Resurrection for the Euro (2)

In the run up to Easter last year I wrote an article which remains topical and worth a re-read as we face another Easter.

RESURRECTION FOR THE EURO - 08 April 2012

The situation did not get any better since then.  Two more countries have had to be bailed out bringing the Euro members in the sick bay to five.   And presently we are seeing scenes on the streets of Nicosia which practically mean that Cyprus is a Euro area member only in name.

How can a Euro area member be considered a full paying member of the Club if a Euro in Cyprus in not the same as a Euro in Germany, Finland or Netherlands?  How can an EU member, let alone a Euro area member, be forced to impose restrictions on movement of capital, and restrictions on bank deposit withdrawal.

Hopefully this is only for a short period and life will return to some sense of normality in Cyprus pretty soon.  Economically Cyprus will undergo a crushing economic contraction over the next few years as its financial services industry gets wiped away and it will have to recreate growth in other sectors, most notably by re-energising its tourism potential and developing its freshly discovered natural gas resources.

As always there is a silver lining.    Probably the scene is being set for a favourable scenario to make another attempt for the reunification of Cyprus based on the Annan plan which the Greek Cypriots rejected in 2004 prior to their EU membership.

Cyprus' has dire need to exploit its natural gas resources to rebuild its economy following the financial disaster suffered.  This basically guarantees that a fresh vote would now produce a strong approval on both sides of the green line.

So many thing have changed since 2004.   Suffice it to say that in 2004 Greece as a Euro area member could easily borrow 10 year money at 4% whereas Turkey as a backward emerging economy would have had to pay double digit rate.   Things have turned on their head.  Turkey can now borrow at 4% and Greece cannot borrow at any price and has to depend on the EU for bailouts.  Indeed Greece not only crushed their own economy but caused collateral damage to protege Cyprus, bankrupting its banking system and causing shocking distress to Cyprus economy.

The Euro system needs a resurrection.  In its present structure it will collapse sooner rather than later.   Such resurrection cannot be engineered before the next German Chancellor puts the elections behind him or her.   But after that the Euro can only be saved and avoid the dismal scenes we saw today on the streets of Nicosia if:

• a Euro area banking union with common supervision and a cross border Euro-wide deposit insurance scheme is implemented
• we start moving to a structure that controls more effectively the fiscal policies and borrowing commitments of separate Euro area sovereigns, possibly creating a central debt agency which issues Euro bonds on collective responsibility and re-lends to the individual sovereigns subject to appropriate conditionality and cost margins to reflect their fiscal prudence or lack of it.

For the time being we enjoy the Easter religious resurrection and with some good reason.  Whilst on the streets of Nicosia the situation is shameful and pitiful, on Wall Street and the streets of other main Exchanges stock markets are peaking to new highs.  They have full faith that after the German elections the EU will do whatever it takes to resurrect the Euro.

Happy Easter!!

And now what?

Jean Claude Juncker
immediately missed
as head of the Euro group

So Cyprus has been bailed-out.   It joins the ranks of Greece, Ireland, Portugal and Spain who have already been bailed out.

Each country has had a different bailout model.  

Greece has had its bailout conditional on a 70% haircut on most of its external sovereign debt.

Ireland has had to force losses on the holders of subordinated debts of its banks and in case of Anglo Irish Bank also of its senior debt holders.

Spain has used its weight to arrange for the bailout to go straight to recapitalisation of its banks in distress without passing through the sovereign.  It has thus avoided increasing the public debt to capitalise its distressed bank which would have put further strain on its fiscal position.

Cyprus would much have wished a similar treatment  as Spain whereby the recapitalisation of its banks would have been effected directly by the ESM.    But either because the Cyprus banks were in deeper state of insolvency ( mainly caused by the losses they suffered through the Greek sovereign debt haircut and by the losses incurred by Cyprus banks largish operations in Greece where the economy is trapped in a never ending recession) or because Cyprus was too small to offer negotiating resistance such approach was refused.

Not only that but the Cyprus bailout established new precedent where for the first time substantial losses were forced on uninsured but ordinary deposits sending a message that bank deposits in Europe were no longer to be considered safe.

The inexperience of  New Euro Group chief Jeroen Dijsselbloem fanned market uncertainty with contradictory statements about the Cyprus rescue and angered colleagues with his glib negotiating style. This never would have happened under his predecessor, say his critics. He is over his head in this new job and must be taught to speak less and with caution.   He could have easily explained that Cyprus presented a unique set of circumstances which required an exceptional bailout approach involving uninsured deposits.  Instead he put his foot in concrete when he is reported to have said that the Cyprus approach could be a template model for any future bailout involving recapitalisation of banks in distress.   He later tried to backtrack on his words but it is difficult to put toothpaste back in the tube.

