As Europe and the IMF announce close to a trillion dollar rescue package, Megan McArdle asks, what’s the benefit to the countries providing the funding? Here are my thoughts.
The Economist calls attention to a new IMF staff report that lays out the challenges ahead for Greece. According to the report, the Greek government’s primary budget deficit in 2009 was 8.6% of GDP. That represents the amount by which spending would have to be cut or taxes raised in order to balance the budget last year even if Greece were to repudiate all its outstanding debt. Interest expense on the outstanding debt added another 5.0% of GDP to the 2009 government budget deficit. The IMF calculates that even if austerity measures amount to 10.9% of GDP by 2013 (turning the primary deficit into a primary surplus), the interest burden on Greek’s debt would still grow to 8.1% of GDP by 2013.
One logical response to these circumstances would have been for Greece to abandon the euro, and at a minimum pursue major debt restructuring such as converting outstanding debt to drachma at some rate. That of course would have invited speculation as to which other European countries would be next, which would show up among other places as a surge in borrowing costs for those targeted countries. There is certainly a benefit to countries of being part of a common currency area, but there are also significant costs. The imperfect synchronization of the business cycle across European countries means that the monetary policy appropriate for some may be causing disruption in others, and the desired long-term inflation rate may also differ across countries. Breaking up the European monetary union would undoubtedly be disruptive. But is it worth a trillion dollars to avoid?
I suspect that the key fear has to do with the consequences of a default or restructuring of the debt itself. Willem Buiter estimates that French and German banks have € 110 billion exposure to Greek debt, and total exposure to a potential domino effect could be huge. The WSJ today has further breakdowns, and Dow Jones reports that JP Morgan’s holdings of non-U.S. government bonds increased by $36.5 billion in 2009, while Citigroup’s increased by almost $40 B.
We could then be talking about a replay of the same kind of bank run as we saw in 2008. As creditors who’d lent short-term to banks worried about the banks’ exposure to these risks, banks would be forced to liquidate holdings at fire-sale prices which could again bring lending of all sorts crashing down.
And, as was the case in the 2008 difficulties, one can either view this primarily as a liquidity problem, for which we simply need the central banks to step in boldly to arrest the jitters, or as a solvency problem, in which case the policy decision is how to allocate the unavoidable capital losses among bank owners, bank creditors, and the government so as to minimize collateral damage to innocent bystanders. The fundamentals facing Greece suggest there is an overwhelming solvency component to the current problems. And the policy response so far seems to be choosing to allocate 100% of losses to the European and U.S. taxpayers.
It is not the role of the ECB, IMF, or Federal Reserve to bail out banks. These measures are profoundly unpopular with voters in countries such as Germany and the United States. I think it is incumbent on the architects of these measures to communicate what is the structural defect in banking regulation that made such intervention necessary, and what reforms have been implemented to ensure that such measures won’t be needed again.
Don’t hold your breath, Jim. These guys will continue ripping off the taxpayers until the taxpayers stop allowing it. Yesterday’s Senate vote to turn down the Ron Paul “audit the Fed” amendment shows that it is still business as usual in Washington.
“It is not the role of the ECB, IMF, or Federal Reserve to bail out banks. These measures are profoundly unpopular with voters in countries such as Germany and the United States. I think it is incumbent on the architects of these measures to communicate what is the structural defect in banking regulation that made such intervention necessary, and what reforms have been implemented to ensure that such measures won’t be needed again.”
Bon dit.
Equity markets appear to be of the opinion that taxpayers will continue to bail. The notion that the U.S. financial sector is once again accounting for 40% of total corporate profits (as reported) is simply a lie.
It is cliched, but you are asking thieves to explain why they felt they needed to steal.
The short answer is, of course, because other people had something they wanted.
The longer answer is that these creditors made very bad investments. These bad investments made possible all the profligate spending that politicians used to secure (and enrich) their own positions. The investors need friendly access to the politicians to secure (and enrich) their other schemes, many of which involve government approval.
If the investors suffered losses here they would stop making these particular bad investments and the music would stop for everyone.
It is incumbent on the politicians–including central bankers; I’m not sure how anyone could argue with a straight face they are not politicians–to make all their creditors whole so that the party can continue another day.
