May 16, 2014 7:29 pm

The eurozone won the war – now it must win the peace

The acute phase of the crisis is over but underlying weaknesses remain, says Peter Spiegel


Martin Feldstein, the renowned Harvard economist, once predicted that the euro could lead to renewed conflict in Europe, raising the risk of US intervention to preventmore serious confrontations”. His article in Foreign Affairs, published a year before the launch of the single currency in 1999, triggered a furore in Europe where officials indignantly rejected the idea of a third world war on the continent.

More than 15 years on, Professor Feldstein’s forecast has proved to be more accurate than many of his critics expected. The euro may not have unleashed hostilities in the old war theatres east and west of the Rhine, but the sovereign debt crisis following the financial crisis created extraordinary confrontation and recrimination among Europe’s leaders – as described in this week’s in-depth series in the Financial Times.

The series featured shouting French presidents, manoeuvres to unseat the prime ministers of Greece and Italy, and even a tearful Angela Merkel, German chancellor and the leading actor in Europe’s political psychodrama. And yet, in the end, these conflicts perhaps the most intense since the Treaty of Rome was signed six decades agowere settled not on the battlefield but in the conference room.

The euro was saved – but is it secure? Nearly two years after Mario Draghi, the European Central Bank president, announced he would dowhatever it takes” to save the euro, the acute phase of the crisis appears over. Italian and Spanish borrowing costs are at the lowest levels since the euro’s launch. Ireland and Portugal have left bailout programmes without the safety blanket of an EU credit line. Even Greece is insisting it will survive without a third rescue when its EU programme ends later this year.

Yet many of the underlying weaknesses remain unresolved. First, the project to create a fiscal union, which many economists believe is the sine qua non for a working monetary union, remains unfinished. There is no federal eurozone budget to provide buffers for countries going through temporary economic setbacks, no commonly backed eurozone bonds to level out borrowing costs, no large-scale harmonisation of national economic policies. And countries such as Greece, Ireland, Italy and Portugal remain heavily indebted.

With the return of market calm, many of those most closely involved in the years of crisis-fighting lament that reform fatigue is not limited to bailout countries such as Greece and Portugal. At March’s EU summit in Brussels, the last before next week’s European Parliament elections, an effort by Ms Merkel to take the next step towards fiscal union binding contracts that would harmonise fiscal reform programmes – was set aside after most other leaders complained they had already done enough.

More worrying, many in Brussels and Frankfurt fret that EU leaders are not only unwilling to continue down the road of eurozone repair but have instead gone into full reverse: governments in Ireland, Portugal and Greece are making policy decisions based on the assumption that the current market euphoria will last. As Willem Buiter, chief economist at Citigroup, said this week: “Those who say the European economy is recovering are smoking something.”

The official response is that the crisis has created a new Europeanarchitecture”, which has replaced the flawed halfway house of the Maastricht treaty that paved the way for the euro. There are new firefighting mechanisms and new rules to curb fiscal indiscipline. Still, the question on the eve of European Parliament elections is whether the monetary union is now politically sustainable.

The present arrangements look precarious. It is no longer just Greece and Ireland and Portugal that are having their budgets shaped by international monitors. 

Just ask François Hollande or Matteo Renzi. Both the French president and Italian prime minister are struggling to generate economic growth, only to risk running foul of tough German-inspired budget rules adopted in the early months of the crisis.

To the federalists in Brussels, the solution is “more Europe”. And in many ways, their arguments are unassailable. If voters do not like the way Brussels is implementing budget rules, they should be able to elect new European commissioners who will do things differently. An elected, polyglot European government running the EU from Brussels would have the democratic credibility and accountability to create a fully fledged economic and monetary union.

However, at a time when anti-EU sentiment is at an all-time high in nearly every eurozone country – and anti-Brussels parties are forecast to finish first or second in next week’s vote in three of the union’s six founding members (France, Italy and the Netherlands) – nobody believesmore Europe” is a realistic solution.

So what are we left with? Has the eurozone crisis moved into a chronic phase where tough budget rules demanding debt reduction, regardless of the economic circumstances, doom some southern EU countries to austerity and anaemic growth for years? And, if so, can mainstream parties continue to hold power indefinitely, even as voters become increasingly disillusioned that their elected governments no longer fully control that most basic sovereign function, taxing and spending?

