Merkel and her team knew nothing about the proposal, so their annoyance was all the more pronounced. While the chancellor was campaigning in Brussels against financial transfers to debt-ridden European countries, her finance minister was unveiling plans designed to facilitate those very same transfers. This created the impression that, in Berlin, the left hand didn't know what the right hand was doing.
It was embarrassing for Schäuble that officials in his ministry were unable to clear up the contradictions. Instead, they were asked to quickly patch together a concept, which their minister presented a few days later in connection with a guest article in the Financial Times Deutschland.
Schäuble's officials have now further refined their plans, but they have not coordinated them with the Chancellery, raising the possibility of new trouble between Merkel and Schäuble. The revised plans include massive financial requirements for a new, Europe-wide bailout fund -- up to 200 billion, according to the Finance Ministry experts. They have already thought about how those funds could be raised. Four options are under consideration:
- The central banks in the Euro zone transfer a portion of their foreign currency reserves to the new fund. Gold reserves, however, are not drawn on.
- The new fund could be authorized to borrow money in the capital markets for its bailout programs. As a result, the member states would be creating an enormous shadow budget.
- The euro countries raise the funds through their own contributions, which would be based on economic strength. Germany would be responsible for about a fourth of all contributions, or up to 50 billion.
- Only those countries inject capital whose budgets are out of balance. A country's contribution would then be based on the extent to which its deficit exceeds the upper limit of 3 percent annual economic output.
All of these proposals have the same flaw: They will likely trigger substantial resistance. Schäuble has found no support for his proposals among his European counterparts. He traveled to Brussels at the beginning of last week, determined to explain his ideas. But he never had the chance, because none of the assembled finance ministers was interested in Schäuble's monetary fund. The chancellor, too, offered only half-hearted encouragement, and she took every opportunity to point out that the project would require amending the European treaties.
In the language of Brussels diplomats, the language used by ECB President Jean-Claude Trichet and Luxembourg Prime Minister Jean-Claude Juncker, this means: The plan is dead. Amending the treaties would take years of negotiations among the 27 EU member states, as well as ratification processes and referendums. This is something no European head of state is willing to take on anymore.
Campaign Against the 'Export Machine'
Merkel's curt reminder wasn't just a rebuff for Schäuble, but also signified a renunciation of Germany's decades-long approach to Europe. In the past, Germany was always prepared to contribute a few billions, if necessary, to promote European unity. This logic no longer applies. Germany is rethinking its financial assistance to other euro countries, particularly when the debtor nations are openly blaming Germany for their problems.
The campaign against what the Economist called the German "export machine" gathered speed last week. Representatives of the southern EU countries, in particular, held the Germans partly responsible for the economic decline of Greece, Spain and Portugal, as well as for France's problems.
Some economists, including United Nations Conference on Trade and Development (UNCTAD) chief economist Heiner Flassbeck, agree. The Germans, they argue, cause problems for their neighbors with the practice of "wage dumping."
From 2000 to 2008, unit labor costs in Greece -- and, similarly, in Portugal and Italy -- increased by 26 percent, compared with a 17-percent average increase throughout the euro zone. In Germany, however, wages increased by only a marginal 3 percent.
This created an enormous competitive advantage for the Germans, and Flassbeck isn't the only critic who says so. Peter Bofinger, a member of the federal government's council of experts, said in a SPIEGEL debate: "We were far too one-sided in emphasizing exports, while the Irish, the Greeks and the Spaniards focused much too heavily on their domestic demand."
Germany as Object of Hate?
, and they are calling for a reversal of German wage and budget policies. "Couldn't the stronger countries do a little?" French Finance Minister Christine Lagarde asked. She argued that the emphasis should not always be placed on "enforcing the deficit principles."
What followed was a pan-European wave of support for Lagarde and criticism of Germany's economic policy. The proposals for Greece would be "perceived as a German dictate," says French economist Christian Stoffaës, and warns: "Germany must be careful not to become an object of hate in Europe."
There are widespread calls for wages and government spending to increase in Germany. This, say proponents, would increase purchasing power and raise imports.
But the government in Berlin rejects such ideas, arguing that Germany has injected close to 90 billion into the economy in the last two years in the form of economic stimulus programs and tax cuts. It is impossible to do much more, according to the German government, because the EU Commission has imposed fixed targets to reduce Germany's budget deficits. It was only on Wednesday that the EU Commission found fault with Berlin for its lack of interest in further saving measures.
It is easy to find flaws in the arguments of those who criticize Germany's export successes. Not only do they fail to recognize that Germany makes many products that are not made by any other country in the monetary union. They also ignore the fact that French products, for example, do not become more attractive because potential buyers in Germany have a few more euros in their pockets. To stimulate sales, the products would either have to be better or less expensive, and both are factors that French companies and the French government can influence.
Besides, Germany's critics act as if the government were setting wages. In reality, compensation levels in Germany are the result of negotiation between industry associations and trade unions. And these don't always lead to lower wages. In traditionally strong exporting sectors, like the automobile industry or mechanical engineering, German employees are still at the top of the wage scale internationally.
The critics, on the other hand, only set their sights on conditions in the euro zone. They ignore the fact that the competitive strength of the countries with a strong trade surplus, Germany, Austria and Finland, also has a significant impact in countries elsewhere in the world, like the United States, China and Japan -- and thereby strengthens the value of the euro.
Finding the Right Strategy
It would not do anyone any good if Germany were to change its course. The country was considered a problem case until the middle of the last decade. Were the other euro zone countries better off then? Not really.
Another frequent objection is that not every country can rely on exports to overcome its crisis. In truth, however, there is no other choice. If the imbalances in the European trade and capital balances are to be reduced, current deficit countries like Greece will have to export more goods and surplus countries like Germany will have to import more goods.
The only question is: Which is the right strategy? If Merkel prevails, Europe will be more likely to orient itself toward its top economic performers. If her critics prevail, the stragglers will become the benchmark.
The opponents will have a new opportunity next week to clarify the alternatives, when Chancellor Merkel is expecting a highly qualified guest at her cabinet meeting, someone with whom she could discuss Europe's growth and debt strategy: French Finance Minister Lagarde.
Also attending the meeting will be Lagarde's German counterpart, Schäuble, who could serve as a mediator between the two women. In addition to being of one mind on many issues, the two finance ministers are also on very familiar terms, applying the French custom of kissing each other on both cheeks whenever they greet or say their goodbyes.
A few weeks ago, a solution to Greece’s debt problems seemed close. The Greeks did their part by adopting a tough new austerity program earlier this month. But Europe has not followed through with the needed guarantee that the money Greece must borrow to pay its bills will be safe from default. That is a big problem for Greece, and for the European Union, whose reputation for effective coordination is suffering. It also is bad for the United States. The nervous decline of the euro pushes up the dollar, making exports more expensive and slowing America’s recovery.
The European Union has been unable to deliver because Chancellor Angela Merkel of Germany, Europe’s biggest, richest country, has been unwilling to lead. If Mrs. Merkel does not do so at this week’s gathering of European leaders in Brussels, Greece may be forced to turn to the International Monetary Fund instead. That would deal a damaging blow to the European Union’s credibility and would also raise serious questions about the euro’s future. Five of the 16 countries that use the euro are now facing serious fiscal difficulties.
Greece does not need, has not asked for, and would not get a bailout loan. But it does need European guarantees to roll over its loans at affordable interest rates. Greece now pays 6 percent interest, twice the German rate. For its austerity program to work, that rate must drop or debt service will wipe out most of the savings. German voters, proud of their economic competitiveness, resist the idea of helping Greece, or other troubled countries like Ireland, Italy, Spain or Portugal. But Germany’s economic strength is not just built on German hard work and efficiency. It is built on consumer demand elsewhere — including its deficit-plagued euro partners. German voters who favor casting Greece and the others adrift seem to miss that connection.
Mrs. Merkel has not slammed the door on a European solution. She says Germany is prepared to support "stability" as long as it does not have to put any money on the table. Greece says it is not seeking bailout money now, just loan guarantees. There is room for a deal, but it will require German leaders to take on parochial domestic opinion for the larger European cause. Mrs. Merkel’s predecessors have done that in the past, and the European Union has been stronger for it.
Barroso ups ante in dispute with Merkel over Greek aid
EU Commission chief Jose Manuel Barroso has increased the stakes in his brinkmanship with German chancellor Angela Merkel over a rescue plan for Greece. In the face of Dr Merkel’s continued resistance to the formulation of a rescue package at an EU summit on Thursday, Mr Barroso says EU leaders have to take responsibility in keeping with their conditional pledge last month to help the country "if needed". Uncertainty about the prospect of a rescue deal have weighed on the euro, which slipped yesterday to a three-week low against the dollar, and on Greek bonds, whose yields rose 11 basis points to 6.46 per cent yesterday.
While Greece’s debt crisis was sparked by a government forecast that its 2009 budget deficit would reach 12.7 per cent, the country’s central bank declared yesterday that the shortfall breached that projection to reach 12.9 per cent of national output. The question has exposed deep divisions at the apex of European power, with Mr Barroso now essentially aligned against the German chancellor. Dr Merkel’s position is complicated by rising opposition to any Greek rescue within her own administration and among the German public. Berlin has also suggested a financial role in any Greek rescue for the International Monetary Fund (IMF), something that Brussels does not want. The chancellor’s chief spokesman said it remained open to EU leaders to decline to take a decision on aid because Athens had not asked for help.
Jean-Claude Juncker, Luxembourgish prime minister and head of the euro group of finance ministers, appeared to back Dr Merkel when he said yesterday that there was "no urgent need" for a decision this week. While Mr Juncker prefers a European solution, he said a plan involving IMF aid and bilateral loans from EU members remained possible. Separately yesterday, European Central Bank president Jean-Claude Trichet said any aid to Greece should take the form of a loan with very stringent conditions. At the European Parliament, Mr Trichet also said aid should be given only if it included an element of stabilisation for the 16-country euro zone as a whole.
"We should not mix up a transfer or a subsidy with a non-concessional loan as those granted by the IMF," Mr Trichet said. "I think we can only be talking about a loan without any subsidy element. That needs to be extremely clear...That loan is the only possibility in our view." He also said verbal discipline by other euro zone members was of utmost importance to maintain fiscal discipline. Mr Trichet called the Greek government’s deficit-cutting measures convincing, and that markets should progressively recognise their importance.
As talks continue in the run-up to the summit, Greek deputy prime minister Theodoros Pagnalos stoked tensions by attributing Dr Merkel’s reluctance to help Athens to the profits made by German banks on the back of the debt crisis. "By speculating on Greek bonds at the expense of your friend and partner, by allowing credit institutions of the country to participate in this deplorable game, some people are making money," Mr Pagnalos said.
Diplomats said his remarks were unhelpful, especially after he accused Germany last month of failing to properly compensate Greece for the costs of the Nazi occupation of the country in the second World War. It is widely held that Greek prime minister George Papandreou cannot ask for aid until Dr Merkel clears the way for a deal. Mr Barroso meets this morning with European Council president Herman Van Rompuy, who will chair the summit. Mr Van Rompuy’s spokesman declined to say whether he backed Mr Barroso’s push for a swift deal.
