Echoes of 2008

Here we go again

The Europeans are pushing the global banking system to the edge

Oct 8th 2011
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YOU know something bad is going to happen in a horror film when someone decides to take a late-night stroll in a forest. The equivalent in finance is a bank boss insisting that his institution is completely solid.


European bankers have been saying things are fine for weeks now, even as their exposure to indebted euro-zone countries strangles their access to funding. The amount of money parked at the European Central Bank (ECB) has risen to 15-month highs as banks hold back from lending to each other. Fears of contagion from Europe have now infected America. Banks there led the S&P500 into official bear-market territory this week, as the index briefly dipped more than 20% below a high set in April. The chief executive of one embattled institution, Morgan Stanley, sent a memo to employees reassuring them that the bank’s balance-sheet was dramatically stronger than it was in 2008, when Lehman Brothers collapsed.


Europe is not the only problem facing Western banks, of course. A long list of woes also includes anaemic economic growth, piles of new regulation and waves of litigation related to America’s housing bust. An ill-conceived congressional bill to punish China for manipulating its currency is yet another sign that America has little to be proud of in terms of economic policy. But the central reason to worry is the euro zone: a series of defaults there would unleash devastation, sparking big losses on European banks’ government-bond holdings, and in turn threatening anyone exposed to those banks.


Earlier this year, the prospect of another Lehman moment seemed remote. Thanks to the abject failure of Europe’s leaders since then, the similarities with 2008 are disturbingly real. Governments are once again having to step in to support their banks. France and Belgium this week said that they would guarantee the debts of Dexia, a lender that was bailed out three years ago but which is weighed down by lots of peripheral euro-zone debt. In another throwback, plans are afoot to create a “bad bank” for Dexia’s worst assets. The cost of buying insurance against bank defaults has surged: credit-default-swap spreads for Morgan Stanley and Goldman Sachs hit their highest levels since October 2008 this week. Rumours are rife: that banks cannot pledge collateral at central banks, that hedge funds are pulling their money from prime brokers.


Name the year


Will the fearfulness of 2011 turn into another panic like 2008? In any sensible world, it should not. Policymakers will surely not repeat the mistake they made then, of letting a big bank go under. The asset class at the heart of this phase of the financial crisissovereign debt—is far easier to value than the securitised subprime mortgages that caused the trouble last time. There is much greater clarity about where exposures to dodgy government bonds lie, although American banks need to become more transparent about their ties to Europe.


What’s more, the components of a solution to the immediate euro-zone crisis, long proposed by this newspaper, are fairly well understood. First, create a firewall around other euro-zone members like Italy and Spain that are solvent but need help financing their debts; second, recapitalise the European banking system, which has done far less since 2008 to fortify its defences than America’s; and third, allow Greece, self-evidently insolvent, to default in an orderly fashion.

The problem with this solution for the rest of the world is that it depends on the Europeans to carry it out. The debt crisis has been running for 18 months now, and the only way that euro-zone leaders have dazzled is through sheer incompetence. It continued this week, with some politicians admitting that a hard restructuring of Greek debt was on the table, whilst others ruled out a default. The result is the worst of all worlds: more uncertainty for banks that hold Greek debt, more pointless austerity for the battered Greek economy.


clear plan for a forced bank recapitalisation in the euro zone is badly needed, too. The mere rumours of it happening sparked a late market rally on October 4th. There are all sorts of reasons to deplore the fact that banks would once again be propped up by public money. It would have been far better if over the past three years more had been done to boost banks’ capital and liquidity, and to create the mechanisms that would force bank losses onto creditors, not taxpayers. Every euro-zone finance minister should be forced to explain the whitewashstress tests” that gave even Dexia a clean bill of health earlier this year. But for now the priority is to prevent a systemic meltdown, not to accelerate it for the sake of principle.


A fragmented, nation-by-nation approach to recapitalisation will not work this time, however. France and Belgium may be able to stand behind Dexia but supporting entire banking systems is beyond the capacity of many sovereigns. The European Financial Stability Facility (EFSF), the euro zone’s bail-out fund, must carry out simultaneous injections of capital into the region’s banks as soon as it can. Central banks must get into full fire-fighting mode, too. In particular, that means offers of unlimited two-year liquidity from the ECB, which was due to meet after The Economist went to press.


