Why higher market volatility is the new norm

Mohamed El-Erian

IMF managing director Christine Lagarde with European economic and financial affairs commissioner Pierre Moscovici at the G20 meeting in Ankara  © Getty Images
The unusual volatility that has taken hold of financial markets in recent weeks, resulting in some impressive moves up in asset prices and many more harrowing declines, will be with us for a while.
Driven by a combination of tactical and structural forces, it is indicative of an ongoing shift in markets’ operating environment. And because of its potential for altering household and corporate behaviour, as well as the heightened risk of financial accidents, it amplifies the need to better manage downside risks to the global economy.
There are six major reasons why higher volatility, up and down, is the new norm for financial markets:

  • First, the emerging world’s spreading economic slowdown is eroding a fundamental underpinning of high and stable asset prices. Gone is the notion of a steady global growth “equilibrium”, albeit at a relatively low level, in which dynamic emerging economies offset the sluggishness in Europe and Japan. Indeed, in virtually every systemically important emerging country (including Brazil, China, Russia and Turkey) growth is slowing; and, as highlighted by Mario Draghi, European Central Bank president, last Thursday, Europe is in no position to take up the slack — leaving too much of a burden on the US to act as a powerful global growth locomotive.
  • Second, asset prices were high and, in some cases, in bubble territory. China is perhaps the best example of this. In a similar way to how the US pursued home ownership as a social objective a decade ago, Chinese officials encouraged broad-based participation in the stock market as part of the country’s journey towards a market-based system. And, again like the US with housing, the phenomenon resulted in a price bubble that is challenging to deflate in an orderly fashion.

  • Third, two markets, unhinged by structural earthquakes, transmit periodic bouts of financial instability to others. Emerging market currencies struggle to regain their footing in the face of multiple shocks — from China’s surprise change to its foreign exchange regime to the detrimental impact of lower global growth, massive capital outflows and, for some, sharply lower commodity export earnings. Oil is facing a similar phenomenon on account of disruptions to its supply, demand and swing producer dynamics.

  • Fourth, there is less confidence in policymakers’ ability to respond quickly and effectively. Part of this is due to prolonged over-reliance on central banks as the only policy game in town; and part to the migration of major global challenges away from the direct reach of the US Federal Reserve and the ECB, the two most powerful central banks. This outcome of this weekend’s G20 deliberations in Turkey will do little to counter the erosion of markets’ confidence.

  • Fifth, the clear and present danger of another “right policy at the wrong time”, this time out of the Fed. America’s central bankers have good internal economic reasons to hike interest rates when they meet next week, supported by Friday’s jobs report. But, just like China’s move to a more flexible currency system last month, this right domestic measure risks adding to global financial instability at this particular juncture.

  • Finally, recent market developments have reinforced concerns about disruptive pockets of illiquidity and product malfunction. Part of this is due to the regulatory and market-driven structural shrinkage of the broker-dealer intermediation role relative to end-user demand, especially when a change in consensus views leads to a broad-based desire for portfolio repositioning; and part reflects the proliferation of products, particularly in exchange traded and risk parity funds, whose promises of performance and liquidity are undermined in periods of market illiquidity.

The influence of these six factors is unlikely to dissipate soon. Moreover, they contribute to a more fundamental phenomenon — that is, the shift in the markets’ operating regime, away from central bank repressed financial asset prices and towards a process of repricing that better reflects the cyclical, structural and secular fluidity of the global system.

So far, the impact of higher volatility — both bad and good — has been contained in finance; and, so far, it has not caused any major financial accidents. But if it persists and gets more disorderly, the risk of spillbacks on to the real economy will rise, by making households less willing to spend and by undermining corporate investment in new plant, equipment and hiring.

In the last few years, financial risk-taking has far outpaced economic risk-taking as investors have stretched far and wide for returns while companies have maintained high cash balances.

The result has been a notable differential between (high) asset prices and (more sluggish) fundamentals. If markets’ volatility continues and becomes more unruly, the consequences could extend beyond the convergence of portfolio risk exposure towards the lower level of economic risk taking. The latter could itself be contaminated, raising the nightmare risk of a self-feeding cycle of economic and financial instability.

Mohamed El-Erian is chief economic adviser to Allianz and chair of President Barack Obama’s Global Development Council

Why Banks Haven’t Finished Their Balance Sheet Diet

By Paul J. Davies

A branch of HSBC in the U.K. The bank has one of the highest risk densities in the top 10 systemically-important European banks and produces among the highest returns.
A branch of HSBC in the U.K. The bank has one of the highest risk densities in the top 10 systemically-important European banks and produces among the highest returns. Photo: Zuma Press

Higher leverage leads to higher returns, right? Well, not for European Banks.

New reporting standards show that the biggest Europe-based lenders still have many more assets per euro, franc or pound of equity than their U.S. rivals and yet their returns on those assets are just two-thirds of those at American banks.