"The president’s clear view is that he would like to see a decision, whether it’s yes or no, this week," said a spokesman for Mr Barroso. "People have to take their responsibilities in line with the February 11th commitment. What he doesn’t want see is continued uncertainty." Although Mr Barroso’s decision to publicly seek a agreement exposes him to the risk of being rebuffed by Dr Merkel, he has taken a calculated decision to demonstrate leadership rather than being seen to do nothing. At a press briefing, Mr Barroso’s spokeswoman made light of his differences with Dr Merkel. "He is hopeful at this point in time that an agreement can be reached."
Europe Increases Pressure on Chancellor Merkel
German Chancellor Angela Merkel has been consistent in her refusal to consider a European Union bailout for Greece. But Brussels continues to insist that a plan is in the works. On Monday, Barroso urged Berlin to make a "constructive contribution" to solving the crisis. For a while there, it looked as though the questions surrounding Greece's budgetary and sovereign debt difficulties had been solved. In early March, Athens passed strict austerity measures aimed at satisfying concerns within the EU that the country was not doing enough to shrink its bloated budget deficit. In the same week, the EU once again signalled that it was working on measures aimed at helping Greece should bankruptcy loom. And Greece successfully floated a €5 billion ($6.7 billion) bond offering, banishing fears that investors would stay away in droves.
Since then, however, confusion has reigned. With just a few days remaining before a European Union summit in Brussels, there is little agreement in the 27-member bloc -- and even less within the 16 countries belonging to Europe's common currency union -- about what exactly should be done to help Greece. Germany, in particular, has been reluctant to agree to any kind of aid. On Monday, European Commission President Jose Manuel Barroso upped the pressure on German Chancellor Angela Merkel. "It is also in Germany's interest to defend the stability of the European currency union," he said in an interview with the financial daily Handelsblatt. "As such, I am confident that Germany will make a constructive contribution to the solution of the current crisis."
In an apparent jab at Merkel, he went on to say, "Of course it is sometimes uncomfortable for heads of government to make decisions not when they want to, but rather when it is necessary." European frustration with Germany has grown in recent weeks as Berlin has consistently refused to sign on to any plan that would create a mechanism for the transfer of money to Athens. Indeed, Merkel's government has even seemed interested at times in slowing the debate with seemingly unrealistic proposals. Earlier this month, German Finance Minister Wolfgang Schäuble suggested the creation of a kind of European Monetary Fund on the model of the International Monetary Fund -- an idea that received only tepid support from a handful of EU states. And last week, Merkel spoke openly about the possibility of throwing out euro-zone members that repeatedly violate the currency union's stability rules.
Both proposals would likely require amendments to the Lisbon Treaty, the reform document which was finally approved in 2009 after years of bickering and setbacks. On Sunday, Merkel once again expressed her doubts about a bailout package for Greece. Speaking to German radio, Merkel said that one shouldn't "generate false expectations for the EU summit on Thursday." A government spokesman added that aid for Greece would lead "all other deficit countries in the EU to depend on aid as well." More than anything, Merkel is concerned about an electorate that is firmly against a bailout for Greece, particularly given that Germany, as the largest economy in the euro zone, would likely have to contribute the lion's share of any aid package -- should one become necessary. Greek Prime Minister Georgios Papandreou once again reminded his EU colleagues on Sunday that Athens was currently in no need of financial aid.
Still, even should a mechanism be created that would allow such aid, there is a significant risk that it would be challenged in Germany's high court. Commission President Barroso is certain that, despite the euro zone's "no bailout" clause, help for Greece would be allowed under Article 136 of the Lisbon Treaty, which provides for the "proper functioning of economic and monetary union." But there are many in Germany, including a number of well-respected economists, who argue that providing money to Athens would mean a further blurring of nation-state borders within the European Union -- the kind of blurring that may not be allowed by Germany's constitution. Some have threatened to challenge any package in court.
Merkel and Barroso weren't the only ones to speak up about the euro's woes over the weekend. European Commissioner for Economic and Monetary Affairs Olli Rehn proposed in an interview with the weekly Welt am Sonntag that the Commission should be tasked with examining member-state budgets before they are passed. The Commission has long had oversight authority, but national budgets are only sent to Brussels once they have been passed by domestic legislatures. "That is too late," Rehn said. Like those from Berlin, his proposal would also require an amendment to the Lisbon Treaty.
The Biggest Greek CDS Speculator Has Been Uncovered - Culprit Is... Greek State-Controlled Hellenic Post Bank!
by Tyler Durden
We have officially moved from a Greek tragedy to a Greek surreal comedy. After nearly a month-long scapegoating campaign in which Greek PM G-Pap said he would spit in the faces and skullf#@* all those who dared to buy Greek CDS (because as we have all been lied to by everyone who doesn't know the first thing about CDS, it is CDS buying not bond selling that drives spreads), with the stupidity reaching as far and wide as the Spanish and German secret services, which said they would spy on CDS traders in London and New York, Greek daily Kathimerini has just uncovered that the biggest speculator, holding 15%, or $1.2 billion of the total $8 billion in Greek notional CDS, has been a firm that operates about 2 blocks away from the parliament building in Athens - the state-owned Hellenic Post Bank (TT)!
Luckily poetic justice is about to be served, as every single media outlet tomorrow will apply the same circus monkey treatment to G-Pap and his clownshoes henchmen, not to mention the chorus of obese idiots over at the European Commission who fell for the ruse (speaking of EU idiots, has anyone heard of Jenny Craig relapse patient Joaquin Almunia in the past 2 months, with his "Greece will never demand a bailout" arrogance). While there had been speculation that Greek banks were selling Greek CDS to hedge funds, it had never crossed anyone's mind that a Greek bank could be betting on the collapse of its own sovereign host (especially one which does not own Bernanke's printing press), and that in such size! Frankly this beats even our very own AIG fiasco by orders of magnitude in stupidity.
What an unbelievable joke the intersection of global capital markets and politics has become.
Kathimerini reports that Post Bank bought $1.2 billion of Greek CDS at 135 bps in August 2009 and sold them at 235 bps in December at 235 bps, making a profit of €35 million.State-controlled Hellenic Post Bank (TT) spent nearly 1 billion euros last year to secure its positions against the possible bankruptcy of the Greek government, according to documents seen by Kathimerini.
In August, the bank bought credit default swaps (CDS) – a form of insurance on financial instruments – worth 950 million euros when the spread on the Greek five-year bond over the German Bund was at 135 basis points.
CDS products allow investors to purchase protection against the default of debt issued by governments, hedging existing positions.
TT’s management, which changed after the Socialists took power in October, sold the CDS when the spread was at 235 basis points in December, earning a profit of some 35 million euros, the documents show.
Hopefully this will finally and forever force G-Pap to shut up in discussing not just the "speculative mania" whose only purpose is the destruction of Greece, but every other thing he does not understand, unless of course, he is referring to banks based in his very own country hell bent on suiciding the country...then again that would leave him with exactly zero things to discuss.
Greece accuses Germany of 'squalid game' in debt crisis
by Ambrose Evans-Pritchard
Greece has further complicated its chances of an EU rescue package this week, accusing Germany of exploiting the debt crisis to enrich its banks and drive down the euro for global export advantage. "By speculating on Greek bonds and allowing credit institutions to participate in this squalid game, some people are making money," said deputy premier Theodoros Pangalos. "As long as southern Europe is under fire and the euro is falling , they (the Germans) can win massive exports in the rest of the world," he said.
It is the second time in a month that Mr Pangalos has lashed out at Germany. In February he said Berlin had no right to lecture Greece because the Nazis had stolen his country’s gold reserves and caused the death of 300,000 people during the Axis occupation. The latest outburst is certain to irritate Berlin where the ruling coalition appears ever more reluctant to back an EU-led rescue. Chancellor Angela Merkel said over the weekend that "help is not on the agenda. I don’t think it’s advisable to upset the markets by raising false expectations for the summit on Thursday," she said, referring to gathering of EU leaders in Brussels."
She was backed by coalition partner Guido Westerwelle who said it would be intolerable to "throw German and EU money out of the window and thereby reduce the pressure on Greece to reform." Germany is leaning towards IMF intervention, a cleaner option that avoids a breach of the `no-bail-out’ clause under Article 125 of the EU Treaties and therefore a breach of German law. The interest spread between 10-year Greek bonds and German Bunds widened sharply to 338 basis points on Monday as markets continued to digest the implications of an IMF rescue and Mrs Merkel’s call last week for treaty changes to allow the expulsion of eurozone sinners.
Mrs Merkel appears increasingly irritated by EU attempts to bounce Germany into an EU fiscal union, a profound change in EU affairs that would leave German taxpayers exposed to huge liabilities in Southern Europe. Ulrich Leuchtmann, currency chief at Commerzbank, said efforts by Brussels to skirt EU treaty law with creative tricks should be resisted. "To annul the no bail out clause would mean taking the first step towards a transfer union. That is unlikely to lead to a stable euro long term," he said.
Greek premier George Papandreou has threatened to go to the IMF unless the EU comes up with concrete help on acceptable terms by the end of the week. This brinkmanship is causing heartburn in Brussels, Paris, and Madrid, but the creditor states of North Europe are almost jumping at the chance to call his bluff. Adding to complications, senior figures in Mr Papandreou’s PASOK party have denounced the IMF option, saying such a course would entail national coalition government. Some voiced concern that recourse to the IMF would be the start of a slippery slope towards Greek exit from the euro.
Mr Papandreou said the crisis risked spinning out of control, throwing the whole European project into doubt. "Many forces forget the political importance of the euro and overlook the essence of the political vision. This could end up destabilizing the EU and leading us in the opposite direction to that of those who inspired and created a united Europe and its common currency," he said. The Greek newspaper Eletherotypiha said there had been a rush to withdraw funds from banks after Mr Papandreou said the country had been "a step away" from being unable to borrow on the capital markets. Critics say the Greek leadership might do the country a favour by keeping quiet for a while.
Rifts Widen on Greece Rescue
European Central Bank President Jean-Claude Trichet jumped into the growing fray over Greece's debt crisis, suggesting the country could receive loans from its euro-zone partners under certain conditions—a position that appears to put him at odds with Germany, which is pushing for the International Monetary Fund to play a central role in any rescue. Mr. Trichet's comments, in testimony Monday to the European Parliament, came as doubts over Europe's commitment to helping Greece weighed on the euro and drove up Greece's borrowing costs. He also took aim at the deepening divisions between European governments and institutions ahead of this week's European Union summit—effectively telling them to get their stories straight on Greece and to stick to them.
"Verbal discipline is of utmost importance," he said. "I would prefer that different institutions think first and then express their opinions as clearly as possible." Loans to Greece from other euro-zone nations are a possibility, Mr. Trichet suggested, as long as they don't "mix up" a transfer or subsidy that would give Athens financing advantages. "We can only be talking about a loan without any sort of subsidy elements. That needs to be clear," Mr. Trichet said. As a precondition for such a loan, the "extraordinary situation" has to threaten the euro zone as a whole, and not just an individual country, he said. Mr. Trichet has strongly rejected an IMF role beyond technical assistance.
