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Who is Europe really bailing out?

Tyler Cowen has some smart thoughts on the European Union's announcement of a $750 billion euro bailout fund:

1. The fundamental cause of the financial crisis has been people and institutions thinking they are wealthy than they are; this spread to Europe as well and now we are seeing the comeuppance.

2. Although accounting conventions differ, and numbers should not be shifted out of context, many major European banks are highly leveraged. The mechanics of the so-called "shadow banking system" -- namely the ability of short-term creditors to flee on a moment's notice -- remain in place.

3. The major European powers would not have come up with a nearly $1 trillion bailout, also involving de facto loss of ECB independence, unless they were scared [expletive].

4. They are trying to do a version of TARP-in-advance-of-the-panic and in my view that panic would have come today.

5. Here is one view, consistent with my own: "My quick thoughts on markets are as follows: great for risk assets, terrible news for bonds, great news for southern European bonds, bad news for the flight to quality UST trade, and ultimately terrible news for the EUR. Maybe the EUR tries to rally on this, but it the end this bailout has done nothing positive for the EUR. The market will inevitably look at the ECB as being forced by the EU to monetize the debts of EU rogue nations..."

More here. Remember that this is no more a bailout of Greece and Spain and Portugal than TARP was a bailout of subprime borrowers. The indebted countries are still looking at low growth, painful budget cuts, aching recession, high-borrowing costs, and an inflexible currency that will stop them from increasing their exports. Remember what Desmond Lachman said.

Rather, this is a bailout of the European banking system (and possibly some international banks), much like TARP was a bailout of our banking systems (and some international banks). The way people understand the European crisis is that a few countries hold much too much debt. But you can flip that around, too: Many banks loaned a few countries much too much money. And if those banks don't get paid back, they're going to go insolvent, and the banking system is going to freeze.

Intra-European resentment is probably going to protect the banks from becoming the villains here (Germans would prefer to blame the Greeks than Deutsche Bank), but they're a big part of the story. Note the New York Times' report on the market's reaction the bailout: "European banks were the early winners. In France, BNP Paribas soared 14 percent and Credit Agricole rose 16 percent; Germany’s largest bank, Deutsche Bank, gained 10 percent."

By Ezra Klein  |  May 10, 2010; 9:34 AM ET
Categories:  Financial Crisis  
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Next: Do we know the right questions to ask Kagan?

Comments

The critics of the EU were right that something like this was probably inevitable; now we'll see if the EU proponents were right that the EU is strong enough to handle it.

Posted by: jduptonma | May 10, 2010 10:14 AM | Report abuse

"Many banks loaned a few countries much too much money" writes Klein, with Samuelson today making essentially the same point by writing "Countries cannot overspend and overborrow forever. [...] Budget deficits and debt are the real problems; they stem from all the welfare benefits (unemployment insurance, old-age assistance, health insurance) provided by modern governments."

Despite the shift of emphasis, there seems to be agreement that governments, indulged by banks, are borrowing too much money. The recognition of the addiction is a positive first step toward the elimination of such overborrowing and overspending on entitlement programs (such as the PPACA).
Eleven steps to go.

Posted by: rmgregory | May 10, 2010 10:24 AM | Report abuse

Amazing, these banks can take all the risk in the world with ZERO DOWNSIDE.

It makes perfect sense... if govt will save you... then there is no reason to be careful... just aim for the sky... without risk of failure.

No wonder I keep making money investing in these firms.

Posted by: docwhocuts | May 10, 2010 10:26 AM | Report abuse

Speaking of moral hazard surrounding sovereigns, sovereign bonds get real nice risk weightings per the basel accord. Oops. Not applying risk weightings would have been a bad call, but apparently using risk weightings isn't perfect either. As Hayek said, 'the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design'.

http://www.ft.com/cms/s/0/f6976c2a-1a26-11df-b4ee-00144feab49a,dwp_uuid=2b8f1fea-e570-11de-81b4-00144feab49a.html

I agree with rmgregory that the problem was that borrowers wanted to borrow too much - were all banks supposed to tell Greece (when it was providing bad date about the size of its budget deficits) when it needed to borrow? No, you guys suck? Somehow I'm guessing Greece would have gotten its money if the banks had balked - probably from a program like this new one, just earlier.

At this point I wouldn't be shocked about commentary calling loans to Greece 'predatory'!

Posted by: justin84 | May 10, 2010 10:50 AM | Report abuse

As Mr. Klein suggests, the European banks (and ours) get to perpetuate their insolvent status for another day, but the European bailout (like TARP) SOLVES NOTHING and will only exacerbate the financial crisis!

