Don't Shock the Countries, Shock the Banks/ters - Part III: Make the banks/ters pay !

As huge sums are needed for the reduction of the sovereign debt accumulated from bank bail-outs and stimulus packages to prevent economic collapse after the 2008 Global Financial Crisis, a healthy consensus across party-lines seems to be emerging in Germany and beyond: make the banks/ters pay for the mess they created. 

In early August, the conservative newspaper Süddeutsche Zeitung wrote: “Instead of spanning ever-larger rescue umbrellas and force the ECB to refinance sovereign debt, it is time for a concession: The attempt to reduce sovereign debt by way of .... austerity and higher taxes has been ineffective. Remains only one alternative....Instead of rolling over the write-downs on toxic assets and sovereign debt to European taxpayers, international creditors ... should carry a share of the losses.” (Süddeutsche Zeitung, “Die Banken müssen zahlen”, August 2, 2012). Outside of Germany, critics are putting the blame on German banks: “Germany’s Banks Helped Create This Mess. Why Not Hand Them the Broom?” (Bloomberg Businessweek, May 28-June 3, 2012). 1/

In German talkshows, it is these days not unusual to find conservatives and liberal-leaning entrepreneurs agreeing with politicians from the left on the principle that those who spent large sums of money on risky deals (and pocketed fabulous earnings when markets were booming) should carry the losses from these deals instead of passing them on to taxpayers. The CEOs of top German corporations, including Bosch, SAP, Heraeus, Munich Re and others put it bluntly: “banks that play casino need to be able to go bust”….if necessary, we need to make everything so small that nothing is too big to fail. They complain about a financial system that seems out of bounds, with financial derivates having reached a global nominal value of $601 trillion, ten times the size of global GDP. (Handelsblatt, Aug. 24, 2012: "Die Realwirtschaft schlägt zurück")

Finally, the German public seems to begin to comprehend that the sovereign debt mountains in the European periphery are in large part due to the 2008 Global Financial Crisis (see chart) and government-financed bail-outs of financial institutions - which are now speculating against the sovereign bonds of the very countries that bailed them out. And the public demands to make the banks and speculators pay ! 

In sum, the atmosphere seems ripe to promote a set of austerity measures for European banks/ters, such as the following 14-point reform and adjustment program:

1. STOP all unconditional welfare payments to banks and other financial institutions, whether they be in the form of capital infusions or bail-outs, interest rate subsidies, zero-interest credit lines, or cheap loans backed by potentially worthless assets. (Bloomberg News, August 27, 2012)
2. Provide taxpayer-financed assistance for financial institutions ONLY against strict conditionality and the regular supervision of performance targets (modeled upon IMF structural adjustment programs for countries). 
3. In the case of private financial institutions, in addition to rule (2), government assistance will be provided ONLY against an equity participation with preferred voting rights and seats on the Board of Directors according to the size of the capital infusion. 
4. Along the lines of rules (1), (2) and (3), restructure and consolidate all European financial institutions that receive taxpayer-financed bail-outs or are ‘too big to fail’. 
5. Close down those financial institutions that cannot survive based on a realistic accounting of all their assets, including ‘toxic’ assets and sovereign bonds valued at current market prices. 
6. Guarantee only deposits up to €100.000, the bank payments system and credits business needed for the financing of real investments. 
7. No guarantee for bank-to-bank debt. 
8. No guarantee for CDS and CDS-derived products and investments. 
9. Disallow all derivative commodity, foreign exchange, and credit risk speculation, i.e. deals that are not linked to the real economy.
10. Reduce or eliminate all financial activities not related or linked to the real economy. 
11. Recall all boni & retirement packages for managers responsible for losses that had to be covered by taxpayer-financed bail-out packages. 
12. Reform the remuneration system for managers of financial institutions along the lines of the IMF wage reform policies recommended for Greece (see IMF Memorandum for Greece, pp.6-7 and pp.20-23).
13. Employees who loose their jobs as a result of the restructuring and consolidation of the European financial sector should be given the option to re-train for jobs in the public service sector, i.e. public schools, elderly care, child care facilities, etc. 
14. Implement the Financial Transactions Tax NOW and raise up to €540 billion per year from a 0.1% tax on foreign exchange transactions alone (based on a current €2 trillion nominal volume per day). 

