Before going ahead, I would draw attention to a Paul Krugman post yesterday, since I agree with this almost more than I can say. The basic point is that the Obama-Geithner plan looks like it may well not work, because people are buying up assets which no one really knows the value of. The thing is why has the banking system dropped so much in value.
If you think it’s just a panic, then the government can pull a magic trick: by stepping in to buy the assets banks are selling, it can make banks look solvent again, and end the run. Yippee! And sometimes that really does work.There is an analogy in the European situation as I try to argue in my Krugman Says Nationalise The (Bad) Banks, And I Say Nationalise The (Bad) Countries post.
But if you think that the banks really, really have made lousy investments, this won’t work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that’s the Swedish solution, it’s what we eventually did with our own S&Ls.
Now, early on in this crisis, it was possible to argue that it was mainly a panic. But at this point, that’s an indefensible position. Banks and other highly leveraged institutions collectively made a huge bet that the normal rules for house prices and sustainable levels of consumer debt no longer applied; they were wrong. Time for a Swedish solution.
And in a subsequent post he makes the following point:
Brad treats the prospect that assets purchased by public-private partnership will fall enough in value to wipe out the equity as unlikely. But it isn’t: the whole point about toxic waste is that nobody knows what it’s worth, so it’s highly likely that it will turn out to be worth 15 percent less than the purchase price. You might say that we know that the stuff is undervalued; actually, I don’t think we know that.
That we simply have no idea what most of this toxic stuff is worth is what I have been tirelessly arguing on this blog (and to many protests from the "analysts" since summer 2007 about the Spanish cédulas hipotecarias. Since we have no idea at all what the Sapin's houses (and the associated mortgages)are worth, how could we? Basically we have no real idea to within any reasonable order of magnitude what Spanish GDP over the next decade is going to be worth. Which is why I have been arguing all along that the ECB should buy up all 300 billion euros (or so) worth of them (30% Spanish GDP) and park them in the vault in a locked box marked "not to be opened till 2030" (like the ECB minutes).
And also why I argue we need another 300 billion euros from those EU Bonds I hope we will be seeing one day, simply to clean out all the bad building and developer loans there are in the Spanish banking system. Do we need a Swedish solution for the Spanish banks, I don't know yet, I think we need to wait and see how the situation develops before making judgements like that. The cyst is swollen and festering, but it hasn't burst yet.
Meanwhile it is the Spanish real economy that is breaking apart at the seams.
Back then to Alan Ruddock. I would single out a couple of paragraphs as worthy of note (as well as all the background on the furor about the ECB bailout fund.
He is definitely for the Swedish solution in Ireland:
If the leaks so far are to be believed, the Government is being guided towards yet another half-way house solution that will shovel all the costs onto the taxpayers, all the rewards onto the banks and will store up more trouble for a later day without freeing up the banks to lend into the economy.
The neatest solution -- temporary nationalisation of the banks, the creation of a 'bad company' to hold the bad debts and the re-privatisation of the cleaned up banks -- is avoided like the plague. Instead, we will either carry the insurance risk for the banks' poor lending decisions, or we will buy those bad debts for ridiculously inflated prices.
So now, here is the complete article.
Kill or cure: Budget is crucial to our survival
The Government must drag the country out of this crisis before the EU comes looking for its pound of flesh, writes Alan Ruddock
There was no ambiguity in Otto Bernhardt's comments last week to Reuters, the international news agency. Bernhardt, who chairs a finance policy group in the German parliament and is a relatively senior member of Chancellor Angela Merkel's CDU party, was outlining the European Union's plans to bail out struggling member countries.
"The finance ministers have agreed the procedures. The core point is: 'We won't let anyone go bust','' he told Reuters. Ireland, he said, was in the "worst situation of all", followed by Greece, and he was clear, too, about the pound of flesh that Germany would extract as the price of its support.
"We would look very closely at past sins. We will not tolerate there being low-tax countries like Ireland for example. We will insist on a minimum corporate taxation rate."
In the event of a default, or imminent default, Bernhardt said: "We are in a position to act within 24 hours. The ECB would take immediate action. The ECB can make an unlimited amount of money available . . . What is the alternative? We would otherwise lose our currency."
His comments caused consternation in Dublin and Brussels and were dismissed out of hand by Brian Cowen, the Taoiseach, and Micheal Martin, the Minister for Foreign Affairs. Peer Steinbruck, Germany's finance minister, was a bit more circumspect. "I can't confirm such a meeting (of finance ministers to agree the plan) or such conclusions," he said.
Bernhardt later claimed he had been misinterpreted, but it is hard to see how. He was speaking the unspeakable, but it makes sound sense: if Ireland or Greece or any other struggling member of the eurozone should tip perilously close to default, Germany and the rest of the EU will have little choice but to lend immediate support, because if they allow default they will invite the destruction of the euro.
Joaquin Almunia, the EU's economics commissioner, said as much recently when he confirmed that the EU did have a plan to help struggling eurozone states but said, "It is not clever to talk in public about this solution". Indeed.