Enjoy the pop in stock prices, it will not last long!

Finally, given all the financial sophism which has come with the European bailout (see the absurbity on CNBC), I would like to congratulate Mr. Klein for his insightful and courageous column!

Posted by: dgward44 | May 10, 2010 11:07 AM | Report abuse

"Remember that this is no more a bailout of Greece and Spain and Portugal than TARP was a bailout of subprime borrowers. "

Wrong.

Many people, including ratings agencies, started to look at risk of Greece et al. not making payments on the money they had borrowed as rising. They were borrowing money to pay off their existing bond holders. When the risk of borrowing is perceived to increase, lenders demand a higher interest rate.

The bond holders were the ones at risk. So, you can say Greece was not the one getting bailed out here, but if they defaulted on their payments to the bond holders, no one would be willing to lend them money. So, you're wrong. What the EU is doing here is saying that when it's member states borrow more money than they can pay back, the central bank will pay back the people that lent them the money (moral hazard pt 1) and the ECB will also buy new debt from the irresponsible countries (moral hazard pt. 2).

So, in this respect, it is like the TARP. The TARP has allowed the interest rates for current home buyers with 3.5% down to remain artificially low, with resultant moral hazard continuing to ensue.

http://twitter.com/nntaleb/status/13410155263

Posted by: staticvars | May 10, 2010 11:10 AM | Report abuse

"The way people understand the European crisis is that a few countries hold much too much debt. But you can flip that around, too: Many banks loaned a few countries much too much money. And if those banks don't get paid back, they're going to go insolvent, and the banking system is going to freeze."

I wouldn't say this crisis is affecting Spain b/c it has too much debt--they ran surpluses during the boom and still have < 75% debt-to-GDP. During the boom, everyone, not just banks, lent money to Spain cheaply; no one saw the difficulties Spain would have regaining competitiveness and growth if the bottom fell out of construction. Krugman said it best: these are problems from having a monetary union, but not a fiscal union (paraphrasing). Since fiscal austerity now would likely raise the deficits of these countries, not including a 'bailout' of their debt would be dangerous. Hopefully, they can enforce fiscal austerity.

Posted by: rglvr | May 10, 2010 11:11 AM | Report abuse

At best, they've kicked the can down the road for a year or two, maybe less. And with the bailout, they've actually made things worse. Why would any country in the Eurozone now impose painful budget cuts? They'll just continue with business as usual until the next bailout is needed.

I guess they took a cue from Paulson and Bernanke. Steal as much money from the people as possible, for as long as possible.
Worry about the long term some other day.

Posted by: John991 | May 10, 2010 11:16 AM | Report abuse

This is just kicking the can down the road. These Eurocrats don't want to see the fictions that the euro currency and the European Union really are. Both are artificial constructs laid over a set of sovereign nations with their own distinct cultures, languages, political and economic priorities. The EU aspires to be an undemocratic political entity that answers to no one but itself.

The Euro currencey, as we are witnessing now, is a vector that can rapidly spread all kinds of ills across Europe. No amount of bailout papering-over will hide that fact. Every country that had the guts to have a public referendum on whether to adopt the euro as its currency wisely rejected it. For the others it was railroaded through undemocratically without the people's consent, or sold as an easy ticket to prosperity.

The euro currency and the European Union are bad for Europe and bad for the world. They should both be exposed for the fictions that they are and be allowed to fail spectacularly and completely -- the sooner the better. We would all be better off without them.

Posted by: pjs1965 | May 10, 2010 11:25 AM | Report abuse

staticvars,

not to get too off the subject but word has it the Dems are trying to reinstate the homebuyers tax credit.

Some political parties will never learn. STOP REINFLATING THE BUBBLE!

Posted by: visionbrkr | May 10, 2010 11:31 AM | Report abuse

Bankers In Euphoric Orgy: "Just Give Us the Dough, To Hell With Society"

Gotterbankerdammerung! What a ghoulish Walpurgisnacht! The IMF, ECB and Federal Reserve unleash hellhounds on the people forsooth.

Posted by: rarnold1953 | May 10, 2010 12:01 PM | Report abuse

This is an interesting article which leads to the same conclusion that I have read elsewhere from the more perceptive commentators. That this is another bank bail out.

In addition I notice that the notayesmanseconomics web blog has a fascinating and thoughtful view on the change in the role of the European Central Bank.

"This means that the ECB will be filling its coffers with low quality assets and selling high quality ones. As it already had the lowest threshold for collateral out of the world’s central banks one can now safely say that it will soon have a quality mismatch between its assets and its liabilities of a frightening dimension. You could put this as a type of sub-prime central banking."