Arianna Huffington of the Huffington Post Media Group has another interesting idea: institute a shock therapy for banks/ters: ….. “maybe there could be some sort of “Clockwork Orange”-like aversion therapy for those inside the banks ….any time a dazzling new financial transaction is mentioned, an electric shock follows.” (Sun Sentinel, May 29, 2012).

Now that’ll teach them ! 

-------------------------------------------------------------------------------------------------------------------        1/ Bloomberg argues that “German banks lent more than they could afford”, building up $704 billion in credit exposures to Europe’s periphery before the crisis. Since the crisis began, German banks pulled out $353 billion, passing a large shunk of these exposures to the ECB, thus shifting the risk to European taxpayers. [As per end of May 2012, the total credit exposure of European lenders in Spanish, Portugues, Italian, and Irish debt is estimated at $1.2 trillion.]

Dont' Shock the Countries, Shock the Banks/ters ! Part II: the role of crises for Troika shock therapy

"Only a crisis—actual or perceived—produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable." 

[Milton Friedman, “Capitalism and Freedom”]

Ever since the 1970s, neo-liberal market-fundamentalist policy alternatives to the mixed-market and social market model have been developed and tested, initially during Chile's infamous 'Chicago Boys' experiment. In the 1980s, they began their victory lap around the world with the ‘help’ of IMF structural adjustment programs and the 10 commandments of the Washington Consensus. The 1980s debt crisis provided the first opportunity to apply them in Latin America and Africa. Then, after the fall of the iron curtain in the late 1980s/early 1990s, IMF structural adjustment programs moved on to former communist countries in Eastern Europe and the former Soviet republics; then to Asia following the Asian financial crisis in the late 1990s. In the 2000s, the terrorist attack of 9/11/2001 provided fertile crisis conditions for their implementation in the United States, including a nearly complete deregulation of the financial sector and the attempted privatization of social security.

Only one major continent was still missing: Europe ! A tough sale, for several reasons: first, because Europeans are particularly attached to their social market policies; second, because the IMF Managing Director has traditionally been a European and thus hesitant to implement highly unpopular IMF adjustment policies in Europe. And third, Europe was not in crisis. And so, while a full-blown IMF adjustment program was not possible in Europe, standard IMF conditionality found its way into major European treaties, such as the Maastricht Treaty (e.g. the 2% inflation target, the 3% public deficit target and the 60% public debt stock target), the Lissabon Strategy and others. But to really remake European economies and apply a broad spectrum of market-fundamentalist neo-liberal policies, Europe needed a crisis.

Enter the 2008 Global Financial Crisis and the ensuing Eurozone debt crisis

The twin crises of 2008/2009 provided fertile ground for real change in the Milton Friedman sense: the “politically impossible” became the “politically inevitable”, namely the dismantling of the European welfare state, the privatization of public enterprises, and the shrinking of government “down to a size where we can drown it in a bathtub” (Grover Norquist, US conservative ideologue). Vis-à-vis the European public, the measures were justified by a Macchiavellian re-interpretation of the Eurozone's second financial crisis caused by government-financed bank bail-outs into a sovereign debt crisis blamed on excessive government spending on social programs, public enterprises and state employees.

And so, true to Milton Friedman's words and the motto "don't ever let a good crisis go to waste", the 'Troika' [1] of IMF, EU, and ECB went to work on the countries of the European periphery most affected by the twin crises: Ireland, Portugal, and Greece.[2] 

Case Study Greece

A quick scan of the IMF Letter of Intent and Memorandum of Economicand Financial Policies for Greece dated March 9, 2012 shows that while the IMF adjustment program for Greece pays lip service to the equitable distribution of adjustment costs, in essence it follows the same market-fundamentalist agenda of  'traditional' IMF structural adjustment programs, with the costs squarely on the shoulders of those who depend on the public sector, i.e. mainly the elderly, students, the sick, and the poor: 

• fiscal austerity, focused on the expenditure side rather than the revenue side 
• reduction of public sector employees, reduction of public sector wages and pensions 
• privatization of public enterprises and services 
• deregulation and liberalization of all markets, including the labor market 

According to the IMF Memorandum, "the bulk of adjustment will be achieved through expenditure cuts that aim at permanently reducing the size of the state....by closing entities....and by targeted reductions in public employment".....The key fiscal reforms include reductions in public sector employment and wages; pension reform (meaning cuts) as well as cuts in health expenditures and other social benefit programs" (pages 6-8).

