SOROS, TRICHET, MERKEL & IF PIIGS COULD FLY

Otto von Bismarck made a speech in 1862 saying, "The great questions of the time will not be resolved by speeches and majority decisions... but by iron and blood", and thereafter was known as The Iron Chancellor, an appellation all subsequent Kanzlers aspired to, some far too much so. of course. There is more than a whiff of iron in the air of the sovereign debt crisis, Governments' own Credit Crunch, iron being also the smell of blood. Angela Merkel and her Finanzeminister Herr Wolfie Schäuble have not appeared tolerant of Diskussionen, preferring summit policy agreement only by Edict of Maastricht, the Euro Growth & Stability Pact.
Since January there have been oft-repeated calls among politicians, public, market traders and newspapers for Greece (its commercial and treasury paper now junk status) to leave the Euro, then later calls for Germany to leave, and most recently France saying it might leave if Germany does not change its economic stance (these two countries being the only ones with triple AAA status left in the Euro Area!) Netherlands should have triple-A status except it allowed its biggest banks to collapse in ignominy (I hope Nout Wellinck becomes the next President of the ECB at the end of next year to replace Trichet?)
The UK stands hunched offshore, on the sidelines, hand-wringing, and navel-gazing only at its own public finances. Ireland, Spain,and Portugal are teeth-chattering to see who or what hits them next, Italy somewhat secure by comparison, a novel experience for Rome, and France feeling it must be the unity champion, but not if Germany fails to hold up its half of the EU project deal.
This story below is a reduced form of the debate, a triangle with Angela Merkel (whom the Daily Telegraph called "brass-necked") representing the EU's biggest economy that stands as creditor counterpart to most of the rest, Jean-Claude Trichet the Euro Area's financier ECB, and George Soros representing international capital markets.
Trichet has decided he must side with Germany that some might conclude is ECB's biggest paymaster, but also its biggest customer-borrower. Germany has net foreign assets of €1tn, while the rest of the Euro Area's is minus €2.5tn, and germany owna 40% of ECB's reserves. It's ex-Euro Area trade surplus also halves the rest of the EA's deficit. These apart from any other reasons are good ones for why ECB President Trichet should remain on Kanzler Merkel's good side.Trichet said after the G20 last week that "Merkel’s actions will boost confidence among households, investors and companies and will help consolidate the recovery", speaking to Italy's La Repubblica. That view is at odds with what many economists and veteren arbitrageur George Soros said on Wednesday, telling a Berlin audience why the euro is flawed: "By insisting on pro-cyclical policies, Germany is endangering the European Union... "I realize that this is a grave accusation, but I am afraid it is justified." Trichet dismissed this, saying the euro [EUR/$=1.2182] is a very credible currency that kept its value and guaranteed price stability for 11'5 years, with average annual inflation of 1.98% in the euro-zone. "A currency that guarantees such stable prices, it's of value in the eyes of domestic and international investors" Trichet told La Repubblica. Of course, as every investor knows, supposedly past performance is no guarantee guide to future performance. Yes, but?
The day before, Wednesday, Soros said that "by cutting its budget deficit and resisting a rise in wages to compensate for the decline in the purchasing power of the euro, Germany is actually making it more difficult for the other countries to regain competitiveness."
That is correct if Germany's €250bn foreign trade surplus is 60% earned within the EA, which I think the data allows us only to suppose to be probably true.
If so it's $120bn ex-EA surplus helps pay via the ECB for most of the rest of the EA's non-€ trade deficit with the rest of the world but for which it gets €150bn trade & payments gain from the rest of the EA, a nice trade. Netherlands also earns a substantial trade surplus, as do a few others, much of it from Germany as in Ireland's case. But, it is from the above interesting that we could put a figure of €50bn on how much more Germany should be importing annually net from the rest of the EA, which I suggest works out at a rise in gross imports from the rest of the EA of €200bn roughly to get a change in the net surplus of €50bn.
That means Germany increasing its imports by over 16%, and from the reast of the EA by 27% or three months worth. That is a big adjustment and practically impossible; looks easier and cheaper just to pay over €50bn annually, but how? The Europen Stabilisation Bank fund of €720bn of which €250bn is from the IMF (using EA member states deposits and drawing rights perhaps) equates to a decade of such payments if the balance all came evenNtually from Germany. Its contrubution is just shy of €150bn.
Merkel defended her actions last weekend, saying they will prevend future crises. Well, er, no, that's what they said about TARP in the USA. All experts are saying that Europe's banks have not disclosed their full losses from the Credit Crunch and Recession. Indeed, looking at some banks such as certain french banks, others too, one would be hard pressed to find signs of either Credit crunch or recession in the balance sheets such as BNPP, with certain notable exceptions as SocGen and of course the small local banks. But, experts can be wrong. Anglo-saxon experts would be wrong if they expect to find continental European banks except for Spain and Greece to be so heavily exposed to property as US-UK banks. The Netherlands banks bought in foreign property exposure e.g. Fortis, and ABN AMRO, ING too but less so, to their cost.
Ireland, remarkably for a small country with a surprisingly huge trade surplus, its banks ran with the credit-boomers, didn't lend to business much, lavished all on property lending and incurred a massive balance of payments deficit double-negating its trade surplus - truly bizarre! The UK banks lent far too heavily on property and mortgages but unlike Spain, and Ireland there is no poperty surplus so residential values fell less than expected, while only commercial property did the expected and tanked. hence, the collateral damage of Credit Crunch and recession is a curate's egg in Europe. let's not forget that Germany is another China in trade volume, surplus and massive over-lending to business while relatively neglecting property and household consumer lending.
In any case the Credit Crunch did not result in a Euro Area recession so much as a big short-lived negative growth shock from the USA-UK bow-wave. The Euro Area boat (Das Boot) has its normal recession still due, if it arrives on time, before this time next year! The socvereign debt crisis may take the blame including Germany's Iron Kanzlership, and people will talk of "double-dip" and UK will catch a feverish cold from it, a dunking from a Euro bow-wave, but actually this would be a misinterpretation. Continental Europe regularly has its recession 24-30 months out of synch with the Anglo-Saxon cycle. Hence, there is something tobe said for battening down the hatches on government finances to make some room for expansionery spending when recession hits.
Could Euro recession be avoided like the UK avoided recession in 2001 by pre-emptive spublic spending increases. The answer is possibly yes, but more probably no, because the Euro Area is too evenly split between credit-boom and export-led economies. Will another or prolonged crisis sound the death-knell for the Euro system, and also be triggered by assuming greater writedown losses to please the Anglo-Saxons, haha? The writedowns from Credit Crunch currently stand as follows: Whatever the triffers appear to be, the Euro System is in a "Merkel of all Crises" (Scots: muckle; US usage 'Mother') such that the Euro system's collapse is more probable than diplomats assume to be thinkable. The currency union may not break-up or the Euro actually crash to the floor, but the system must change. And, do not under-estimate the power of financial speculators to smell blood in the water and what they will do to garner the tens of $billions of speculative profits on fears of Euro-collapse, even if the Euro never truly falls apart! Pitted against that is the political will of the EU, which should prove stronger, not least to avoid political security crises within and along EU borders.
This is more than just deflation Risks. But Trichet does not believe that austerity measures being by European governments will cause deflation. can he back that up with systematic evidence - no! he hasn't got a macroeconomic model to tell him what to say on that score. his job is spin-doctoring for confidence raising.
Some bearish investors are betting that cuts in government spending across the European Union will add to deflationary pressures at a time when consumers and businesses are de-leveraging, lending and borrowing less, battening down until the storm passes.
Growth will fall sharply, with zero growth effect coming from household consumption, business investment or bank lending when government too is deflationery. Where is growth to come from? Will it be trade with the rest of the world or asset sales to foreignors? hardly. Whatever is imagined cannot be currently foreseen or computed by the financial markets experts, words I offer up with a dry taste and pained smile. Some speculators seem more like agent-provocateur rioters or muggers to me. Private sector deflation is pushing yields on 10-year bonds down to 2 percent, triggering a new wave of quantitative easing, Bob Janjuah, chief markets strategist at RBS told CNBC. Is that telling us something? Not in my book. Markets are not economists and they read their capital market screens like Chinese courtesans read tea-leaves.
"I don't think that such risks could materialisee," said the great seer Trichet, adding that inflation expectations are well anchored. They would be if deflation's coming? "As regards the economy, the idea that austerity measures could trigger stagnation is incorrect." one has to ask, why not? How can stagnation be triggered except by austerity on all fronts beginning with government? trichet has an answer to that chiming with merkel but totally opposite to Soros. This is not a love triangle at all! Reforming the real economy in each country in the euro zone is what is needed, according to Trichet.
That is just so easy to say and as anyone knows it is a long term gameplan, but not one that governments sho believe in leaving matters to free enterprise and financial markets engage in trying to achieve beyond a relatively passive (supply side fiscal economics) second guessing.
"We ask all governments to be determined to carry out structural reforms to increase the potential growth," trichete said. "I insist on the need to boost work productivity: in the medium- and long-term, growth depends right on this." If PIIGS could fly!
It is bizarre that Trichet can say Governments have to restructure, or economies do so, when we know it is already proving exceptionally hard to restructure the banks, something the ECB needs to take more responsibility for and relieve EA member states of the bruden on their budget balance sheets. None of this economic competitiveness restructuring can happen unless Europe's banks in all countries dramatically change the composition of their lending between productive and non-productive investment, from demand to output and vice versa. Export-led economies' banks are far too heavily exposed to industry assets and credit-boom economies' banks even more exposed to property assets. If the EU and EA simply rely on radically restructuring without coordination and financial rebalancing measures how the chips will fall may turn into a game of chance. The Commission's meisterwerk of a €720bn stabilisation fund appears to be a keystone, but it has to cope with Europe's banks refinancing €5 trillion in funding gap finance ove the medium term that could very easily take all of that and more.
There is more darkness to come before the dawning dawn.

