Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

30 October 2011

Europe’s New Bailout Plan

Announced last Wednesday, the EU’s new bailout plan could be the beginning of a solution to the European debt crisis. The plan’s most important feature by far is forcing banks to take a 50% haircut on shaky Greek bonds.

The best current estimate of those bonds’ market value today is a 60% discount from their face value, for a market value of 40% of face. Early reports of the apparent deal were ambiguous. They did not make clear whether the 50% was the percentage of loss to be shared by banks and taxpayers or the percentage discount from face value (haircut) that banks would have to bear. Wednesday’s report made clear that the latter deal was in mind, making banks eat 50% of a 60% drop in face value, or 83% of the loss.

So for the first time since fall 2008, some Very Serious People want to put the lion’s share of the risk of default where it belongs: on the banks that are supposed to be experts in, and make a routine business of, assessing the risks of lending.

After all, a “bond” is just a securitized and formalized loan. And if banks aren’t good at deciding to whom to lend, at what interest rates and on what terms, what the hell good are they? If the public is to bear the loss, why shouldn’t it eliminate the middleman (banks) and fix the rates and terms through elected or appointed public officials with the public interest in mind? The idea that the public should bear the core risks of the banking business for private bankers’ benefit is nothing less than a frontal assault on the foundations of capitalism and free markets.

If implemented as reported, the EU deal could be the beginning of a solution to the central cause of the Crash of 2008 and all the angst since: a massive and systematic shift of the normal and proper risks of the banking business from banks and their “insurance” casinos (like AIG and Goldman Sachs) to governments and taxpayers.

Who is the hero (or heroine) so far? A woman―Chancellor Angela Merkel of Germany. According to reports, it was her leadership that led to putting the risk back where it belongs, on the banks, and her support that motivated expansion of the EU bailout fund to lower the risk and fear of problems in Italy, the EU’s third largest economy (after Germany and France).

France’s intrepid president, Nicolas Sarkozy, who courageously led the world in backing liberty in the form of Libyan rebels, wimped out. He would have opted to do more for the banking welfare queens. Go figure.

If nothing else, this result shows the wisdom and power of collective leadership, of the type that China has institutionalized and the EU now has in somewhat chaotic form. No single individual can be smart, wise, courageous or right all the time. So when you have good, thinking leaders of roughly equal power and influence, you can have good results in Libya and in finance, too. (We Yanks have the opposite: one good, wise leader and 535 crazed Lilliputians persistently trying to tie him down and emasculate him.)

I am working on an essay that will have much more to say about the value of collective leadership and its global progress, especially in China. But today the scoffing and jeering from American exceptionalists about Europe’s dysfunction and the EU’s imminent collapse sound hollow. Europe, unlike us, has begun to address with courage and clarity the central economic problem of our new century: rampant gambling by banks at public expense.

We are by no means out of the woods yet. The EU is indeed a congeries of separate polities, much like our own country as it struggled (briefly) under the Articles of Confederation. National approval of the announced deal and its implementation remain to be seen. The EU could backslide, or the overhang of the $600 million of outstanding derivatives could be more disastrous than anyone now expects.

But at least with Chancellor Merkel’s leadership the EU―unlike the US―has finally begun to address the central problem that led to the Crash of 2008 and all its aftermath, namely, an utterly unsustainable epidemic of reckless gambling by banks relying on implicit or explicit guarantees of governments and taxpayers to relieve them of the hazards that have been the very core of the business of banking since banking began.

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  • At Mon Oct 31, 04:01:00 AM EDT, Blogger seanseamour said…

