I have a great deal of sympathy for the German Chancellor Merkel’s stated project of “maintaining the primacy of policy over the markets”. This wish has led Germany to underwrite the giant European attempt at salvaging the Euro zone from collapsing under the speculation against government debt issued by Greece, Ireland, Portugal, Spain, and soon Belgium.
I am, however, afraid that the chosen method is making things worse. By effectively guaranteeing government debt from various EU member countries, Germany effectively tells the speculators that there is no problem in holding the debt of those countries. It is possible to operate in the bond markets without having to factor in the risk that the issuer will go bankrupt. Merkel is not alone in underwriting certain kinds of market behaviour.
Since the creation of the US Federal Reserve it has been the practice that if economic trouble was brewing in the US markets, FED would simply open the monetary spigots and the crisis would go away somehow. Currently, it is known as the “Bernanke Put”, a free insurance against capital losses. When the bank sector was effectively insolvent, it was bailed out by the US government with few conditions attached. The people who through monumental greed and incompetence had created the crisis, are mostly still holding on to their handsomely paid jobs. And they pay each other silly bonuses.
Having learnt the lesson that if they behave stupidly, they will receive generous help to get themselves out of trouble, they are now back to their old ways. By underwriting fully the debt of European sovereign borrowers, Merkel and her political allies are exactly supporting the behaviour they want to stop. If there is no real risk of loss, gambling against the troubled countries become a pastime, where you just have to adapt your strategies to the short term trends. Real caution is not called for.
For every rescue package put together, moral hazard becomes more and more engrained in the working of the financial markets. More and more money can participate in the speculative runs, making such runs more and more difficult to handle.
Ms Merkel has the common sense of believing that lending money should be a risky business. If a lender does not check the quality of the borrower, there is a risk of losing money. But when she had the guts to say it out loud, she was met by a storm of protest from the financial markets and their political backers: Never should there be any risk of losing moneys lent to a sovereign. The prices of Irish debt plummeted and Ms Merkel was rapidly forced to issue a calming message that it was only something she meant from 2013, when the current rescue system is to be replaced by something more permanent.
It still baffles me that the Swedish bank rescue action from 1991-92 has inspired so few of today’s politicians. Sweden’s banking problems were in every way as serious as the problems seen now (with the exception of the global systemic risk if we do not get out of the trouble).
In brief, the Swedish package saw management and shareholders of failing banks wiped out, banks were nationalised (i.e. integrated in the government balances) for a while, essential services were continued, banks were restructured, recapitalised, and sold. Bad loans were floated in the market with a temporary guarantee. The operation was quick and efficient – not the least because the government obtained full insight into the loan books. The whole action was run in a perfectly capitalist way: If you screw up, you lose your shirt. Such straight forward action was never taken in this crisis.
Now politicians are afraid of taking on the ever-larger banks, whose lobbying activities are based on huge resources. Politicians allow banks to obfuscate and hide the real magnitude of the problems. It all ends up being more expensive to the taxpayers than necessary. And when somebody – even with Ms Merkels position of strength – has the nerve to tell a few obvious truths, they are forced to beat a hasty retreat by a howl of protest from the banking sector.
I am afraid we are in for a very, very long time of trouble. So far it is becoming increasing clear that because of the attempts to “maintain the primacy of policy” the markets are being given a golden opportunity to speculate against the governments. Obviously, the influence of the bank sector lobbyists continues to grow. The markets strengthen their primacy over politics with every timid step aiming at reducing their influence.
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