Herding Eurocrats


Above all, no amount of recapitalisation would be enough to protect banks from a cascade of euro-zone defaults. Nothing matters more than putting a firewall around the likes of Italy and Spain. Here, the news is bleak. Jean-Claude Trichet, the outgoing president of the ECB, describes this as the worst crisis Europe has faced since the second world war; but the institution he runs is unwilling to respond in kind. It is reluctant to keep buying government bonds itself, and is unimpressed by suggestions that it should boost the EFSF’s firepower by lending to it. Politicians are contorting themselves to try to strengthen the EFSF without relying on the ECB.


In 2008 governments were credible backstops for their banks and the Fed, the central bank at the heart of the crisis, was willing to do everything it could to create confidence. Now the sovereigns are the problem and the ECB’s help is limited and conditional. That is the real horror film.


10/05/2011 05:50 PM

The Ticking Euro Bomb

How a Good Idea Became a Tragedy
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The Greek crisis has revealed why the euro is the world's most dangerous currency. The euro was built on a foundation of debt and trickery, where economic principles were sacrificed to romantic political visions. The history of the common currency is the story of a good idea that turned into a tragedy of epic proportions.


By SPIEGEL Staff.


This is Part 1 of SPIEGEL's recent cover story on the history of the common currency. The remaining installments will be published in English on Thursday and Friday.


Before Germany's Horst Reichenbach had even stepped off the plane in Athens, the Greeks knew who was coming. He had already been given various unflattering nicknames in the Greek media, including "Third Reichenbach" and "Horst Wessel" -- a reference to the Nazi activist of that name who was posthumously elevated to martyr status. The members of his 30-strong team, meanwhile, had been compared to Nazi regional leaders.


The taxi drivers at the airport were on strike, while hundreds stood in front of the parliament building, chanting their slogans. One protestor was wearing a T-shirt that read: "I don't need sex. The government fucks me every day." Within the first few hours, Horst Reichenbach realized that he had landed in a disaster area.


Reichenbach is the head of the task force the European Commission sent to Athens to provide what Brussels officials call "technical assistance" in the implementation of necessary reforms. For the Greek media, the task force is the advance guard of an invasion force, the bureaucrats that have arrived to transform beautiful Greece into a German colony.


Reichenbach describes his tasks as follows: restructure the tax system, streamline the administration, accelerate privatization, strengthen legal certainty, open up access to protected professions, restructure the energy and healthcare sector and remove structures that are hostile to investment. The effort, says Reichenbach, requires "thinking in terms of years instead of months." He was the vice-president of the European Bank for Reconstruction and Development and had planned to retire at the end of December. But then he received a call from European Commission President José Manuel Barroso, who then dispatched Reichenbach on this mission impossible.


He is a middleman between two Europes, the north and the south. The euro was intended as a currency that would help Europe grow together, but the first major euro crisis is in fact pitting the north and the south, the deutschmark economy and the lira economy, against each other. To make matters worse, there are also two different speeds in Europe, with one part of Europe moving at the high-paced speed of financial markets and banks, while the other drags along at the speed of governments and parliaments. And then there is also the Europe of two versions of the truth. One is at home in Brussels, Berlin and Paris, in the centers of power, while the other resides in the living rooms and on the streets of European cities.


As admirable as it is for Reichenbach and his 30 nation-builders to be bringing order to Athens, no amount of reorganizing can simply do away with €350 billion ($473 billion) in government debt. How to cope with this debt without ruining the European project is the most pressing question of recent weeks. After 20 years of bad decisions, spineless reforms and postponed actions, it isn't the citizens but the markets that have forced united Europe into an endgame over the euro. How can this currency have a future? Is there a risk that Greece is only the first domino in a row that could end with Germany? Is the euro zone a faulty design?


team of SPIEGEL reporters went to Brussels, Luxembourg, Athens, Berlin and elsewhere to find answers to these questions. They have reconstructed the rise and fall of a currency that can only survive if the mistakes that were made over two decades are corrected in the next few months.