A new feature in the IMF adjustment program for Greece is the focus on nominal wage reductions to lower unit labor costs and thus enhance competitiveness, a ‘structural’ measure close to the heart of the Schwabian housewives and housemen in Berlin. They seem to forget (again) that economic policy is more complicated than the budgeting of Schwabian housewives. The unit labor cost ratio, for example, has a denominator (output) as well as a numerator (cost of labor): so, instead of reducing the numerator (cost of labor), the unit labor cost ratio can also be reduced by an increase in the denominator, i.e. output, hence productivity. And productivity can be enhanced by investing in human resources (training, education) and the tools they work with (investment in research and development). Wouldn’t that be a more humane approach, with the added benefit of an increase in aggregate demand, employment, and economic growth ?

Instead, the IMF adjustment program for Greece recommends wage cuts, interferes with national labor market policies, seeks to permanently reduce the size of the state, and imposes market-fundamentalist, pro-cyclical austerity measures in a recession, setting in motion a vicious cycle of economic declines [3] which, if not halted, will eventually lead to the complete economic collapse and bankruptcy of Greece. 

We have to stop this craziness NOW, or else Greece will go down....and the rest of Europe with it ! Because - let's not be naive - Greece is just the beginning. Similar programs are already being designed for other countries, including prosperous Germany ! (see the 15-point plan of last Sunday's Welt am Sonntag: "Agenda 2020")

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[1] The 3-part commission composed of officials from the International Monetary Fund (IMF), the EU Commission (EC), and the European Central Bank (ECB) is charged with the monitoring of the economic conditionality and structural benchmarks attached to the IMF adjustment loans and the European bail-out funds extended to highly indebted European countries.

[2] Spain and Italy are applying IMF-style austerity policies on their own to regain investor confidence.
[3] See the description of the vicious economic cycle in the welcome note of this blog.

Don't Shock the Countries, Shock the Banks/ters ! Part I: economic shock therapy in Europe ?

In September 2007, a year away from the fall of Lehman Brothers and the ensuing Global Financial Crisis, award-winning investigative journalist Naomi Klein introduced her new book "The Shock Doctrine: the Rise of Disaster Capitalism" at the studios of Democracy Now. Klein explained that

 "the shock doctrine"...."is a philosophy that holds that the best way, the best time, to push through radical free market ideas is in the aftermath of a major shock. That shock could be ....a natural disaster....a terrorist attack....or an economic meltdown."

One year later, 10 days after the collapse of Lehman Brothers in September 2008, Klein commented on the emergency actions to stem the spread of the financial crisis, including the $85bln rescue and takeover of AIG by the US government:

"Whatever the events of this week mean, nobody should believe the overblown claims that the market crisis signals the death of 'free market' ideology.....The massive debts the public is accumulating to bail out the speculators will then become part of a global budget crisis that will be the rationalisation for deep cuts to social programmes, and for a renewed push to privatise what is left of the public sector."

Doesn't that sound eerily, scarily familiar in the midst of the eurozone crisis ?

Haven't events evolved exactly as Naomi Klein predicted 4 years ago, including the convenient  interpretation of the eurozone crisis as a public debt crisis instead of a financial crisis 2.0 ?

And isn't it a fact that, instead of cleaning up Europe's banking sector and going after the billions of Euros stacked away by financial speculators, the so-called sovereign debt crisis has been presented as a consequence of people living 'above their means' and thus, as a justification to punish innocent people with drastic cuts in public social programs, pensions and wages, as well as staff reductions and privatizations of public sector enterprises and services ?

If you answered 'yes' to all three questions, you are ready to arrive at a correct diagnosis of the eurozone crisis as well as a consequential path toward a solution.

                                                                                                          ......more on this in upcoming posts

Message to Mme La Chancelière: STOP this austerity non-sense, you are destroying the €uro !

With all due respect for all your hard work in the interest of Germany and the German people, may I remind you that as the leader of the largest economy of the €uro currency area, you are responsible for ALL the people in the €uro area, not just the Germans. So, instead of partying with Friede Springer* I suggest you take a trip to Greece to see the needless human misery caused by the austerity policies you insist upon. Have you no heart ? And where is your Christian conscience?