Many euro members fear that IMF involvement in a potential bailout would undermine confidence in the single currency. But in Germany, the euro zone's largest economy, the government faces strong domestic resistance from voters and lawmakers to footing a large bill for bailouts of euro members that have pursued loose spending policies in recent years. Germany on Monday continued to distance itself from the ECB and Germany's own national central bank, the Bundesbank, which also argues against IMF financial assistance to Greece. "I say this very explicitly, in my opinion [help from] the IMF is a subject that we need to consider and that we must continue to discuss," German Chancellor Angela Merkel said. Ms. Merkel repeated that European Union leaders won't decide on an aid package for Greece at their summit in Brussels on Thursday and Friday.
Meanwhile, European Commission President Jose Manuel Barroso said in Monday's editions of Germany's Handelsblatt newspaper that he wants EU leaders to agree on a system of coordinated credit for Greece at this week's summit. Euro-zone governments will intervene to help Greece only as a last resort if the bloc's stability is threatened, Ms. Merkel's spokesman Ulrich Wilhelm said. In that scenario Germany would be open to financial assistance by the IMF, he said, hinting at a potential joint aid package involving the IMF and euro-zone governments.
European policy makers' divisions put pressure on the euro Monday. It briefly sank to a three-week low of less than $1.35 after Greece's deputy prime minister Theodore Pangalos said the euro would "have no meaning" if Athens is left unprotected in the face of market speculation against its government debt. It later recovered as higher U.S. equities spurred greater risk-taking by investors. Still, the risk premium Greece must pay on its debt rose, with the 10-year bond yield spread over safer German bonds rising about 0.10 percentage point to 3.35 points. The cost of insuring Greek sovereign debt against default using credit-default swaps also rose.
Calling speculation against the Greek bond market a "despicable" game, Mr. Pangalos said the German government was implicitly allowing German banks to attack a fellow euro-zone member. "Some people in Germany are making money," he said. Greece's central bank added to the pressure, saying the nation's gross domestic product will contract by 2% this year, a bigger drop than the finance ministry expects. A deeper-than-expected recession would make it even harder to achieve the ambitious deficit reduction Athens has promised. Greece's deficit was 12.9% of GDP last year, the central bank said, even higher than the government's previous 12.7% estimate. The country faces a "vicious circle" as it tries to repair its finances, as budget cuts will compound the recession, the central bank said.
Mr. Trichet offered some verbal support to Greece, calling its steps to rein in its deficit "courageous" and saying they should bring down borrowing costs. He also strongly hinted that its debt would still be acceptable as collateral for cheap ECB loans even if credit ratings agencies cut Greece's rating, provided Greece reduces its deficit as promised. Under current relaxed rules introduced during the global financial crisis, Greek debt's eligibility as collateral at the ECB isn't in danger. But under pre-crisis rules to be reinstated next year, further credit-ratings downgrades could render Greek debt ineligible.
Mr. Trichet said he expects financial markets to "progressively realize" that Greece's fiscal measures are "convincing," and "if it would appear that this working assumption is too optimistic...then we will look at the situation." Mr. Trichet, one of the architects of Europe's common currency, also moved to quell talk that countries could face expulsion from the euro zone, an idea he has repeatedly called "absurd." "The euro area is not a la carte," Mr. Trichet said. "We share a common destiny."
Jim Rogers Discusses the Euro and the Prospect of a Greek Bailout
James Rogers, chairman of Rogers Holdings, talks with Bloomberg's Andrea Catherwood on March 19 about his investment strategy for the euro and the pound. Rogers, speaking in London, also discusses the prospect of an international bailout for debt-stricken Greece.
Gaps in the eurozone 'football league'
by Wolfgang Münchau
At last we are heading towards a resolution, albeit a bad one. After weeks of pledges of political and financial support, Angela Merkel appears ready to send Greece crawling to the International Monetary Fund. Germany cites legal reasons for its position. In past rulings, its constitutional court has interpreted the stability clauses in European law in the strictest possible sense. These rulings have left a deep impression among government officials. It is hard to say whether this argument is for real or is just an excuse not to sanction a bail-out that would be politically unpopular. It is probably a combination of the two.
I have heard suggestions that a deal may still be possible at this week's European summit, but only if everybody were to agree to Germany's gruesome agenda to reform the stability pact. That would have to include stricter rules and the dreaded exit clause, under which a country could be forced to leave the eurozone against its will. I am not holding my breath. But either outcome will mark the beginning of the end of Europe's economic and monetary union as we know it. This is the true historical significance of Ms Merkel's decision.
While Greece faces the most acute difficulties, it is not the only member in trouble. There are at least four - Greece, Spain, Portugal and Ireland - that are probably not in a position to maintain a monetary union with Germany under current policies indefinitely. There may be several more, where the problems are not yet quite so evident. In the presence of extreme current account imbalances and a lack of bail-out or fiscal redistribution mechanisms, a monetary union among such a diverse group of countries is probably not sustainable. In a column several weeks ago I put forward three conditions necessary for the eurozone to survive in the long run: a crisis resolution mechanism, a procedure to deal with internal imbalances, and a common banking supervisor. Since then, things have been moving in the wrong direction on all three counts.
For a start, we have come from a situation in which the "no bail-out" clause of the Maastricht treaty, having been almost universally disbelieved for 10 years, is suddenly 100 per cent credible. The minute the IMF marches into Greece, all ambiguity will end. The debate on imbalances is also regressing. It would be unreasonable to ask Germany to raise wages or cut exports, but there is a legitimate complaint about Germany's lack of domestic demand. Berlin should accept it needs to develop a strategy. But the opposite is happening. Rainer Brüderle, economics minister, said last week there was nothing the government could do about demand because consumption was a decision by private individuals. A senior Bundesbank official even compared the eurozone to a football league, in which Germany proudly held the number one slot. The long-term direction of fiscal policy is even more alarming, as the gap between Germany and the others will widen.
On banking supervision, the main reason for a common European system is macroeconomic. In a monetary union, imbalances would matter a lot less if the banking system were truly anchored at the level of the union, not the member state. As banks can obtain liquidity from the European Central Bank, even extreme and persistent current account deficits should not matter in good times. But they matter in times of crisis. For as long as bank failures remain a national liability, persistent imbalances could ultimately lead to a national insolvency. If the banking sector were genuinely European, imbalances would still be an important metric of relative competitiveness but we would need to worry a lot less, just as we do not worry about the current account deficit of a city relative to its state.
The lack of a bail-out system, of an agenda to reduce imbalances and of a common banking system are realities that investors should take into account when making long-term decisions, as should policy-makers when they make important choices for citizens. The reality is that the eurozone, as it works today, is not a monetary union but a souped-up fixed exchange rate system. In the past, global investors have placed a lot of trust in European politicians. They believed Peer Steinbrück, the former German finance minister, in February 2009 when he ended a speculative attack on Ireland, Greece and others with a simple statement of support. They also believed, as I did myself, that political leaders would ultimately do the right thing to save the system, having first explored all the alternatives. As I follow the political debate in Berlin, I am no longer certain that is the case.
Ms Merkel is not a politician driven by a strong historical destiny, unlike Helmut Kohl, her predecessor but one as chancellor. However real the constitutional problems may be, I suspect Mr Kohl would never have hidden behind a technical or legal argument on such a crucial issue. Europe's current generation of leaders lacks this accident-avoiding instinct. So when Ms Merkel and her colleagues in the European Council see the iceberg coming, they will tend to rush not to the helm but to the nearest constitutional judge. I am not predicting a catastrophe. I am merely pointing out that the present policy choices are inconsistent with the survival of the eurozone in its current form.
Spanish 'economic miracle' loses its splendour
After joining the European Union, Spain was quick to join the ranks of richer nations. Now the economic crisis has halted its advancement. The first half of 2010 should have been a time of glory for Spain. For these six months, a crucial time in European history, Spain holds the rotating presidency of the Council of the European Union. In the midst of economic crisis, the EU has to devise its own answer to the economic emergency. The Treaty of Lisbon, which reforms the European government, needs to be implemented. A successful stint as EU chair would be a boost to Spanish morale, or so the government of prime minister José Zapatero hoped.
Things did not go as planned. Greece was cast into crisis as its budget deficit soared. Spain, the European country that - together with Ireland - had suffered most from the credit crisis became a target on international financial markets. The country is continuously compared with Greece, after its comfortable budget surplus turned into an 11.4 percent deficit in only two years. The crisis has left Spain on the defensive. According to Cristina Manzano, editor in chief of the Spanish edition of Foreign Policy, the country had the illusion it had finally caught up with the rest of Europe in recent years. "We thought we were playing in the same league" Manzano said. "Even though we might not have reached European averages for certain economic variables yet, we compensated for those in other departments. But now the inferiority complex that weighed so heavily on us for so long seems to have returned."
The Spanish feeling of inferiority has a long history. After its global colonial empire collapsed in the early 19th century, Spain became an isolated and backward nation and remained so for centuries. After the Franco dictatorship, which ended with the general’s death in 1975, the country was quick to leave this dark era behind it – partially thanks to help of Europe. Since it joined the EEC (the EU’s predecessor) in 1986, Spain has received 200 billion euros in support from Brussels. The funding has served as a belated Marshall Plan. Spain was quick to embrace EU membership as an extra safeguard of its young democracy. Spain became a model member state. It met all the requirements for joining the euro without fudging its books. During the last economic crisis, in 2002 and 2003, Madrid stuck with the rules laid down in the Stability and Growth Pact, keeping its budget deficit below three percent of its GDP, even while Berlin and Paris did not.
The economy prospered in recent years, growing faster than the European average. Year by year, Spain’s per capita income came closer and closer to the European standard. In 2006 the country surpassed Italy in this respect. It seemed only a matter of time before it would catch up with France. But now the crisis has cast the country back. The real estate bubble that served as the economy’s main driving force for a decade, together with tourism, has burst. Suddenly the rapid growth of the past seems to have been unsustainable. Unemployment rates, now near 20 percent, are the highest of the entire eurozone by a wide margin. "The country is awakening to a bitter hangover after years of partying," said economist Ángel la Borda.
Many Spaniards complain their country does not have an answer to the crisis. But if foreigners dare voice the same type of criticism, Spaniards are quick to react disgruntled. Especially when derogatory terms like ‘PIGS’ (an acronym for Portugal, Italy, Greece and Spain) or ‘Club Med’ are used. Or when the old ‘mañana, mañana’ cliché is mentioned to explain the current crisis. Deprecatory references are particularly prevalent in the Anglo-Saxon business press. "Foreign magazines tend to paint a rather stereotypical picture of us," said José Ignacio Torreblanca, managing director of the Madrilenian branch of the European Council on Foreign Relations (ECFR). "Until 18 months ago they called us Europe’s economic miracle. They sung praises of our dynamic and open economy. Spanish companies were the ‘Trojans of the South’. We had spent European funds so wisely. Why has this all changed now?" Torreblanca asked.
Torreblanca said the outside world has to learn to understand that the crisis is hitting Spain especially because Europe’s peripheral economies tend to develop more rampant. "When the EU is doing well, we do better. When the EU is doing badly, we do worse. This has nothing to do with our national character. You see the same in Estonia, and no one will contend we have a lot in common with them." Whether the criticism is deserved or not, the Spanish government has to pay heed to it. Financial market anxiety over Spain’s economy and the government budget has definitely not subsided in recent months. This has caused the interest paid on Spanish treasury bonds to rise in comparison to the interest paid over the bonds deemed most reliable: the German ones. "The game the government now has to play," Torreblanca said, "consists of introducing reforms to keep financial markets happy on the one hand. On the other hand it should not reduce the deficit to such an extent that they end up paying an enormous political price."
