¿A QUE PRECIO LA NUEVA DEMOCRACIA?

"What price the new democracy? Goldman Sachs conquers Europe

While ordinary people fret about austerity and jobs, the eurozone's corridors of power have been undergoing a remarkable transformation

The ascension of Mario Monti to the Italian prime ministership is remarkable for more reasons than it is possible to count. By replacing the scandal-surfing Silvio Berlusconi, Italy has dislodged the undislodgeable. By imposing rule by unelected technocrats, it has suspended the normal rules of democracy, and maybe democracy itself. And by putting a senior adviser at Goldman Sachs in charge of a Western nation, it has taken to new heights the political power of an investment bank that you might have thought was prohibitively politically toxic.

This is the most remarkable thing of all: a giant leap forward for, or perhaps even the successful culmination of, the Goldman Sachs Project.

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Simon Johnson, the former International Monetary Fund economist, in his book 13 Bankers, argued that Goldman Sachs and the other large banks had become so close to government in the run-up to the financial crisis that the US was effectively an oligarchy. At least European politicians aren't "bought and paid for" by corporations, as in the US, he says. "Instead what you have in Europe is a shared world-view among the policy elite and the bankers, a shared set of goals and mutual reinforcement of illusions."

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Mr Monti is one of Italy's most eminent economists, and he spent most of his career in academia and thinktankery, but it was when Mr Berlusconi appointed him to the European Commission in 1995 that Goldman Sachs started to get interested in him. First as commissioner for the internal market, and then especially as commissioner for competition, he has made decisions that could make or break the takeover and merger deals that Goldman's bankers were working on or providing the funding for. Mr Monti also later chaired the Italian Treasury's committee on the banking and financial system, which set the country's financial policies.

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Perhaps the most prominent ex-politician inside the bank is Peter Sutherland, Attorney General of Ireland in the 1980s and another former EU Competition Commissioner. He is now non-executive chairman of Goldman's UK-based broker-dealer arm, Goldman Sachs International, and until its collapse and nationalisation he was also a non-executive director of Royal Bank of Scotland. He has been a prominent voice within Ireland on its bailout by the EU, arguing that the terms of emergency loans should be eased, so as not to exacerbate the country's financial woes. The EU agreed to cut Ireland's interest rate this summer.

Picking up well-connected policymakers on their way out of government is only one half of the Project, sending Goldman alumni into government is the other half. Like Mr Monti, Mario Draghi, who took over as President of the ECB on 1 November, has been in and out of government and in and out of Goldman. He was a member of the World Bank and managing director of the Italian Treasury before spending three years as managing director of Goldman Sachs International between 2002 and 2005 – only to return to government as president of the Italian central bank.

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"My former colleagues at the IMF are running around trying to justify bailouts of €1.5trn-€4trn, but what does that mean?" says Simon Johnson. "It means bailing out the creditors 100 per cent. It is another bank bailout, like in 2008: The mechanism is different, in that this is happening at the sovereign level not the bank level, but the rationale is the same."

So certain is the financial elite that the banks will be bailed out, that some are placing bet-the-company wagers on just such an outcome. Jon Corzine, a former chief executive of Goldman Sachs, returned to Wall Street last year after almost a decade in politics and took control of a historic firm called MF Global. He placed a $6bn bet with the firm's money that Italian government bonds will not default.

When the bet was revealed last month, clients and trading partners decided it was too risky to do business with MF Global and the firm collapsed within days. It was one of the ten biggest bankruptcies in US history.

The grave danger is that, if Italy stops paying its debts, creditor banks could be made insolvent. Goldman Sachs, which has written over $2trn of insurance, including an undisclosed amount on eurozone countries' debt, would not escape unharmed, especially if some of the $2trn of insurance it has purchased on that insurance turns out to be with a bank that has gone under.

(…) This is the rationale for the bailouts and the austerity, the reason we are getting more Goldman, not less. The alternative is a second financial crisis, a second economic collapse.

Shared illusions, perhaps? Who would dare test it?”

STEPHEN FOLEY

THE INDEPENDENT

LA DEUDA EUROPEA: ¿QUIEN DEBE CUÁNTO A QUIEN? (BBC)

LA CRISIS DE LA DEUDA EUROPEA

LA CRISIS DE LA DEUDA EUROPEA SEGÚN SATYAJIT DAS

SIGUEN EXTRACTOS AMPLIOS DEL ANALISIS EN INGLES DEL CITADO AUTOR

DE LA PARTE 1 (4 DE ENERO DE 2011):

Misión Interrumpida

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“As of August 2010, the level of ECB funding was as follows:


Euro (billions)
% of Deposits
% of Gross Domestic Product
Greece
96.1
26
40
Ireland
95.1
14
60
Portugal
50.1
15
30
Spain
119.0
5
11

Following the Irish crisis in the second half of 2010, the funding demands on the ECB have increased. Ireland’s borrowing from the ECB has reached Euro 136 billion (86% of Gross Deposit Product ("GDP")), around a quarter of Euro-zone member drawings on the facility.