Mind you, thieves don’t care if this is a net losing deal, so long as they get theirs. If I pay $1000 for a TV, but the thief only gets $500 when he pawns it, he doesn’t care that there is $500 lost in the ether by the transaction: he got his.
Hits the nail on the head. Unfortunately at this point I’m afraid the banks will just tell us that they can’t afford haircuts, and use the contagion threat for the next 10 or 20 years.
Vox Populi Vox Dei again?
The ECB is a liquidity provider through the 3/4 trillions euros TARP and not assumed to be in risk unless the counter party is in default.
The major issue today is to provide liquidities to Banks that are carrying sovereign bonds and not specifically Greek Bonds, the major issue is autarky in the financial world,
The world of equities being always more adventurous for five minutes does not read the same as lenders do.
Seeing many estimates flying on cross countries exposure on Greece one may hastily gather a number as definite.
May be a study of BIS statistics could be used as a thread and help to assess the real countries risks,foreign exchange exposure and duration mismatches.
http://www.bis.org/statistics/provbstats.pdf#page=7
External positions of all banks vis a vis all sectors as of September 2009 {billions usd}
France 2634.8
Germany 3202.2
UK 5544.8
External position of banks in foreign currencies vis a vis all sectors
in foreign currencies (billions usd}
France 768
Germany 882
UK 4961.4
External position of banks in FC viv a vis the non bank sector (in billions usd)
In individual reporting countries
France 281.3
Germany 410.6
UK 2149.3
P16 P44 UK is the largest provider of banks loans when aggregated.
P21 UK is still the most exposed in FC volatility
P64 UK is the most exposed on loans duration
The banking and financial exposures have to be read when making a distinction between banks having establishments in the foreign countries and offshore banking where currencies exposure, deposits resources and risks concentration are more relevant as exposures.
Off to my roller skates
The following statement is significantly incorrect because it is missing an important and very expensive consideration:
“as a solvency problem, in which case the policy decision is how to allocate the unavoidable capital losses among bank owners, bank creditors, and the government so as to minimize collateral damage to innocent bystanders.” – Hamilton
The missing consideration is timing (i.e. when) for the allocation of unavoidable capital loss. As already identified in the author’s analysis, systemic risk to the global economy is very serious at the current moment. As such, an intermediate policy that buys time until the world is in a stronger economic health will significantly reduce the cost of systemic risk. Timing is critical and should be explicitly call out in above statement. Any policy maker that ignore timing is being grossly callus.
Where the world is at today is already sunk cost. Therefore, a strategy that delays reckoning is a win/win for the world and for Greece.
Privatize profits and socialize risk…its the “golden age” of banking.
The following statement is grossly incorrect with regards to the current global financial crisis:
“It is not the role of the ECB, IMF, or Federal Reserve to bail out banks.” – Hamilton
If the issue is over any particular individual bank, the above statement is correct. However, the current global financial crisis is not about an individual bank.
Today’s financial crisis is about the entire global financial sector!
From the Great Depression, we already know very well what will happens to everyone’s livelihood when a financial system collapses. It is incredible that after 2 years since the start of current crisis, many (including economists) still have difficulty overcoming the above misconception.
The ECB, IMF, the FED and many world central banks understood this. It is really unfortunate the larger public still don’t.
Re Anonymous:
“If the issue is over any particular individual bank, the above statement is correct. However, the current global financial crisis is not about an individual bank. Today’s financial crisis is about the entire global financial sector! ”
Ok, you’re right its bigger than one bank. We’ll have punish failure with orderly disolution one at a time. Alphabetically is as good a system as any, though I’d prefer to start with the letter ‘F’. FNM, FRE …
Prof Hamilton wrote:
1. “And the policy response so far seems to be choosing to allocate 100% of losses to the European and U.S. taxpayers.”
2. “I think it is incumbent on the architects of these measures to communicate what is the structural defect in banking regulation that made such intervention necessary, and what reforms have been implemented to ensure that such measures won’t be needed again.”
I agreed and I would add the fundamental problem identified in the 2nd quote justifies/demands the consequence of the 1st quote. Both greed and fear are like gravity. They have always been and will always be part of us. We, through our government, have setup regulations to prevent the general failures of our economic system. We expected and demanded our regulations to be robust in the face of human greed and fear. Well, our regulations failed, our government failed, and by extension we’ve failed. We, therefore, have to collectively pay the price.