The present generation of European leaders deserves credit for holding its nerve and keeping the eurozone together with a mixture of political courage and deft improvisation. How the next crop copes with the new Europeone in which the euro has been saved but economic stagnation and political insurgency are the order of the day could be as bracing a challenge as the last one.


Copyright The Financial Times Limited 2014.

miércoles, mayo 21, 2014

BONDED BANKERS / PROJECT SYNDICATE

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Bonded Bankers

Mark Roe

MAY 16, 2014
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Newsart for Bonded Bankers


CAMBRIDGESince the global financial crisis, regulators have worked hard to make the world’s big banks safer. The fundamental problem is well known: major banks have significant incentives to take on excessive risk. If their risky bets pay off, their stockholders benefit considerably, as do the banks’ CEOs and senior managers, who are heavily compensated in bank stock. If they do not pay off and the bank fails, the government will probably pick up the tab.

This confluence of economic incentives to take on risk makes bank managers poor guardians of financial safety. They surely do not want their bank to fail; but, if the potential upside is large enough, it is a risk they may find worth taking.

Several solutions to this problem have been proposed, and some – such as increased capital requirements and restrictions on risky investments – are headed toward implementation. More recently, two other important solutions have emerged.

Under the first, more developed proposal, banks would undertake large obligations via long-term bonds, which would be paid only if their operations are sound. In effect, the long-term bondholders would guarantee the rest of a bank’s debts, including the riskiest ones. If the bank faltered, the guaranteeing bondholders would stabilize the most troubled elements of the firm. The bondholdersnot the bank’s core operations – would take the hit.

Proponents hope that this would soften the systemic cost of bank failure. They also hope that the guarantees would motivate the bondholders to monitor banks’ activities and pressure bank managers to limit their risky operations.

The second solution that is gaining ground is to revise bankers’ compensation. Senior bank managers would be paid not in cash or equity, but in the bank’s long-term bonds, thereby giving them a larger financial stake in the bank’s long-term stability, instead of its long-term stock price. If the bank failed, it would be unable to repay the bonds, and the managers owning bonds would be that much poorer.

Bank regulators in the US and elsewhere are now seriously considering such changes, but they have yet to determine how comprehensive the compensation makeover should be. In general, though, a substantial share of senior bankers’ pay would be deferred for several years. If the bank did not survive that long, the managers would lose that money.

This could be achieved by unfunded pension obligations, which do not require that banks set aside the money in advance. Banks overseen by managers who had larger unfunded pensions weathered the financial crisis better than their counterparts, presumably because they had a stronger incentive to keep them safe.

A more aggressive approach would compensate bankers with the same bonds that guarantee their institutions’ short-term, volatile, and risky debts. As a result, bank managers would have a personal financial stake in ensuring that the risky obligations do not blow up, as they did during the 2007-2008 financial crisis. If the obligations deteriorated and the bank failed, the managers would be left unpaid. Because the obligations would be guaranteeing the rest of the bank’s operations, the managers would, it is hoped, be especially vigilant in ensuring that basic operations were safe.

By tying senior managers’ pay to the bank’s stability, the financial sector, advocates argue, would be forced to police itself. This incentive-based regulation could bolster economic stability more effectively than expecting regulators to keep pace with banks’ risky activities.

The proposal is not perfectnot least because bank managers’ compensation would still be tied to profits. If a banker is told that he or she will be compensated entirely in bonds this year, with the bank’s annual profits determining the number of bonds to be received, the banker would obviously want to boost this year’s profits – even if it required taking bigger risks.

After the banker receives his or her first bond payment, the incentives become more complex. The banker wants last year’s bonds to be paid (creating an incentive to safeguard stability) but wants a high payment this year (creating an incentive to maximize profit, which usually entails risk-taking).

Moreover, bankers could find ways to sell the long-term bonds. While regulators can require that the bonds remain unpaid by the bank, and even that bankers prove that they have not sold them, senior bankers are adept at finding loopholes. They could, for example, retain ownership of the bonds, but sell off their economic interest. Bank executives who hold large numbers of these bonds would have an incentive to lobby to dilute the bonds’ guarantee. If the bank’s financial condition deteriorated, their bond holdings might motivate them to conceal that and hope for a turnaround before their bonds were wiped out.

All of this highlights the imperative that regulators develop a shrewd and comprehensive strategy for supervising such a compensation system. Otherwise, it would lose its effectiveness. Compensating bankers with bonds helps to promote safety, but it does not let the regulators off the hook.