Verdammtnochmal; diese einseitige Konjunktor schon wieder! - of Europe' biggest economy!

GERMANY as usual yet again plays only its one note economic flute - a picture postcard to the rest of the world hiding a domestic ruthless economic selfishness that does not extend to its over 3.1 million unemployed and rising (or 5 million, 3 or 5 depending on your preferred measure)! Since the mid 1970s Germany has maintained a high unemployment rate and in most years a depressingly low consumer spending. The effect is partly borne by migrant workers, but less than imagined; very much by German youth and by early retirees. This coincides since the 1970s with local and regional government spending restrictions and cuts. German industry has been forced to rely heavily on exports. Germany's economy is a good example alongside Japan of how year after year substantial trade surpluses do not a happy economy make, and do not translate well into general economic growth. In US dollar terms the economy experienced long recessions and near-recession periods in the first half of the 1980s and second half of the 1990s and first half decade of the twenty-first century - half of the last three decades. These were only growth periods in Deutschmark terms.Both Germany and Japan have been inflation, export surpluses, high currency exchange rate, and monetary policy obsessed with one major difference, Germany kept its national debt low and unemployment high while Japan did the opposite. Both countries, however, sacrificed domestic consumer-led growth (thereby restricting imports) on the alter of exports above all else. They do not make happy trading partners - a model and brand followed by China that can at least claim some good reasons for doing so until now. Following their failures to become world military superpowers, Germany became mesmerised like Japan by the wonder of being perceived around the world as an economic superpower. Once the post-WW2 decades of reconstruction ended in the 1970s oil-price recession shock, since then Germany and Japan preened themselves as creditor nations, and in Germany's case especially the cost has been lower growth, mainly export-led and therefore high unemployment. Economic conservatism was excused for many years by national anxiety in general, a pervasive sense of economic insecurity, paranoid fear of inflation, and of hyper-inflation in particular. I know Germany very well and can confirm that these feelings of fearfulness were genuine even in the halcyon days of fast growth and full employment.
The second half of the twentieth century confirmed Germany's reputation as a strong economy, the world's engineer, a land of discipline, quality and precision in design as in manufacture. Japan developed a similar production ethos supplemented by diligent sales-marketing, reverse-engineering innovation, and price competitiveness. The problem is that what impressed foreign markets became the sum total of what impressed Germany and Japan about themselves! Their only wish is for this to continue indefinitely. Meanwhile German manufacturers have been not even reliant on German bank loans but able to self-finance investment and rely on bank borrowing in its trade partner countries. Today, Germany's goods exports are 41% ratio to GDP, one third more by value than total of German industrial output (compared to goods exports in UK of 17% ratio to GDP, 40% less by value than total UK industrial output, and 6% in USA, only 30% of total industrial output). Services in Germany are 66% of GDP, compared to 82% in UK and 77% in USA. Germany's imports are 33% ratio to GDP (half of which is energy and some of the rest for re-export), compared to imports ratio to GDP of 23% for the UK and 10% in the USA. Germany can claim to be a substantial importer, but its greater reliance on the external account bespeaks an repressed domestic economy. This, it was hoped by other EU members, would change with the Euro single currency whereby the German economy as the EU's largest (equal to UK and Spain combined) would open up more to become a more balanced two-way trading partner with the rest of the EU, not least because of the reconstruction and development of East Germany. That did not happen! German policy setters did not allow it to happen! The Einheitssteuer tax to fund reconstruction was sufficiently harsh to dampen demand in the whole country - it was a totally unnecessary tax other than helping to keep the economy relatively closed within the EU. Unlike the UK in the nineteenth century when it ran decades of trade deficits because of following a 'free trade' policy alone that benefited the growth of continental Europe more than the UK, Germany found ways of maintaining trade surpluses even within the free trade zone of all of the EU!
Germany’s reliance on manufacturing to spur export-led growth was highlighted on Friday by an exceptional spurt in industrial orders, reported as parliamentarians showed the fiscal discipline they are famous for by trimming €5.6bn from this year’s German budget. Industrial orders leapt by 4.3% in January, largest monthly increase since June '07, helped by the weaker euro.
The rebound followed a 1.6% fall in orders in December at the end of a period when de-stocking dominated over output investment. Eurozone services have been hit by weak domestic demand causing and caused by rises in unemployment and cut-back in governments' stimulus measures.
As usual, cuts in the German federal budget will mostly affect spending on welfare and job creation. This beggar-my-neighbour via trade action should trigger complaints from trading partners, especially in EU countries that have been urging Germany to increase public spending to stimulate domestic demand and help the recovery of the whole of the eurozone.But, like Japan, Germany is well-versed in evading domestic stimulation (also known as endogenous growth impulse). As a recipe for everyone else it is of course impossible for all others to similarly shift their policy stance to focus only on export-led growth; exporters need importers - if some countries insist on running high trade surpluses other countries have to run high trade deficits. It does not therefore behove Germany to tell Greece or any other countries how to manage their growth, and certainly not on the German model, a model that can only ever suit the few, not the many!
Members of the ruling centre-right coalition pushed through the cuts, which will trim government spending from €325.4bn ($443.5bn, £294.5bn) to €319.5bn, and reduce the forecast deficit for 2010 from €85.8bn to €80.2bn, to only 2% of GDP, which is simply callous, appallingly low when the EU and the rest of the world is recovering from recession, and shows an indifference to national unemployment, which today is only 16% below what it was in the Germany of 1933 (although 6 millions unemployed was only the official figure; other figures suggest 11 millions)!
There is a historic logic to Germany's obsession with exports. The German economy failed to heed the export mystique only in the years up to and after 1933-45 that was, however, also based on seeking economic independence from the global economy. Between 1910 and 1913, exports accounted for 17.8% of Germany's GDP, then 14.9% in the second half of the 1920s falling with the Great Hyperinflation and persisting in falling to only 6% in the second half of the 1930s under the Nazi regime, then the war. But by 1950 accounted for 9.3% of West Germany's GDP. With postwar economic boom, exports rose to 17.2% of GDP in 1960, and to 23.8% in 1970, rising through economic downs and ups and domestic retrenchment to 26.7% by 1980, and 33% in 1990, up to 41% today. Fine, but this cannot continue! The original budget was tabled by Wolfgang Schäuble, the finance minister, and proposed the highest deficit ever recorded in absolute terms – more than double the previous peak figure of €40bn (but if today only 1% of GDP!). The FT commented that "it is rare for parliamentarians in Germany to attempt to reduce federal spending, rather than try to increase budget lines for their favourite projects". Er, not so, what planet has the journalist been living on? The coalition government's majority Christian Democratic Union party and minority Free Democratic Party decided that Germany needed to send a signal to the rest of Europe – particularly in light of the ongoing Greek economic crisis and pressure on the euro. What Europe do they imagine they have been living in?
The gradual recovery of the German economy, and the continuing only relatively lower unemployment by Germany's high levels it has become inured to, made the cuts supposedly possible. The spending figures and the cuts were opposed by Social Democrats and Greens (a party I helped to found in the late 70s), but will be passed March 19.