We cannot fix the human conditions greed and fear. We can fix regulations. Therefore the root cause of the financial crisis is our regulations.
By the way, IMF is funded by the many nations of the world. US and European countries are only some of it’s members. Indeed a not insignificant amount of the IMF bailout is a direct wealth transfer from poor nations to the rich. We in the rich nations owe at least a debt of gratitude.
Silly things: “As such, an intermediate policy that buys time until the world is in a stronger economic health will significantly reduce the cost of systemic risk.”
Gambling on “stronger economic health” in the current climate is not wise, unless policy-makers are very confident that they know how to create economic health. (I have to admit the Fed’s done a good job of that with our banks — not that I’m happy with the returns on my savings.) The Dawes Plan was also an intermediate policy designed to buy time until economic growth would solve all ills. How’d that work out?
Anonymous: “From the Great Depression, we already know very well what will happens to everyone’s livelihood when a financial system collapses.”
A few Depression facts: (i) the deepest depths of the Depression were triggered by the collapse of the CreditAnstalt bank in Austria (ii) CreditAnstalt failed because it couldn’t afford to carry the losses imposed on it by the government orchestrated takeover of a failed bank a few years earlier (iii) CreditAnstalt failed because previous bank bailouts had created a bank that was simply to big to bailout.
“From the Great Depression, we already know very well what will happens to everyone’s livelihood when a financial system collapses.”
Be afraid, very afraid…
Unfortunately, the actions of CBs and governments have rewarded the societally destructive activities of “high finance” that were at the root of this deflationary credit crisis. Instead of redistributin trillions of wealth to IBs and their wealth clients we need to fund and reinvigorate traditional banking. We also urgently need to end the capture of our government by high finance. A good start would be anti-trust actions against IBs, a punitive Tobin tax, the banning OTC derivatives, and the reinstatement of Glass-Steagall.
OK, another ingnorant question, but in any case, why is it that Greece would need 1 trillion, when the United States was able to be rescued on a mere 800 billion? I believe the answer is one is sovereign debt, while the other was simply the financial sector. Is this correct? If so, how much when the United States defaults and who is going to rescue us?
Steve,
It’s not just for Greece. It’s all the sovereign debt of the PIIGS. They are doing it mainly because of the threat of banking system contagion.
Eat more chicKen.
“I suspect that the key fear has to do with the consequences of a default or restructuring of the debt itself. Willem Buiter estimates that French and German banks have 110 billion exposure to Greek debt, and total exposure to a potential domino effect could be huge. The WSJ today has further breakdowns, and Dow Jones reports that JP Morgan’s holdings of non-U.S. government bonds increased by $36.5 billion in 2009, while Citigroup’s increased by almost $40 B.
We could then be talking about a replay of the same kind of bank run as we saw in 2008. As creditors who’d lent short-term to banks worried about the banks’ exposure to these risks, banks would be forced to liquidate holdings at fire-sale prices which could again bring lending of all sorts crashing down.”
Will economists ever admit the problem is too much debt?
I doubt it. It seems to me they are incapable of getting beyond price inflation targeting and employment unless their own jobs are at risk.
“It is not the role of the ECB, IMF, or Federal Reserve to bail out banks.”
It seems to me it is. They just don’t want to admit it because voters might actually talk about getting rid of all three worthless organizations that are only concerned about themselves and their spoiled, rich friends and banking buddies.
“These measures are profoundly unpopular with voters in countries such as Germany and the United States.”
Don’t vote for democrats. Don’t vote for republicans. FIRE all central bankers. FIRE at least 95% of the economists. The world will be a better place when those people have no jobs!!!
Once again, economists are talking about countries – not classes within and throughout a set of countries.
The bailout package was a transfer of wealth from workers to failed finance investors. It was not done through ‘the market’ but through the sheer ability to do so . It’s a relationship of power. That’s how life works.
James, not your area, but I wonder what you think of this: FHWA data revision
I can understand that for a couple months numbers may changes as new/late data is evaluated and approved. This is the case for EIA data. But that usually is fixed after two months. These large adjustments going back several years seem spurious. I can imagine many biases that can creep into this organization. Many vested intersts in ITS and other traffic systems and pressure to show validity of EPA rating systems.