Investors attracted by low valuations in the European sector should note that even the best performing banks face a battle to improve returns at a time when they have little hope of seeing any support from higher interest rates in the region.

Leverage ratios are in focus for European regulators as a way to guard against failure in the complex risk models that banks use to set capital requirements.

Before the 2008 crisis, U.S. banks had simple rules that set limits for balance-sheet leverage, while Europeans were judged only on risk-based capital.
In fact, both approaches had problems. U.S. banks took more risk on their books and made more use of off-balance-sheet vehicles that they later had to support. European banks, meanwhile, had far too little capital as they used leverage to juice returns from low-yielding assets.

As all banks try to hit more stringent rules on leverage, Europeans have further to travel in ditching assets that produce poor revenues and cutting their cost bases to match.

Investors can now see the difference between the regions more clearly after banks this year began publishing comparable numbers for balance-sheet size. New rules on measuring leverage exposure iron out most differences between how Americans and Europeans account for things like derivatives and off-balance-sheet exposures.

The results under this measure are stark. In Europe, the 10 systemically important banks that report the relevant data produced an average annualized return on assets of 0.45% in the first half of 2015 compared with 0.73% at six big U.S. banks, according to WSJ calculations.

Part of the difference is down to investment banking. U.S. investment banks have a bigger set of capital markets at home that drive more revenue, which helps explain why many Europeans remain reluctant to give up U.S. footholds.

Analysts at Morgan Stanley MS 2.98 % reckon that the investment banking arms of European banks are producing half the average returns on assets, as measured for the leverage ratio, that Americans make.

Risk is a factor, too. The more risk-weighted assets a bank has per unit of total assets, the more capital it needs compared with total assets and so the lower its leverage. For Europeans, this risk-density measure is 31% versus 50% in the U.S.

But higher risk, which also should produce higher returns, doesn’t explain everything. HSBC HSBC 3.78 % has one of the highest densities of the 10 European banks and produces among the highest returns. However, its returns are beaten by the two banks that have the lowest risk density: Nordea and UBS.

Conversely, Standard Chartered STAN 3.25 % has the highest risk density in Europe, but among the worst returns.

Most European banks have targets to increase capital, with some targeting leverage ratios explicitly. Regulators, especially in the eurozone, are also likely to force an increase in risk weightings to narrow the gap between core capital ratios and leverage ratios.

Even if Europe’s economic outlook starts to improve, its banks still need to be fitter and slimmer to take advantage.