Such common sense should be reassuring, but it is not. The knowledge that help is on hand is balanced by the realisation that the rest of Europe thinks we will need that help and is already manning the lifeboats.
For Cowen and Brian Lenihan, the Minister for Finance, Bernhardt's comments are nerve-jangling. Next month's emergency Budget will determine the country's future: within weeks, possibly days, of its delivery, Ireland will be declared a basketcase, or it will limp into remission.
And if that were not enough pressure, the slow-burning crisis in the Irish banking sector is still far from resolution. If the leaks so far are to be believed, the Government is being guided towards yet another half-way house solution that will shovel all the costs onto the taxpayers, all the rewards onto the banks and will store up more trouble for a later day without freeing up the banks to lend into the economy.
The neatest solution -- temporary nationalisation of the banks, the creation of a 'bad company' to hold the bad debts and the re-privatisation of the cleaned up banks -- is avoided like the plague. Instead, we will either carry the insurance risk for the banks' poor lending decisions, or we will buy those bad debts for ridiculously inflated prices.
First up is the Budget, though the point of crisis moves so swiftly that the banks could easily force their way to the top of Lenihan's agenda over the next two weeks.
Until the publication of last week's retail sales figures, the Government had been leaning ever closer to the opportunistic populism of the Labour Party and the rest of the redistributive Left, softening us for a series of punitive tax increases on the 'wealthy' (code for the middle classes) and lesser tax increases on everyone else.
Those tax increases would be presented as a sign of Government toughness, but in truth they would be just another device to avoid tackling the real problem: the Government's spending.
Huge tax increases and headline cuts in some capital programmes might raise money on paper, but they will do nothing to deal with the structural problems that have caused the Government's borrowing requirement to spiral out of control, and they risk causing deeper harm to the economy.
The awfulness of those retail sales figures -- down 20 per cent in volume terms, the worst fall on record -- must have stopped Cowen and Lenihan in their tracks. The figures gave the clearest evidence yet that this country is gripped by fear -- fear of job losses, fear of tax increases, fear of shadows.
There is no chance of confidence returning to Irish consumers until they are certain that all the bad medicine has been administered, so the Budget has to be tough enough to make people realise that the Government has woken up to its responsibilities. If people fear that yet another emergency Budget is just a few months down the line, or that the December Budget will impose yet more pain, then spending will shrivel and last month's record will soon be broken.
The figures should also have made Cowen realise that taking yet more money out of consumers' pockets carries enormous risk. He must see that his priority is to cut government spending, and only turn his attention to tax increases once he has exhausted all other possibilities -- including privatisation and tax reform.
It is an incredibly difficult balance to strike and his task is made far, far more difficult by the failings of the Bertie Ahern years. His and Ahern's abject failure to reform the public sector or embrace privatisation -- a direct result of the sclerotic effect of social partnership on Government thinking -- has left him with a huge problem.
The public sector trade unions are already flexing their muscles, calling strikes and filling the airwaves with disingenuous cries for 'fairness', when what they mean is 'let the private sector take the pain'. It is class warfare by a subtler route, but it is still class warfare.
Cowen has been conditioned by social partnership and is frightened by its breakdown, so he tries to rebuild it when he needs to confront it. His task is made more difficult by the opportunism of the opposition parties, who court populism to inflict political damage, but by so doing put the country at even greater risk.
Richard Bruton, Fine Gael's finance spokesman, made a powerful case for politics as normal in Friday's Irish Times. "Adversarial scrutiny and accountability will not be abandoned in favour of a phoney consensus," he said, dismissing out of hand the notion that Opposition and Government should form a united front to deal with the economic crisis. It is a valid point if the opposition parties can find the courage to scrutinise honestly. For the moment, they can not. They are blinded by the prize of destroying Fianna Fail and cannot see that they risk destroying much more than just a political party.
Honesty is required urgently: from Cowen, Enda Kenny and Eamon Gilmore. They might all dismiss the idea of a national government, but they must agree on a unity of purpose. Whatever their political differences (which are slight), they must put aside personal animosity and personal ambition to deal honestly with this crisis. If they do not, the Government will not find the courage to tackle its spending and the markets will pass a very hostile verdict on the April Budget. And then we can prepare for Otto Bernhardt and his pound of flesh.
27 comments:
Yes this budget is going to be a harsh one...but I fail to see how it will lift the Irish economy out of the mire. Everything pretty much has collapsed in Ireland..unemployment up to 11%, tax revenues that even Brain Cowen is admitting will be €6 billion short of targets this year, car sales down by two thirds, shops closing left right and centre. How does he respond? By hiking taxes and cutting salaries, and slashing all completely non-essential public works. No positive thought present, no stimulus package or longterm plan, just short term panic measures. Ireland's transport system desperately needs upgrading, its school are at bursting point, hospitals overrun...but budgets are getting slammed.