CLUB MED COUNTRIES GET ROD OF IRON?

Portugal, Spain, Italy and Greece are all in breach of 3% Maastricht crieria budget deficits and 60% national debt to GDP ratios. That is an issue currently shaking the Euro system and is being talked up as a major challenge to EU integrity - even if everyone else in the EU are also in breach of the 3% ceiling for budget deficit ratios. It is not far fetched to point to a North-South EU divide between the self-proclaimed prudent beer-swilling cold-hearted North and an imprudent impudent wine-savouring sunny South, between an iron north and a malleable south? Passing our Edinburgh statue to one of my great great grandfathers, The Duke of Wellington (Duke of Douro in Portugal), I was reminded in a Radio 4 discussion about the history of UK national debt, by historian Niall Ferguson that Wellington was nicknamed the Iron Duke not for his defence of Portugal or for victory at Waterloo, but for installing iron shutters on his windows at Apsley House that were regularly being stoned, almost daily, by the mob protesting about economic hardships and his opposition to the Great Reform Bill in 1831. Today the stones are being thrown for similar reasons in the so-called 'Club Med' countries, and the The Guards charging the mob, who were nicknamed the "Piccadilly Butchers", are in today's EU supposedly the Germans. FT's Lex looked at the Club Med countries as a group perhaps because they are currently each experiencing street protests, sometimes violent, against budget cuts imposed. some say at the behest especially of 'Iron' Germany, to make them and all other fiscal recalcitrants comply with Maastricht deficit rules, that Germany itself is marginally in breach of? Two centuries ago, to help balance its books, the French under King Joseph invaded Andalusia and began the long two and a half year long bloody siege of Cadiz! Let's not indulge economic equivalents, to traduce the idea of the EU as having kept the military peace in Europe, only to replace it with open economic-warfare. The EU runs a modest trade deficit with the rest of the world. If Germany persists in maintaining a substantial export surplus internally and externally to the EU, then it has to live with the fact that many of its EU fellow member states must run deficits and therefore Germany has to buy the deficit countries' bonds to fund the current account imbalances.German politicians have particularly decried the profligacy of the Club Med states, no doubt mainly for domestic political consumption plus a little leverage at the loans negotiations. Athens politicians complain this is Berlin bullying and the mob and expert commentators agree. FT Lex says, "Amid a rash of strikes in Greece, Spain and Portugal, emotions are running high. Yes, Greece and the other big-spending Club Med countries must tighten their belts. They also need to increase their competitiveness. But to insist, as Berlin has done, that austerity is the only way out for these countries is both unrealistic and untrue. Germany must play a role too." I agree, except this is not yet the time for so-called 'belt tightening'. Much of the anciety is caused by the evidence of Greek sovereignty rating crisis hitting the Euro, example of tail wagging dog, or as Soros would say 'tails' given similar problems in Ireland, Portugal and Spain. Greece, Spain and Portugal, less so Italy, have been running large trade and current account deficits for many years. Italy, unlike the others, did not indulge in credit boom growth. In credit crunch terms, Italy has been the most prudent economy in the EU. The ECB has provided loans to support bank aid, abd as can be seen Germany and France have also received support.Last year, these current account deficits summed to about €127bn, of which trade deficits were €100bn, half of which was due to trade within the eurozone. The 4 countries shrunk their deficits significantly in 2008 and 2009's recession.
Germany, meanwhile, retained a large current account surplus of a $135bn (€120bn c/a), down from €200bn in 2007 – over half of which is from trade with EU partners. For decades Germany enjoyed export-led growth, while the rest of the EU supplied the demand for much of its exports - a synergy that continues.
Germany's advocacy of fiscal austerity may be merely political grandstanding or a genuine concern that market confidence is more important than economic realities - whichever? Even germany must know that if now the four Club Med countries deflate their way to shrinking their budget deficits to 3%/GDP ratios, this means a €135bn cut, or about 7% of German output - a huge slump in demand, including for imports -see data below.
And, then what if everyone has to do the same in the EU? Economies and markets do not run on straight lines. Maastricht criteria are an equilibrium ideal and the Euro is a strong currency protection of sorts, but underneath that allowance has to be made for very different, countervailing, if complementary, economic structures and growth policies. The kicker in all this of course is that The Euro and its Maastricht Treaty conditions are being levered to make the case for political union.
We took a big step in that direction with the Lisbon Treaty. But, so far, the new voting dispensation, our new President, the various councils, and the European Parliament, are not on the battle-scene.
As lex concludes, "Germany would not be able to substitute with increased exports to other countries. The economy, which is already stalled and only currently propped up by exports, would go into reverse. Berlin would then face some tough choices... If only out of self interest, German opposition to a Greek bail-out plan is therefore likely to soften."

ARE EURO STATES A MUTUAL SOCIETY OR NOT?