How to Fight the Islamic State

Joseph S. Nye
battle for kobane syria

CAMBRIDGE – The Islamic State has captured the world’s attention with gruesome videos of beheadings, wanton destruction of antiquities, and skilled use of social media. It has also captured a large part of eastern Syria and western Iraq, proclaimed a caliphate based in Raqqa, Syria, and attracted foreign jihadists from around the world.
US President Barack Obama says that the Islamic State must be degraded and ultimately defeated. He has appointed General John Allen to lead a coalition of some 60 countries in the task, relying on air strikes, special forces, and training missions. Some critics want him to send more American troops; others say that the United States should settle for a doctrine of containment.
In the current US presidential campaign, some candidates are calling for “boots on the ground.” They are right: boots are needed. But the soldiers who wear them should be Sunni Arabs and Turks, not Americans. And that says a lot about the nature of the triple threat that the US and its allies now face.
The Islamic State is three things: a transnational terrorist group, a proto-state, and a political ideology with religious roots. It grew out of al-Qaeda after the misguided US-led invasion of Iraq; and, like al-Qaeda, it appeals to extremist Sunni Islamists. But it has gone further, by establishing a caliphate, and is now a rival to al-Qaeda. Its possession of territory creates the legitimacy and capacity for offensive jihad, which it wages not only against infidels but also Shia and Sufi Muslims, whom it considers “takfir,” or not true Islamic monotheists.
The Islamic State extols the purity of seventh-century Islam, but it is extremely adept at using twenty-first-century media. Its videos and social-media channels are effective tools for attracting a minority of Muslims – primarily young people from Europe, America, Africa, and Asia – who are struggling with their identity. Disgruntled, many are drawn to “Sheikh Google,” where Islamic State recruiters wait to prey upon them.
By some estimates, there are more than 25,000 foreign fighters serving in the Islamic State today. Those who are killed are quickly replaced.
The tripartite nature of the Islamic State creates a policy dilemma. On the one hand, it is important to use hard military power to deprive the caliphate of the territory that provides it both sanctuary and legitimacy. But if the American military footprint is too heavy, the Islamic State’s soft power will be strengthened, thus aiding its global recruiting efforts.
That is why the boots on the ground must be Sunni. The presence of foreign or Shia troops reinforces the Islamic State’s claim of being surrounded and challenged by infidels. So far, thanks largely to effective Kurdish forces, who are overwhelmingly Sunni, the Islamic State has lost some 30% of the territory it held a year ago. But deploying additional Sunni infantry requires training, support, and time, as well as pressure on Iraq’s Shia-dominated central government to temper its sectarian approach.
After the debacle in Libya (where the Islamic State supports jihadist militias and has announced the creation of three “distant provinces”), Obama is understandably reluctant to overthrow Syrian President Bashar al-Assad’s regime, only to see the Islamic State take control of more territory, accompanied by genocidal atrocities against Syria’s many non-Sunnis. But Assad is one of the Islamic State’s most effective recruiting tools. Many foreign jihadists respond to the prospect of helping to overthrow a tyrannical Alawite ruler who is killing Sunnis.
The US diplomatic task is to persuade Assad’s supporters, Russia and Iran, to remove him without dismantling the remains of the Syrian state structure. A no-fly zone and a safe zone in northern Syria for the millions of displaced people could reinforce American diplomacy. And providing massive humanitarian assistance to the refugees (at which the American military is very effective) would increase US soft power enormously.
As it stands, the funding and coordination of America’s soft-power strategy is inadequate. But we know that hard power is not enough, particularly to contest the cyber territory that the Islamic State occupies – for example, by developing a capacity to take down botnets and counter hostile social-media accounts.
Even if the US and its allies defeat the Islamic State over the coming decade, we should be prepared for a similar Sunni extremist group to rise from the ashes. Revolutions of the type the Middle East is experiencing take a long time to resolve. The sources of revolutionary instability include tenuous post-colonial boundaries; arrested modernization; the failed “Arab Spring”; and religious sectarianism, exacerbated by the interstate rivalry between Sunni-ruled Saudi Arabia and Shia-ruled Iran.
In Europe, wars of religion between Catholics and Protestants lasted for nearly a century and a half. The fighting ended (with the Peace of Westphalia in 1648) only after Germany lost a quarter of its population in the Thirty Years’ War.
But it is also worth remembering that the coalitions of that time were complex, with Catholic France aiding Dutch Protestants against Catholic Habsburgs for dynastic rather than religious reasons. We should expect similar complexity in today’s Middle East.
Looking ahead in a region where the US has interests as varied as energy, Israel’s security, nuclear non-proliferation, and human rights, American policymakers will need to follow a flexible strategy of “containment plus nudging,” which implies siding with different states and groups in different circumstances.
For example, whether or not Iranian policy becomes more moderate, sometimes Iran will share US interests, and sometimes it will oppose them. In fact, the recent nuclear agreement may open opportunities for greater flexibility. To seize them, however, US foreign policy toward the Middle East will have to develop a higher level of sophistication than the current debate reveals.
Joseph S. Nye recently co-chaired an Aspen Strategy Group discussion on the Islamic State and radicalism in the Middle East.
Read more at https://www.project-syndicate.org/commentary/how-to-fight-the-islamic-state-by-joseph-s--nye-2015-09#I18dbPFe6SXfykDw.99

Asylum's Dark Side

The Deadly Business of Human Smuggling

Photo Gallery: Heading West

Every day, thousands of refugees entrust their lives to human smugglers as they make their way to Europe -- and many of them die en route. The smugglers, meanwhile, are making handsome profits, and aren't particularly concerned about safety. By SPIEGEL Staff

He's a car freak, his mother says. A tinkerer, a hobby mechanic. His wife and daughter saw him as a good husband and father, even if he was seldom at home. For the rest of Europe, though, Metodi G., who goes by Mitko, is the man partially responsible for the deaths of 71 refugees.

Mitko is a smuggler of humans.

Five days after a truck was found on the A4 highway in Austria with 71 dead bodies inside, Mitko's mother invites us into her living room in Lom, a town in northwestern Bulgaria. Her son, along with four additional suspects, has been in pre-trial detention for the last several days. He insists he is innocent, but the situation doesn't look good for him.

His mother serves coffee and says that Mitko never would have wanted people to die. She says she hasn't seen her son for quite some time, but she is of course aware that many people in the area are involved in the lucrative refugee business. It's no wonder, she says, that poor Bulgarians are helping refugees across Europe's borders. The Syrians, in particular, she says, are well-off people. "They have the money to pay for such trips."

Seventy-one people who sought to flee war and suffering, but died shortly before reaching their destination. Fifty-nine men, eight women, three boys and a one-and-a-half year old girl, all suffocated. They didn't die somewhere in the Mediterranean, but in the heart of Europe. They were found on the side of the highway just 50 kilometers (31 miles) from Vienna.

The decomposing bodies were found in a Volvo refrigerator truck that had once been used to transport frozen chicken meat. On Thursday, Aug. 27, an employee of ASFiNAG, the Austrian motorway operator, found the truck on the shoulder of the highway, parked as though it had broken down.