Posted by: andyjo | May 10, 2010 12:01 PM | Report abuse

It's not just European banks who are being bailed out. U.S. banks like Goldman Sachs are too. And it isn't just European money that is being used. Through the IMF, Barack Obama has committed at least $40 billion of good old U.S. dollars, some of which will be used to bail out banks! It just doesn't end.

We are still being taken to the cleaners. Even the Federal Reserve is printing hundreds of billions of new dollars in another inflationary move to "trade" dollars for Euros. We are being duped again and again.

Posted by: infuse | May 10, 2010 12:27 PM | Report abuse

Where did the trillion come from? Part from the US. Japan and US money swap back in play. California looms like dark creature from a grade B movie. Loans from US banks to business still tight. But, with the upswing of today one can cash out. Not a bad time to get some $ under the mattress. Lets enjoy this while we can and hope it may have some long life to it.

Posted by: onlooker2 | May 10, 2010 12:40 PM | Report abuse

For those who are saying that if Greece defaulted on their debt, they would no longer have access to capital markets, this is not a real argument against Ezra Klein's point. You're assuming that the total of Greece's debt is caused by social spending, welfare, pensions. Whereas the debt was bloated by 30+ billion in bank bailouts, 26 billion in Olympics, 50 to 100 billion in arms purchases above and beyond the European average over the last 10 years, 5 billion for a Bridge to Nowhere. That's 150 billion of 250 billion in debt. Greece's GDP would simply need to cover the remaining 100 billion in debt after a default.

Crunch the numbers and you might find that Greece could subsist on its measly 30k a year per capita, especially when the tax revenue is 12.8k a year (105 billion in tax revenues collected last year).

I think Ezra's point about this being a bank bailout stands.

Posted by: Dan25 | May 10, 2010 12:59 PM | Report abuse

For Justin, read the Eurostat report on Greek statistics dated January 8, 2010, and you'll find that banks had an absolute awareness of Greek debt. Greek predictive figures were faulty but Eurostat together with the FM conducted a review yearly in which the actual figures were printed. Check the Eurostat records yourself and you will find that Greece was showing 115% debt to GDP in 2004. There's no way that could have been reduced to 100% in ensuing years unless the yearly deficit had dropped to the range reported (around 3%).

Posted by: Dan25 | May 10, 2010 1:02 PM | Report abuse

Great we and europe are suppose to give greece a trillion dollars that neither of us have so they can continue their failed socialist system until it fails again. This is our future if we continue down the socialist path, only jobs in the private sector can save us from becoming like greece and europe. Right now the only industry in a massive growth is the federal government, but government jobs don't pay in they take out. We need to clean out washington, greece and europe needs to bite the bullet and restructure. Maybe in a controlled change they can handle the number of free loaders that riot with a shoot to kill policy, wait until the entire system fails and it will be chaos and they may not have the military or police force

Posted by: democratnomore1 | May 10, 2010 1:16 PM | Report abuse

One tiiiny detail is also lost here: The bail-out of Greece and other "poorer southern Europe countries" will get the Central European Bank (read Germany&France) more power over those countries then any military invasion could have provided, minus the cost of a war... pure win/win here.

Finally they won the war...

Posted by: diakrite | May 10, 2010 1:33 PM | Report abuse

Erza's point on the Greece's bailout is more like bailing out the banks because they are the ones holding the debt at this point. Greece made the error of borrowing money just to repay the interest on its debt and that tells the market that it is insolvent all because of the new PM telling the public the he went through the books to find 12% GDP debt while saying it is 6.5%.

Part of the problem is many of these countries are getting around the rule the EU membership has imposed on the amount of debt it can hold just to be part of the EU and that has the effect of dragging down the rest of the countries which is beyond its control-mainly the EURO currency.

Many people make simplistic assumption that much of the debt was from the social programs when it is something else - just Dan25 @12:59 pm said.

Posted by: beeker25 | May 10, 2010 2:27 PM | Report abuse

One tiiiny detail is also lost here: The bail-out of Greece and other "poorer southern Europe countries" will get the Central European Bank (read Germany&France) more power over those countries than any military invasion could have provided, minus the cost of a war... pure win/win here.

Finally they won the war...

Posted by: diakrite
-------

That's true.

Posted by: beeker25 | May 10, 2010 2:33 PM | Report abuse

Dan25,

I fail to understand your point supporting Ezra Klein's ridiculous claim that this is not a bailout of Greece. You seem to be claiming that Greece's structural deficits are small and they could have kept borrowing money. I don't think your $150B restructuring (a 60% haircut) would have led people to start lending to them at anything but shark rates again. The pension problems are real, and have been projected for years.