Otmar Issing, who was very important in dictating the form of European Monetary Union (EMU) has issued a provocative challenge using the fiscal embarrassment of Greece within the Euro Area. He makes several statements of partial facts. His purpose is to argue that EMU’s rules are absolute and can only be flexed by European Political Union (EPU), as if to swing the Euro rules like a bat on the pivot of Greece to hit a home-run for EPU, which he argues, as he did in the 1980s, should have preceded EMU. To be fair, Issing clearly dislikes the idea of leveraging EMU to gain EPU – that it should have been the other way about, but that is how he sees matters now standing.
What are his provocations? They include that the Euro Area system is a monetary stability system that does not permit any direct or indirect transfers of aid between member states. In truth, it does permit transfers far more than would be the case if the Euro did not exist. But, these are indirect transfers between states via inter-bank loans and bond sales i.e. private to finance trade deficits between states, for which, as the credit crunch crisis has shown us, central banks and state treasuries are ultimately solvency guarantors.
Jean-Claude Trichet, ECB President, also says, however, that there can be no special cases i.e. Greece can swap assets with the ECB for short term roll-over loans, but only if the assets are rated suitably high enough by the ratings agencies. This is a Catch-22 circular argument since the ratings agencies’ sovereign ratings for Greece are influenced by Greece’s EU, EMU and OECD membership, and too by the flexibility of the ECB’s lender-of-last-resort role. To play tough and say each state must absolutely balance its books as if there are no external circumstances, effectively makes policy responses to the credit crunch and recession within the Euro Area a hostage to the ratings agencies whose models and role in the crisis, while central, are profoundly discredited.
Issing concedes there are transfers at the full EU level via the budget of the European Commission, but he avoids any references to transfers via the short term money market operations of the ECB. In the 1980s, when EMU was conceived and Issing argued EPU first, EMU second, The Jacques Delors and European Recovery plans proposed up to a trillion in bond issuance that would be self-financing to provide for a system of transfers to ease the readiness for EMU. This sensible idea was voted for by all states except UK, Germany and The Netherlands. If today’s EU majority voting system had applied back then a system of transfers would have been part of the Maastricht, EMU and Euro treaties. I would go further and say if the EU had a system of transfers similar to what operates within sovereign states (to compensate for imbalances between regions) then there would surely be far more support and impetus towards EPU within the EU by now.
Issing says European taxpayers would not stand for ‘transfers’ from states who obey the rules to those who do not. But, following the rules is not the real issue and is not simple at any one point in time. It is more a question of what follows from very different economic growth policies within the EU. In the EU Single Market transfers are inevitable either private or public, interbank lending or inter-governmental transfers. When interbank lending (and buying and selling of net financial assets such as securitised bonds) broke down, governments everywhere have had to step into the breach. Greece may be rightly accused of running a far too high annual trade deficit and external account financing (up to 18% ratio to GDP). But its credit-boom led growth, while imprudent, was not outside of the rules. Indeed, Ireland, Finland, Greece and Spain were repeatedly praised for contributing to EU growth and jobs recovery much above their weight within the EU economy.
All states cannot seek after only export-led growth! For most of my lifetime it has been the case that the world economy has accommodated only a few net exporters (e.g. Germany, Japan and OPEC). The extreme special case of the past decade was that a few credit-boom economies (mainly the USA) generated trade deficits that allowed almost everyone else to generate surpluses or get nearer to balance. The conditions that led to the credit crunch were a boon to emerging countries generally, and of course to China.
What Issing neglects to say is that when states gave up their individual currencies they also handed all their off-balance sheet short term bonds operations (treasury bills) to the European Central Bank (ECB).
It has been precisely by using treasury bills that the UK and USA have been able to generate trillions of aid for their insolvent banks at no material cost to taxpayers – no taxpayers’ money applied, aid is off-budget in assets for treasury bill repo swaps. Greece, Ireland and Spain, and others in the Euro Area when directly bailing out their banks have had to issue bonds ‘ on budget’. They would not be in such fiscal difficulties if they could have relied on the ECB for a similar scale of money market response on behalf of the whole Euro Area and Single Market without regard to who got more or less help relatively.
The unstated implication of Issing’s argument is that only political union would permit such flexibility by the ECB. This is debatable. Some argue the ECB’s inflexibility is because it is not backed by political union. Another view, my own, is that the inflexibility comes from the EU being composed of countries that followed opposite growth impulses. Germany pursues export-led growth (why its employment gains have been less than others) alongside economies who pursued USA and UK style credit-boom growth (what we used to call deficit-led growth), such as Ireland, Greece and Spain, which meant having to sustain large trade deficits by selling financial assets. These diametrically opposing growth and monetary policies stymies the ECB in its response to the credit crunch.
Greece had further to go to catch up economically with the rest of the Euro Area and the banks went further than others in pushing a mortgage-led credit boom, and did so against Central Bank of Greece advice and in years when the ECB did not express its concerns. Like banks elsewhere, Greek banks capital reserves were wiped out and Government had to pick up a bill to provide support equal to one year’s GDP. But, Greece has to accommodate much of this ‘on-budget’ and that is hard to do and keep within the Maastricht Treaty rules.
Issing says “Emu is a “no transfers” community of sovereign states”. But, if taxpayers accept aid transfers internally between regions within states and externally at a global level why not within the EU? Does the ECB constitution and treaty really forbid ‘special cases’. Statements by Trichet and EU finance ministers in December and January did not seem to think so.
“No transfers” has clearly not been a macro-economic reality since the 1930s in the world economy. The idea of states sharing the same currency is that they may trade fearlessly with each other without currency problems. But, this happy view neglected to consider how external accounts are managed and financed.
The ECB cannot claim to be a force for stability when it ignored these fundamental stability issues. The ECB needs to broaden its operations and treaty scope or it risks becoming a force for instability by religiously enforcing rules on government fiscal policy as if this is the only monetary policy factor and thereby ignore the underlying economy’s money supply as dictated by commercial banks.

NOTE:
Issing is president of the Centre for Financial Studies and former member of the board of the Deutsche Bundesbank (1990–1998) and of the Executive Board of the European Central Bank (1998–2006). He conceived the 'two pillar' approach to monetary policy decision making adopted by the ECB. His statement in the FT (15th January):
"To bail out Greece or not? The question is grabbing headlines daily. Supporters of a bail-out argue that if Greece collapses, others would follow. Financial markets have already identified the next candidates. As such, European economic and monetary union is at risk. Only financial aid and “solidarity” with highly indebted members can rescue the euro.
It is certainly true that this is a decisive moment for Emu – but for the opposite reason. Greece will continue to receive support from several European Union funds. But financial aid from other EU countries or institutions that amounted, directly or indirectly, to a bail-out would violate EU treaties and undermine the foundations of Emu. Such principles do not allow for compromise. Once Greece was helped, the dam would be broken. A bail-out for the country that broke the rules would make it impossible to deny aid to others.
It seems that quite a number of observers have forgotten what Emu is, and what it is not. The monetary union is based on two pillars. One is the stability of the euro, guaranteed by an independent central bank with a clear mandate to maintain price stability. The other is fiscal solidity, which has to be delivered by individual member states. Member countries are still sovereign. Emu does not represent a state; it is an institutional arrangement unique in history.
In the 1990s, many economists – I was among them – warned that starting monetary union without having established a political union was putting the cart before the horse. Now the question is whether monetary union can survive without such a political union. The current crisis must be handled in such a way as to produce a positive answer. The viability of the whole framework – nothing less – is at stake.
By joining Emu, a country accepts its rules. Greece, moreover, also knew that adopting a stable currency that was not controlled by its own central bank implied a total break with the past. Devaluation of the national currency and an inflationary monetary policy were no longer options. A single monetary policy is implemented by the European Central Bank and it is the responsibility of each country to adjust its economic policies so that this one size fits all.
Participation in Emu brings huge advantages. The benefits of joining a stable economic area are greatest for countries that were unable to deliver such conditions before. Thanks to the euro, Greece has enjoyed long-term interest rates at a record low. But instead of delivering on its commitment at the time of entry to reduce public debt levels, the country has wasted potential savings in a spending frenzy. The crisis with which it is now confronted is not the result of an “external shock” such as an earthquake, but the result of bad policies pursued over many years. Bailing out Greece would reward such behaviour and create moral hazard of a dimension hardly seen before.
In this context, one conclusion becomes obvious: financial assistance for countries that violated the terms of their participation in Emu would be a major blow for the credibility of the whole framework. By its construction, Emu is a “no transfers” community of sovereign states. Transferring taxpayers’ money from countries that obeyed the rules to those that violated them would create hostility towards Brussels and between euro area countries. Among ordinary people, it would undermine a badly needed sense of identification with the great project of European integration.
This moment is a turning point for Emu, and for the future of Europe. Most observers point to the high risks – which cannot be denied. However, any crisis also presents an opportunity. This is a big chance – probably the last for Greece, and others – to adapt fully to a regime of stable money and solid public finances.
For Emu, the crisis represents a final test of whether such an institutional arrangement – a monetary union without a political union – is viable for an extended period of time. Lax monitoring and compromises when it comes to observing implementation of rules have to stop. Emu is a club of states with firm rules accepted by entrants. These rules must not be changed ex-post. Governments should not forget what they promised their citizens when they gave up their national currencies."