The site soon became Ground Zero for Europe's refugee catastrophe. The horror was suddenly close by and palpable -- and if there is any kind of a silver lining in this horrific incident, it is this: Europe may finally be waking up from its torpor.

Every day, people are dying because of the policy that refugees must first get to Europe before they can apply for asylum. And because of the fact that they are required to remain in the country where they fill out their application and are not allowed to travel further. It is a situation that human smugglers have found to be extremely profitable and one that enables them to charge €300 ($335) to €400 per head for the trip from Budapest to Vienna in a jam-packed truck even though a train ticket doesn't even cost €50.

Oversight and Stupidity

Refugees are dying because Europe is failing. But the drama continues. One week after the catastrophe on the A4 in Austria, a new batch of horrific images has emerged, this time of a Syrian boy lying dead on a beach. He drowned while attempting to cross the water from Turkey to the Greek island of Kos. His family, too, had put their fates in the hands of human smugglers.

These tragedies serve to illustrate just how great is the desperation gripping the refugees -- and how irrepressible is the greed of those in whom they entrust their fates. There are several indications that the deaths of the 71 people inside the truck were not the result of a planned crime but that it was probably the result of an oversight, of stupidity. But it could happen again at any time; that is the incident's uncomfortable lesson. At least if nothing changes.

Thousands of people continue to cross into Europe every day. In just the first eight months of this year, almost a quarter of a million people crossed the sea to Greece, including young men, families, pregnant women and children from Syria, Iraq, Egypt, Eritrea, Sudan and elsewhere. Many are fleeing from bombs and terrorism -- and they are prepared to use the last of their money and to entrust their lives to people they don't know.

In the end, during recent days at least, they get stuck at Keleti Station in Budapest where Hungarian authorities have prevented them from boarding trains to continue their journeys westward. Some refugees have made signs reading: "We love to go to Germany." At some point, someone starts chanting the German chancellor's name, quietly at first before getting louder and louder. "An-ge-la! An-ge-la!" Those who pay particularly close attention to the calls for help are waiting outside, next to taxis and minibuses. They are the true profiteers of Europe's refugee drama.
The trip from Syria to Germany currently costs at least €2,500 per person, with the human smuggling market likely worth several hundred million euros per year. The organization The Migrant's Files, a consortium of journalists from over 15 European countries, estimates that migrants have paid smugglers around €16 billion since the year 2000. Those who profit include recruiters, boat captains, middlemen, people who rent out illegal apartments, scouts and money launderers. There are big fish and small fish -- and men like Metodi G. from Bulgaria. They are the logisticians of the shadows.

They find ways where there should be none.

Fertile Soil

The rise of the smugglers to central figures in the refugee drama is a direct result of the EU's failure to adequately address the crisis. Europe still has no plan or strategy for dealing with the rising numbers of refugees. Instead, they blame each other for the humanitarian disaster that has slowly moved from Europe's periphery to its heart.

The political chaos provides fertile soil for the smugglers because they, in contrast to Europe's leaders, have a plan. They transport their clients along three main routes: across the Mediterranean from North Africa to Italy or Spain; across the eastern land-route from Turkey via Bulgaria; and across the Western Balkans from Greece, via Macedonia, Serbia and Hungary. Currently, that route is favored because the borders in Macedonia and Serbia are porous and the officials there overwhelmed.

In comparison with the eastern route, it is expensive, but the route across Bulgaria became less attractive after Sofia sent 1,500 police to fortify the border with Turkey. The story of Metodi G. shows how tempting it is for young men to make money out of the chaos that reigns in the Western Balkans.

Metodi grew up in the Roma quarter of Lom, a desolate Bulgarian town of 24,000. Cars, mobile homes and minivans sit rusting on the side of the sandy road that leads to his family's house.

Garbage lies about on the road and a group of men is slaughtering a pig. It is one of the poorest regions in the EU, and it is here that smugglers recruit their helpers. Many of the drivers who cart migrants and refugees on the Serbian and Hungarian portions of their journey come from here. At least three of the five suspects currently behind bars in connection with the 71 deaths in Austria call the region home.

They are from Lom, Archar and Brusartsi -- rural, decaying places at the fringe of Europe.

Metodi was a quiet boy, his family says. He left school after the 10th grade, began buying cars, fixing them up, and reselling them. "Just like everyone here," says his mother Goranka from the sofa.

Mitko, 29, is the oldest of her three sons. "He's well-meaning and generous, but he has always been a bit lazy." Her husband is a construction worker, as are her two younger sons. The family has a total of €500 at its disposal each month.

Goranka shows pictures of family excursions and celebrations, her sons with a cake and a tricycle. Mitko was shy, she says, but apparently he was well-suited for the transportation industry. He began working as a driver almost immediately upon receiving his license. Perhaps it was a kind of escapist reflex. Initially, he drove workers from Bulgaria to Italy and Germany for €100 each. He ate and slept in the car and drove fast. In Bulgaria, he soon began racking up speeding tickets and didn't always pay his fines, leading to the loss of his license. When it began looking like he might have to go to jail for eight months, his wife, Velichta T. explains, he left Lom.