What's going to get us out of this recession (should I say nose dive?)...a tax on text messages...a hike in VAT that sends even more money out of the country as shoppers go to the North? Amid all this this minimum wage remains among the highest in Europe while the euro/sterling exchange rate renders Ireland extremely expensive for Brits-who make up 50% of all tourists, and take the majority of Irish exports. Ireland MUST find a USP...perhaps should pull out of the euro and align with sterling (will never happen because of past grudges...) I don't know what to suggest, become the energy centre of Europe? But surely doing something is better than nothing...Or else Ireland must face a very long recession that will only end when its devalued to the point where its v cheap to ooacte too
Callum, what is eventually going to get you out of the mire is better services and better products, sold to the world at more competitive prices.
I am no expert at Irish economy and can judge by anecdotal evidence only, but my last trip to Ireland (November 08) left me with mixed impressions. From the viewpoint of a tourist: mediocre, but overpriced hotel services. Very expensive highways with very few gas stations. Very very costly, but not-so-excellent food.
However, maybe the most lasting impression was left in my mind by the organisation of the Dublin marathon, in which I wanted to take part: it was visibly costly, resembled something very much like army manoeuvres, but at the end of the day it was no better and much less user-friendly than the organisation of similar events in, say, Hungary or Italy.
So maybe it will all come down to adding some enterpreneurial spirit, lowering taxes, reducing the level of state paternalism and getting back to the business of selling good things at good prices.
For the time being, I would suggest adding at least one, please one single petrol station to the ridiculously expensive M4 motorway to Kinnegad. Until then, I will keep on drifting in the space between Holland and Hungary.
Hi Callum,
Nice to see you here. Yes. Ireland is in rather a mess, isn't it.
"By hiking taxes and cutting salaries, and slashing all completely non-essential public works."
Yes, its curious isn't it how quickly the bank funding problem hit the Irish banks when compared with Spain. Have you any idea of why this is?
"What's going to get us out of this recession (should I say nose dive?)."
Very, very difficult problem Callum. I don't see any short term solution. Like Spain you need to reinvent your whole economic model. Exports will help, since domestic consumption is going to be mired in debt deflation for years. But really all this needs quite some time to put in place. In the short term, hold on tight I suppose.
As as economics journalist, I read your blog with interest and enjoyment. On the issue of pricing toxic assets, but without necessarily resorting to bank nationalization, have you seen the suggestion in the February 2009 issue of the McKinsey Quarterly, and what do you think of it (a) in general (b) with regard to Spain? See article at link
http://www.mckinseyquarterly.com/A_better_way_to_help_banks_2314
SPAIN's REDUNDANCY LAWS THREATEN BUSINESS SURVIVAL
From personal experience, it is becoming increasingly clear how the high cost and hassle of laying off staff in Spain threatens to drive more companies to the wall than might be the case in countries with more 'flexible' and less costly labour regulations. Faced with a catastrophic and unexpected fall in sales, a small, family owned, sole trader business owned by a friend is reluctantly bracing itself to shed employees until conditions improve. For a 26 hour week, the monthly cost of a member of staff is around 1500 euros, of which fully 450 euros is social security paid by the employer. Reverting to part-time contracts with a significantly reduced social security payment would be the preferred choice, but cannot be done under Spain's rigid laws. So the apparent choice becomes one of continuing down the road to ruin or of laying off employees. But this choice is illusory. For Catch-22 is that employers' redundancy payments are so high - 21 days pay for every year worked - that the small business would be hard put to survive paying off even one employee of 7 years' standing. Thus the choice becomes one of keeping staff employed and going bust, or laying off staff and probably going bust because of redundancy costs. Thus is the folly of the the labour regime exposed by economic shock. The regime will amplify the failure rate of small firms that compromise the bulk of Spain's stock of businesses. The government must surely be aware of this, but appears gutless in the face of undoubted union opposition to revamping protectionist labour laws.
I follow your informed blog from the Canaries, it complements Burbuja.info which I regret has too much dross now - about 2 years ago it was very much predictiing the Spanish situation: "Chup-prime", over-construction farse etc.
With respect to Naricha's comment and closing in on points raised:
1. laying off staff - indeed the 'liquidación' costs are very high, even when tinged with a "justness" of repayment for services rendered. But two points arise: if a business has to pay so much at the end (and for Seguro Social) it will inevitably cut salaries to cover this cost. Also it is absurd that Hacienda regulations do not allow the creation of a tax deductible fund to cover this future cost - a pre-emptive amortization as it were,
2. Banks and bankruptcy of individual citizens. It seems preferable to keep the debt of unpaid loans (failed 'hipotecas' on the books as assets... than to do a clean sweep UK/USA bankruptcy write-off - though I fear that the 'picaresca' of many people would abuse this option. The 'concursal' at present is absurd both in legal expenses and with unsatisfactory slow results.
The goose
Hello Robert and Goose,
Very interesting points. Before I respond to some of them, the big news of the moment is the fact that Japan's land and property prices hit 1984 levels yesterday. This gives us some indication of what may be in store for Spain, that is prices in 2025 could be at 1998 levels - in nominal terms (given the deflation we almost HAVE to have).
I think almost no one here is ready for this. Few noticed that all those sharp rises in property prices between 1980 and 1992 were fuelled by drops in currency values and rising inflation. That is, in real terms (as measured say in dollars) the value of Spanish property was not up anything like it seemed in book terms.