GREECE 'HELL'N ISM' BANKS

Global investors and EU analysts are beginning to learn the lessons of Greece's crisis. It is delusional to think of Greece as an isolated case, like simply another Dubai.
Greece is credit crunch plus concomitant recession impacts in miniature. It is an example of a credit boom economy, more extremely so than the USA.
The US economy has massive size with a trade deficit and currency weight able to act as counterpart to the rest of the world, and with a 'soft dollar landing' power that economists know well. Greece may be tiny by comparison but it too has a soft landing capacity, if at one remove, by being sustained as part of the EU and of the Euro common currency Area. How Greece got into trouble is comparable. It was seduced by the examples of US, UK, Ireland, Spain - lend and borrow so long as property collateral is rising in value fast; banks only have to chase where profits are greatest and not worry about the sustainability of the economy - take the bonus first, ask questions later.
Among OECD countries Greece ran the highest trade deficit risng to 19% ratio to GDP. It is a classic example of 'isms, where Monetarism was the advice advised to the country externally, while most Greek economists are more intelligent Keynesians, but were politically sidelined in the policy debate. Greece's present and future is now Keynesianism. As in other countries there has been a shift in universities and growth of business schools tending toward micro-economics such that the big picture of the external account deficit's importance were greatly under-estimated,
The burgeoning trade deficit was both enforced and financed by Greek (Hellenic) banks pushing mortgage business out of all sensible balance relative to lending to exporters. Mortgage books were securitised and sold to foreign investors - about one fifth of total loanbooks worth about 30% ratio to GDP. The government also securitised future revenues to about 10% ratio to GDP. USA has a technology and services strength in exports, Greece a dominance in world shipping. Greek shipping operated at near 100% capacity for years and did not demand fast growth in borrowing. Other Greek manufacturers were, however, denuded of loans as banks weighed into mortgages, property boom and consumer credit - refusing to re-balance their loan books despite Bank of Greece pleas to do so. The banks took the view that as part of the Eurozone they did not need to worry about the external account. The Hellenic banks also bought and grew banking subsidiaries in SE Europe and Turkey.
In 2006, I forecast the coming crisis for Greece precisely, with 90% wipe-out of bank capital from recession impacts alone, mainly property and construction collapse.
With time, analysts will see Greece as epitomising the problem of unsustainability of credit boom growth when the country's external account is ignored. The budget and banks' solvency crisis of Greece is currently somewhere near the top of the EU agenda, even in some over-active feverish minds threatening to EU integrity! The symbol on its 2-euro coin is the rape of Europa (after which Europe takes its name) and also represented in a large bronze at Bank of Piraeus's HQ. The myth (see notes at end of this blog) may be exercising some metaphorial minds? How the problem is resolved is also instructive. Greece received ECB and EU loans and the Government has provided direct capital support to the big banks and is necessarily running a budget deficit fiscal stimulus. Because it is part of the Euro zone it has to do this on-budget by issuing bonds. If it still had its own central bank money market powers it could do off-balance sheet asset-repo swaps for treasury bills with the banks. But, had it not been a Euro Area economy, arguably, it would not have been able to sustain such a credit-boom growth. The Drachma would have depreciated to rebalance the external account and domestic growth would have been lower. Greece's property boom was its first based on massive mortgage growth i.e. on home-ownership. This broadened and deepened the domestic economy, but governments exploited that feel-good wealth without doing enough to ensure it was being externally supported by trade. The economy was on a trajectory that some hoped could defy gravity, so long as the risks could be rolled up and thrown as far away as possible - Europa's moon accompanying Jupiter would do just fine. Like other astrophysics, Greece's external trade is something of a mystery, not unlike the question of how big its GDP really is. In 2006, GDP was severely revised upwards to allow for a 10% (probably truly 15-20%) black economy and thereby squeeze its budget deficit and national debt ratios to satellite closer into cosmic proximity with the EU's Maastricht criteria. There was a debate at the time as to whether the Greek stock exchange should be classed as an 'emerging market' with the possible consequence of it losing its OECD status. This would have severely raised the sovereign cost of banks' cross-border borrowings. Political instability factors and exposure to the Balkan economies were also negatively viewed. Greece was the fastest growing EU country in GDP terms if only 3% of the EU total - both assuring and very worrying? Since the mid-'90s, Greek banks penetrated deeply the banking systems of Balkan countries. 7 Greek banks established 20 subsidiaries in Romania, Bulgaria and other countries amounting to nearly 2,000 branches, employing nearly 25,000 people, with the goal of growing retail banking (mainly consumer and housing loans and credit cards, which under-developed emerging countries' own banks are least able to compete in). By '05, Greek banks granted nearly 40% of loans in Albania, 30% in Bulgaria, 40%in Macedonia, 15% in Romania and 20% in Serbia, altogether totalling at end of '08, to €147.1bn, against €126bn deposits with transfer funding from parent banks of €121.8bn equivalent to one third of Greece's GDP, . This is quite a large and generous benefit to the economic development of neighbouring states, if also twice the black market valuation. Quite how and what the black market is and what it means for the economy is a study yet to be completed convincingly. Greece was not big enough to really matter to global investors, and not anyway so long as the EU stood by as a safety net. Athens port of Piraeus is the biggest in the Mediterranean and the suspicion is that imports where entrepot trade with much of its through-trade exports being smuggled across its northern borders and therefore not appearing in the official statistical records. Arguments rage back and forth still about the accuracy of its GDP national income accounting.
The trade deficit was financed by banks securitising large parts of retail loanbooks, as much as 20%. This should have been a major concern in 2007 and 2008, but it was not transparantly obvious to analysts, no more than the funding gaps in the big banks' balance sheets and how these were financed was obvious. They were financed largely by other banks looking to expand their business in Greece including Citicorp, among others. And, when the credit crunch hit USA, UK and EU, Greece was below the radar of global concerns, well behind Ireland with which it ould and should have been compared. greece therefore had some time to usefully spend before the ripples of the crdit crunch uncovered Greece's crisis. sadly, that time, two years, was wasted, not least because of poor focus by the government to understand the key issues. The Central Bank was totally aware, but its advice discounted in the general viw that a combination of being informally associated with emerging markets and being under the defence umbrella of the EU meant it might survive through to when US and other major economies would recover, which the EU did achieve generally quite rapidly. The error was in not seeing that unlike other emerging economies, which is what Greece really was, like most of central Europe and the Balkans, and there was a huge external debt that developed (in ratio to GDP) and proportionately at more than three times that of the USA.
Greece will be sustained of course, but by the time it gets back on track I predict the EU will then enter its normally due recession. The EU's brief recession in 2008 was a shock response to the credit crunch. It normally recesses 8 quarters after US and 6 quarters after UK. Analysts may class this as 'double-dip', which will not be exactly correct.
The advice of the Central Bank of Greece's advice to the country's banks still stands - shift your lending to productive and exporting industry, now including shipping, but especially small firms and SME's as well as the few big food processing producers. It will hard.
If any country is going to have a tough ten years it will be Greece. What will emerge is a much more savvy economic management of the country.
NOTE: RAPE OF EUROPA
Europa (Εὐρώπη) was a high-born Phoenician lady whose name became that of the whole continent. Her abduction by Zeus in the form of a white bull carryuing her off to Crete where Zeus made her the first Queen - a Cretan story.
Zeus today, in our more secular panoply must be the USA, and the modern Crete is Brussels, depressingly?
Most love-sex stories concerning Zeus originate (like also Leda & The Swan) in ancient tales describing his couplings with goddesses - Europa's name is also among that of daughters of Oceanus / Tethys. The daughter of earth-giant Tityas and mother of Euphemus by Poseidon is also Europa.
Europa's earliest literary appearance is in Homer's Iliad, a story of exuberance gone wrong, nearly 3 millennia old. The earliest vase-painting identified as Europa, dates from mid-7th century BC. As a goddess she represented the lunar cow, at least on some symbolic level, and therefore as a broad-faced moon of a Mother, Astarte, and mythical nymph beloved of Zeus, who was transformed into a heifer.
Such myths are as complex as the financial economy. Ovid's poem on the matter is depicts the classic first half stages of a credit cycle:

And gradually she lost her fear, and he
Offered his breast for her virgin caresses,
His horns for her to wind with chains of flowers
Until the princess dared to mount his back
Her pet bull's back, unwitting whom she rode.
Then — slowly, slowly down the broad, dry beach —
First in the shallow waves the great god set
His spurious hooves, then sauntered further out
'til in the open sea he bore his prize
Fear filled her heart as, gazing back, she saw
The fast receding sands. Her right hand grasped
A horn, the other lent upon his back
Her fluttering tunic floated in the breeze.

JC Trichet speech September 3 '09

We have been waiting to see what the ECB will do to match the latest measures by US (sons of TARP e.g. TARF + US Treasury & FDIC soft terms for non-banks to buy impaired bank assets, Germany's 'bad bank' emulated by Ireland, both using bonds, and UK's Asset Protection Scheme with the innovation of payment by unremitted cheque as opposed to the usual Treasury Bills). The answer is ECS - enhanced credit support?
The ECB's concept here applies to the Euro Area. In the total EU, the regulatory authority is the European Commission, which is setting up an intricate approvals and review system to examine aid-schemes for banks by Governments (states) and each individual case to check for competition issues and possible restructuring requirements.
For the ECG, Trichet said in his speech (as per article in the FT), "Exceptional times call for exceptional measures. The European Central Bank, like other central banks, has introduced non-standard measures to tackle the financial crisis and cushion its impact on the economy – what I call 'enhanced credit support'. These have contained the threats to the stability of the euro area’s financial system and supported the flow of credit to companies and households over and above what could be achieved through interest rate cuts alone. Because of their exceptional nature, these measures will have to be unwound once economic and financial conditions normalise. We at the ECB designed the non-standard measures with our exit strategy in mind, and we are ready to implement this strategy when the appropriate time comes. Stressing the importance of the exit strategy should not be confused with its activation: it is premature to declare the financial crisis over. Today is not the time to exit. Four issues will shape our approach to exiting the non-standard measures." The criteria for normal conditions may be debated, but are likely to turn on whether banks continue to have a need for government and central bank help i.e. it may not be the ECB that can determine when consitions are normal, by which it may be inferred is also meant 'stable' where wholesale funding is again flowing thickly! Another implied criterion is maintaining flow of credit to households & companies. It has become assumed that the tap is turned on or off by banks. But, in reality, banks either respond to demand or not. At present, while many borrowers need loans rolled over and many may seek 'equity release' for high borrowing, the majority seem to be rentrenching and restructuring their debt as well as reducing their net debt. Banks may think they prompt borrowing levels, but are now learning that borrowing levels do also depend on what customers want, and customers (unlike banks) are not always seeking to borrow more even when rates are relatively low; they are risk averse. Furthermore, borrower confidence in the general economy and in their own businesses take as a strong indicator the ease with which they can borrow from banks. Whatever the central banks do, even in terms of conditions attaching to bail-out measures, the fact is that borrowing is now more complex and banks are giving out strongly negative signals about their ease and willingness to lend.
Trichet has four planks to his raft:
"First and foremost, should the non-standard measures trigger risks to price stability, we will immediately begin to unwind them and ensure the continued solid anchoring of inflation expectations. The timing and sequencing of our exit strategy depends on our real-time assessment of the economic outlook and the health of the financial system in line with our contribution to financial stability.
Second, a degree of phasing out has been built into the exit through the design of our measures. In the absence of new policy decisions, several of these measures will unwind naturally. Given that the overwhelming majority of the liquidity has been provided through repurchase agreements, a new policy decision would be necessary in order to roll these operations over once they mature.
Third, the ECB’s operational framework is well equipped to facilitate the unwinding of non-standard measures as the need arises. This framework comprises a varied and flexible set of instruments, including fine-tuning operations, allowing the absorption of surplus liquidity – promptly, if necessary. Moreover, with its interest rate corridor, the framework allows short-term interest rates to be changed while keeping some non-standard measures in place, should continued credit support be needed. The governing council can therefore choose the way in which interest rate action is combined with the unwinding of the non-standard measures.
Fourth, the outright purchases of securities by the eurozone’s central banks have been measured in both scope and volume. They have focused on the market for covered bonds and have acted only as a catalyst. We opted for a purchase programme with a volume that was significant enough to improve the activity and functioning of the market, but not so large as to dominate the market or the balance sheets of eurozone central banks. The measured programme facilitates its future unwinding or its offsetting by other policy operations." It is in the nature of the ECB being multinational that it cannot take action or make statements out of synch with its constitutional remit. It 'owns' the money market (treasury bill) operations of its constituent central banks on the basis that this gives it a collective firepower to defend the strength of the Euro. But, Treasury Bills have many other useful functions such as facilitating short term transfers and balances between arms of government, between Ministry of Finance funds and so on, and these days most of all in providing an off-government-budget on central bank balance sheet funding power to make asset swaps with troubled banks - to support the finance sector when it is in systemic crisis. This important aspect of the role of central banks has not been clearly enunciated in the ECB's charter and this is why Trichet has to refer to 'exceptional' measures. In reality, such measures should not be exceptional or abnormal, merely doing what central banks should be doing to ensure financial stability at any time, except this time on a much larger scale than is usual when economies are not at the bottom of a credit cycle and economic cycle. It is the use of "exceptional" and by stating there is a strategy well worked out for getting back to normal working that Trichet uses to be able to say, what he has been unable to say until now, that the ECB is thereby now 'unrestricted' in what it may do!
"With regards to future actions, we are unrestricted in our ability to take decisions, given the strong ­institutional independence of the ECB. This reflects the clear dividing line in the euro area between the responsibilities of the central bank and those of the fiscal sphere (Government deficit spending). That the ECB has not purchased government bonds is in line with this institutional framework."
The ECB is restricted in issuing bonds - how else could it buy Euro Area governments' bonds? It has been a political obstacle for two decades since the Delors Plan (which proposed one trillion in ECU bonds) that led to currency union that the Commission and ECB should not be able to issue a lot of debt to equalise national debts or make transfers between EU states. The ECB is stating that it absolutely dislikes having to intervene in exceptional ways and wants to get back to normal inflation-setting and currency defending for whcih it was exclusively established. Hence, the repeated emphasis on 'exit strategy'.
"The ECB has an exit strategy from its non-standard measures in place. Its implementation will build on three self-reinforcing elements: credibility, alertness and steady-handedness. These form the basis for the strong anchoring of inflation expectations in the euro area – our main asset. This strong anchoring is based on our determination and ability to act decisively whenever the need arises. The ECB’s governing council will continually assess whether policy adjustments are necessary and implement those adjustments to maintain price stability in the euro area over the medium and longer term."
Fine abstract phrases expressing conservative prudence - no Keynesian culture here. The ECB's main economic model for assessing all these matters in the wider economy is a New Keynesian model (a newspeak term for non-Keynesian micro-, supply-side, Monetarist & general equilibrium synthesis) with only about 90 simultaneous equations i.e. a small model that cannot really assess individual countries or the finance sector/s in any detail. Despite a prponderance of trained economists on the ECB board, the ECB is flying blind (a drone operated by humands back at the office working off a simple flight simulator). The ECB therefore will not be ahead of events leading from the front. For that the Euro Area will still rely on individual states to make their own assessments and pay for interventions expensively using longer term bonds (i.e. taxpayre' funds on account).
trichet ends with, "Our fellow citizens can have full confidence in the determination and ability of the ECB to deliver price stability. This confidence will, in turn, contribute to a sustainable recovery." I had hoped for more following the meeting of central bankers at Jackson Hole, Wyoming, but it seems we are still having to wait for the ECB to get all ducks in a row before it is prepared to envisage any real duck-shooting on the scale of USA & UK financial authorities. There will not be much complaint about this politically just now because the Euro Area states are hoping they are already through the recession, uniquely in history out before the US & UK despite falling into it later. My view is this was a fals recession period for the Euro Area, merely a shock effect of the Credit crunch. Euro Area's real recession is around the next corner.