    Hello Jay,
    I agree with most of your analysis but am once again uncomfortable with what I perceive is an anti-French bias. Yes France’s approach to managed capitalism is anathema even to our progressive political spectrum, closer to a Bundestag where certain MP’s have been quasi industry employees. Neither France nor Germany could have reached the established solution alone, Sarkozy bent to the will and relative fragility of support within the Bundestag as French banks would have suffered more than many if Greece defaulted.
    Looking back a few years I must emphasize that it was Sarkozy who mobilized a reluctant and mostly blindfolded Europe in 2008-9 to the oncoming crisis. I was in the UK during the run on Northern Rock watching Brown's "Atlantist" dismissal of the onslaught to come, leading to the first taxpayer funded bailout (the second was in Germany). His management of the crisis during his rotation as European Council President, and in France where he leaned on industry to manage in a socially responsible manner was critical to the outcome of the first tidal wave, the resulting Euro being the second .
    The Euro crisis is far from resolved, there will be further hurdles but I was encouraged to hear Sarkozy make the untimely but definitely political statement last week “it was an error to admit Greece… they were not ready” (even with their books cooked by Goldman Sachs). It is a shot across the bow for certain countries as well as constituencies ever pushing for expansion.
    Finally looking from a broader societal perspective I don’t know of you picked up on the Bertelsmann Stiftung study just released on discrepancies in poverty prevention and fair access to education within the OECD, a most shocking illustration of the results was published by Charles Blow in the NYT a few days ago : Discrepancies in poverty prevention access to education OECD . We have much to learn. chart

  • At Sat Dec 03, 12:53:00 AM EST, Blogger jay said…

    Dear Sean,

    I’m late in responding comments but wanted to get to yours first. The primary reason: to refute your charge of “anti-French bias.”

    I don’t know where you got that perception, but hope and trust that nothing I wrote contributed to it. If anything, I’m biased in favor of the French generally, and especially with regard to France’s leadership in Libyan liberation and in quality of life. I earnestly hope that you would not in any way associate me with the know-nothings at Fox, who regularly deride France (without which we would not exist as a nation) as “old world” and “socialist.” I would never use either of those words to describe either France or Sarkozy.

    That said, at this particular time I favor the German position over the French. Perhaps for the wrong reasons, Germany appears to be resisting the American solution of finding some way—any way—to bail out shaky governments and thereby the banks that foolishly invested in them. I think that American “solution” is the most disastrous international economic mistake of my lifetime.

    Today the global economy has a short-to-medium-term problem and a shorter term problem. The first is that we Yanks have established a precedent for letting the world’s largest financial institutions gamble at will, to the tune of hundreds of trillions, safe in the knowledge that they are “too big to fail” and that governments and taxpayers will bail them out when they lose. Not only is that approach unsustainable. When it reaches a critical point it might well bring on a second, global Great Depression that would make the first look like child’s play. The shorter-term problem is keeping the EU and the Euro from collapsing and throwing us back into recession.

    In my mind, the EU is as worth preserving as the US is, and for much the same reasons. So I don’t belittle the second problem at all. But if the EU solves the second problem without also addressing the first, I’m afraid we won’t have long before the second shoe drops, and drops hard.

    This analysis may well be simplistic. I certainly don’t command the detailed knowledge of European financial history that you display in your comment. (Nor do I have the time or interest to verify its accuracy.) But I can’t see how any EU financial rescue that doesn’t require substantial “haircuts” of banks and other private investors will solve the epidemic of gambling that has seized the Western financial sector for the past decade.

    So, for me, the size of the “haircuts” is by far the most important variable, and the best determinant whether any EU rescue will also rescue the global economy from going down the toilet (perhaps soon) for other reasons.

    By the way, I’ve been putting my own money where my mouth is. I’'ve got over 95% in cash and safe (guaranteed) investments, perhaps missing out on what might be a significant rally. I think that the rally we had last week (and whatever rally we may have next week) will be premature until the Western financial sector gets out of the casino. I may dip a toe back in by way of options or safe investments in energy, but any substantial move I make will have to await some sign that leaders outside of China understand that banking is not derivatives roulette.



  • At Sat Dec 03, 02:03:00 AM EST, Blogger jay said…

    Addendum to Reply to Seanseamour:

    To enhance my credibility and thereby help protect my loyal readers, I’d like to add this link to how I saved my own retirement from the Crash of 2008. I lost about 5% in the Crash, but only when I got back into the markets prematurely.

    So I may be paranoid about a possible derivatives meltdown if Europe saves itself by continuing the Yankee (bailout) “solution.” But as Andy Grove, the former CEO of Intel, once said, “Only the paranoid survive.”

    Best to all,



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