Act I: The Birth of the Euro (1991 to 2001)
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Why the mistakes that would later threaten the euro were already made in the foundation phase. How Greece and other countries cheated their way into the monetary union. Why the common currency is a trillion-euro bet made by politicians against the markets -- and one that they would ultimately lose.


The bold, visionary project of creating a common currency for different countries and populations cannot be understood without reminding ourselves that the Berlin Wall came down in the late 1980s, the world still felt that World War II was a relatively recent event, and that Europe was still discussing whether Germany could pose a threat again.


Jacques Delors was the president of the European Commission for 10 years, and he was the lead author of the Maastricht Treaty, which defined the basic features of the euro. Now Delors is forced to listen to the daily criticism of how illusory his vision of a common currency was. But if he had had his way completely, he says, Europe would have been far better equipped, would have a more uniform constitution, and would be centrally governed by a Commission whose work would not be constantly undermined in the European Council, which comprises the heads of state and government.


Delors always wanted to go further than the political elite he was dealing with. At the time -- unlike today, he says -- that elite was consistently filled with dedicated Europeans, people like then-French President Francois Mitterand, then-German Chancellor Helmut Kohl, then-Dutch Prime Minister Ruud Lubbers and then-Portuguese Prime Minister Aníbal Cavaco Silva. But they too were not bold enough to integrate their countries to a degree that could count as true European coordination.


The Maastricht Treaty, which marked the establishment of the European Union when it was signed in 1992, made it all possible. It placed Europe on "three columns," the first of which was an economic column, complete with an "Economic and Monetary Union." The treaty provided the necessary legal framework, so that a common financial policy would have been conceivable, as would a coordinated fiscal and interest-rate policy. But the political will to fill out the Maastricht framework was missing.


The "United States of Europe" remained little more than a soundbite. And yet the introduction of the euro created a fait accompli that could no longer be rolled back. This European Big Bang, if you will, was to be followed by a process of evolution, during the course of which all the details were to be resolved.


Perhaps most importantly, the common currency was also a political symbol. Delors says that he always perceived Greece as being very far away, different and foreign. The country's acceptance into the euro zone happened much too early, he adds. But at the time, in the 1990s, politicians stood up in front of microphones and said that Europe was inconceivable without Athens, the "cradle of democracy." And Portugal, with its Carnation Revolution, also surely deserved to be part of the club. And the Irish, oppressed for so long by the British, had to be helped too. And who would have wanted to show Italy the door, merely because of its high unit labor costs and inflation rates?


And so, when the euro zone became a reality, elephants like Germany and France came together with mice like Portugal, Ireland and Luxembourg. Stable, prosperous countries of the north shared their common currency with shaky, underdeveloped countries of the south, mature industrialized nations joined forces with what were hardly more than developing countries. Strict Protestants mixed with sensual Catholics.


The promises of the euro were recorded in the Maastricht Treaty. It was to be a currency that would make Europe strong in a competitive globalized world; that would bring the European economies closer together; that would oblige countries to limit their debts and deficits; that would guarantee that no country would be liable for the debts of another; and that would promote political unity.


And the details? Well, they would be ironed out later.


The Greeks Jump at the Opportunity


In Greece, the euro fueled hopes of a better future. In October 1993, socialist Andreas Papandreou was reelected as prime minister. Then-Finance Minister Yiannos Papantoniou recalls today that the cabinet of Papandreou's new administration quickly became convinced that Greece's accession to the monetary union was the only chance to solve the country's financial problems.


Greece was already well over its head in debt at the time. The country's liabilities exceeded its real economic strength, with the national debt amounting to 114 percent of the gross domestic product. Athens was battling more than 14 percent inflation and the economy was shrinking.


Any economist could have recognized that the Greek economy was not competitive, and that the country, without outside impulses, seemed incapable of fundamentally changing its situation. The euro and its regime were to forcibly bring about necessary reforms, and in particular make it easier to obtain credit. Gaining accession to the euro zone became Finance Minister Papantoniou's mission.