I don’t find the FHWA response adequate:
In response to:
JDH: It is not the role of the ECB, IMF, or Federal Reserve to bail out banks. These measures are profoundly unpopular with voters in countries such as Germany and the United States. I think it is incumbent on the architects of these measures to communicate what is the structural defect in banking regulation that made such intervention necessary, and what reforms have been implemented to ensure that such measures won’t be needed again.
You and I both know the only way such measures will not be needed again (where central banks are on the line for private banking messes) are substantial changes to required reserve ratios, and unarbitrageable/zero-loophole ones at that. It’s simply a problem of too much leverage.
A solution to your dilemma (without causing a deflationary panic) is simply to do what the Fed has been doing (but to a larger extreme), ramp up base money and bring down banking system money creation. ie a $20T Fed balance sheet and a 40% reserve ratio.
“One logical response to these circumstances would have been for Greece to abandon the euro, and at a minimum pursue major debt restructuring such as converting outstanding debt to drachma at some rate.”
I don’t understand why this would help. If you borrowed in Euros, aren’t you obligated to pay back Euros. If you pay back in some other currency, then it has to be at the market exchange rate, which doesn’t help you at all. If you don’t convert at the market exchange rate, then you’re just defaulting (partially).
Adam Thompson: “Restructuring” debt in general refers to not paying back everything at the terms originally promised. Converting euro debt to drachma is indeed in effect a partial default. That’s exactly what seems needed for Greece to get out of the hole it’s in.
“‘Restructuring’ debt in general refers to not paying back everything at the terms originally promised. Converting euro debt to drachma is indeed in effect a partial default. That’s exactly what seems needed for Greece to get out of the hole it’s in.”
And that’s exactly what is coming, sooner or later. And not just for Greek debt. What truly aggravates me is that taxpayers will surely be forced to take the bulk of the losses, and by extension, to pay for a substantial part of the financial sector compensation that is still dramatically bloated.
“French and German banks have 110 billion exposure to Greek debt”. How does the distribution look like? Are those debt concentrated in 1 German bank or 1 French bank?
If we look at the Germany or France bank balance sheet. Each has about 7.5trillion euro assets. It is about 1.5% of the bank BS. Also, if there is a default, likely there will be a less than 100% haircut, so, they should be recap part of the debt. So, the 110bil euro seems not significant to collapse their banking system.
What I think is the bailout is for preventing contagion to Spain. The spread is moving together before bailout. A problem in Spain is a problem to the eurozone. In that sense, if European govt is able to ring fence the major countries from contagion with the bailout, it is likely to let Greece go or default/restructure sooner or later.
They do call the program “Shock and Awe”, if you want any glimpse into how the future actual implementation will go.
The immediate goal was to kill the evil speculators who have been screwing up the otherwise pristine finances of the PIIGS.
Next, the EU, ECB and IMF are supposed to either loan money to banks and/or afflicted countries or buy unpopular bonds in the market. None of these rescuers have much money. So the first hurdle will be to raise it somehow. Just about everyone thinks at least partial default is inevitable someday, and you can do it in euros too. So that means whomever goes first among the EU, ECB, and IMF looses, and if the size of the problem continues to grow, they all get totally sucked in eventually. That’s assuming the EU can find enough investors to buy a half trillion in EU debt, which is being lumped on top of say, France and German finances.
So it will be interesting to see how this actually plays out, once the savior players start jockeying again to limit their risk.
Calvin – I’m fairly confident that Spain will go too, sooner or later. Michael Pettis has an excellent post on this.
“The IMF calculates that even if austerity measures amount to 10.9% of GDP by 2013 (turning the primary deficit into a primary surplus), the interest burden on Greek’s debt would still grow to 8.1% of GDP by 2013.”
Wow. How do you avoid default with numbers like that? So either Greece goes down, or the EU and US pony up.
While I agree the CB’s should not, in principle, bail out banks, still, what would you have banks invest in, if not in sovereign debt in an EU country with an implicit EU guarantee? It’s Fannie and Freddie all over again, but the EU, not the US, providing the implicit guarantee.
I keep coming back to Gorton. If there’s too much money floating around, it will find a way to destroy the system.
