Tuesday, May 17, 2011

Trash Trichet’s Stockholdings to Save the Euro Zone

The best hope for the euro zone may be to find a few bank stocks rattling around in European Central Bank (ECB) Governor Trichet’s brokerage account. There’s no chance that the long-time French civil servant would compromise his policy views to benefit himself, but it’s the kind of made-for-muddled-media factoid that, if found, could put a quick end to the farce he and the ECB perpetuate in pretending Greece is not bankrupt. Europeans tolerate this farce and the crisis it prolongs only because it keeps the euro low and blocks export-led recovery in the US. And if there’s one thing more attractive to the Euro-policy crowd than ending a crisis of the euro, it’s blocking US recovery.

A leader in this week’s Economist lays out the dimensions of the problem. The editors write:
Both the Greek government and its European and IMF rescuers admit that the country has no hope of tapping private capital markets in 2012, a central assumption of the original plan.
That original plan was to give Greece €110 billion ($157 billion) more in loans to keep things running while Greece magically transformed itself into an economy able to pay debts one and a half times its output – something it must start doing in 2012. Everyone now admits no magic is strong enough to accomplish that.

So the choices between now and 2012 are either more-money-in or less-money-out. More-money-in means that the ECB and the IMF give Greece yet more cash to pay off bonds it cannot repay even with the last bailout. Irrationally, the ECB continues to insist on this option. But it’s worse than irrational. Those bonds are largely held by European banks. Why should Chinese, Brazilian, and Nigerian taxpayers pay European banks through the IMF to protect those banks from losses on their own investments?

With IMF President Strauss-Kahn detained in New York City, the IMF no longer has much to say on the subject. The ECB has no answer, either, but seems to believe that European banks are people, too, and very special ones. As the Economist has it:
The [central] bank’s officials have argued, in increasingly hysterical tones, that any tampering with Greek debt…would cause a crisis far worse than the collapse of Lehman Brothers in 2008.
And who are we to argue with the ECB about financial crises?

We are people who have been here before, that’s who. Starting in 1982, Mexico could not pay off its bonds to foreign banks. The Reagan Administration’s Treasury Secretary Baker insisted on badgering and threatening even small banks holding Mexican loans to lend yet more money so that Mexico could stay current on its old debt. That way no bank needed to recognize losses. But it left Mexico even deeper in debt, causing capital flight – and it left the banks no better off. This is essentially the ECB’s position on Greece, today.

In 1986, Senator Bill Bradley argued that banks needed to treat Mexico like any private-sector bankruptcy – reducing the terms of their loans for the borrower to regain enough health so that it could eventually pay at least a little more than it could afford under current conditions of intense distress – less-out instead of more-in. By recognizing loan losses up front instead of making new loans to cover them up, the plan avoided adding to Mexico’s external debt. And that would eliminate the cause of the capital flight that was further withering the country’s financial condition. Bradley’s position was eminently logical. But both the banks and Secretary Baker dug in – for very different reasons.

Like the ECB today, a broad array of banks and bank apologists screamed out that if Mexico restructured its debt it would never again borrow in private capital markets. Not only did the banks, the Federal Reserve, the various European national central banks, the IMF, and the banks’ lobbying organization paint restructuring as the first chapter of a financial apocalypse – but so did the Economist magazine! In fact, Mexico did restructure its debt using a plan agreed by Bradley and Baker’s successor Brady in 1989 – and the country was borrowing on competitive terms once again before the end of the year. The ECB is lying and knows it.

Meanwhile, the press had dubbed the 1986 version of more-in as the Baker Plan, thus neatly engaging the Treasury Secretary’s ego. Here again, history may be repeating itself. True, the Economist has changed its tune and now supports restructuring. In a powerful echo of the earlier episode, however, its editors have concluded that egos really matter in international economic affairs:
The still more alarming possibility is that, blinded by pride, the bank and its hitherto sensible president, Jean-Claude Trichet, are unable to accept that a euro-zone country is bust.
The very possibility that egos have driven bad decisions in both episodes makes the resolution of the earlier Mexican debt crisis relevant today.

The end of the Baker Plan was an accident. The Washington Post discovered Secretary Baker held most of his wealth in a trust containing bank stock. There is no chance that Baker hoped to feather his own nest by insisting on a foolish policy to let banks avoid recognizing losses at the expense of a sovereign borrower. Within one week, nevertheless, the Reagan Administration deftly moved Baker from Treasury to State, and rationalized its position on Mexico by advocating an orderly debt restructuring in cases where borrowers really can’t pay.

Now the ECB is threatening to block liquidity lines to banks offering Greek debt as collateral. Since that is most of the collateral that Greek banks can offer, the ECB is basically threatening to stop serving them. It would be like the Federal Reserve shutting the discount window on banks from Louisiana. It will force Greece to drop the euro and set up its own central bank.

For the sake of both Europe’s brave monetary experiment with the euro and US recovery – which still awaits a higher euro and a more competitive dollar – we must hope for that article finding a few bank shares in ECB Governor Trichet’s private brokerage account. That the man is purer than alpine snow is beside the point – it would be the kind of trivia that has brought financial folks to their senses before. It doesn’t even have to come from Le MondeLe Canard Enchainé would do nicely.

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