He used every opportunity to remind people of Greece's claim. When the EU finance ministers met in Brussels in April 1997 to discuss what the new money would look like, Papantoniou proposed that the coins be embossed with both Latin and Greek letters. Then-German Finance Minister Theo Waigel curtly rejected the idea.


Greece was not in a position to make demands, he said. And then, turning to Papantoniou, he added: "You are not part of this, and you will not be part of this."


When the two finance ministers spoke later on, Papantoniou proposed a bet to Waigel, namely that Greece would get the euro. Indeed, it would only take a few years for Papantoniou to win his bet.


Waigel, who recently described Greece's acceptance into the euro zone as a "mortal sin" in the German newspaper Süddeutsche Zeitung, eventually became a fan of Greece, says Papantoniou. "It was Waigel who brought us into the euro," he says. "It is absolutely untrue that he was opposed to our accession to the euro."


The former Greek finance minister dismisses the charge that his country used falsified figures to cheat its way into the euro zone. "We didn't do anything differently from all the other countries," he says.


The Trickery of Euro Candidates


In his book "Herausforderung Euro" ("The Euro Challenge"), Hans Tietmeyer, the then-president of Germany's central bank, the Bundesbank, confirms that "questionable cosmetic surgery" was performed in some countries to make data on inflation rates, government debt and price trends conform to the euro zone's requirements.


Italy's government debt of 115 percent of GDP was dramatically higher than the 60 percent debt limit agreed to in the Maastricht Treaty. Belgium was also massively in violation of treaty provisions.


At the time, then-Bundesbank President Tietmeyer noted with concern that, in 1998, the Europeans, inspired by the sheer magnitude of their project, had eliminated the final test of whether enough countries even satisfied the requirements for the euro, from their roadmap for switching to the new currency. They were determined that the euro would be introduced on Jan. 1, 2002.


In a German government meeting that was supposed to make a decision on the currency, Tietmeyer raised his objections against certain euro candidates -- to no avail. In fact, the outcome of the meeting had already been determined in advance, and it had even been stated in writing.


Then-German Chancellor Helmut Kohl, a thoroughly committed European who belonged to the school of thought that there should never again be a war in Europe, wanted the historic decision. As Tietmeyer recalls, the chancellor said solemnly: "May we look back at the euro in 50 years' time as positively as we do today with the deutsche mark."


Numbers and data were constantly being thrown around at the time, in the late 1990s. The gathering of data was left up to each EU country, and Europeans trusted one another. But there was one question that hadn't been clarified: When the figures came together in Luxembourg, what would happen if Eurostat, the organization tasked with assembling the data, discovered mistakes or violations of the rules? What authority or body would implement sanctions, and at what level?


Schröder and Eichel Inherit the Euro


Germany was still preoccupied with other issues. After 16 years under  Kohl, a coalition of the center-left Social Democratic Party (SPD) and the Green Party won the German national election in 1998. In Germany, it felt like the beginning of a new era, but there was little enthusiasm for the European project. For the new Chancellor Gerhard Schröder, the euro was no longer a question of war and peace. Schröder flippantly referred to the new currency as a "sickly premature baby."


But the euro was also a consistently political currency, says Eichel. Spain, Portugal and Greece were all former military dictatorships that had only found their way back to democracy in the mid-1970s. The strong connection to Europe, says Eichel, was also seen as a means of strengthening democracy.


Greece's democracy received the validation it desired in 2000, when the European Commission and the European Central Bank concluded that the country had made great strides in the previous two years. The ECB warned against Greece's high debt levels, and yet the Commission recommended that Athens be admitted to the common currency. "Greece has completed a successful convergence process after a long and difficult path," then-Finance Minister Eichel told the German parliament, the Bundestag.


Then-Greek Finance Minister Papantoniou had reached his goal, winning his bet with Theo Waigel. Greece became a member of the euro zone.