So far, the government has not been very successful in pulling off this balancing act. Earlier this year, it announced hasty measures to get the budget deficit under three percent by 2013, as Brussels has demanded. But ever since it has only half-heartedly attempted to find support for the unpopular measures, including 50 billion euros in cutbacks, raising the eligibility age for state pensions and reforming the labour market. The outside word has therefore remained wary. The government’s leeway is limited. In the 1980s and 1990s, there was widespread political support for far-reaching measures in Spain. At the time, those were necessary for joining the EU and later the euro. In addition, the measures were rewarded with large sums of European monetary assistance. Since the EU expanded eastward in 2004 and 2007, a lot of European support has also been diverted in that direction.
The Spanish political climate has also become extremely polarised since the beginning of this century. The centre-right opposition is not exactly keen to help the centre-left government tackle the current crisis, while unions are resisting reforms from the left. "The government is not truly willing to pay the political price for this crisis back home," Cristina Manzano of Foreign Policy said. According to Torreblanca of the ECFR, the crisis could mark the beginning of a new relationship with Europe. Pro-European sentiment in Spain "has always been intuitive and ill informed," he explained. In 2005 for instance a large majority voted in favour of the proposed (but never realised) European constitution even though few people knew it well. Torreblanca believes, the Spanish lack of interest was calculated. "People do not collect information on a subject that does not concern them. If your country gets six billion euros from Brussels every year, that is all you need to know." Now that the European flow of money is drying up and Brussels is pushing for far-reaching reforms, the Spanish attitude towards the EU looks to become less pliant. "But Spain is still far away from protests like the ones we saw in the streets of Athens, where European flags were burnt," Torreblanca said.
Madrid Reaches Deal on Budget
Under pressure to cut one of the European Union's biggest budget deficits, Spanish Finance Minister Elena Salgado on Monday reached a broad agreement on cost-savings measures with the finance chiefs of Spain's powerful regional governments. The agreement represents a crucial step forward for the government of Socialist Prime Minister José Luis Rodriguez Zapatero in its plans to narrow the budget deficit to 3% of gross domestic product in 2013, in line with European Union requirements. The government said the final budget deficit for 2009 was equal to 11.2% of GDP, narrower than its previous estimate of 11.4%.
At a meeting with journalists, Ms. Salgado said Spain's regions had signed on to a plan under which her government proposes to reduce the structural deficit by around €60 billion ($81 billion), or 5.7% of GDP, by the year 2013. The central government would shoulder the bulk of the reduction—around €55 billion— while regional and municipal governments will be responsible for cutting the remaining €5 billion. Spain's decentralized structure of government makes the task of deficit reduction more difficult than in some other European countries. The central government—excluding the state's social security administration—directly controls less than a third of public spending and can set only broad guidelines for the regional and municipal administrations that control the rest.
Spain's powerful regional governments actually control the biggest portion of spending—36% of the total in 2008—and have a long history of rapidly increasing their spending and budget deficits. Responsible for basic services like health and education, they have borne the brunt of absorbing the millions of immigrants who have arrived in recent years to take advantage of Spain's formerly buoyant economy.
Spain is grappling with the collapse of a decadelong housing boom that has pitched the wider economy into a deep recession, sent tax revenue plummeting and social-welfare costs soaring. With an unemployment rate nearing 20%—by far the highest in the euro zone—Spain expects to spend more than €30 billion on unemployment benefits alone in 2010. Spain continued to lag behind the euro-zone economic recovery in the fourth quarter, data showed last month, but its rate of output decline eased, prompting Ms. Salgado to forecast that Spain would achieve quarter-to-quarter growth this year.
Is It...or Isn't It?
by Michael Panzner
Larry Doyle, a long-time Wall Street veteran and publisher of the Sense on Cents blog, hosts a Sunday night show, "No Quarter Radio's Sense on Cents with Larry Doyle," on Blog Talk Radio. In this week's edition, which features an interview with Phil Davis of Phil's Stock World, Larry raises a question that a few of us, who are amazed at and unsettled by the willingness of investors to throw caution to the wind and repeat the mistakes of the past (see "Back Buying the Same Kind of Crap" for one example), have occasionally wondered about ourselves:Is the stock market being manipulated?
I can not count the number of times I have been asked that question over the last 9 months. Rather than my offering personal opinions which market pundits may view as sour grapes or worse, I want to revisit a ten-minute segment of my interview last evening with Phil Davis.
The segment runs from 29:45 until 40:00 (audio player provided below). If you do nothing else today, please listen to this dialogue between Phil and myself. Neither of us goes into this conversation with agendas or preconceived notions in an attempt to score points. I will offer an edited version here. I think you will find the information, thoughts, and opinions offered to be enlightening.PD: It’s getting more and more likely that there’s going to be an event that takes the market down and that’s because of the nature of the market rally. The rally has been a very thinly traded, low participation rally.
LD: I want to pursue that….the idea that there could be or will be some sort of an event. Obviously, all of the governmental support that has come into the market, all of the quantitative easing, the easy money, the 0-.25% Fed Funds rate…all sorts of other backstops. Now they’re trying to figure out how to ease some of those supports out of the market while China and India have increased their rates. Are we overextended? Have we created a little bit of an asset bubble?
PD: I think we have created a ‘helluva’ asset bubble…..Let’s be honest. We were delusional in 2007. Those valuations were completely wrong….the earnings were fake and I want to emphasize again fake because they were fake. They were not only not real earnings but what were reported as earnings turned out to be tremendous losses. The financials were putting out fake numbers…it was all fake…..How did we get the market back to where it is then? How is this even possible?
LD: How much are we overvalued?
PD: Don’t forget the Dow is fake also. They took out GM and Citibank from the Dow. Those are two zeros and they put in Travelers and Cisco…that’s 640 Dow points that were added because they swapped GM and Citi for Travelers and Cisco. Now is that real?
LD: I look at the most actively traded stocks. Almost everyday the most actively traded stock in the market is Citi…this isn’t real…
PD: Whether Citi is real or not, I think you touch on something more important, though. The most active stock is Citi. The next most active stocks are Bank America, Wells Fargo…
LD: Also AIG.
PD: Those trades are 80% of all trades in the market and the total market volume is less than half of what it was back then. In other words, you’ve got half the market participation of what it was and of that half, 80% of it is concentrated in less than half a dozen financial firms.
LD: What does this say about the future of Wall Street?
PD: It says that the people who are running the system are in total control of the marketplace. There is no retail participation….on a relative basis.
LD: They don’t believe it.
PD: ….it looks like a bunch of crooks….
So, is the market being manipulated? I would guess that depends on how one defines manipulation. That said, market volume and market depth tell us a lot. I thank Phil Davis for providing this ’sense on cents.’
Research shows a third of Londoners are jobless
Almost a third of the working age population in London are jobless, costing billions of pounds a year, research showed today. Worklessness in the capital costs more than £5 billion a year, including welfare benefit and employment programmes, a study by London Councils found. The group, which represents 33 councils in the capital, said national employment programmes are "under-performing" in London, adding that boroughs are better placed to deliver job-related services.
Around 2,000 more jobs would have been created in London if national programmes were as effective as in other parts of the country, it was claimed. Stuart Fraser of London Councils said: "National employment programmes are less effective in London than elsewhere in the country. "This is a serious issue when you consider that almost a third of the working age population are unemployed and the costs of worklessness are so high in London. "Boroughs are already in contact with people who are out of work, and given more opportunity from Whitehall, councils can provide unemployed people with a whole package of support which is individually tailored to their training, childcare and housing or health issues."
A Department for Work and Pensions spokesman said: "Unemployment is half a million lower than expected last year, however we will not cut back on support for jobs. "In fact, we have invested £5 billion to help people back to work, part of which has created around 7,500 jobs in London for young people. "Of the 1.2 million economically inactive in London, just over 400,000 are students. The numbers also include people looking after their families, carers and people who have retired early." Shadow minister for London Justine Greening said: "This report is a damning indictment of Labour's failure in London and yet Alistair Darling still plans to go ahead with the rise in National Insurance, a tax on jobs."
Treasury’s Geithner Urges End to Fannie, Freddie 'Ambiguity'
U.S. Treasury Secretary Timothy F. Geithner said the government should end the "ambiguity" over its involvement in mortgage finance companies Fannie Mae and Freddie Mac. "Private gains can no longer be supported by the umbrella of public protection, capital standards must be higher and excessive risk-taking must be appropriately restrained," Geithner said in testimony prepared for the House Financial Services Committee that was obtained by Bloomberg News. The hearing is scheduled for today at 10 a.m. in Washington.
Geithner said the Treasury Department and the Department of Housing and Urban Development will issue a request for comment by April 15 on how to overhaul the U.S. housing-finance system and its regulatory structure. The government needs to make sure there is "no ambiguity over the status or allowable activities of any private entity which enjoys any benefits or protections from the government," he said. At the same time, Geithner pledged that the Obama administration would seek to avoid disruptions in the market for Fannie Mae and Freddie Mac’s debt and mortgage-backed securities. He said investors should not doubt the U.S. government’s commitment to backstop the obligations of the two companies, which have been in conservatorship since 2008.
"It should be clear that the government is committed to ensuring that the GSEs have sufficient capital to perform under any guarantees issued now or in the future and the ability to meet any of their debt obligations," Geithner said. "The administration will take care not to pursue policies or reforms in a way that would threaten to disrupt the function or liquidity of these securities or the ability of the GSEs to honor their obligations."
The testimony expands on Geithner’s call yesterday for a "fresh, cold look" at the government’s role in housing. In a speech at the American Enterprise Institute in Washington, the Treasury chief said he is "looking forward to reforming" the government-sponsored enterprises -- or GSEs, as Fannie and Freddie are known -- even though that process has been put off while the Obama administration focuses on priorities including a financial regulatory overhaul. The administration’s delay in offering its plan for Fannie and Freddie has drawn criticism from Republican lawmakers who are already critical of President Barack Obama’s approach to toughening financial oversight.
Representative Jeb Hensarling, a Republican from Texas, said yesterday that the administration should explain why it has "no exit strategy" from its 2008 takeover of the two mortgage- finance companies. Geithner said in his prepared testimony for today’s hearing that the government had "few viable alternatives" to its extensive support of Fannie Mae and Freddie Mac because the two companies are so central to the housing market. Private capital isn’t available in sufficient strength to fund the mortgage market and make credit widely available, he said.
Before the government stepped in, the two companies guaranteed more than $5 trillion in residential mortgage-based securities, or almost half of the U.S. residential mortgage market, Geithner said. They also had more than $1.7 trillion in outstanding debt, held equally by foreign and U.S.-based investors, he said. The Treasury in December said it would provide as much support to the GSEs as needed over the next three years. At that time, the Treasury also eased its requirements for the two companies to shrink their portfolios.