Now from 1995 to 2008 we have a huge bubble. Whatever happens next isn't going to be pleasant, even on the best case scenarios.
Here is an entire article about Nomura economist Richard Koo (who I have mentioned before on this blog). I think there is far too much arrogance floating around at the moment from people who haven't the faintest idea why Japan has had deflation all these years. As a long time Japan watcher (my Japan blog was one of the first I started back in 2002, and my affinity with Krugman really comes from our common interest here, although I am not sure whether we think the same since we have been following Japan, or we have been following Japan because we think the same :) ). And Koo doesn't even mention the demographic, ageing and declining populations angle, which, if you add it in surely makes things worse not better.
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FOR Nomura Research Institute's chief economist Richard C. Koo, Main Street fame is a case of better late than never.
Until now, many in the West have paid scant heed to his theory that Japan's 15-year-long economic stagnation was a result of debt-choked companies struggling to pay down their liabilities, and not just a big housing bubble that burst in 1990.
Many Japanese prime ministers had prevailed upon the Taiwan-born American to help them through the country's 'lost decade'. In fact, Mr Koo, 55, was the first non-Japanese to be invited to help formulate Japan's five-year economic plans.
His feat is bettered only by his paternal grandfather, the late Koo Hsien-jung, who was the first Taiwanese to be made a congressman in the Upper House of Japan's Diet in 1934.
The younger Mr Koo joined Nomura in 1984 after stints in the US Federal Reserve System. He writes for BusinessWeek, and his latest book, The Holy Grail Of Macroeconomics: Lessons From Japan's Great Recession, was described as 'brilliant' by The Financial Times' Martin Wolf .
Mr Koo remains modest about his acumen. 'I was lucky on that score because I work for one of the largest financial firms in Japan and could see the flow of money,' he says. 'If I were not working in that kind of environment, I would never have come to my conclusions.'
An 'invisible' recession
HE HAS a big bone to pick with his fellow economists and journalists. They bashed Japan over 18 years for pumping in trillions to stimulate its economy only to see zero growth. The assumption behind that 'accusation', as Mr Koo describes it, is that Japan's economy would not have grown no matter how large the stimulus and so it must follow that the country has squandered huge sums of money on useless projects - bridges to nowhere and the like.
But without such stimuli, Mr Koo stresses, Japan Inc would have collapsed.
Affable and garrulous, he flips through a copy of his latest book, The Holy Grail Of Macroeconomics, and points out a chart that he says Japanese Prime Minister Taro Aso used to convince his G-20 peers recently that fiscal stimuli was the way to jumpstart their sputtering growth engines. The chart shows that, with recurring stimuli, Japan's GDP kept growing year after year even though its property prices plunged by 87 per cent between 1990 and 2007.
He then flips to another chart which shows that few Japanese companies were borrowing even when banks were willing to lend money to them interest-free. This counterintuitive trend led him to conclude that Japan - and now the world, he believes - was mired in a 'balance-sheet recession'.
Balance-sheet what?
Well, he says, for anyone who has bought into talk that 'the worst is yet to come' without actually knowing what that means, this is what a 'balance-sheet recession' means:
'This recession is an invisible one. No one wants to talk about it, especially if his balance sheet is underwater...(so) even in the very big companies, only a handful of people might be aware of their balance sheet problems, but they're not going to tell their employees that they're actually bankrupt.' Banks, he adds, are similarly keeping mum on why their borrowers now have poor net worth.
In circumstance when the private sector is busy repairing its balance sheets, the usual tool of monetary policy - slashing interest rates - will not work. Companies intent on saving will not borrow to spend on capital goods. This means that the only way out of a downturn as sharp as the current crisis was 'a very quick response' in the form of governments themselves spending heavily on infrastructural projects
In this, he feels United States President Barack Obama's US$787 billion (S$1.2 trillion) stimulus plan lacked a decisive punch. 'In 10 months, the US will be losing more than six million workers,' he forecasts. 'Obama's package is for 3.5 million workers. So by the time this fiscal stimulus starts working, you're already behind the curve.'
What he really wanted the President to tell Americans is this: This is wartime, not peacetime. We're going to start digging ditches now and fill them up to keep our GDP from falling. He muses: 'That kind of crisis mentality, emergency thinking, which I think is essential, I haven't seen from Obama yet.'
He is also puzzled as to why the Obama stimulus plan was presented as 'a one-time thing' when the US - and thus, the world - was in the midst of a prolonged depression. Japan learnt that lesson painfully: 'When the economy turned bad, we put in fiscal stimulus, the economy grew and then we said 'oh, the budget deficit's too large'. We cut it, the economy collapsed again. We had a zig-zag the whole 15 years (of Japan's prolonged economic decline).'
Mr Koo thinks China was doing 'the best job' in tackling the crisis with a 4 trillion yen (S$880 billion) stimulus. That is a bigger proportion of its GDP than the US stimulus package is of America's GDP. He quips: 'So China can argue: 'We're not free-riding on you, you're free-riding on us!''