Despite these challenges, a new, bond-based compensation strategy could enhance bank stability considerably. Though there is no silver bullet for bank regulation, implementing such a system with care and vigilance would be an important step in the right direction.


Mark Roe, a professor at Harvard Law School, is an expert on securities law and financial markets. He is the author of numerous studies of the impact of politics on corporate organization and corporate governance around the world.


Recovery stalls in Europe as austerity grinds on

ECB needs to launch "shock and awe QE" to arrest slump in eurozone, says think tank

By Ambrose Evans-Pritchard

9:12PM BST 15 May 2014
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A young France fan watches from behind the French flag during the IRB Rugby World Cup Semi Final match at Stade de France, St Denis, France
France slipped back to zero growth and seems caught in a vicious circle Photo: PA


Growth wilted across large swathes of the eurozone in the first quarter, dashing hopes of durable recovery and prompting demands for shock and awe action from the European Central Bank.

Finland fell into recession, while output contracted by 1.4pc in Holland, 0.7pc in Portugal and 0.1pc in Italy. “The recovery has vanished,” said Italian think tank Nomisma.

Bourses tumbled across Europe, with Milan’s MIB index down 3.6pc, led by a plunge in bank stocks. Madrid’s IBEX was off 2.35pc and France’s CAC fell 1.25pc, as investor dumped shares to buy bonds.

France slipped back to zero growth and seems caught in a vicious circle as it keeps cutting spending further to meet its EU deficit targets. The country’s hardline premier, Manuel Valls, has vowed to push through €50bn (£40bn) of spending cuts, with fiscal tightening of 0.8pc of GDP this year.

The country’s Observatoire Economique said the outlook was even more troubling than it looked. France has seen a complete stagnation for the last 10 years, an unprecedented situation since the end of the Second World War,” it said. The body said fiscal cuts of 5pc of GDP from 2010 to 2013 had been premature and self-defeating.

Prof Charles Wyplosz, from Geneva University, said the relapse should not be a surprise. Austerity has been reduced but it has not stopped. Countries are still being told to reduce their deficits and they should not be doing that right now,” he said.

The ECB has yet to offer stimulus to cushion the effects or to offset passive tightening” from a strong euro and falling credit. Eurozone inflation was 0.7pc in April, with a bloc of countries already in outright deflation.

Michel Martinez, from Societe Generale, said the latest grim figures cried out for action, predicting a cut in interest rates to 0.05pc and a negative deposit rate of 0.1pc. He expects the ECB to buy €100bn of asset-backed securities later this year, with full-blown quantitative easing of up to €1.5 trillion in reserve if the recovery dries up altogether.

While the eurozone as a whole eked out growth of 0.2pc, this was largely due to Germany, where output surged by 0.8pc. The country is in a unique position, trading heavily with East Asia and benefiting from a chronically undervalued exchange rate within the EMU structure.

Spain racked up growth of 0.4pc, but this was due to a compression of imports and use of a “GDP deflator” of -0.4pc. Spanish exports fell 0.6pc. “This was a statistical mirage,” said Simon Tilford, from the Centre for European Reform.

“We are not seeing real recovery anywhere apart from Germany, and the picture becomes more troubling the more you drill into it. Nominal GDP growth is very weak, so we’re going to see a significant rise in debt rations,” he said. “We think it is highly unlikely that the ECB will launch the kind of shock and awe QE needed to convince the markets that they are really going to stay the distance,” he said.

The slump in Dutch output is a nasty shock for the government, which declared victory too soon after a deep double-dip recession.
While a fall in gas output due to the warm winter may have distorted the figures, the economy remains close to a debt-deflation trap.
Bruno de Haas, a former official at the Dutch central bank and author of Why The Euro Will Break Us, said membership of EMU had a disastrous effect on the country’s credit structure and was now blocking recovery.

“The sooner the Netherlands returns to the guilder, the better,” he said. Dutch property prices have fallen by 20pc, leaving a quarter of mortgages in negative equity. As the slump drags on, it makes it even harder for Dutch households to cope with loans near 250pc of disposable income.

Dario Perkins, from Lombard Street Research, said the Netherlands faced a 70pc risk of deflation under the International Monetary Fund’s deflation risk model, which uses a complex mix of ingredients, including credit contraction, that goes beyond the headline price level.

Perhaps the most worrying data are in Portugal, where exports have fizzled and deflation is gaining a foothold.

This is an ominous development for a country with a public and private debt nearing 400pc of GDP by some estimates