The Suspects

He drew the attention of authorities in Germany as well. Six years ago, he allegedly robbed a gas station in Bochum, getting away with €1,000. Twice, he was caught driving without a license by police in Bavaria. Later, he joined the smuggling business. On July 25, it is thought that he was in a truck carrying 38 refugees that was pulled over in Bavaria. Metodi fled and public prosecutors opened up an investigation.

The evidence points to Metodi G. being a small-time criminal, but it seems doubtful that he played a leading role in the smuggling business. Investigators believe that he was not among his group's leaders. His mother says she knows nothing about any of it. A week ago Friday, he called to tell his mother that he had been arrested and was in jail in Budapest. She had long ago stopped asking her son how he earned his money. Mitko's wife says she read somewhere that there are diamonds in Syria.

Samsooryamal L., who goes by Samsoor, is another of the suspects. He's from Jalalabad, Afghanistan, and lives in Budapest. He is thought to be the leader of the smuggling group, and he too has been arrested. German authorities also have a file on Samsoor, who police in Bremen determined to be staying in the country illegally. He is married to a Hungarian woman, which is likely how he got a residence permit for Hungary. He, too, insists that he is innocent.

Samsoor wasn't particularly secretive. His Facebook page contains dozens of photos showing a slender man of 28 with a well-kept beard. In the images, he is standing in front of a BMW sedan or on Margaret Island in the middle of Budapest.

Kassim S., 50 -- a Bulgarian with roots in Lebanon -- was also taken into custody. The truck's registration is in his name and he is listed as its owner. On Facebook and Badoo, photos show him smiling with his granddaughter. In his profiles, he writes that he is from the Lebanese city of Tyros.

At the end of last week, investigators searched his apartment on the fourth floor of an old residential building in the government district of Budapest. Neighbors recognized photos of Kassim S. and say he had just moved in a few months before and that he had spoken very loudly on the telephone. Samsoor L. is thought to have visited him there.

Kassim S. was involved in the car business, buying and selling used vehicles from a lot in Linz. He registered the truck where the refugees died on Aug. 25 in Hungary. The logo of the Slovakian chicken firm Hyza was still on the truck.

Investigators believe the journey that ended in death was the first time the smuggler group had used the Hyza truck. They have also been able to identify other minivans and small trucks that the group is thought to have purchased. It looks as though the smugglers had planned to establish a fleet of trucks plying the Budapest-Vienna route. Refugees in Austria have since contacted police and said that they, too, had been transported to Austria inside a refrigerated truck with the Hyza logo on the side. Some said that they had fainted during the journey and that there had not been sufficient fresh air. Police are now looking for the other vehicles belonging to the group.

A Bit More than an Hour

German authorities are also familiar with Kassim S., whose name has been linked to several different investigations into refugee smuggling. Investigators believe he was involved in the acquisition of the vehicles, though he also maintains his innocence.

But somebody has to be guilty -- someone who shut the two doors behind the 71 men, women and children. The truck was outfitted with a Carrier refrigeration unit, which can lower temperatures to minus 20 degrees Celsius, but only if the cargo area is hermetically sealed.

As soon as the doors were shut, the world for the 71 people inside shrank down to just 15 square meters (160 square feet), enough room to stand, but not enough to move around. It was not possible to open the doors from the inside and the truck was apparently wrapped with wire as well. An adult breaths roughly six liters of air a minute and the cargo area held roughly 45 cubic meters of air. The 71 people locked inside had about an hour, maybe a bit more.

Not much about the victims is known. Investigators say that their teeth indicate that they come from prosperous backgrounds and a dozen of them were carrying Syrian papers.

The trip from Syria to Western Europe leads over plains, through forests, cities and towns. It is a 3,000- to 4,000-kilometer stretch of torture in boats, buses, trains and by foot -- under barbed wire, over walls and across the sea. The smugglers on the Balkan section of the journey operate not unlike travel agencies and range from well-organized concerns to smaller agencies to individual service providers. They sell all-inclusive packages with restful nights in hotels for the more prosperous refugees or charge by the journey segment for those watching their money. For many of the refugees, the trip begins in Istanbul, perhaps even with a man named Yasin.

Yasin, 28, is from Damascus and speaks surprisingly openly about his job. He is sitting in a teahouse in the Istanbul working-class quarter of Aksaray where those looking for asylum often make their first contacts with smugglers. Yasin's job is that of recruiting customers, particularly fellow Syrians, on the streets, in Internet cafés or other places where Syrians hang out. Once he gains a refugee's trust, he makes an offer.

Yasin worked as an IT expert in Syria before fleeing to Istanbul one-and-a-half years ago. He wears a jersey brandishing the name of the Fenerbahce football team, has short, black hair and is unshaven.