The ECB has expressed concern about Europe’s "addicted financial groups". But with banks affected by their sovereign’s debt problems and maturing debt not being rolled over, the ECB has little option but to continue the arrangement.

The approach of the EU/ ECB assumed that the problem was temporary liquidity not solvency. The solution was to ensure that the troubled countries could continue to finance. The restoration of confidence would enable a rapid return to market financing and the status quo.

Nothing exemplified this better than the ill-conceived and poorly designed EFSF. Amongst the multiplicity of problems were the limited guarantees from Euro-zone countries and a reliance on CDO rating methodology. The preliminary analysis of the EFSF by the credit rating agencies confirmed the view that the facility was not designed for use. Close inspection also revealed that the facility was only capable of being drawn for an amount as low as Euro 250 billion, well short of the advertised Euro 750 billion. It was a pure confidence trick.

DE LA PARTE SEGUNDA (5-01-2011):

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PLATOS AMARGOS

The EU and IMF are hoping that the bailouts of Greece and Ireland will restore market confidence. In combination with stronger growth, greater fiscal discipline and domestic structural reforms, they hope that the fear of default or restructuring will recede. Eventually, the troubled countries will regain access to markets. The emergency facilities and support mechanisms will be gradually unwound. While not impossible, the chances of this script playing out are minimal.

A more likely scenario is that the support measures do not work and increasingly Portugal and Spain, initially, find themselves under siege. As market access closes, they too will need bailouts straining existing arrangements, necessitating new measures. If Portugal (debt around Euro 180 billion) was to require assistance, then it will reduce the available funds in the existing EU’s bail-out mechanism. Spain (with debt of over Euro 950 billion) is simply too big to bail out using the present facilities.

Under such a scenario, available options include greater economic integration of the EU, expansion of existing arrangements or a decision to allow indebted countries to fail.

Greater economic integration would entail adoption of a common fiscal policy, encompassing strict controls on fiscal policy including tax and spending. It could also include the issue of Euro zone bonds ("E-Bonds") to finance member countries. Championed by Jean-Claude Juncker, Luxembourg’s Prime Minister and chairman of the Euro Zone finance ministers’ meetings, the E-Bond would lower borrowing costs for peripheral economies and facilitate access to markets.

Fiscal union would prevent default of over-indebted borrowers without necessarily addressing the fundamental problems of individual economies. The likelihood of greater fiscal union in the near term is limited, as it is unlikely that nations will surrender the required economic powers and autonomy.

The E-Bond proposal, for up to 50% of a State’s funding requirement, is unworkable given large differences in credit quality and interest rates between Euro Zone members of around 10%. The E-Bond credit support structure would resurrect the ill-fated EFSF on a larger scale.

In any case, Germany takes the view that national governments should bear responsibility for their own decisions. Germany also opposes E-Bonds, as they would increase its borrowing costs. France’s early enthusiasm for E-Bonds seems to have diminished.

The cost of full fiscal union is prohibitive, entailing between Euro 340 billion and Euro 800 billion, depending on the degree of fiscal imbalances. Much of this cost would have to be borne by Germany and other richer economies.

If Portugal and Spain experience problems, then in absence of a full fiscal union, the only available actions are further EU support or default.

There have been proposals to expand the EFSF/ ESM as needed. While Germany currently has opposed any expansion, it remains an option. Perversely, increasing the funding available to support troubled countries may signal that problems were imminent, with a resulting loss of confidence necessitating a bailout.

The ECB can increase support for the relevant countries, in the form of purchases of bonds or financing Euro Zone banks to purchase them. Interestingly, the ECB will increase its capital base, from Euro 5.76 billion to Euro 10.76 billion by end 2012, the first such increase in its 12-year history. The increase in capital allows greater support from the ECB, whilst providing reserves against potential losses.

In an extreme scenario, the ECB could simply print money, following the US Fed’s lead, to support its members, known technically as "unsterlised purchases". Such action may not be permissible under its existing rules, requiring amendments to EU treaties. It would severely damage the ECB’s already tenuous credibility and be resisted by Germany and other conservative EU countries.

"Extend and pretend" measures would allow orderly default or debt restructuring by some countries over time. It minimises losses, controlling the timing and form of restructuring. It would also minimise disruption to financial markets and solvency issues for investors and banks with large exposures.

If the EU does not agree to fiscal union or continuing support, then pressure on Portugal, Spain, Italy and Belgium may reach a tipping point, making default or restructuring the likely end game. Presumably, existing programs, such as those for Greece and Ireland, would be suspended. Governments would announce debt moratoriums, defaulting on at least some debts and forcing write downs. This would be followed by a domino effect of defaulting countries within Europe.