The only way out of this crisis, he says, is 'a seamless, medium-term package of fiscal stimuli', for it will take many years for companies to get their balance sheets back to black.
That said, he wonders if something should also be done about the over-exposure of some capital markets - such as Russia's. When he asked a Russian TV reporter recently why she had quizzed him so much on the yen's prospects, she told him that it was because she'd mortgaged her house in yen, and the rouble was tumbling.
'Even though the (Russian) central bank is trying to control this and that, Russian companies just go abroad and borrow more money. And then later on... the value of the rouble collapses and their earnings collapse relative to the currency they borrowed in.'
What should Asia do once the world recovers? Mr Koo's answer: Start growing domestic demand for luxury goods in fairly rich Asian countries. Asian income levels had risen so much that there were only so many necessities a person could bulk-buy. But, he cautions: Asians would have to cut back a bit on their work ethic for that shift to work.
As he puts it: 'If you want them to buy luxury goods, you need to give them time to play with it.'
Richard, I will come back to your McKinsey poinyt tonight (although I am not a bank solution "specialist", indeed far from it).
But on the employment protection regulations, I couldn't agree more, under current circumstances they just produce bankruptcy. So they are not employment protection laws, they are employment destruction ones. Probably Austrian economists should welcome them, since they are the sure fire way to put the maximum number of companies out of business in the shortest possible time.
Unfortunately I am not an Austrian, and fear they may well put good and bad companies out of business, willy nilly, and cause a kind of destructive destruction to Spain's core economic sectors from which it will take years to recover.
Koo really does know what he is talking about, and makes some very good points.
This, for example:
"In circumstance when the private sector is busy repairing its balance sheets, the usual tool of monetary policy - slashing interest rates - will not work. Companies intent on saving will not borrow to spend on capital goods."
And it is a kind of "innocentada" to suggest that large numbers of loans be made to consumers and households at this point in time, since they are also all repairing balance sheets, and saving like hell, or should be.
This piece about corporate balance sheets and the NPLs too:
"'This recession is an invisible one. No one wants to talk about it, especially if his balance sheet is underwater...(so) even in the very big companies, only a handful of people might be aware of their balance sheet problems, but they're not going to tell their employees that they're actually bankrupt.' Banks, he adds, are similarly keeping mum on why their borrowers now have poor net worth."
So, as he says:
"This is wartime, not peacetime. We're going to start digging ditches now and fill them up to keep our GDP from falling."
I am off to fight another day at the front. I will try and find the time to respond to the specific point about the McKinsey piece this evening.
Have a good day everyone,
Edward
I may be a bit of a bank solution expert, as I have been responsible for the liquidation of the most toxic assets in one of the largest Czech banks, following our little banking crisis of the late 1990s.
I have worked with the local McKinsey team, so I also tend to have some experience with how McK people think.
As a whole, the proposal to which Robert Naricha refers, is a sound one. We did pretty much the same in the Czech republic and it more or less worked.
There are two major catches in the plan:
a) it is highly politically incorrect and unpopular, but the assets (mainly bad loans) need to be recovered. If the creditors do not take every step possible to enforce their claims, they will not recover anything and the assets will be worth zero. What that would mean for the plan is plain and obvious - it would not work, because it assumes relatively low discounts (in the world of debt recovery, 20 cents off a dollar is very very little). So the debtors, both corporations and private citizens, must be told that even though the state does everything it can to help the banks, the truly efficient help may come only from the debtors - namely, that they keep on repaying their debts.
b) you will need plenty of extremely qualified, streetwise professionals who will be able to manage the badly non-performing loans (aka toxic assets) and make sure that they retain at least some value whilst not entirely destroying the debtors, most especially large corporations. Now, there is a big catch. The administration will need to admit that such people are scarce and must be paid well enough in order to be willing to effectively work for the governement sorting out the big mess called large American banks. I am afraid that these days half a million (current) dollars per year will not buy a very senior professional even here in Prague. How the American public will be able to swallow the necessary million-dollar paychecks, remains to be seen.
Hi Edward,
I'd like to bring to your attention a cuople of analisys from Carlo Pelanda. I don't know if you know him, I highly respect him, he's able to express original and keen ideas in very short articles ("brevitas" is a gift I'd like to have).
Here is the translation of the first one, from the end of february
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it's not true it's impossible to evaluate the quantity of toxic assets that contaminate the balance sheets of european and american banks.
The transparency operation has not been done because the main banks, managers and shareholders, feared to unveil that the quantity of
non marketable toxic finance imply a bankroup condition. For the same reasons governments and monetary authorities did not entered heavily
to inspect the balances. Moreover they allowed the banks to falsify the balance sheets by changing the toxic asset value from mark-to-market to book data. Central banks financed with infinite liquidity this insolvency instead of solving it.