Geithner said the Treasury is still "firmly committed" to shrinking the firms in the long run. He also reiterated that the two companies are unlikely to exceed previous projections on government assistance. "Neither company was near the previous $200 billion per institution limit in December, and neither is likely to exceed those caps even under a range of very conservative assumptions," Geithner said. The Treasury secretary laid out broad objectives for weighing how to change Fannie Mae and Freddie Mac, along with other housing organizations such as the Federal Home Loan Banks and the Federal Housing Administration. He said there are "a variety of mechanisms" the government could use to promote stability and also provide subsidies to parts of the market.
The housing finance system needs to have incentives that are aligned to encourage the mortgage industry to work toward long-term health instead of short-term gains, Geithner said. Private gains shouldn’t be allowed when the public bears the brunt of losses, and mortgage finance companies should be required to hold sufficient capital and avoid abusive practices. Mortgage products should be standardized and support a liquid secondary market, with a broad base of investors and "accurate and transparent pricing," Geithner said. Government housing policy should aim to promote widely available mortgage credit, financial stability and affordable housing options for lower-income households, he said.
"Action is needed to ensure that markets are more stable, consumers are protected, credit is widely accessible and important housing policy objectives, such as affordable housing for low and moderate income families, are administered effectively and efficiently," Geithner said. "Government has a key role to play in that new system, but its role, and the role of the GSEs in particular, will be fundamentally different from the role played in the past."
Fannie and Freddie: A market to prop up
by Suzanne Kapner
T heir nicknames are affectionate and they have long been known as the kindly siblings that help millions of Americans to buy a home. But Fannie Mae and Freddie Mac, just like many of their mortgage holders, have fallen on hard times. The government helped out with a multi-billion dollar rescue but now wants them back on their own feet - and that is turning out to be the trickiest part of all.
Hearings begin today in Congress that will help determine whether the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation are to be split up and part of their operations wound down. The issue is fraught as November's midterm congressional elections loom - not least because these so-called government-sponsored entities (GSEs), along with the Federal Housing Administration, provide financing for nearly all of the mortgages being issued in the US today.
Overhauling agencies that are together propping up a fragile market is not only a political quagmire but one that holds serious economic implications as well. "No one wants to rock that boat," says Bert Ely, a banking consultant. But doing nothing is not an option either. Barney Frank, who as Democratic chairman of the House of Representatives financial services committee will conduct the hearings, says: "When it comes to resolving the financial crisis, housing finance is the next piece of the puzzle."
A mishandling of the problem would have implications not just for US homeowners, who could face scarcer financing, but also investors the world over, including the Chinese, Japanese and other governments and central banks. For instance, foreign investors own about one-third of Fannie's and Freddie's noncallable notes. The notes, which cannot be redeemed prior to maturity, are used as a barometer because they are easily trackable. Although the agencies' debt does not carry an explicit government guarantee, the US Treasury has gone out of its way to reassure investors that it is almost as safe as investing in its own bonds.
If investors came to doubt the soundness of Fannie and Freddie debt, they would demand a higher return or shift their money elsewhere, which could drive up the cost of housing finance. For that reason, it is unlikely that the Treasury would renege on its promise. Nevertheless, some politicians, including Mr Frank, have pointed out that because this debt is not on the same legal footing as US Treasuries, investors could be forced to accept a valuation that is less than full - the feared "haircut", in other words - in the event that Fannie and Freddie were restructured.
"I don't know if the American taxpayer recognises that in bailing out the GSEs we're really bailing out foreign investors, and we're doing that despite the fact there are no explicit guarantees," says Scott Garrett, a Republican member of Mr Frank's committee.
At an estimated cost of $177bn (€131bn, £118bn), the rescue of these entities is already shaping up to be the mother of all bail-outs. It is set to exceed the $153bn spent during the savings and loans crisis of two decades ago when nearly 750 thrifts that made mortgage and other personal loans failed, as well as the projected $117bn price of the troubled asset relief programme, which in 2008 threw a lifeline to ailing financial institutions and automakers.
The final price tag may be even higher. Spencer Bachus, senior Republican on the committee, accuses Democrats of ignoring the problem and hiding the cost by keeping Fannie's and Freddie's debt out of the federal budget. "You can't address the cause of the financial crisis without reforming Fannie and Freddie," he says.
The Congressional Budget Office estimates that if the entities had been included in the 2009 federal budget, they would have added $291bn to the deficit, pushing it up by 20 per cent. "We've got to wean ourselves off government support of the housing market or else we're heading for disaster," says Anthony Sanders, a professor of real estate finance at George Mason University and one of the panellists scheduled to testify at the hearings.
Unlike most developed countries, in the US the government has long played a direct role in the housing market. Fannie Mae was created in 1938 and Freddie Mac in 1970 to provide liquidity by buying mortgages originated by banks, thereby freeing the banks to make more loans. Over the years the companies, which are chartered by Congress, became the underpinning of a policy that made home ownership as American as apple pie by purchasing an ever-larger number of mortgages from borrowers on low and moderate incomes.
The goals for affordable housing, set by regulators, climbed dramatically through much of the past decade, from 42 per cent of overall purchases in 2000 to 56 per cent in 2008. (They have since fallen to roughly 43 per cent.) Critics have suggested that this sharp rise contributed to the financial crisis by encouraging Fannie Mae and Freddie Mac to buy riskier and riskier loans.
"It became all about getting everyone into a house," says Mike Berman, chairman-elect of the Mortgage Bankers Association and another scheduled panellist. "Regulators, congressmen and prior administrations all lost their discipline with respect to underwriting standards. The whole country was complicit in this."
Leading the charge were Wall Street banks, which were going wild over subprime securities and other types of exotic mortgages that were predicated on the belief that house prices would continue rising indefinitely. The banks originated these loans and then sold them to investors as pools of mortgage-backed securities. When home prices collapsed in 2007, private investors stopped buying these securities, essentially leaving Fannie and Freddie as the only game in town.
As losses on Fannie's and Freddie's bad loans mounted, the government seized control of both companies in 2008. Taxpayers have since pumped in close to $112bn and the tally is expected to rise. Although possible solutions range from privatisation to full-scale nationalisation, a consensus seems to be emerging that calls for breaking Fannie and Freddie up into public and private pieces.
The first part, containing the bad debt that is backed by the government, would wind down by collecting on the loans, investments and insurance fees, and use that money to repay existing debt as it matures. No new debt would be issued. Any losses would be met by taxpayers. The second part would be a government agency with an explicit, but limited, goal of supporting affordable housing. Importantly, the cost of running this agency would be accounted for in the federal budget. The third part would consist of a private company, or series of companies, charged with originating as well as buying mortgages.
The debt issued by the privatised bits of Fannie and Freddie would not be backed by the federal government. In one sense these new companies would add competition, but by eliminating the two large GSEs they would also level the playing field. Orphaning the bad debt in an entity to be wound down could meanwhile have negative implications for investors by making it less liquid and, therefore, less valuable.
Perhaps the biggest criticism of any plan to break up the GSEs and withdraw government support from the housing market is that it could make mortgage financing less available.
The market for privately financed mortgages is unpredictable and, as the past couple of years have shown, can dry up. For "jumbo" mortgages - those in excess of $417,000 that are generally too big for Fannie and Freddie to purchase - financing is very difficult to obtain and borrowers are being required to put down as much as half of the loan value.
"With less government support, mortgage rates are likely to rise and credit is likely to become less available," says Peter Niculescu of Capital Market Risk Advisors, a financial advisory firm.
Also drawing scrutiny is the durability of the fixed-rate mortgage, which protected homeowners when interest rates soared in the 1970s and 1980s. Although countries including Canada, Britain and France survive with variable-rate mortgages or those that are fixed over a shorter period, the vast majority of Americans can lock in rates for 15 or 30 years. Doing away with that system injects further uncertainty into the mortgage market and could mean that homeowners will face rising rates at times when they are least likely to be able to afford them.
Amid all this, there remains the question of what the final cost to the taxpayer will be. One immediate stumbling block is the 10 per cent dividend that the GSEs are required to pay the government on preferred stock issued as part of the bail-out. "Payback is wishful thinking," says Robert Eisenbeis at Cumberland Advisors, a fund manager. "That money is gone."
Next, there may be a further price to pay. The FHA, intended to help some of the lowest-income borrowers own homes by allowing them to put as little as 3 per cent down, could end up being another drain on taxpayers. "The question is not their embedded losses but how much more will they put on the books over the next two years," says Mr Ely, the consultant.
Last, if the GSEs are privatised, they will be forced to recapitalise. Congressional legislation proposes requiring lenders to retain 5 per cent of the loan value for every mortgage that is sold into the secondary market, in an attempt to get the originating banks to keep some "skin in the game". Given that the GSEs have a combined balance sheet of $5,500bn, they would need to raise some $250bn to meet those requirements.
As a result, any changes will be a long time in the making. Tellingly, in its latest budget last month the administration provided no details of how it wants to reform the GSEs. Tim Geithner, Treasury secretary, has said that there are no plans to tackle the issue until next year. If the housing market continues to falter, any meaningful overhaul could be pushed even farther into the future.
Yet, in spite of that uncertainty, there is a growing sense of urgency that something needs to be done. "The current model for Fannie and Freddie isn't working," says Mark Calabria of the Cato Institute, who plans to argue for the break-up of the entities when he appears at the hearings. "No one is suggesting we should go back to what was. And that, in itself, is a sea change."
'If you are lending your own money, you are a bit more diligent'
Whenever mortgage rates fall, US homeowners such as Steve Persky try to lock in lower monthly payments. Such refinancing can be done by agreeing a new loan and paying off the old one, usually without any penalties. It is a system that has resulted in a steady stream of business for banks and brokers.
Having refinanced the mortgage of more than $800,000 on his California home seven times in the past decade, Mr Persky had come to regard this as a routine process. He would call his banker, fill in a few forms and about six weeks later he would have a new mortgage - and reduced monthly interest payments.
Last year, this changed. "My bank wanted three years of tax returns, all my financial statements, three years of corporate tax returns. It took months," says Mr Persky, an investor who buys, among other assets, securities backed by subprime mortgages.
Nothing has changed in Mr Persky's financial situation and his mortgage remains less than one-third of the value of his home. What has changed is the way mortgages are financed in the US. Banks used to sell mortgages into the mortgage-backed securities market, which allowed them to keep selling new mortgages. With the collapse of the housing bubble, parts of the MBS market previously used to finance such debt also collapsed.
Banks are still selling home loans financed by MBS - but the only buyers are the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, the government-sponsored mortgage financing entities (GSEs) known as Fannie Mae and Freddie Mac. However even they will not take very large "jumbo" loans, traditionally defined as above $417,000. Now, though, the GSEs have agreed to increase the ceiling to $729,750 in high-cost areas such as New York and California.
Banks agreeing to make new loans to homeowners that are bigger than the increased upper limit now have to keep the loans on their books until they are paid off. This is why lending standards have become so strict. "If you are lending your own money you are going to be a bit more diligent," says Keith Gumbinger of HSH Associates, which tracks mortgage rates.
As well as the extra paperwork, the breakdown of the mortgage-backed securities market has resulted in higher rates for homeowners who borrow large amounts. This is causing concern, as it may deter people from buying or selling homes and thus delay a recovery in prices. In 2005, for example, new jumbo mortgages worth $570bn were agreed, 18 per cent of all home loans, according to Inside Mortgage Finance, which tracks the sector. Last year, it was $92bn, or 5 per cent of all new mortgages. "It is not a normally functioning market," says Guy Cecala, chief executive of Inside Mortgage Finance.
