Archive for October, 2011
‘Eurozone on the brink’ screams the latest headline. And indeed, as the Eurozone (EZ) lurches from one crisis to the next, the whole structure seems increasingly imperilled by its lack of political cohesion. British Tories may wring their hands in glee, but the demise of the euro cannot but lead to the unravelling of the whole integration project, with disastrous consequences for a unified approach to jobs, growth and the environment.
Let the same British euro-sceptics reflect on two simple facts: first, there is little respect in Europe for the imperious and arrogant British—the image of Nigel Farage’s antics in the European Parliament are not easily effaced.2 Secondly, as much as Britain may criticise the euro’s construction, our own economy is not exactly thriving. Not only is Britain stagnating, but its social infrastructure is crumbling while its wealth and income inequalities are the largest in the region.
But back to Europe—which uniquely for Brits means ‘continental’ Europe. The single most worrisome manifestation of the EZ’s predicament is the near-total marginalisation of the Commission and the Parliament in the context of the crisis. Instead, it is the national politicians—Merkel, Sakozy et al.—who have made all the running. What could be more indicative of a ‘democratic deficit’ than the fact that Europe’s elected MEPs have become invisible!
There is a paradox here. Europe cannot go back to what it was before the crisis, nor can it tread water. But neither can a large EZ economy run by squabbling small-minded politicians from 17 countries thrive. Even George Osborne admits that full fiscal integration is the way forward—‘un gouvernement économique européen’ to use the jargon.
Such a form of governance would need far more powerful political institutions including quite possibly a directly elected President. Equally, the legitimacy of a far more centralised EZ would depend on its delivering—nay, on being seen to deliver—secure jobs, higher incomes and common social services. Take pensions: although a strengthened EZ cannot take over the entire pension system given current productivity differentials, it could deliver a basic citizen’s pension, a payment which would guarantee a subsistence minimum for all its retired citizens financed by an FTT (Robin Hood tax).
The principle is clear: if the EZ is to prosper politically, it must deliver tangible benefits. The young French and Dutch voters who voted against the Constitutional Treaty in 2005 were not generally anti-European; they merely wanted a more social Europe.
Whatever the free-market fundamentalists may say, greater social cohesion/social justice lies at the very heart of the European project. To deliver a genuinely social Europe, a new social contract is needed. Democratic governance is not about national politicians fighting for their narrow interests by drawing red lines, still less about 17 national Parliaments agreeing to each line of some new regulation. It is about a genuinely European political debate over our common interests. Only when this lesson becomes clear to all can we overcome the sort of gridlock we see today.
As the Euro Area (EA) dithers about bailing out Greece in the short term and continues to argue about how to expand the European Financial Stability Facility (EFSF), the sovereign debt crisis is turning into a full-blown banking crisis. Shares in Dexia, the Franco-Belgian banking group, are down 72% on their 52-week high—closely followed by other pillars of western finance such as Bank of America (-66%), RBS (-57%) and Deutsche Bank (-50%).  In effect, financial markets have seen the wiring on the wall and have been pulling out of bank shares—both banks that hold euro sovereign debt assets and those that hold shares in other banks that do. This means that the asset side of banks’ balance sheets are contracting and that insolvency looms.
True, the gloom lightened briefly when both Angela Merkel and EU President J-M Barroso announced they favoured a pan-European recapitalisation programme—causing EU bank shares to rally for a time. Governments are trying to pour cash into the banks—in the UK, Mervin King has announced an extra £75bn of quantitative easing (QE), allegedly to help industry get more and cheaper credit, but in reality to ward off a new credit crunch along the lines of what happened after Lehman’s collapsed in 2008. In his words, we face the ‘worst financial crisis ever’.
However, the recapitalisation of Europe’s banks faces a serious credibility gap. First, Dexia was one of the banks to pass the European Banking Authority’s (EBA) ‘stress tests’ with flying colours. Secondly, one result of these tests was a serious underestimation of the degree of recapitalisation required. In consequence, a new round of tests will be required adding further to delays. Perhaps more importantly, there is growing pressure from investors to make banks ‘mark to market’; ie, report the current market value of their assets. Adoption of such a rule combined with current market volatility would doubtless lead to a large number of banks failing the stress tests.
And of course, the prospect of a Greek default looms larger by the day. The problem is not so much that a Greek default is unaffordable; doubtless, were the country to default on its own, it would take some banks down—starting with its own banks. The real danger is that of contagion. We know that Spain and Italy are ‘too big to fail’, and the markets have already begun to mark down commercial banks with exposure to them, not just in Spain and Italy but in France and even the UK. Whatever one may think about financial markets, their analysts are not fools; what they are telling us is that a Greek default will trigger widespread contagion.
Meanwhile, EA Parliaments dither about just how the EFSF’s limited capital can be stretched to meet the bill. Since the €440bn available cannot be miraculously turned into the €2tn required for ‘shock and awe’ to be sure of succeeding, the latest twist involves turning the EFSF from a lending institution into a insurance company, in effect selling credit default swaps (CDSs) to those most in need of insurance. These would be structured into equity, mezzanine and senior layers just like their Wall Street cousins, thus enabling €440bn to be hugely leveraged.
But as more than one commentator has pointed out, there are several problems here. First, one is using over-leveraged instruments to deal with the problem of over-leverage. Second, there is no ‘lender of the last resort’—if the scheme goes wrong, governments cannot bailout the losers since it is governments who hold the equity tranches. In principle, the ECB could perform this role—but the Germans are resolute in their opposition to the ECB acting as a Central Bank for governments.  For that matter, tiny Slovakia is threatening to upset the EFSF applecart unless collateral is provided for its pledged assistance.
An obvious way out of this nightmare would be to forgive Greece at least half its debt (which the markets believe is in any case unpayable) while further reducing the interest on its loan, lengthening its debt maturity profile and aiding the country to become more competitive. Cynics might say this has been obvious from the start, and that it is now too late. If a European financial crisis does not happen next week, it will occur as part of a disorderly default in December when the pain finally becomes too much for Greeks to bear. It is then that we shall all feel the pain of a full-blown financial crisis, most probably followed by more years of economic recession.
 See D Blanchflower ‘As bankshares tumble ..’ New Statesman, 10 Oct 2011.
 See http://on.ft.com/qi7ZIw