Early during his stay in Istanbul, he washed dishes before finding work with a smuggling ring through a friend. Yasin's network offers both the Western Balkan route as well as the Eastern Balkan route and charges $500 per person to be driven across the Turkish-Bulgarian border in a minivan. The trip across the Aegean in a rubber dinghy costs $1,000 while the same trip in a more solid craft costs $3,000. Those wishing to continue onward, to Germany for example, have to pay another $4,000. An airplane ticket to Frankfurt, complete with falsified papers, can be had for $15,000.

'Safe Transfer'

Smugglers don't just look for potential customers on the streets, but also hang out in social networks and operate Facebook pages with names like "Smuggle to Europe" and "As an Illegal to Sweden."

One man, who calls himself Abu Ali, writes: "You can't get to Europe for less." Another talks about offering a "safe transfer" from Egypt to Italy for $2,500. Some even post their mobile phone numbers.

Yasin has never met those who are higher up in the hierarchy. His boss employs dozens of recruiters, financiers, drivers and guards, not just in Turkey, but also in Greece and other Balkan countries. One Turkish police officer who has been investigating the scene for years says that the smuggling business inside Turkey is controlled by just a few groups, with their leaders being Turks or Kurds.

They hire people like Yasin to do the dirty work.

In Izmir, the scene is allegedly controlled by a Turkish-German -- a middle-aged man whose underlings call him "The Whale." The Whale once served one year in jail in Germany for selling cars illegally and then became involved in the smuggling business once he returned to Turkey. His network now extends all the way to Germany while in Izmir, he owns restaurants, office buildings and hotels.

Yasin's job is done as soon as the deal is made. He then passes the customers on to a financier, who takes care of the money transfer via the so-called hawala system. The advantage of this informal money transfer system is that no banks or overseers ever find out about it. Smuggling rings operate at least three hawala offices in Aksaray, with branches in cities like Izmir, Bodrum and Mersin. The offices usually tend to be money exchange booths, but sometimes they are maintained in jewelry stores or telephone centers. They are given Muslim names such as "Al Rasheed."

The system is based on trust. The refugees deposit the agreed upon sum in one of the offices, along with a commission of around $20. In exchange, they are given a sheet of paper with a numeric code that they are instructed to provide to their smugglers when they arrive at their destination. The aim is to prevent drivers from abandoning refugees before they reach their ultimate destination -- and to prevent drivers from stealing from their bosses.

From Istanbul, many travel to Bodrum, the Aegean coastal city in Turkey that has become a hub for both smugglers and refugees. The Greek island of Kos is located just a few miles offshore, and small-scale smugglers, especially, have taken over the business on the Turkish side. For between €500 and €1,000, their customers are loaded onto rubber dinghies and left to paddle their way to Europe. As many as 70 passengers are packed into boats that are only five meters (16 feet) long. Bodrum is the gateway to the Western Balkan route.

Turkish police patrol the coastal stretch nightly, on both water and land, but without much success.

Bodrum's small-scale smugglers have developed a system to avoid detection. They comb the beach, walking between sun loungers and umbrellas; they position themselves on jetties and constantly assess the situation. They talk frequently with each other by phone and, as soon as the coast is clear, they launch as many as 15 boats towards Kos in one go. This safety in numbers approach increases the chances that many will make it. The week before last alone, the coast guard rescued more than 2,160 people from the water.

As dawn breaks, shoes, socks and empty water bottles can be found along the beach, evidence of what happened the night before when the refugees climbed barefoot into the dinghies and began the journey to Europe.

Growing Risks

Indications of just how big the smuggling industry has become can also be found in Istanbul, Belgrade and Budapest. With the number of customers growing, the smugglers' business model is also evolving. The boats and trucks being used are getting bigger, as are the risks smugglers are willing to take to transport their customers.

So far, the business has largely attracted petty criminals in Turkey and the Balkans. The number of tightly organized networks is relatively small, although they do exist. After all, if you want to get rich exploiting poverty, fear and war, it is necessary to have a network of people on several continents who are intelligent, unscrupulous, ambitious and have the ability to plan precisely. You have to be a person like Ermias Ghermay.

Ghermay, who is originally from Ethiopia, is a middle-aged man who speaks Arabic, English, French and Italian. He lives in Tripoli, the Libyan capital. Italian prosecutors suspect he's one of the big fish in the Mediterranean business. They believe Ghermay is responsible for the mass transport of refugees from Libya and allege that he has smuggled as many as 15,000 people from Africa to Europe through Italy. His organization is thought to generate annual revenue in the millions.

Findings by Italian investigators provide detailed insights into the system Ghermay has developed to profit from war and displacement. His specialty are all-inclusive trips, with the cost per person, per stage of the trip at between $2,000 and $2,500, payable before the start of each leg. Italian prosecutors investigated for around two years, monitoring telephone calls and conducting surveillance on intermediaries. Close to two dozen helpers have been arrested, but their boss remains a free man in Tripoli, where he is believed to be living under the protection of Libyan militias.