The defaults would affect the balance sheets of banks, potentially forcing governments, especially in Germany, France and UK to inject capital and liquidity into their banks to ensure solvency. The richer nations would still have to pay, but for the recapitalisation of their banks rather than foreign countries.

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Large volumes of maturing debt mean that the test is likely to come sooner than later. The heavily indebted European sovereign states face $2.85 trillion of maturing debt in the period to 2013. Portugal, Italy, Ireland, Greece and Spain have bond maturities of $502 billion in 2011. The financing needs of Greece, Ireland, Portugal and Spain over the last quarter of 2010 and 2011 are Euro 320 billion, rising to Euro 712 billion if Italy is included. In addition, private sector borrower in these countries face maturities of $988 billion of corporate bonds and $200 billion of syndicated bank loans over the same period. Likelihood of low economic growth, failure to meet IMF plan targets, further banking sector problems and credit downgrades exacerbate the risk.

If Europe muddles it way through the refinancing crisis, then the expiry of existing support facilities in 2013 and the changed regime of the ESM poses new risks and may continue the instability.

DE LA PARTE TERCERA (6-01-2011):

UN CONTINENTE LEJANO


(…)

China, which contributed around 80% of total global growth in 2010, has expressed growing concern about the problems in Europe. Trade between China and the EU, its largest export market, totals around $470 billion annually, contributing a trade surplus of Euro 122 billion for China in the first nine months of 2010. Any slowdown in Europe would affect Chinese growth. China is also a major holder of Euro sovereign bonds, standing to lose significantly if problems continue. China has indicated preparedness to use some of its $2.7 trillion of foreign exchange reserves to buy bonds of countries such as Greece and Portugal.

A slowdown in China would affect commodity markets, both volumes and prices, and commodity exporters such as Australia, China and South Africa. Minutes of a 7 December 2010 from the central bank of Australia, one of the world’s best performing economies, indicated increasing concerns about developments in Europe.

A continuation of the European debt problems, especially restructuring or default of sovereign debt, would severely disrupt financial markets. Losses would create concerns about the solvency of banks, in particular European banks. In a repeat of the events of September 2008 (when Lehman Brothers filed for bankruptcy protection and AIG almost collapsed) and April/ May 2010 (prior to the bailout of Greece), money markets could seize up, as trust about the ability of parties to perform contracts evaporated. In turn, this volatility would feed through into the real economy, undermining the weak recovery.

Unless resolved, the European debt problems will affect currency markets and through that channel the global economy. Any breakdown in the Euro, such as the withdrawal of defaulting countries or change in the mechanism, would result in a sharp fall in the new currencies. In turn, this would, in the first instance, result in large losses to holders of debt of those countries from the devaluation.

Depending on the new arrangements, the US dollar would appreciate abbreviating the nascent American recovery. This may compound existing global imbalances and trigger further American action to weaken the dollar. Further rounds of quantitative easing are possible, setting off inflation and de-stabilising, large scale capital flows into emerging markets. In turn, the risk of protectionism, full-scale currency and trade wars would increase. A breakup of the Euro would adversely affect Germany, which has been growing strongly. A return to the Deutschemark or, more realistically, an Euro without the peripheral countries may result in a sharp appreciation of the currency, reducing German export competitiveness.

As the Australian central bank noted in its December 2010 minutes: "… the deterioration in the situation in Europe over the past month had increased the downside risks to the global economy. How this would ultimately play out, and the implications … were difficult to predict. It was possible that conditions could settle down, as they had after the episode of financial instability in May. Alternatively, an escalation of the current problems was not out of the question. If this prompted a fresh retreat from risk-taking in global financial markets, it would probably have more impact … than any trade effect."

FINAL DE LA PARTIDA

Events since the announcement of the bailout package in early 2010 have been reminiscent of 2008. Then, the optimism following bailouts of Bear Stearns and other troubled American banks produced premature. The promise of China to purchase Portuguese bonds is similar to the ill-fated investments of Asian and Middle-Eastern sovereign wealth funds in US and European banks.

Eventually with each successive rescue and the reemergence of problems, the capacity and will for further support diminished. The EU rescue of Greece and Ireland are also reminiscent of US attempts to rescue its banking system, with more and more money being thrown at the problem. The strategy was defective, preventing the creative destruction required to restore the system to health. The actions may have doomed the economy into a protracted period of low growth, laying the foundations for future problems.

At the time of the Greek bailout, the real question was: "If Euro 750 billion isn’t enough, what is?" Increasingly, markets fear that there may not be enough money, to solve the problem painlessly.

In 11 May 1931, the failure of a European bank – Austria’s Credit-Anstalt – was a pivotal event in the ensuing global financial crisis and the Great Depression. The failure set off a chain reaction and crisis in the European banking system. Some 80 years later, European sovereigns may be about to set off a similar sequence of events with unknown consequences. As Mark Twain observed history does not repeat, but it may rhyme.”

© 2011 Satyajit Das

Satyajit Das is the author of "Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives".

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