But the question remains : and now what?   Out of 17 Euro countries, 5 have been bailed out and are in the sick bay.   Two others are in serious condition as Slovenia and Italy may be heading in the bailout direction.

Are we solving any problem by forcing extreme austerity on countries seeking bailout as the EU tries to force harsh internal devaluation to Germanise them and make them export competitive again?   Can we do so by wasting idle resources in the form of lost growth and high youth unemployment which risks becoming chronic and irreversible?

What nobody seems to be asking are these simple questions:

• Is it logical to expect that so disparate countries as Greece and Germany be locked in the same monetary union?
• Can external competitiveness for countries in distress be regained merely through never ending rounds of austerity?
• Should not surplus countries also be taking corrective measures to bring back macro-economic equilibrium among Euro member states?

The present bailout pattern is unsustainable.   As more members join the sick bay the members outside will become fewer and less able or willing to carry the load.

We are adopting a Versailles method when we really need a Marshall Plan method.

Anyone who thinks that the German taxpayer is being short changed by having to finance the bailouts of countries in distress should take a cold shower and look reality in the face.

Germans haven't just paid for the crisis, they profited from it.  The savings in interest payments, which Germany have enjoyed since the beginning of the crisis, amounted to €10 billion last year alone. Plus there are the interest payments from debtor nations. The reality of the euro crisis is this: The poor of Athens are paying the rich in Germany.

And above all Germany is benefitting from export led economic growth as the Euro crisis is keep the Euro value on the foreign exchange market much softer than would have been the case if under similar conditions Germany's currency was still the Deutsche Mark.

The Euro crisis is in fact a party for the Germans.   But they cannot expect it to last long.   They have been warned.   Italian elections have given the biggest share of the popular vote to anti democratic Beppe Grillo who is speaking much the same language as Mussolini used to speak to erode trust in politicians and pave the way for the scrapping of democracy.

Such experiments failed in the past, and they will fail in the future. Europeans will not allow it. As Germans keep cheering on their Chancellor, they should mark the words of former Euro Group chief Jean Claude Juncker: 

"Anyone who believes that the eternal issue of war and peace in Europe has been permanently laid to rest could be making a monumental error. The demons haven't been banished; they are merely sleeping."

Whoever is the next German Chancellor, he/she must switch from Versailles to Marshall Plan mode or otherwise what was gained in six decades since the origins of the EU will be washed down the drain.

Bringing sense to Cyprus

Published in The Malta Independent on Ssunday 24 03 2012

So I don’t have to write an apology for getting my prediction about the outcome of the elections wrong. In my last article I wrote:

 “I just cannot imagine that the polls will be proved materially wrong by the final result.”

And they were not. Anyone who doubted the final outcome of the elections was probably living on another planet. Anyone who did not expect a wide margin just did not have their finger on the pulse.

That is now water under the bridge. No sooner had he been sworn in as Finance Minister, Minister Scicluna must have had his baptism of fire attending one of the most tumultuous euro finance ministers meetings at which the Cyprus bailout was discussed and agreed to.

I say “agreed to” with reservation, as while it was agreed to by the Cyprus delegation at the meeting, the package was then roundly rejected by the Cypriot Parliament.

Cyprus is getting it awfully wrong and it is behaving irresponsibly and in a matter that could prejudice not only its own interests but also possibly, although unlikely, the interests of other countries who, like it, are having to go through fiscal sanitisation demanded by bailout arrangements.

Firstly, let everyone realise that when a country requests a bailout it does so because it is in a tight spot and has no real alternative left but to seek one. The only alternative would be to exit the euro, but the consequences of this could be far more socially painful than actually working through the bailout. As they say, the euro is like the Hotel California: you can check out (i.e. break the rules for some time) but you can never leave.

Cyprus made three bad mistakes in its negotiations with the EU and has been very badly served by its political leaders. Firstly, it failed to flag out the collateral damage it would suffer as a result of the bailout conditions imposed on Greece. That was the point at which Cyprus should have put on the table the predicament that would befall its banking system through the haircut on Greek sovereign debt imposed as part of the Greece rescue package. It should have demanded instant redress as part of the Greece package.