BANKERS' vBONUS pBONUS gBONUS fBONUS aBONUS

There are many kinds of bankers bonuses as there are types of well-worn shoes and sandwich-for-lunch briefcases. Variable bonuses depending on relative performance measures using peer-group data, narrow performance bonus, guaranteed absolkute bonus, fixed % bonus, various algorithmic bonuses, and on and on. The general public is enraged. the fact is that for people employed in investment banking especially, remuneration is the only moral incentive, whether ethical or not, and the prospect of extraordinary above average lump sum winnings is what creates the culture of 'gold-rush city' that defines the society we know of as investment banking. Change the bonus culture and everything changes! Revolution!
Yet, it is wholly clear to shareholders and policy-holders that years of "we are here first and foremost to serve our shareholders/policy holder" was pure cant, apalling hypocrisy. This is how it seems to joe public and joe politician!
Ms Christine Lagarde, France's Minister for Economic affairs, according to Forbes Mag one of the world's 100 most influential women, acknowledges that it is “tough” imposing higher standards on French banks, in terms of pay, that could put them at a competitive disadvantage in recruitment. “It is not fair that some players are playing by the rules and that some players – especially when they are highly subsidised – are simply ignoring the rules.” This is surely an all too simple and obvious objection to reining back bonus culture. Are we to believe that higher ethical standards will not attract customers seeking to do business with more ethical banks? Why should stamping on the flames of bonuses not work when all countries apparantly agree they must do the same? What are bonuses worth for people whose jobs are no more taxing than keeping odds at a racetrack, something the cleaning staff could do just as well in many banks? But she said Paris as a financial centre stood to benefit from the enhanced reputation of its universal bank business model – combining investment banking with retail operations, – and of its regulatory system, and from London’s tarnished image. Why oh why must trivial inter banking centre competitiveness be part of the ethical equation? “I don’t think we have been guilty of the same excess, not to say that we have been paragons of virtue,” she said. Ms Lagarde has made the promotion of Paris as a financial centre one of her priorities since becoming finance minister two years ago.
Banks that have started to pay their staff guaranteed bonuses again are an “absolute disgrace” and should be reined in by governments at the G20 summit in September, according to Ms Lagarde. The same is being said by UK's Treasury select Committee. They valiantly continue to say that bonus culture lay at the heart of the factors creating the credit crunch crisis. All are however stumped not a little by Goldman Sachs recent quarterly results indicating average bonus of half a million per employee! The trading eranings may not be repeatable. In the US it is argued by some commentators that much of Goldman's golden performance was pump-primed by the cheap $10 billions loaned to it by the US Treasury? In what she described as a “cri de coeur” against the return of “the old ways”, Christine Lagarde urged other G20 governments to stop “procrastinating and introduce curbs on pay practices deemed to encourage too much risk-taking. I think it is an absolute disgrace that guaranteed bonuses of several years could still be paid, or that some people are thinking of reinstating the old ways of compensating with insufficient relationship between compensation and lasting performance and risk management” (in a Financial Times interview). Citigroup, Deutsche Bank, Nomura, and others have offered multi-year guarantees to recruit and retain key personnel, although they insist that the practice has been limited to recruiting and keeping top talent. bankers of the investment variety are very keen to maintain the illusion that personal contacts and individual intellects make all the difference.
One of the reasons banks have resisted economic models and linking their performance to macro-prudential analysis as required by Basel II Pillar II is because even when a rising tide lifts all boats they wish to maintain the fiction that absolute performance has been entirely generated by increased staff productivety and reward bonuses accordingly, however that 'accordingly' is calculated? It has undoubtedly been because banks have been diffident and negligent about economics that they have collectively got themselves into the mess of losing twice their reserve capital, double what a severe recession could be expected to diminish.
The staff retention and recruitment argument is of course bizarre since this is not formally part of bonus calculation models as banks describe them, in their annual report to shareholders, and because it is only arguable when banks are not all being forced at the same time to severely cut down on bonuses. The fact is that banks have always varied the golden hellos, share options, and wage rates and bonus deals to compete for key staff however and whenever they choose to. Ideally, we would make this a matter for shareholders to exert control over and for regulators to analyze from a systemic risk aspect. The problems are that shareholder votes are not open and fair, especially not when sufficient support for retaining the bonus culture is always available from the major shareholders who are also financial institutions with bonus cultures. The regulators and legislators however have built up ammunition to argue strongly for a radical change. The last refuge for the scoundrel has to be "but this will damage the competitiveness of our financial centre" argument. That is of course ludicrous. Bankers are sticking their heads in the sand with respect to admitting what went wrong and why, and moreover saying yet again to shareholders "we own this bank and this banking centre, not you!" Ms Lagarde's view is a shared one and correct to say this should be a G20 and therefore also an EU-wide issue. To set the agenda in proper detail, hwoever, some centres should and could move first. French banks have agreed to forego such payments, to link bonuses to the profitability of the bank and include claw-back provisions. If they do not they face the possibility of higher capital requirements imposed by the national supervisory regulator. The UK’s FSA this week warned that banks that have agreed to guarantee executive bonuses for more than a year risked similar heavy penalties. Undoubtedly others now have to follow suit, the quicker the better some may say.
In my view, it should happen anyway because those 'stars' at the top are not the performance difference makers they fondly imagine themselves to be. And, finance being global is inevitably forced to apply common accounting, risk regulation and therefore also remuneration standards. FSA'a draft 2,000 word code suggests higher fixed salaries, more emphasis on risk management and withholding back the bulk of bonus payments until it is clear they were based on good business sense. The FSA does not set any limits on the multimillion-pound rewards. The amount of pay that can be earned, says the FSA, remains "a matter for firms' boards". Are we supposed for 'boards' to read 'shareholders' votes? I wish the FSA had made that plainer.
Like much else, especially short-selling, one feels that the FSA's rules-drafting has been reluctant and duplicitous in allowing glaring gaps. Many banks demand that bonuses continue to be payable to persuade key staff to stay and reward talent, even though their firms would have collapsed into bankruptcy without government help.
A survey by efinancialcareers. com showed two-thirds of experienced bankers accept the bonus system requires reform. Amazing to think that one third does not? It is scarecely one third who receive bonuses! However, three-quarters of front-office operators oppose caps on cash bonus payouts and more than half said they would consider moving abroad if bonus caps are imposed. This response is the bonus-culture talking. It is the very fact that so many staff think they can walk and take business with them that is the delusion at the ehart of this culture. let them go and see what happens! Call their bluff!
According to the new FSA code, bonuses should be based mainly on profits, rather than gross or operating revenues, so that the net quality of business growth generated can be assessed. The individualism of bankers militates against a holistic accounting. They want to be rewarded for their profit centres and not for the the group performance. This shows how banks have become more like franchise conglomerates with only the capital at the centre! It is a view that is indifferent to professional financial risk management where risk diversification and liquidity management are key. Investment bankers believe capital is always available for a profitable deal and it makes no odds to them where that capital comes from i.e. from retail deposits or interbank funding gap finance.
