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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