Steven, ” keep coming back to Gorton. If there’s too much money floating around, it will find a way to destroy the system.”
This is something that goes around in my mind forever, and I still can’t make any economic sense of it. Is far as I can tell, economics has not figured out a way that an aging world demographic, without any huge wealth cancellation events since WW2, can in fact retire off of savings.
But shouldn’t there be?
The real question is “what’s in it for Greece”? Greece should have chosen not to be “rescued”. The people being rescued are the holders of Greek bonds not the Greeks – the Greeks are going to have to go through the pain of “cold turkey” addiction withdrawal. The Greeks should have left the Euro, set the drachma at 1 Drachma = 1 Euro with respect to its Euro denominated debt and then let the currency markets cause it to de facto default by drastically lowering the Euro value of its new drachma denominated debt. Let France and Germany take care of their own careless bankers.
What we are seeing with this Eurozone bailout is how completely dependent the global financial system has become on low interest rates. Even with Euro rates at 1%, the Eurozone already needed this mutual support mechanism to keep private debt markets open to its more questionably solvent members. The guaranteeing of Spain, Portugal, Ireland and Greece by the rest of the Eurozone is at least somewhat plausible. But imagine Eurozone rates went a mere 1 or 2 points higher, and how much that would add to roll-over costs, and thus how many other countries would need guarantees. Italy, Belgium, maybe even France? And how many local governments, eg German municipalities, would need bailouts from their national governments?
Despite the US’s far greater capacity to sell government debt especially at times of crisis, the US is just as locked-in to low interest rates for the same reasons. With a primary deficit around 10% and total deficit near 14%, the US can’t afford to increase rates as that would sharply increase the cost of rolling over its debts.
Mark_K,
Some have have noted that all business contracts are denominated in Euros, and there would be legal problems with paying in monopoly money, for those who do not have the ultimate Holy Power of Sovereigns.
It would also result in a 100% run on banks within Greece, and happen slightly slower than the speed of light.
“I think it is incumbent on the architects of these measures to communicate what is the structural defect in banking regulation that made such intervention necessary, and what reforms have been implemented to ensure that such measures won’t be needed again.”
The structural defect is fiat money rather than market produced money. How can a market not fail when its most central price is continually manipulated by central banks?
JDH:
And the policy response so far seems to be choosing to allocate 100% of losses to the European and U.S. taxpayers.
It is not the role of the ECB, IMF, or Federal Reserve to bail out banks. These measures are profoundly unpopular with voters in countries such as Germany and the United States. I think it is incumbent on the architects of these measures to communicate what is the structural defect in banking regulation that made such intervention necessary, and what reforms have been implemented to ensure that such measures won’t be needed again.
The profound structural defect that was ultimately responsible for this crisis was the unwillingness of Greek taxpayers (or should I say nontaxpayers) to act like adults. I don’t have a lot of sympathy for the banks, but the Greek structural (as opposed to cyclical) deficit preceded the “structural defects in the banking system.” And of course that’s a lesson that goes beyond Greece. The monetary union was supposed to constrain a member country’s ability to run massive structural deficits, so something broke down there. And again, just to be clear, I’m talking about permanent structural deficits and not transient cyclical deficits.
Yawn … the EU money managers take cash from one pocket and put it into another pocket and call it a ‘rescue’. What will they do for an encore?
What is salient about this ‘Greek’ crisis is its inevitability. Since the beginning of the year the default of several European economies and the ultimate demise of the euro for fiscal reasons has been the issue.
Months – and several pocket- to- pocket ‘bailouts’ later the default of several European economies and ultimate demise of the euro for fiscal reasons is STILL the issue. What are these people doing over there (here)?
No single country (save non- entities such as Latvia or Ireland) will abandon sovereignty but the issue is for the Eurozone to do just this for at least a trial period. Another in the endless series of Euro- meetings to do just that – and to do so quickly – would be sensible. Hang together or hang separately … you know what I mean?
An alternative would be government- swapping. Sarkosy government would run Ireland, the new UK coalition run Portugal, Merkel AG could boss Slovenia, etc. Just like wife- swapping but for the short term the inability to absorb blame might allow for some statesmanship. The US could swap governments with Ecuador.
Cuba would be even better, citizens here might become better gardeners.