Let's give up critics to the past and let's see the future. Do we have to force for the transparency operations and cleaning or is it useless at this point? Lehman insolvency's consumptive data suggest even a minimum level can be profitable. The insolvency was of around 600 billion $, but the good assets were evalued circa 380 billion $. that means, apart that those catastrophic bankroup could have been avoided, that many
assets were less toxic than espected. Under this view the EBC is right in sponsoring the creation of a European specialized market in currently non marketable assets. This market solution, strangely not considered by Fed, could lower at least of 20% the amount of the toxic products. But the remaining volume - tens of trillions of scraps - will never have a market again and at the end will sink down the balance sheet.
It's happening now.
For that reason the states will have to handle all the (main) banks nationalising them directly or indirectly (like the Italian model) backing their operations. Under this perspective, the evaluation of the toxic assets, even if sacrosanct, is an old issue.
credit statalization will transfer the instability to the currecies market as it's the only one still working (stock exchange market no longer indicative). The next front line will be there, we will se the crisis contained or amplified. It's not sure the dollar will fall. European banks have insolvecy risks at a level of 4 trillion $ in the emerging markets, the american banks only 500 billion. Dollar must regain its forse to sustain american debt, Euro could fall apart. Or may occur the opposite. Anywway only one of these events will destry the globalization.
To stabilize the situation, and restore the confidence, it's needed a global monetarian agreement and on the currencies. Only few months left.
Caldo Pelanda, from "Il Foglio"
Rytu, it is not impossible to valuate even the most sophisticated "toxic assets". It is only difficult, but neither extremely difficult nor impossible.
However, one has to have courage to just sit back, forget the mass hysteria and hysteric calls for "immediate-action-to-prevent-end-of-the-world" and do some calculations.
At the end of the day, it is just a financial crisis, not a real one. If it were a real crisis, a major epidemic, a war, a Richter 9 earthquake, then an immediate action would obviously be needed. But here, you know, we surely have the time to think and to find out what (apart from the rodents) has been left in the vaults of our venerable banks.
You know, I guess that the Chinese may do fairly well just because of the 2008 Sichuan earthquake. Having dealt reasonably well with a catastrophe that left five million homeless and close to 70.000 dead, they will surely know that a financial crisis leaves you ample time to think.
Hy Hynek,
I've no doubt about that. It's completely my point that before giving aid to the banks, or thinking to an overall action like the creation of a bad bank, the total amount and nature of the toxic asset have to come out and be visible in each balance sheet.
I read comments that the banks will give the information once the decision regarding the bad bank, or any other vehicle where to store and lock up those liabilities, has been taken. My approach is the opposite, and in my view quite plain straight and logic: first you tell me how much are your losses, than I decide wheter to help you or let you down. I also argue that it'd be better that the banks that want to apply for public aid have previously to change the executives. I don't want them in jail or ruined, just take the million you got in the previous years and step down, someone else will be in charge with different ideas.
The article I posted focused on different implication, more politic and fore the future economic global framework. The point was, forgetting for a while the toxic assets, how to preserve the stability for the global trade, finance, in a word globalization, aka our way of living.
I will post also another article, as I find some time to translate it
Regardind the crisis, well it started as financial, but had the time to break up many fantasy world, like the ones where the Baltics, Spain and Russia were living. For many countries the crisis now is in real economy and structural.
Russia will have again a lot to say, I may be wrong but it looks like they are learning now, that all these former KBG officers are not so sound in running corporation. So apart of the immense fortune they seat on, they may open again (not completely) their economy to FDI and let them manage the business, restructuring many sectors.
Leaving the other countries to their specific blogs, I see dark for Spain. It is highly depending on a single market (RE) that is now frozen and will remain for I don't know how many years. Financial sector is doubled tied to it and will go down under with it.
Spain needs a huge and fast correction, to reinvent "Corporate Spain" entering new market where they will find famelic competitors.
Old economies like Germany, France and Italy can try (I think they have to do, even without any crisis) to slash the taxes, the rules, the costs and wages, but Spain is yet in a low level of taxation, almost business friendly and the wage levels are at a very low level.
Households and companies have a hube debit burden that will bring prolonged stagnation in internal consumption and investments.
Spain has no space for mass correction, it can't even agree to a painful transition, as it's bleeding now with a 15% unemployment rate. A turn around from RE to other activities means that number to to to above 30%, not affordable even in china I think.
Ending, the only thing the can do is to transfer the private debt to the public one, maybe to a rate of 80% of the GDP, or at the Italian level or 110%. Well I'd prefer, also to confirm my "Austrian soul", anything else then that. Even if the plan works out, this kind of burden will probably have the Italian effect, a structural gap in growt. Actually Italy always grow 07%-1% less than Eurozone countries, when other state contracts at 1%, italy goes for -2%. Debt it's not the only reason, but it's the main one not to do other reforms.
So, it's better to go down some % more now, and in the next year, than having a structural gap, it accounts a looooooot in the long medium-run
Rytu, you mentioned one strange point about the Spanish economy which I am not really able to understand - namely the extremely high level of unemployment, most especially the current 30% unemployment in the under-26 age group.