But that meant that the European treaties weren't worth the paper they were printed on. Greece's public debt wasn't at 60 percent of GDP, the required maximum, but at over 100 percent. And even back then, there were already doubts about the numbers that Athens was officially reporting.


The Critics of the Euro


There were opposing voices in society, particularly in Germany, where the deutsche mark was not just a means of payment but also a psychologically important symbol of Germany's postwar reconstruction and economic miracle. The 1990s were a decade of squabbles over the euro.


In 1992, for example, 62 German professors issued a joint warning against introducing the euro. They feared that the monetary union, the way it was structured, would "expose Western Europe to strong economic fluctuations, which, in the foreseeable future, could lead to a political acid test."


In the end, the political will prevailed over the economic objections. In April 1998, the two houses of the German parliament, the Bundestag and the Bundesrat, which represents the interests of Germany's 16 states, cleared the way for the last step toward monetary union.


After that, whenever a government official spoke out against the euro, it would set off an enormous commotion throughout Europe. Hans Reckers, the president of the central bank in the German state of Hesse, learned that when he dared to voice his concerns publicly.


Reckers was a member of the Bundesbank executive board at the time. In April 2000, near the end of a speech to a handful of financial journalists in the conference room of the state central bank, he cleared his throat and said: "In my view, Greece is by no means ready for the monetary union. Its accession must be postponed by at least a year."


It took about 20 minutes for the first news agency reports to be sent, and another five minutes for prices to begin plunging on the Athens stock exchange, prompting Greece's central bank to buy up drachma to prevent it from declining in value. Eichel, the finance minister, called then-Bundesbank President Ernst Welteke, and Welteke called Reckers, who was promptly muzzled. But today Reckers claims that all 15 of the bankers on the Bundesbank executive board felt that the Greece accession was a mistake.


A mistake, some said, that could be absorbed because Greece is such a small country.


A dramatic mistake, others said, warning against underestimating the power of the financial markets.


The true problems were not addressed in the wake of the Jan. 1, 2002 introduction of the euro. Despite all the declarations of intent in Maastricht, the 12 new euro countries drove up their debt by more than €600 billion in the five years of preparations for the introduction of the euro. By the end of 2002, they had a combined debt of €4.9 trillion, with Italy's debt alone amounting to €1.3 trillion.


The Skepticism of the Americans


Across the Atlantic, American economists were busy examining Europe's plans, which they felt were half-baked and "oversized," in the words of financial economist Kenneth Rogoff, a Harvard professor and adviser to US presidents and governments around the world. His office is in the Littauer Building on the edge of Harvard's manicured campus in Cambridge, Massachusetts.


When the euro became a real currency, Rogoff had just taken the position of chief economist at the International Monetary Fund (IMF), and he was teaching at Princeton when the euro began to take shape in the 1990s. He agreed with his fellow US economists' view that the euro was conceived "on too grand a scale."


Rogoff observed that a trans-Atlantic rift was developing between two groups of economists. The Americans and the Western Europeans, who usually more or less agreed on key macroeconomic issues, were suddenly arguing to the point of insult. The Europeans accused their overseas colleagues of failing to recognize the historic processes, the grand vision and Europe's great leap forward. The Americans, dry and pragmatic, accused their European counterparts of downplaying the risks. Once again, they felt that Old Europe was being overly romantic and blind to reality.


Rogoff did find some good ideas in the work of the EU and the architects of the euro. The Maastricht debt criterion, for example, remains a brilliant and valid idea to this day, says Rogoff. He is still convinced that setting an upper limit for the ratio of government debt to GDP at 60 percent proved to be a great success.


"It was something new at the time," says Rogoff. "It was a great insight."


The only problem, as soon became apparent, was that the Europeans had a tendency to betray their own ideals.
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REPORTED BY FERRY BATZOGLOU, MANFRED ERTEL, ULLRICH FICHTNER, HAUKE GOOS, RALF HOPPE, THOMAS HÜETLIN, GUIDO MINGELS, CHRISTIAN REIERMANN, CORDT SCHNIBBEN, CHRISTOPH SCHULT, THOMAS SCHULZ AND ALEXANDER SMOLTCZYK