Still, it doesn't appear that there are any mafia leaders in the smuggling scene with the decades of experience of the type often seen in the international drug trade. German security agencies believe that smugglers and their helpers are themselves often former refugees who got stuck somewhere as they were trying to flee -- in addition to the local criminals with whom they have established contact.

And although the refugees do represent a source of income, that money is then distributed among many people. Analysis of wiretapped communications between smugglers didn't turn up evidence of any kind of distinctive network. It appears that Ermias Ghermay is more the exception than the rule.
For most refugees, the trip continues from Greece through Macedonia -- often by bus or train, but sometimes on foot. Many have a long list of telephone numbers for different smugglers, with contacts in every country. Similar lists were found in the pockets of the dead in Parndorf.

The Hotel Mr. President

The Western Balkan route continues northward to the Serbian capital of Belgrade, a sprawl of gray buildings and cement. Right at the central train station, not far from the Danube River, the four-star Hotel Mr. President has become the unofficial headquarters of the influx of refugees.

Many refugees are staying at the Mr. President, at least the more prosperous among them, before they continue their journeys to Austria, Germany, Belgium or the Netherlands. They sleep in rooms in which oil portraits of Vladimir Putin, Lenin, Ronald Reagan and other past and present world leaders hang above the beds. There are a total of 61 rooms spread out over seven floors.

But the truly powerful men here can be found sitting in chairs in front of the entrance talking on the phone. They wear Hawaii shirts open at the neck and fanny packs. Each man has three mobile phones, headphones in their ears and a charger on the table in front of them. The Hotel Mr. President is their headquarters. All the men speak Arabic. Refugees pay up to €1,500 to be smuggled through the stretch of forest a little less than 200 kilometers away from here that borders Hungary.

Only a few weeks ago, the price of the trip from Belgrade to the Hungarian border had been a maximum of €300, but the prices have since exploded. There aren't enough cars available to do the job and there are simply too many refugees.

Last Wednesday night, around 60 refugees could be found waiting in front of the hotel with backpacks. Shortly before they departed, the smuggling bosses drove up in a Porsche Cayenne and a ruby-colored Porsche Panamera sedan. They sat down on chairs at the hotel café, pleased with how business was running. Here at the Mr. President, both rich and poor refugees are united, often in the same vehicles that will take them to Europe.

Two Syrians explain that every refugee knows that the Hotel Mr. President is the staging ground for getting to the EU. Often, recruiters approach new arrivals soon after they cross into Serbia from Macedonia, telling them that they can help get them to Belgrade and later to Budapest.

A whistle hisses through the air. It's coming from one of the men with the fanny packs. Around 60 men get up and follow him through Belgrade's central station. Small trucks and vans are waiting for them at the other side of the station. The men climb in and the vehicles drive away.

Razor Wire

The Balkans end, and the EU begins, amid corn fields, and it is exactly here, at the Hungarian-Serb border, that Hungary's government wants to stop the flow of migrants -- all the trucks and vans coming from the Hotel Mr. President. For weeks now, border patrol guards have been erecting a 175-kilometer border fence made up of three layers of razor wire. It had been planned as a bulwark against the influx of refugees from the south. The government plans to build a solid, four-meter-high (13 feet) fence soon, but until then it will have to rely on the razor wire. That, though, isn't working.

Some areas are impossible to fence, like the tracks on the Szeged-Subotica train line that leads through the Hungarian border town of Röszke. From here, it is only two hours by car to Belgrade, and the refugees come when it gets dark. They walk across the border between Serbia and Hungary as if it didn't exist -- young men with backpacks, elderly people, families with children, emaciated figures, most of them Syrians.

A week ago Saturday, some 3,080 refugees crossed the border, followed by 2,890 on Sunday and 1,797 on Monday. No one is doing anything to stop them because there are far too many. The smugglers in Röszke are recognizable by the code words they use. "Arabic, Arabic?" they call out under the cover of darkness.

Two women in white tank tops can be seen standing at a truck stop on the lookout for police. Some low-rider Audis with tinted windows pull up. Standing between them are bald-headed Roma men waiting for potential customers. One of the smugglers says the driver can only take the refugees as far as Budapest. The trip costs between €200 and €300, and the traffickers can earn several thousand euros a day.

The trip up north with the refugees goes fast from here, over well-built roads and the M5 highway. The drive goes past poppy fields and dried up sunflowers, roadside motels with rooms for eight euros, wind turbines, the Paradiso chain of bordellos and a border sign with the circle of EU gold stars. The trip from Röszke to the rest stop near Parndorf is close to 400 kilometers.