I do agree with Ezra, insofar this is creating further moral hazard incentive in the sovereign debt category, allowing banks to loan to EU members with the knowledge that the countries will be bailed out with the bonus of the ECB acting as IMF Jr. and imposing conditions that may ultimately force these countries to live within their means.

Posted by: staticvars | May 10, 2010 2:45 PM | Report abuse

This article demonstrates how little you (and WP) understand the underpinning of Maastricht Treaty under which Euro/ECB and Stabalization & Growth Pact was introduced - without sanctions.

What was decided was to introduce a stablazation fund mechanism to protect the euro (and non-euro) member states and their fiscal condition.

There will be a lot more...to come in terms of conditionality and progress on fiscal consolidation (ie. budget imbalances!).

In June, finally, Ecofin (euro-16) will deal with externality factors including rating agencies, derivatives and bank fees to recover (most) of the cost of EU market intervention.

Bottom line, you've to understand how Brussel (executive) works under EU Council.
Lisbon Treaty introduced EP (European Parliament)as an equal party in executive decision-making - ie. politics of EP will ultimately reflect public opinion and, at times, challenge EUs executive madarins.

Posted by: hariknaidu | May 10, 2010 2:57 PM | Report abuse

Dan,

Eurostat seems to think that Greece fudged its numbers. No one thought Greece was a poster child for fiscal prudence, but going from 6% of GDP deficits to 13% is a huge misrepresentation. Also, according to Eurostat, Greece's budget deficit never was better than 3.6% of GDP over the past decade, and most years was between 4.5% and 8%. If they were reporting 3% each year as you say, then yes they had bad numbers for more than just 2009.

http://www.marketwatch.com/story/eurostat-chides-greek-data-as-bonds-slammed-again-2010-04-22

In particular, one of restatements had a much larger change in terms of debt to GDP than deficits to GDP, suggesting a misstatement of past deficits.

http://ftalphaville.ft.com/blog/2010/04/22/209291/eurostats-bell-tolls-for-greek-debt/

For that matter, Greek debt as a % of GDP didn't fall from 115% to 100%, but actually rose to 125% per reuters.

http://www.reuters.com/article/idUSTRE6212YZ20100302

It does take two to tango, and yes this does protect the banks, although keep in mind Basel regulations made getting long Greece debt more attractive, but think of what Greece would have to go through if it outright defaulted. This is as much a bailout of the Greece welfare state as of the banks.

If Greece had a 13% deficit last year when interest rates were normal, the welfare state would need to be slashed. Assume that ~5% of GDP went to interest costs last year, and you've got to raise 8% of GDP. Tax rates in Greece are already sky high - raising tax revenue isn't going to be easy even with higher rates, so you've got to go with spending cuts. Cutting the military in half only gets you 2% of GDP, so you need to slice 6% of GDP in additional spending. As the economy adjusts to those cuts, GDP declines, probably requiring cuts of another 2%-3% of GDP in cuts to make up for lost tax revenue. So after slicing its military in half, Greece would still need to cut spending by 8%-9% of GDP - this would absolutely wreck the social welfare state.

Posted by: justin84 | May 10, 2010 3:07 PM | Report abuse

So how do you survive the aftermath of a debt bubble? Think about it...

Posted by: mtpeaks | May 10, 2010 3:12 PM | Report abuse

Justin, the Eurostat report says Greece gave faulty predictive numbers each year, and that each year Eurostat together with the Greek FM conducted a methodological review, and that the actual numbers were printed each end year. So we knew what shape Greece was in. The Eurostat report gives the numbers I'm looking at and it shows 115% in 2004 debt to GDP, 100% in 2008. The 3% was only for one year, not every year. I never said that.

For static, I wasn't assuming a 150 billion haircut on Greek debt. I was just showing the bad and corrupt deals that bloated Greek debt. The Greek pension and gov't worker payout is much smaller than you imagine. They have 3.4 million people over the age of 50, and 670k gov't workers. You can't do the math that gets them to a high number. Most of the debt is due to corruption. if Greeks were shut out of financial markets AND they defaulted, they should do just fine IF they stay in the eurozone.

Remember, the gov't budget is 120 billion. Do the math on Greek workers/pensions. I did. Even if every Greek retired at 50, and assuming that every Greek man AND woman worked till 50 and earned a pension, and assuming each bureaucrat made 20k, you'd still only get to 60 billion, about half the gov't budget.

Posted by: Dan25 | May 10, 2010 7:28 PM | Report abuse

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