I can hardly imagine it possible, after all, this is the EU, and the year is 2009, but if the overall Spanish unemployment rate goes up to 22, maybe 25%, then the youth unemployment is sure to exceed 40, maybe even 50%. Given that the Spanish unemployment will almost certainly
top 20%, 40+% youth unemployment is near certain as well.
Maybe a question for Edward and others - do you know the reasons behind such horrible figures? And another one, if one half of the Spanish youths seeking work becomes unemployed, is it not so that Spain may soon see riots, vandalism and sharp increase in crime?
Well I'm not an economist, nor a specialist in labour market.
I can try to guess some key factor.
1. Spain comes from a reality with huge unemployment rate, especially among the younger part of the population, as it was one of the less developed european contry and with the typical non-flexible labour market.
2. The recent fast development was not homogeneous, ans the southern and internal regions still remain underdeveloped, with growth concentrated in real estate sector.
3. Spain, the developed regions, created million of new employers, but mainly low skilled. In order to keep cost at low competitive level, Governments allowed 4.5 million, if I do remember right, immigrants (low skilled labour force from south america and eastern europe) to come.
I guess there are many other structural reasons Edward knows and can explain to you.
So, with all those immigrant wellcomed (and I firmly agree, I favour open border policy and "ius solis" principle), the labour costs remained well down.
i.e. Baltics needed a lot of workers, but their borders remains sealed, they experienced some 35% yoy growth in hourly wages.
but unemployment rate has always remained the higher in Europe. For sure among all those million on people laid down, there are many spanish but also many foreigners.
Regarding the riots, well I think that in those areas where high unemployment rates are structural and long coming, this is not enought to bring violent strikes. I espect riots more likely from foreign community, or clashes among spanish and foreign groups (classic war of poors), sometimes in the futures when people realize social aid is running out and there is no tangible solution on the horizon. People can move around, but I think Spanyards (like al the "old europeans") are not so likely to pick up a bag and go abroad as the eastern
As I understand it, Spain's high unemployment relative to the EU average is multifactorial. Issues include: an increase in the workforce due to demographic shifts, including the impact of immigration; rigidities in the labour market - e.g. over hire and fire, pay and contracts - which have skewed employment towards short-term, unstable jobs; large and growing 'black' or 'grey' informal markets that encourage some people to define themselves as jobless while knowing thay they can earn a living unofficially; generous unemployment benefits that also encourage staying officially unemployed; and rapid modernisation from a low base immediately post-Franco and pre-EU entry. In my experience, I would also add endemic corruption and nepotism to the list. I would argue that this 'cheat's economy' undermines competition, thereby weakening a key driver of innovation, investment, higher productivity and so on along the line of reasoning to a dampening of endogenous growth. For example,I have recently been made aware of a large and growing publicly owned enterprise that is widely believed to ask potential employees to show their political party membership card at the outset of selection interviews. It is referred to by those in the know as 'the vote machine'. Is this an urban myth or reality? My sources suggest that it is pretty much close to the truth. Yet you will never read about such matters in the largely supine Spanish regional and local media that appear afraid or unwilling to rock the boat or to bite the hand of the political parties that hold the purse strings on which so much local development depends. The knee-jerk, begging-bowl response of local communities that expect the public purse to provide everything reminds me of the United Kingdom in the 1970s and much of the 1980s before it got weaned off Mother State's milk. Diminishing the crowding-out effect of the public sector was arguably a key factor in unleashing entrepreneurism in Britain. The savagery of political partisanship in Spanish local affairs is also a brake on developments that could improve infrastructure/productive capacity. At pueblo, ciudad and regional junta level - and between the towns and the junta- 'black and white' divisions frequently lead to an off-off, stop-start history for important projects that may take years to become reality. Institutional reform, reform of local government financing, anti-corruption drives and allied measures need to be part of a package of solutions alongside labour market reform. Encouragingly, I hear more sense talked by the younger generation of Spanish managers and executives, many of them well tutored in business schools at home and overseas, who know that things have to change. I hope that the vision they display does not crumble to cynicism in the face of traditional inertia and cronyism.
Richard,
Going back to your question about bank bailouts, the more I think about them the less I think I know.
They are really definitely my area. When we get into country bailouts I am much more at home.
I mean I really believe, like Hynek says, that there are lots of good experts on how to clean banks up around, and they are the ones who need to put forward plans, and at the end of the day, we just have to suppose that they know what they are doing. I know for sure that I don't have the time to get involved in this end.
So I would bow to Hynek, and people like him, with the proviso that the key to the problem now isn't the financial one, but what is happening in the real economy.
This is no longer simply a cyclical crisis, and it is very important to recognise that. The fall in the value of these bank assets has triggered an unwind in the real economy, so until we put a brake on the real economic contraction the banks will only continue piling up toxic assets. So there are not a countable quantity of them to remove, our economies have become machines for creating them.
Thus:
"So the debtors, both corporations and private citizens, must be told that even though the state does everything it can to help the banks, the truly efficient help may come only from the debtors - namely, that they keep on repaying their debts."
The point that worries me about this, is that as long as salaries and prices continue to fall, people lose their jobs and companies keep going bankrupt the number of people able to pay their debts is only going to fall, which is what keeps producing more and more toxic assets.