Three-quarters of an hour from Parndorf, Gerald Tatzgern is sitting on the second floor of the Austrian criminal police office in Vienna. As leader of the Taskforce Human Trafficking and Smuggling, he is the country's most important investigator when it comes to the fight against smuggling groups, both large and small. The most difficult cases end up on his desk, and he knows the route to Serbia, and the Hotel Mr. President in Belgrade, extremely well. The father of three children, Tatzgern is 47-years-old and speaks rapidly and precisely in a friendly tone.

He and his officers are doing what they can to prevent the kind of disasters like the one that played out on the A4. Indeed, just two hours before our meeting, which took place at the beginning of last week, they arrested an additional suspect in the case, he says. Tatzgern is well acquainted with the Western Balkans smuggling scene, describing it as a chaotic mix of small-time criminals, regional groups and a few organized networks with up to 200 members. Regarding their profits, he says they are "absolutely comparable to the drug trade."

Brutal Recklessness

He tells the story of one network that he and his people found in Turkey way back in 1994 after the deaths of five Tamils. Although he knows who is responsible, he says, the network's leader remains free and is still active in the smuggling scene in Turkey. Tatzgern says the man has contacts within the Kurdistan Workers' Party (PKK) in addition to Turkish political and business leaders.

Tatzgern is a pragmatist: He sees the world as it is and not how it could be. Paradoxically, he notes, it is safer for refugees to choose a well-organized smuggling group. "The mafia, at least, has more know-how and not this brutal recklessness, which costs human lives in the end."

That brutal recklessness, though, is everywhere and disasters can happen at any time. Indeed, the refugee drama that is currently taking place, after all, is made up of countless moments of fear and unimaginable risk. In hostels and temporary shelters, it seems that everybody has such stories to tell.

Among them are three Syrians who were part of a group of 50 refugees shut into a minibus, not unlike the 71 from the end of August. They were lucky: They were able to cut a hole in the roof with a knife and escape. Then there is the story told by Reza Golshir of Iran and Majid Khan from Pakistan. They met their smuggler, a man from Turkey, in Belgrade. For $300, he promised to take them to Vienna in a Mercedes with just five passengers. Ultimately, though, the smugglers packed 30 men, women and a few children into a small truck that was lined with plastic. They were able to free themselves with the help of a screwdriver they found in the cargo bay. The next day, they were back in Belgrade -- $300 poorer, but alive.

The trip through the Balkans is full of such moments, and not everyone comes away unscathed.

Refugee shelters along the route are full of people with broken bones, oozing infections and bloody cuts. But they are unfazed and will continue trying to reach Austria, Germany, Sweden or Great Britain. Those who have escaped the bombs of Aleppo of the violence of Sudan, Somalia or Afghanistan -- those who have crossed the Mediterranean and walked through Macedonia on foot -- are not going to be held up by a couple of rolls of barbed wire.

Higher Prices

They are propelled by hope and desperation, and they need help for such a journey -- and the smugglers offer that assistance. Even if Hungary seals up its border as it has repeatedly threatened to do, the smugglers will simply find another route, via Croatia, for example, or through Slovenia. They may also refocus their attentions on the route across the Mediterranean to Italy. Politicians, of course, will continue to try to stop them, not least because the recently declared war on smugglers gives the impression that Europe's leaders are actually doing something.

But for as long as war rages on in Syria and Iraq, as long as poverty and conflict remain a fact of life just outside Europe's borders, the smugglers will continue to ply their trade. And, like the drug war before it, the war against human-trafficking is likely to have one effect above all else: higher prices for customers.

The Balkan Route comes to an end in Bavaria -- and it has become the end of the road for many a smuggler as well. The state is currently holding over 730 suspected smugglers in pre-trial detention, with more being arrested almost daily. The judiciary is struggling under the strain and the jails are full. Viorel C., from Romania, is one of 28 suspected smugglers being held at the Würzburg prison. He is suspected of having driven nine Syrians in a VW bus from Budapest to Passau.

Speaking in his cell, C. says his superiors promised to pay him €500 for the trip, adding that he only wanted to earn a bit of money. "Instead, I have lost everything," he says. If he's lucky, he'll get a suspended sentence. His defense attorney says that, as a rule, the courts are only making drivers serve prison time if they were carrying more than 20 refugees.

People like C. are recruited in Hungary and are given strict instructions. They are told not to stop until they get to the first German city after the border. Then, they are told to let everyone out and return to Budapest immediately. The periodic loss of drivers and vehicles is calculated into the prices they charge -- such losses can hardly be avoided. But when someone like C. gets caught and locked up, someone else simply steps into his spot. There are many more like him.

By Maik Baumgärtner, Sven Becker, Rafael Buschmann, Uwe Buse, Jörg Diehl, Fiona Ehlers, Özlem Gezer, Ralf Hoppe, Katrin Kuntz, Maximilian Popp, Jan Puhl, Anna Reuß, Christoph Scheuermann, Andreas Ulrich, Andreas Wassermann