Its second grave mistake was to take the package agreed with the EU last Saturday to be voted upon by its own parliament, when it was clear that it would be rejected. Rejecting a bailout without having a realistic alternative is never wise and Cyprus should have re-opened immediate negotiations with the eurozone to tweak the package enough to gain parliamentary approval.

The third biggest mistake Cyprus made this week was that, after rejection of the bailout plan by its parliament, rather than entering into immediate negotiations with the Euro Group, it wasted precious time and political goodwill negotiating a financial salvage package with Russia. Even if Russia had been prepared to talk seriously about such a financial rescue plan – which clearly it was not, unless Cyprus was prepared to put its sovereign soul on the negotiating table – Cyprus needed the ECB liquidity lifeline even more than it needed the bailout. So seeking the elusive Russian rescue and ignoring the ECB lifeline forced the ECB to rightfully issue a unique and stern warning that unless an EU bailout was agreed to over this weekend, it would shut the liquidity lifeline and force the collapse of the main Cypriot banks.

The Cypriots have over-played their hand and ignored the following facts of life:

· EU countries cannot easily justify a bank rescue for Cyprus, the main beneficiaries of which would be Russian depositors, many of whom have funds of dubious origin.

 

· Germany has an election this autumn and Chancellor Merkel is under severe domestic pressure to be tough in granting such bailouts, which are exposing German taxpayers to substantial credit risk.

 

· Cyprus is small enough to risk collapse without causing contagion and so it was a good opportunity to send a clear message to other countries to urge them keep their fiscal houses in order so that bailout requests become the exception, not the rule.

 

· There is no way it can be in the interests of Cyprus to take on its own shoulders the financial burden to bail out all depositors, given that the banking sector in Cyprus is eight times larger than the country’s GDP. So a haircut on depositors was an inevitable ingredient in the bailout package, but the burden of this should be spread over the bigger depositors. ‘Insured’ deposits of up to €100,000 should have been protected and exempted from the haircut.

 

· The Cypriot offshore banking business model is broken beyond repair and cannot be protected. Plundering pension funds and selling potential gas assets while in distress to save a broken model cannot be a sober solution.

It is to be hoped that realism will return to the negotiating table this weekend, with the Euro Group and Cyprus will agreeing to a modified package that protects insured depositors but transfers the burden onto the larger depositors. For those interested in what shape and form such a revised package could take, they can access my blog (as hereunder) where this week I posted several pieces on the morass of the Cypriot banking sector and the Cyprus situation in general.

Closer to home, we should be thankful that our main banks have remained a domestic affair (unlike the Cypriot banks, which established substantial operations through subsidiaries in Greece that now have to be sold under the hammer) and that their operations are fully and very comfortably financed by stable domestic deposits. Our native banks have never raised wholesale lines of credit to expand their balance sheet by taking activities beyond our shores and very justifiably command the full trust of Maltese savers.

I do not, however, understand why our banking regulators – rather than protecting what has served us well and what has saved us – have adopted a liberal attitude to licensing foreign investors, often private equity and hedge funds, as full service banks when their business model is based on limiting their activities to pure domestic deposit taking under the protection of the deposit insurance scheme.

Rather than deploying the deposits raised in our own economy, such banks often leverage them in order to finance overseas operations that are either speculative or meant to ‘abuse’ the subsidies that the ECB is having to allow real banks in distress, by providing cheap and plentiful liquidity whilst they undergo a de-leveraging exercise to their balance sheets. Why we should offer deposit protection (which is mainly funded by the truly domestic banks that offer a full banking service) to such foreign institutions with unsound banking business models, escapes me.

I have been the lonely voice protesting about this situation for several years. At least this week, probably awakened by the happenings in Cyprus, other economists and financial operators have expressed similar concerns. It is never too late.

This leads me to a wider reflection on our regulatory set-up. When financial regulation was hived-off from the Central Bank to the MFSA, in line with similar trends at the time, the main argument was to protect the full independence of monetary policy operators from conflicts of interest in case regulators had to rescue this or that bank. Never mind that by so doing we were creating another conflict of interest within the MFSA, with it serving as both the regulator and supervisor – as well as the promoter – of our financial services industry.

The crisis of 2008 showed that, when push came to shove and we were faced with across-the-board systemic risks, only central banks could provide the necessary liquidity to save the system, and not the regulator, who created the problem in the first place by adopting light touch regulatory and supervisory system. Internationally, authorities are reversing the process and the trend is for regulation to migrate back to the central bank. Rather than create complicated hybrid systems, which cannot work when truly needed, we should seriously consider calling a spade a spade and move financial regulation and supervision back to where it should have always been.