Bonus payouts should also, according to the FSA, reflect the cost of capital and liquidity. In which case many profits of many profit centres would turn to zero or negative in the last 2 years. You try telling an M&A fee earner that because of cost of capital, risk reserve ratios and the collapse in private liquidity finance, that he, or she, should now get no bonus! These arguments make macro-prudential sense, but front line investment bankers treat such bankerly concerns with abslute derision and distaste, albeit for the most obvious self-serving reasons!
The code also says that staff must forfeit bonuses, regardless of profits, if firms have poor risk management or fail to work within regulations. this would be terrific in practise and suddenly the risk managers walking the trading floor might actually get some long overdue respect. Risk managers dream on!
The FSA also says that remuneration committees should use "independent judgment" and they may be asked to submit an annual report to the watchdog. The chairman of the remuneration committee may also be asked in for interview with the FSA to presumably explain the bank's various algorithms for determining bonuses. This presumes such matters must have a logic. But, the logic about staff attraction and retention, essentially blackmail or bluff, will drive a coach and horses through such deliberations. Some bankers undoubtedly believe themselves when they say or think that hedge funds would be only too happy to employ them and would not baulk at rich rewards and be unlikely to suffer the same constraints as banks. Hmmm, wait and see!
I, as a topflight investment banker, will have a lifestyle to maintain: school fees, club fees and a multi-million pound mortage plus my various other investments for pleasure or financial gain and these will tell me what my minimum annual bonus requirement is. A bank cannot argue with key staff unless it also forces the individual bankers to disclose what lies on their side of their view of the matter such as what they can evidence they need to remain personally solvent etc. Mostly, however, the arguments will proceed in the absence of that and be heavily mis-alligned, coded, and diverted onto bogus performance measurement issues. How different from the good old days of trade union negotiations? If only the banking unions were still in place the banks might have quite welcomed some long strikes in the last two years.
Risk and compliance staff, says the FSA code, must have different targets "determined independently of the business areas". "Firms must ensure that their remuneration policies are consistent with effective risk management." Hey ho, this is regulatory rule by guidance principle and as we know that doesn't work. Either the FSA comes up with precise models and equations or they may as well forget it. This is just political fig-leafing.
The new rules will cover all organisations regulated by the FSA, including the UK operations of foreign-owned businesses. The new code aims to ensure that pay and bonus structures in financial organisations do not encourage staff to take excessive risks. An FSA spokeswoman said the watchdog would "work with" firms whose remuneration policies it finds "inappropriate". Peter Montagnon, director of investment affairs at the Association of British Insurers, which represents many institutional shareholders, said the code was welcome and based on the right principles. But he added: "The code itself needs a lot more work on the details and we are ready and willing to help in this."
Michael Rendell, a partner at accountants PwC and the group's head of HR, said the code would ultimately have an impact beyond financial services and it was "absolutely right" that good corporate governance be placed at the top of the list of pay principles.
One has to laugh if anyone thinks HR consultancies have the capability to work with banks internal HR departments to tackle this thorny bush? The FSA consulted on its proposed code to the end of March.
In may the UK treasury select Committee issued its report. Committee Chairman John McFall said: "Bonus-driven remuneration structures led to a lethal combination of reckless and excessive risk–taking. The design of bonus schemes was not aligned with the interests of shareholders and the long–term sustainability of the banks and has proved to be fundamentally flawed. Our report outlines clear failings in the remuneration committees within the banking sector, with non–executive directors all too willing to sanction the ratcheting up of senior managers’ pay, whilst setting relatively undemanding performance targets. Looking forward, we are also concerned that the FSA seems not be taking tackling this issue seriously enough."
http://www.publications.parliament.uk/pa/cm200809/cmselect/cmtreasy/519/51902.htm
In June, the FSA awarded itself a 40% increase in bonuses!
A full treatment of this issue has to include all remuneration channels including soft loans, share options, postponed bonuses and pension contribution etc. two weeks ago Chancellor darling warned banks not to slip back into their old habits and accused some of complacency now that the credit crisis has eased. "If they go back to the way they were without asking themselves over and over again whether they understand what they are doing, that would be disastrous for them and the rest of the world," (interview in the Independent). "There are people who are too complacent in my view. They need to be brought back to earth." Yes indeed, but then the get-out.
Darling rejected the idea of a salary cap on City workers to stop previous excesses recurring. "You can't have a pay policy in legislation," he said, which seems contrary to his saying that controls on financial institutions generally will be tightened in forthcoming White Paper on financial regulation. Perhaps he believes that bonus culture may be curtailed indirectly rather than by directly capping remuneration per se? He also dismissed talk of a battle between the FSA and Bank of England over which agency regulates the UK's financial sector in systemic risk going forward. "It is not a turf war," Darling said in the interview. "It is a question of ensuring they both do the job they are set up to do and both do it effectively. They are not competing with each other. They are complementary". That is indeed true. The media comments overlooked the fact that the Bank of England always retained responsibility for systemic risk. And, it is arguable that bonus culture is a systemic risk or macro-prudential matter, not a micro-prudential matter at the level of individual firms.
The FSA Consultation paper 09/10 (http://www.fsa.gov.uk/pubs/cp/cp09_10.pdf) titled 'Reforming remuneration practices in financial services' was published in March 2009 on the same day as the Turner report thereby conveniently evading media scrutiny. Turner mentioned bonuses a dozen times, but made one definitive statement only: "...illusory profits were however used as the basis for bonus decisions, and created incentives for traders and management to take further risk. This carries implications for remuneration policies, considered in Chapter 2.5(ii)" (http://www.fsa.gov.uk/pubs/other/turner_review.pdf) Turner says, "A reasonable
judgement is that while inappropriate remuneration structures played a role, they were considerably less important than other factors already discussed – inadequate approaches to capital, accounting, and liquidity." This is I have to say an entirely subjective view. One has only to ask what is the motivation for bankers trading with inadequate approaches to capital, accounting, and liquidity, if not because of the short term bonus culture? Turner discounts bonus culture heavily as a priority. he rehearses the FSA discussion points but ends on a dismissive note. In this respect his judgment is in direct variance with that of the Treasury select Committee and politicians and the general public who see bonus culture as a high priority issue. The FSA draft code (over 80 pages of guidance principles) offered another period for consultation responses up to 18 May 2009.
HM treasury are moving ahead too. The FSA and the Bank of England are both set to get more powers, with hedge funds likely to come under the sway of the FSA. This will change the context considerably if hedge funds are subject to similar oversight and rules as apply to banks.
Ms Lagarde said that all leading economies should quickly adopt similar principles to those laid out by the Financial Stability Board, an international forum of central bankers, treasury officials and supervisors. “We have the rules now. It is not a question of reinventing the wheel, or procrastinating about them. It is a question of applying a set of rules that have now been agreed by the Financial Stability Board. The utmost priority should be given to their implementation,” she said. Her ‘cri de coeur’ is against a return of ‘the old ways’, but i have to say that such a return is porecisely what most of my banking friends and acquaintances expect once this temporary glitch of worldwide recession and credit crunch silliness is out of the way, and meantime what blind bit of economic good would be done by harming their "ability to pay the school fees and the five grand a month mortgage,I ask you? And the sooner Cameron and his chums get into power who at least understand this much, the better!" Oh, if only PG Wodehouse was alive and writing a City column!