Meanwhile, Mr Persky has found a way to lock in lower mortgage rates once again. He has reduced his mortgage to below $729,750 - meaning it can now be bought by Fannie Mae or Freddie Mac - and in doing so reduced his interest rate.
Covered way forward
To reinvigorate private investment in housing finance, some US bankers and lawmakers are pushing to create a market for covered bonds. Widely used in Europe, these are senior secured liabilities backed by the cash flow from underlying real estate.
Because the issuing bank is required to keep the bonds on its balance sheet, they are considered safer and more transparent than mortgage-backed securities, which banks were able to sell to investors and thereby divorce themselves from the risk of default. Covered bonds do not transfer the risk to a third party.
"The bank that issues the bond is responsible for maintaining the flow of redemptions," says Tim Skeet at Bank of America Merrill Lynch.
Scott Garrett, a Republican congressman, has launched a bill to create a covered bond framework. But the proposal has run into opposition from bank regulators, who worry that holders of the bonds would be ranked ahead of depositors should an institution fail.
Feinberg to Review Pay at Bailed-Out Firms
The U.S. pay czar will review executive compensation at Goldman Sachs Group Inc., J.P. Morgan Chase & Co., Morgan Stanley and 416 other firms that took government bailout funds, to determine if compensation paid during the height of the financial crisis should be returned, according to government officials. Kenneth Feinberg, the Treasury Department's special master for compensation, will send a letter Tuesday requesting compensation data for as many as the top 25 executives at each of the 419 firms that received Troubled Asset Relief Program funds. The pay review will cover only a short window, but one that captures the 2008 end-of-year bonus season at most large firms.
The inquiry marks the first time the government will look into pay at a broad swath of firms that took government bailout funds. Mr. Feinberg's primary mandate has been to review and set pay at seven firms receiving large sums of government aid, such as American International Group Inc., General Motors Corp. and Citigroup Inc. Other firms that took TARP funds have been subject to compensation restrictions but haven't been subject to a government review. Mr. Feinberg's review comes amid continuing anger over Wall Street pay at a time of high unemployment. As financial firms recover and return to profitability, they have resumed paying large sums to executives, triggering anger among the public and lawmakers.
Some on Wall Street said they expected the report to be routine but others said there could be potentially embarrassing nuggets of who made what during the depths of the financial crisis in 2008. Mr. Feinberg's review is required under the 2009 statute creating the special master's role. It could result in some firms returning bonuses, salaries or other payments. The pay czar doesn't have the power to demand compensation be repaid, but he can seek to use his bully pulpit renegotiate payments deemed "inconsistent" with pay rules required by Congress last year or any payments "contrary to the public interest." Government officials said it isn't clear exactly what type of pay might fit in that category.
Many firms, including Goldman Sachs, J.P. Morgan and Morgan Stanley, have repaid their government funds, often at a profit to the U.S. taxpayer, a move that could be seen as being in the public interest, one government official said. Large payments, particularly cash not tied to company performance, are likely to draw scrutiny. Mr. Feinberg has sought to limit cash payments at the firms he oversees, requiring that employees get the bulk of their compensation in restricted stock tied to the long-term performance. In several cases, he has renegotiated cash payments, such as bonuses he viewed as too large.
The review, which is expected to be completed by late spring, is primarily aimed at larger banks. Mr. Feinberg's letter will instruct firms to submit data for any of those top 25 officials whose annual compensation totals more than $500,000. Mr. Feinberg is also expected to issue his 2010 pay determinations today for the firms he primarily oversees, including AIG and GM. The retroactive review will look at the relatively short window during which firms received TARP funds but weren't subject to executive-compensation restrictions mandated by Congress as part of the February 2009 stimulus law. Many firms, including the biggest banks, received taxpayer money in late October 2008. In effect, that period was the only time TARP wasn't accompanied by pay restrictions.
During the period under review, many banks lowered pay for top executives. In 2008, Goldman Sachs didn't pay its top employees a bonus, and its chief executive, Lloyd Blankfein, saw his pay fall in 2008 to $1.1 million from $70 million the previous year. Morgan Stanley's John Mack took no bonus in 2007, 2008 and 2009, leaving his pay far below the $37 million he earned in 2006. Most of that award was in restricted stock. Another executive at a TARP recipient, Wells Fargo & Co. Chairman, President and CEO John Stumpf, collected $9 million in pay for his work as president and CEO in 2008, about 39% less than the $14 million he collected in 2007 and less than half the $21 million he received in 2009.
In a report filed last year, New York Attorney General Andrew Cuomo found that 1,600 employees at J.P. Morgan made more than $1 million in bonuses, compared with 953 workers at Goldman Sachs, and 428 at Morgan Stanley. Mr. Cuomo's report showed that compensation stayed relatively high at major banks even in periods when the banks were losing money. Mr. Cuomo is collecting pay data for 2009 as well. Mr. Feinberg "could push for renegotiation, but he has no legal basis to do so," said one Wall Street official, who still worried that Mr. Feinberg could pick out individual pay contracts and publicly criticize them unless the firms involved would agree to lower the pay retroactively.
Others were surprised that Mr. Feinberg is looking anew at firms that paid back their TARP funds nearly a year ago. Mr. Feinberg's relationship with Wall Street is complicated. Some top executives who have met with him compliment his straightforward approach, but his mandate is to police an area that most financial executives view as the last place they would like to see the government intervene. Mr. Feinberg's mandate of looking after taxpayer's investments in various banks is strongest at companies that accepted government money more than once or that have been kept on taxpayer life support for months. Other firms like Goldman Sachs accepted the government investment, but were able to repay it quickly after getting private investments to boost capital.
Too big to fail is too costly to continue
by Thomas Huertas
The world is well aware that it needs an exit strategy from the massive monetary and fiscal stimulus that started in the final months of 2008. But we also need an exit strategy from too big to fail. It is simply too costly to continue.
In October 2008 – in the wake of the panic that gripped financial markets following the failure of Lehman Brothers – governments promised that no systemically important institution would be allowed to fail. Governments backed up that promise by recapitalising major institutions. Providing this backstop was just as important as monetary and fiscal stimulus in arresting the slide in the real economy. Instead of the Great(er) Depression, the year 2009 turned into the Great Recession.
But, for two reasons, it may be unsustainable for governments to continue to promise that no systemically important institution will be allowed to fail. First, it removes market discipline from such institutions. That increases the probability that systemically important institutions overstretch themselves such that governments will be required to perform on their guarantee. Second, the promise may be unsustainable simply because of the potential expense involved. Even if countries were willing to stand behind these liabilities, they may not find the means to do so.
Arguably, that is exactly what happened in the case of Lehman. The market expected the US government to bail out Lehman. When it did not, chaos resulted. Spreads on bank funding surged. Liquidity contracted and further failures followed. The global economy went into free fall.
So the answer is to get into a position where there is no guarantee, implicit or explicit. We have to move to a point where the market does not expect institutions to be bailed out. That requires an effective resolution regime. It would restore market discipline, so banks pay a risk premium in line with the risks that they take rather than the government support they might obtain.
We therefore need to map out what our long-term resolution policy should be, and consider how we will take steps to move from where we are today to where we need to be. Ideally, we want a resolution policy that allows governments to resolve failing institutions promptly without recourse to taxpayer funds, but at the same time avoids the social disruption that could occur from widespread interruption to deposit, insurance and/or securities accounts. This would allow for maximum continuity in customer-related activities whilst assuring that capital providers remain exposed to loss and avoiding the need to give widespread or long-lasting guarantees of the bank’s liabilities.
To ascertain how we can approach this ideal, the authorities have asked a number of large banks to prepare so-called "living wills", or recovery and resolution plans. Although it is premature to draw conclusions from this exercise, recommendations are likely to fall under three complementary headings:
1. Change the bank. Identify and perhaps require steps that the institution itself could take under current law and regulation to improve the possibility that it could be resolved by the authorities’ actions, were intervention required, without recourse to taxpayer funds.
2. Change the law. Identify changes in laws and/or regulations that would facilitate resolution methods that do not require taxpayer support. Such changes might include the introduction of special resolution regimes for banks and/or their extension to non-bank financial institutions; the reform of deposit guarantee schemes so that they can pay out insured deposits promptly in the event of a bank failure; the introduction of depositor preference, and/or provisions that would allow the authorities to transform non-core tier one and tier two capital instruments into common equity in the event that the supervisor makes a determination that the bank no longer meets threshold conditions.
3. Charge the firm. If neither of the first two recommendations is feasible, consideration must be given to charging the firm for characteristics of its make-up – such as its size and interconnectedness among institutions – that make a firm systemic. If there is to be a charge, it should take the form of supplemental capital and/or liquidity requirements, for they would strengthen the firm itself. But any such charge should not
be based on a list of systemic institutions. Such a list could be construed to mean that institutions on the list would definitely be rescued rather than resolved, were intervention to be required. That would be – for the reasons outlined above – a recipe for further crises down the road.
We should exit from too big to fail, not perpetuate it.
Thomas Huertas is Vice Chairman, Committee of European Banking Supervisors, and Director, Banking Sector, Financial Services Authority (UK).
Pension Woes May Deepen Financial Crisis For States
by Tamara Keith
There's a looming U.S. financial problem that's big, is getting larger and could threaten the solvency of some states. From Connecticut to California, pension funds for teachers, firefighters and other public employees are severely underfunded. "Generally, they're in an abominable state," says Joshua Rauh, an associate professor of finance at the Kellogg School of Management at Northwestern University.
A recent report from the Pew Center on the States put the tab for unfunded pension liabilities at $452 billion. But Rauh and others say pension funds are using unrealistic assumptions about investment returns, meaning the pension funding hole is likely much deeper. "Our calculation is that it's more like $3 trillion underfunded," Rauh says. And the kicker is that taxpayers are on the hook.
Stuck With The Bill
"People say, 'Well that's ridiculous. We're just not going to pay it. Let [the pension funds] go broke,' " says Robert Gentzel, policy director for the Pennsylvania State Employees' Retirement System. "That's not what would happen. The taxpayers are ultimately going to have to pay the bill." That's because public employee pension funds are backed by the full faith and credit of the government. Over the past several decades, many states and local governments made pension promises that will be expensive to keep. Now, they're struggling to fund their obligations.
Take Cranston, R.I. "Right now, the unfunded liability is $240 million," Cranston Mayor Allan Fung told NPR's Jim Zarroli. That's more than double the city's annual budget. Fung added, "It's a big obligation, and it's basically a ticking time bomb for the city of Cranston that we are trying to get a handle on."
Underfunding Becomes Next Generation's Problem
The Pew report found state pension obligations nationwide were 84 percent funded. That doesn't sound so bad, but that figure does not include the full impact of the 2008-2009 market collapse, which hit pension funds hard. Disappointing returns isn't the only funding challenge pension funds face. Many local and state governments haven't been putting enough money into the funds. When budgets are tight, shorting pension funds is a lot more politically palatable than raising taxes or having to make painful cuts.