Assuming that you are well informed about the pain and misery in Greece and also Spain, your latest pronouncements out of Canada are infuriating and ignorant. Praising Canada for its budget discipline and for "not living on borrowed money" and recommending the country as "the right solution for Europe" (Bloomberg press, Aug.16) shows that - with all due respect - you don't know what you are talking about (see para below). I hope you listened to Prime Minister Harper when he said at the end of the news conference: "we can't loose sight of the necessity...to focus on the creation of jobs and growth." Take that home to Europe, Madame la chancelière.

According to IMF data, Canada's public debt has continued to grow in absolute terms. The only reason why it did not grow in relative terms is because economic growth recovered quickly after the financial crisis, in large part thanks to the huge stimulus in the United States, Canada's largest trading partner. But the key difference between Canada and Europe lies in Canada's well regulated banking sector. Canada's banks are sound and financial markets are stable because they did not allow private debt levels and the financial casino to  get out of hand as in Europe. As reported today in the Frankfurter Allgemeine Zeitung, European banks hold €1000 bln (Milliarden) of credits at risk of default, of which €196 bln are held by German banks. THAT is something you should worry about and do something about - the European banking sector should have been cleaned up long time ago.

While dilly-dallying on the truly urgent problem of the €uro currency area, you insist upon imposing your moronic austerity policies which only damage the economy and the social peace of the countries, punish innocent people who had nothing to do with the financial mess, and cause massive capital flight out of the euro zone.  

If you don't want to listen to me, listen to the internationally respected Co-CEO of PIMCO, Mr. Mohamed El Erian:

"IMF [austerity] programs so far have allowed the exiting of private capital as opposed to crowding in of private capital. And that is really problematic."..."Every time the IMF has supported a European country, it has been a signal for the private sector to completely disengage." 

(Bloomberg interview of Mohamed El Erian, August 13, 2012)

I suggest you read up on the history of IMF austerity programs in developing countries, Madame La Chancelière. Perhaps you will then understand the havoc you are wreaking in Europe.

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* Friede Springer is a former housewife-turned millionaire who inherited the Springer media empire from her late husband.

How to raise public revenues, reduce public debt, and stimulate job-creating growth

In economics and economic policy, as in any other social science, it's always more effective to draw lessons from real-life history rather than follow an abstract theory that is impossible to verify or replicate in real life.

Fortunately, recent history (1990s) provides an excellent example of how to successfully raise public revenues, reduce public debt and stimulate job-creating growth: An effective combination of several coordinated policy measures generated sufficient revenues to pay down public debt, finance a well-designed economic stimulus, and lay the ground for the longest period of economic growth and record job creation in US history.

The initial economic situation was similar to the predicament of the Southern European periphery today:

- high levels of public debt
- rising interest payments on the debt
- rising budget deficits as a consequence of a banking crisis
- rising unemployment

The policy measures that helped reduce the public debt and laid the groundwork for strong job creation and long-term economic growth:

• To quickly raise much needed public revenues and reduce public debt, the Clinton administration (1993-2001) implemented drastic tax increases on corporations and the rich (people with incomes over $180.000). The super-rich (people with incomes over $250.000) had to pay an additional 10% surcharge. 
• To relieve the tax burden on lower income people and to promote consumption, the tax rate for lower income groups was lowered. For those who had so little income that they did not pay taxes at all, the Clinton administration introduced the negative income tax, i.e. they would get money from the US Treasury after filing their tax return. 
• To further reduce the debt, there were also expenditure cuts, but these were focused on corporate welfare (i.e. unproductive subsidies) or line items that provided little economic benefit. 
• To create approx. 500.000 jobs, the Clinton administration implemented an economic stimulus package including tax rebates for small and medium enterprises (SMEs), i.e. enterprises that create the majority of new jobs; 'empowerment zones' and community banks to finance investments in run-down regions; financing of investments in public infrastructure projects well as for the repair of environmental damages. 
• To ensure long-term growth, the Clinton administration drastically raised expenditures for education and investments in 'new technologies/sectors with future growth potential, i.e. the information technology 'highway' and others. 

These policies were so successful that, at the end of the Clinton administration, the United States government had a budget surplus so large that the Federal Reserve began to worry about zero interest rates on US Treasury bonds. As mentioned above, they also generated a record number of jobs (in the millions) and produced the longest period of economic growth in US history, not to speak of a booming stock market.

Whether this or a similar combination of policies will be as successful in Southern Europe as they were in the United States no doubt depends on a variety of individual country factors. But I think it's worth a try !