"Underfunding is very easy because all you're doing is making this the next generation's problem," says Rick Dreyfuss of the free market-oriented Commonwealth Foundation in Harrisburg, Pa. "The next generation doesn't understand the magnitude of this, and they're too young to vote, so there's not a lot of political opposition to that." Dreyfuss says there's a high political rate of return for increasing benefits, and there's basically no political upside to actually paying for those benefits.
Public Pension Deficits Are Worse Than You Think
by Andrew G. Biggs
How can fund managers assume an 8% rate of return?
Pension plans for state government employees today report they are underfunded by $450 billion, according to a recent report from the Pew Charitable Trusts. But this vastly underestimates the true shortfall, because public pension accounting wrongly assumes that plans can earn high investment returns without risk. My research indicates that overall underfunding tops $3 trillion. The problem is fundamental: According to accounting rules adopted by the states, a public sector pension plan may call itself "fully funded" even if there is a better-than-even chance it will be unable to meet its obligations. When that happens, the taxpayer is on the hook. Yet public pension plans ignore market risk even as they shift into risky foreign investments, hedge funds and private equity.
A simple example illustrates the flaw. Imagine that you borrowed $100, which you absolutely, positively must repay in 20 years. How much money would you need today to consider that debt "fully funded?" Here are two correct answers, followed by an incorrect one. All three rely on "discounting," a method of calculating the sum of money needed today to fund a given liability in the future.
- First, discount $100 at the 4.5% yield on safe, 20-year Treasury notes. This produces a present value of $41.46, which you invest in Treasury securities. Barring federal government bankruptcy, you can repay your debt with certainty.
- Second, discount $100 at the expected return on stocks—say 8%. This produces a present value of $21.45, which you invest in equities. Next, purchase a "put option" giving you the right to sell your portfolio 20 years hence for no less than $100. This option would cost $20.08, for a total cost today of $41.53. Barring the collapse of the options exchange, you also can be certain of repaying your debt.
- But here is a third answer: discount $100 at an 8% interest rate. Invest $21.45 in stocks. Declare yourself "fully funded." This doesn't work because there's a very good chance your risky assets won't appreciate in value enough to cover the debt. Yet this is how public sector pension accounting operates.
Vested pension benefits are constitutionally guaranteed in eight states and protected by law in two dozen more. And in most every state politics makes accrued benefits impossible to cut. Orange County, Calif., in the 1980s and New York City in the 1970s effectively made pension obligations senior to government debt by paying full retirement benefits even as they inflicted losses on bondholders. Yet public pensions discount ironclad liabilities at the high rates of return they project for risky investment portfolios. Consider New York state's Employees Retirement System (ERS), which assumes an 8% return on its assets. Discounted at this interest rate, ERS's liabilities had a present value of $141 billion as of 2008. ERS assets at that time were $152 billion, making the program overfunded by 7%.
But New York's portfolio is hardly likely to produce a steady 8% each year. Since 1990 its returns have varied widely, ranging from 30.4% in 1998 to -26.4% in 2009. A "Monte Carlo" computer simulation (a standard technique for modeling financial risks) incorporating fluctuating asset returns shows that New York's ERS has only around a 45% probability of meeting its liabilities. Instead of an $11 billion surplus, the ERS is almost $100 billion shy of funding its benefits with certainty.
In a recent AEI working paper I've shown that the typical state employee public pension plan has only a 16% chance of solvency. More public pensions have a zero probability of solvency than have a probability in excess of 50%. When public pension assets fall short, taxpayers are legally obligated to make up the difference. The market value of this contingent liability exceeds $3 trillion. Public pension plans are hiding behind unrealistically low deficit figures. This allows policy makers to dodge difficult choices today at the cost of a much heavier burden on taxpayers in the future.
Master of the universe: Can Hugh Hendry teach us to love hedge funds?
A stack of hardbacks sits on the windowsill in the office of hedge fund manager Hugh Hendry. They make up a reading list perhaps now common in London's embattled financial community. The Volatility Machine: Emerging Economics and the Threat of Financial Collapse sits under a copy of Lords of Finance: The Bankers Who Broke the World, a timely examination of the Great Depression. On top of the pile, lies a dog-eared dictionary open at the page with words beginning "sco-". What was Hendry looking up? He bounds around his desk. "Oh, yes," he says, running his finger down the page, "it was for an article I wrote about hedge fund managers last week. I was looking up 'scourge', as in 'scourge on society'."
Hendry does not see himself as "a person who harasses or causes destruction", but he is painfully aware that that is how many of us see him. Originally a byword for staggering personal wealth apparently derived from having licences to print money, hedge funds have become, after the recession, a symbol of something more sinister. When I canvass opinions of Hendry before our interview, they are generally negative. One knowledgeable denizen of Wall Street, who prefers not to be named, writes in an email: "Hendry is the Person I'd Most Like To Punch." It's the same story in Europe. Poul Rasmussen, the former prime minster of Denmark, who is waging a war against speculators like Hendry by pushing for more EU regulation, tells me on the phone from Brussels: "Hedge funds are like vultures, or hunting dogs. When a state is in trouble, you can be sure that in a nano-second they'll make attacks."
It's an ugly characterisation that Hendry hears more and more. And he's had enough. Combining staggering self-assurance – the product of more than 20 years in investment finance – with the zeal of a preacher and a remarkable facility for extended metaphors, the 41-year-old Scot has become the self-appointed defender-in-chief for a secretive profession under siege. "Of course it bothers me that I'm hated," Hendry says. "I listen to some of the things people say on debates on Radio 4 and it terrifies me to hear such hostility. What bothers me is that the silence of rich guys who are embarrassed about being rich helps whip up this frenzy that makes us seem like villains." Hendry, who will later argue that hedge fund managers offer a "social service", says the public "is being fed a line that preys on their ignorance. The person who would like to punch me doesn't have that insight."
Hendry is the boss at Eclectica Asset Management, which he launched five years ago. Like all hedge funds, it takes money from investors and uses it to make bets on their behalf. A good bet means a healthy return for investors – and, of course, a fat fee for the fund manager. Eclectica is, by his own admission, a hedge fund minnow. "The total size of the assets we have under management is about £450m," he says. "There are funds that manage $20bn [£13bn]." Leading a team of a dozen or so fund managers, analysts and traders, Hendry asks his clients (most of whom he says are individuals) to invest a minimum of 100,000 dollars, pounds or euros. He says that most funds demand at least $5m. Talking later about the real big hitters, Hendry says, "Some of these guys, I should be shining their shoes."
But it's clear that Hendry does okay. He responds to enquiries about his personal wealth (and many other questions about his private life) with a polite "fuck off", but his financier's uniform of well-cut blue shirt, navy tie, Gucci specs and a chunky Louis Vuitton watch shouts money. Not that all areas of his life conform to the stereotype. His stark, mahogany-free office is not in Mayfair or Knightsbridge but in the shadow of the Whiteleys shopping centre in Bayswater, a short hop in his G-Wiz electric car from his Notting Hill home. Sure, he has a house in the country ("a Cotswolds caricature"), but he reaches it, with his wife and three young children, in a second-hand Land Rover Discovery.
Whether or not his relatively modest lifestyle is something studied rather than a product of a tight budget, Hendry has carved out a nice life. And he's terrified that a backlash against his profession will force him out. "I don't want to go and live in Switzerland or some Caribbean island," he says. "I like it here." But for many people, Hendry has become persona non grata. Poul Rasmussen, who is now an MEP and president of the Party of European Socialists, has been the driving force behind proposed EU regulation of the hedge fund industry that would significantly trim its powers. The Alternative Investment Fund Managers directive and the popular, speculators-as-devils sentiment it represents, amounts to such a significant attack on the largely Anglo-American hedge fund industry that it has almost sparked a diplomatic crisis.
First Timothy Geithner, the US Treasury Secretary, made a veiled threat of US retaliation if the directive were pursued. Then, on the eve of a meeting of EU finance ministers last Tuesday, at which the reforms were due to be discussed, Prime Minister Gordon Brown made a late-night telephone call to his Spanish counterpart, José Luis Rodríguez Zapatero, also appealing for restraint. Spain, which holds the EU presidency, then dropped the directive from the agenda. Rasmussen calls the Spanish retreat, after "incredibly heavy lobbying" by the London hedge fund community, "a disgrace".
Rasmussen and Hendry have come to represent two sides in an increasingly bitter and, at times, personal war of words about the moral and financial value of the hedge fund in a post-recession society. The two came head-to-head on the BBC's Newsnight earlier this month. While Rasmussen kept it civil, his disdain was palpable. Hendry, meanwhile, listened to his foe while wearing a permanent sneer, before suggesting that Rasmussen was a "champagne socialist travelling business class on the back of money created by risk-takers like me".
So who's right? Both sides see answers in a nation on its knees. Greece's economy is in meltdown after years of massive borrowing and spending. Now, as the banks that lent to Greece scramble to shore up their finances after the global economic crisis, they want their money back. Greece can't pay. That means it risks going into default, which means banks would have to take massive write-offs, which would affect lending, hammer the euro and send economic shockwaves across the world. What has this got to do with Hendry? "As Greece spends less, its economy will prove weaker and it could go back into recession," he explains. "In that event, it seems unlikely that the European Central Bank would raise interest rates, because if it did, it would precipitate further financial duress and strain upon a vulnerable country. I have substantial investments which are betting that interest rates will not go up this year. If they do, I will lose money, but if I'm right, I could make a return of about 20 per cent of the size of my fund." He adds: "I don't think that makes me a bad guy."
Others do, however. Hendry's is one example of many positions held by hedge fund managers that mean they and their clients will profit as the Greek economy sinks. Rasmussen and his supporters believe that some of these positions make things worse for Greece by forcing up interest rates on the debt it is already struggling to repay. The country's Prime Minister, George Papandreou, said in a speech in Washington earlier this month, "An elected government, making huge changes with the consent of its people, is being undermined by concentrated powers in unregulated markets – powers which go beyond those of any individual government." Hendry is in effect being accused by a Prime Minister and a leading MEP of exacerbating the suffering of people, of causing mass unemployment and widespread strikes that have seen the closure of schools, and violent clashes on the streets of Athens. He has a lot to answer for. But is Rasmussen right? Hugh, are you a vulture? "It wouldn't be a pretty metaphor," he replies, "but you could say that when you see a vulture picking the bones of a springbok, it's picking the bones on a dead carcass. The vulture wasn't responsible for the death."
Okay, so it's not his fault. Hendry did not bring down Greece, whose trials have been widely blamed on reckless lending by banks, reckless borrowing by Greece, and book-fiddling in Athens to hide the scale of public debt. But when did vultures start offering a social service? To illustrate one of his more surprising arguments, the hedge fund manager moves from the savannah to my house: "Say I buy insurance on your house burning down. I don't live in your house, so why on earth would I want to have anything to do with any future outcome there? Well, I'm not dumb. I give great consideration to spending mine and my clients' money. So if I'm buying insurance that pays out on your house burning down, then there's a strong probability there's a fire hazard. I suggest you do something about it. You would perhaps discover your wiring was faulty and replace it. If you do, my curiosity and information has helped to prevent a catastrophe."