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Further details of the policies described above may be drawn from Bill Clinton's autobiography, "My Life". To verify the claims made in this post regarding the success of the policies described above, you are welcome to check the statistics for the United States in the 1990s.

Austerity causes capital flight and discourages investors

As if to underline the arguments in my previous post of August 4, two days later Shell's CFO Henry Simon announced that the Shell Group would withdraw €15 bln in cash from Europe and deposit the funds in non-European assets "to avoid the growing macroeconomic risk" in the euro zone. On August 7, Bloomberg reported that Italy's biggest manufacturer Fiat SpA intends to suspend investments in Italy due to the slump in demand. Today, the head of European foreign exchange at PIMCO, Allianz's asset management arm, wrote that the "crisis of confidence in the euro zone" had reached "a new dimension", with investors not only withdrawing funds from the European periphery but out of the euro zone altogether (Bloomberg report, Aug.9, 2012).

All this is no surprise to non-mainstream economists who have warned about the negative economic effects of austerity until they became fuzzy-mouthed (den Mund fusselig geredet). The flight of capital and investments may still get much worse as more corporations reassess the macroeconomic risks and prospects in the €uro currency area.

.....unless Germany's Schwabian housewife decides to put an end to the moronic austerity strategy she is insisting on and instead starts to focus on a €uro area-wide strategy for economic growth and job creation, coordinated with our European partners and financed by taxes on rich banksters and their speculative activities.

Austerity chickens are coming home to roost in Germany

While the eurozone's central bankers fight about the technicalities of ECB emergency measures to save the euro, people in the Southern periphery continue to suffer and the economic downturn is reaching Europe's core: the latest PMI data show that manufacturing slumped in France and Germany and that the slump worsened in Italy, Spain and Greece. Markit's eurozone PMI for the manufacturing sector fell to 44.0, below the 50.0 level that divides growth from contraction and the lowest reading since June 2009. The eurozone's output index fell to 43.4, the lowest since May 2009, with Spain showing the 15th month of contraction, Italy the 12th, and Greece over 30 months of declining output ! (Reuters Business News, Aug. 1, 2012)

More evidence for Larry Summer's argument that "the idea of expansionary austerity is oxymoronic"...  "you can drop the prefix"  Already in September 2011 Summers admonished European policy makers for their incrementalism and their "oxymoronic doctrine of expansionary fiscal contraction"  which claims that fiscal contraction is necessary to raise investor confidence and will lead to new investments and economic expansion (the famous story of the confidence fairy).

There is absolutely nothing expansionary about austerity as we can all witness in Europe: in Spain, where the new conservative government (elected in December 2011) followed the expansionary austerity doctrine to the letter, the economy slipped even deeper into recession, unemployment, bond yields and CDS-spreads sky-rocketed, and private capital took flight to the tune of €100 bln (so much for the confidence fairy). Shortly thereafter, European taxpayers had to rescue Spanish banks by injectiong roughly €100 bln into the system to prevent a collapse.

Bravo ! Quite successful, this expansionary austerity strategy modeled on the finances of Schwabian housewives !

Similar developments can be observed in other Southern European countries undergoing expansionary austerity programs: Italy saw €160 bln in flight capital exiting the country (probably to Germany) and Greece's private capital has been fleeing for months as the country moves closer to an economic collapse with each new expansionary austerity program imposed by the Troika. It's obvious to anybody but the Very Serious People in power that investors are not concerned with too little austerity but too much of it ! Seems logical, as most rational investors would want to invest in an economy where demand is growing, not shrinking !

Hellooooo! Anybody home among the economic policy makers in Berlin ? Nope - all on vacation.

Hopefully, when they return from their undeserved leave, they will understand that there is no confidence fairy and that sometimes, there is a role for government to step in and provide the start-up funds for investments in Europe that will generate attractive returns and growth for both the public and the private sector. I can already hear the dogmatists now: 'this is just the old Keynesian recipe and will only lead to higher debt.' Well, yes and no. Yes, it is a Keynesian recipe because Europe finds itself in a typical liquidity trap situation so aptly analyzed by Keynes and hence, the solution might just be the one proposed by Keynes.

And no, it does not have to lead to higher public debt levels. Not if you finally make those pay who caused the crisis and who profited from it, by implementing a financial transactions tax, a wealth tax, a higher property tax, whatever it takes. Just do it and save Europe !