Hendry goes further. He says it's common for hedge fund managers to write letters to company bosses, telling them what they are doing wrong and what they should do to fix it. So, less vulture and more canary in the coal mine. A prettier metaphor, but one that, in many minds, doesn't fly. Company bosses appreciate his input about as much as the Greek Prime Minister does. "We are their worst nightmare because we're well-financed, we're intelligent and the problem is that, right now, the message we have is rather unpalatable," Hendry says. "Our business is to say that the emperor has no clothes." But surely Hendry's biggest hurdle in convincing us he does good is that, when hedge fund managers make millions at the same time that others lose millions, it looks bad. Hendry saw it for himself when he dropped his kids at their private school the day after the 2008 Lehman Brothers collapse. "A lot of parents were immediately affected, because the majority of senior employees at Lehman's had most of their savings invested in the stock," he recalls. "Suddenly they woke up and it was zero and they were wondering if their children could still go to school. The misery was palpable and I was shocked by the human cost. But it was weird, because I knew my fund was up 20 per cent that day. I was cockahoop."
Hendry's conviction and antagonistic tendency are the result of a life in which he has never conformed. The son of a Glasgow lorry driver, he always wanted out: "I knew that if I knuckled down I'd be in control of my destiny... and, for a kid from that background, your ticket into the middle classes was law or accountancy." He chose accountancy, becoming the first member of his family and one of few pupils from his school to go to university (at Strathclyde). He was then the first non-Oxbridge graduate to get a job at the prestigious Edinburgh investment management firm, Baillie Gifford. But, as fearless then as he is now, he was labelled a troublemaker. After a move to the City, he became a frustrated nobody on a floor of 400 traders. Still he spoke up, but his voice wasn't welcome and he was fired inside a month. It was only after a chance meeting with Crispin Odey, the millionaire grandee of the London hedge fund scene, that Hendry felt he belonged. "It was a meeting of minds," says Hendry, who won awards as a fund manager with Odey's outfit, after being hired in 1999. "He checked my references, got the message that I was a troublemaker, and said, 'You're one of us, you're one of the pirates'."
Now in charge at Eclectica, which he launched in 2005, Hendry says it's his job to operate outside the herd. During our 90-minute interview, his phone, which he says is not on divert, hasn't rung once. His desk isn't scattered with company reports and spreadsheets but instead with books, a pile of CDs and a Chronicles of Narnia DVD. His day begins with the school run, followed by a visit to his local coffee shop and a 10am start. He attends a Spinning class and does yoga. He writes commentary, published on his website, which is as colourful as his language and quotes anyone from Keynes to Roald Dahl. He says he has "no dialogue" with anyone else in the City: "I make the greatest profit from contentious posturing. But because that posturing is deemed now to be no longer economically contentious but also politically contentious, I feel as if I have gone into a conflict with society at large."
Perhaps the pirate/vulture imagery isn't helping. Neither beast is renowned for its emotion or compassion. It can make Hendry appear cold-hearted as well as infuriatingly self-assured. The man who wants to punch him was moved by another notorious Newsnight clash. Last month, Hendry came up against Joseph Stiglitz, the Nobel prize-winning American economist and former chief economist of the World Bank. When Stiglitz was being, in Hendry's words, "egregiously wrong" about Greece's woes, Hendry delivered a finger-pointing rebuke that began with the words: "Erm, hello. Can I tell you about the real world?"
But if emotion is one luxury Hendry can rarely afford, he says it's because, in global finance, it comes at too high a price. He springs from the table back over to the window, where the dictionary is now closed, and pulls out a copy of The Economic Consequences of the Peace, by the visionary British economist, John Maynard Keynes. Published in 1919, the book argues that the massive reparations demanded of Germany after the First World War jeopardised the European economy. Keynes prescribed forgiveness, economically at least. Hendry draws parallels between the Allies and today's banks. "They should be generous," he says. "By insisting that Greece, for example, should repay everything they are impoverishing us all."
But it's a message not heard by the banks, which leaves countries like Greece relying on official bailouts. Hendry says that's damaging. "German and French banks have got billions of euros in Greece, even though everyone knew Greece was using its credit card too much. And now they're stuck and want to pull the money out. But if they do, you'll get a bank failure in Greece and the whole thing unravels. And so you've got the politicians on the other side who keep rescuing them with your money – that impoverishes you. If Keynes were alive today he would write a book called "The Economic Consequences of the Bailout".
So, what, just let everything go up in flames – savers, bankers, Greeks be damned? "I believe in tough love. Let's look at Iceland. I didn't invest money in Icesave because they took risks I would never take to offer very high interest rates. You take a risk, you get it wrong, you pay. Instead the government says, don't worry, here's my friend the taxpayer with a cheque. You're impoverishing us all to bail out people who make bad decisions." Hendry says it's the same in Greece, where "the champagne socialists I refer to want to bail out the bankers not the people. But they can confuse the people by saying, look, here are these evil speculators – it's their fault."
And so it comes back to the war with Rasmussen, who's still hell-bent on cutting hedge funds down to size. You get the sense that it's Hendry's character as much as his argument that enrages his enemies. Why should I listen to this jumped-up financier? "This isn't personal," Rasmussen says. "It's about fundamental ethics. Compare ordinary, hard-working families earning their money to what these guys in the hedge fund industry are doing. We want to tell these guys, you have to behave in accordance with what's decided by society. If I were in the hedge fund industry I would feel a bit lonely." But Hendry doesn't feel lonely, and is hopeful that Rasmussen's directive, which he says would ultimately cause greater inflation and make us poorer, will fail. He says he has had messages of support from other managers unable, or unwilling, to speak out. "I got an email from a financial journalist telling me there was now an acronym for me – BHFMTFH, or 'boutique hedge fund manager turned folk hero'. I don't think it will take off." Hendry has found an instant audience for his voice because it's rare for anyone from his profession to speak out, never mind become a minor celebrity with a following on YouTube (that Stiglitz take-down has 35,000 views). He claims his openness is bad for business. "A lot of guys play golf or shoot furry animals," he says. "I don't. My vice is speaking to fuckers like you."
Leaving his office, Hendry shows me to the main floor, where young men in polo shirts are eating lunch hunched over their monitors. Bolted to the far wall, a giant plasma screen sporting a spreadsheet offers a live update of Eclectica's funds. "Can you imagine having a screen on your wall saying, every minute, 'you're a great journalist, you're a shit journalist, you're a shit journalist, you're a good journalist'? I have that. I risk my money and my clients' money every day." Right now, Hendry is just an average fund manager – the figures on the screen show he's losing money, albeit a fraction of a per cent of his funds (and it's only 1pm). "If I get things wrong, don't worry about me – I'm not going to get bailed out. I'll lose everything and you'll never hear from me again."
In the meantime, what remains is that nagging question about the moral implications of the work of hedge funds, which is only growing in the popular imagination, even if Hendry doesn't see it. "PEOPLE DO NOT SUFFER WHEN I SUCCEED," he 'shouts' when I press him in an email the day after our interview. Taking him back to my house, which has now burned down because, presumably, I haven't heeded his warnings and haven't checked my (faulty) wiring, I ask if, before cashing in, he stops to think about my lost possessions and memories – the fact that I'm now homeless. "I guess that if I retain my UK citizenship and therefore am subject to paying taxes, then when the fire engines come to hose down your house, you know what? I paid for the fire brigade."
Long and short of it: What are hedge funds? Machiavellian manipulators of markets, or successful servants of savers? The truth is that the term 'hedge fund' covers a multitude of sins. In a nutshell, a hedge fund is a professionally run investment vehicle that takes in money from a group of savers – usually high-net-worth individuals or institutions such as pension funds – and makes bets on their behalf. Assuming the bets pay off, the hedge fund manager gets a generous fee and investors earn a good return on their money. Different hedge funds pursue very different strategies and invest in all sorts of different assets, from shares to commodities to debt. But the sector is associated with two trading techniques in particular: short selling and leverage. Short selling means selling an asset you don't own in the hope of being able to buy it back at a cheaper price later. It's a way to bet on the price of something falling. Leverage, meanwhile, means borrowing extra money to invest; it can make winning bets many times more profitable, but losing wagers are correspondingly painful.
Much of the notoriety that surrounds the hedge fund industry stems from the fact that as private funds, usually off-limits to ordinary savers, they are lightly regulated and don't have to tell the world too much about what they're up to. Many funds are highly secretive and committed to keeping a low profile. For conspiracy theorists, that makes the sector an easy target. European officials, for example, have accused hedge funds of conspiring to use the Greek crisis as an opportunity to provoke a run on the euro. Two years ago, hedge funds were accused of planting false rumours during the banking crisis. There's no doubt that some hedge funds, worth billions of pounds, are very powerful. For example George Soros, the best-known of all hedge fund managers, made £1bn by aiding and abetting the UK's exit from the Exchange Rate Mechanism in 1992. But the sector has no more bad eggs than any other part of the financial services industry. And it played almost no part in causing the financial crisis of the past three years.
Oil reserves 'exaggerated by one third'
The world's oil reserves have been exaggerated by up to a third, according to Sir David King, the Government's former chief scientist, who has warned of shortages and price spikes within years. The scientist and researchers from Oxford University argue that official figures are inflated because member countries of the oil cartel, OPEC, over-reported reserves in the 1980s when competing for global market share. Their new research argues that estimates of conventional reserves should be downgraded from 1,150bn to 1,350bn barrels to between 850bn and 900bn barrels and claims that demand may outstrip supply as early as 2014.
The researchers claim it is an open secret that OPEC is likely to have inflated its reserves, but that the International Energy Agency (IEA), BP, the Energy Information Administration and World Oil do not take this into account in their statistics. "It is necessary to investigate ambiguities and sources of error that are broadly acknowledged but not taken into account in public data due to political sensitivities," the researchers said. The paper also raises concerns that public statistics have started to incorporate non-conventional reserves such as the Canadian tar sands, where oil and gas are much more difficult to extract and may never be economically attractive to develop.
Sir David said that although the IEA was doing a good job of warning that more investment in oil and gas exploration is needed, governments need to pay more attention to independent research. "The IEA functions through fees that are paid into it by member companies and has to keep its clients happy," he said. "We're not operating under that basis. This is objective analysis. We're not sitting on any oil fields. It's critically important that reserves have been overstated, and if you take this into account, we're talking supply not meeting demand in 2014-2015."
The concept of "peak oil" has gained traction in recent years, although energy companies such as BP and Shell insist that production will be able to keep pace with growing Asian energy needs. Sir David said he was "very concerned" that Western governments were not taking the concept of "peak oil" – where demand outstrips production – seriously enough, while China is throwing all its efforts into grabbing as many energy resources as possible. Sir Richard Branson , founder of the Virgin Group, and Ian Marchant, chief executive of Scottish & Southern Energy, are members of the Peak Oil Industry Taskforce, which is trying to raise awareness of potential shortages in the coming decade.
Dr Oliver Inderwildi, who co-wrote the paper with Sir David and Nick Owen for Oxford University's Smith School, believes radical measures such as switching freight transport to airships could become common in future. "The belief that alternative fuels such as biofuels could mitigate oil supply shortages and eventually replace fossil fuels is a pie in the sky. Instead of relying on those silver bullet solutions, we have to make better use of the remaining resources by improving efficiency."