So while I am quite happy to go with Hynek on the financial clean up side, I am not so happy on the real economy thing, since I think the only answer is print money to staunch the bloodletting. This means big fiscal engagement.
The net worth of the whole Spanish economy is much lower than people previously thought. So the whole thing is, if you like, a toxic asset, and needs cleaning up.
I then agree with Hyneks formula, the banks, the government, and the debtors are going to have to share the responsibility for the clean-up, in what proportions needs to be negotiated between the parties, there is no "scientific" formula to this, but of one thing I am sure, if Spain's households and companies and government assume part of the responsibility for the mess, the other part needs to be sorted by the EU, since without the euro, and its one size fits all monetary policy, this mess would never have been created in the first place.
Richard,
I would also go back to this point in Koo:
"'This recession is an invisible one. No one wants to talk about it, especially if his balance sheet is underwater...(so) even in the very big companies, only a handful of people might be aware of their balance sheet problems, but they're not going to tell their employees that they're actually bankrupt.' Banks, he adds, are similarly keeping mum on why their borrowers now have poor net worth."
This is where we are in Spain at this moment. We are just coming through the "invisible recession" part. Well, it hasn't exactly been "invisible" but a big part of it has been hidden. All we have seen so far is the tip of the iceberg, the main part of the mass is about to surface, as banks and companies, and households come out of denial.
As I keep saying, Japan house prices are now back at 1984 levels, and no one in Spain is currently ready for this, morally or psychologically, so we are into a long transition process.
But the problem for the "financial experts" is just how to tease all these NPLs etc out, and stop the contraction at one and the same time. Since, as I keep saying, if you don't stop the real economy meltdown you just have a huge NPL production machine.
This is not the Czech Republic in 1998, since Spain can't devalue to jump start exports, and the external environment is not benign, but hostile. So stopping the contraction is going to be damn hard work, and we haven't even gotten started yet. People are still blinded by the force of it, and looking on in awe, like they would go out at night to watch a "super nova" or something.
Rytu
"the total amount and nature of the toxic asset have to come out and be visible in each balance sheet."
Definiitely, the proposals will stand or fall by their ability to draw out the "bad assets", but there is no total amount, this is a process, until we stop it.
Russia's Alexei Kudrin had this to say only yesterday:
"Russian Finance Minister Alexei Kudrin said the country’s banks face a second wave of problems from companies in the real sector that fail to repay loans. “Some held off to the last minute, waiting for the market to revive,” Kudrin told an Economy Ministry meeting in Moscow today. This strategy didn’t pan out, and there’s no reason to expect a rise in demand for Russian products in the near future, he said."
Hi Edward,
thanks for answering to all the posts. Yes I know the toxic assets are still a forming mass, current good assets can turn into NPL, but the 2008 balance sheets have to do a clearance of the assets, their nature, obliously the value can change and have to change. Also for that I'd favour the creation of secondary dedicated markets, global, European and even national in case.
Anyway, I was more interested in knowing your opinion in the previous post, where i reported the Carlo Pelanda's article
if you can spend some word on it, I'd be very thankful
"[...]but of one thing I am sure, if Spain's households and companies and government assume part of the responsibility for the mess, the other part needs to be sorted by the EU, since without the euro, and its one size fits all monetary policy, this mess would never have been created in the first place."
Sorry, maybe I don't get it right:
Spain has a pinched Real Estate bubble and a highly non-competing economy (apart of other problems delivered by the global crisis).
Without malice, the responsibility for these two problems must be searched at the spanish governments.
Spain had a decade of a fast growing
economy, taxes surplus, a positive flow of EU founds, ..and both governments (PSOE and PP) were not able to establish an economy which were less depending on the construction sector. Had not they the responsibility (and opportunity) to soften the boom in the Real Estate market my applying more restricting regulations? (Limiting credits to 80% of collaterals, Tobin-tax against speculation,..) Why they were not spending more money in R&D or emerging markets? Were there any reform of the labour market or in the pension system in the last decade?
For these failures you can not blame the EU. So if we were talking about sharing responsibilities for the spanish mess. 90% Spain, 10% EU.
I agree that there will be an european solution for Spain, but this will not happened because the rest of the EU thinks that Spain deserved help because it plunged without own fault into a mess. There will be an european because if not the euro currency area would maybe blow up.
Just my 2 cents.
Steve, marriged with a Spaniard
Hello Steve,
Well your point is entirely legitimate, and I understand why you make it.
I am trying to strike a balance here. There is no doubt in my mind that the Spanish people need to shoulder part of the responsibility for the mess they are now in. Each and every Spaniard needs to ask him or herself (just as every Brit and Irish man or woman needs to) how the hell it was they ever swallowed that nonesense about how prices of property ALWAYS go up in Spain, without noticing the large devaluations and high inflation which characterised the pre 1995 (and closing in on EMU) era.
But on the other hand, Spain was only following EU and ECB monetary and fiscal policy. They even ran a surplus. And no one was giving them advice or instructions about how to avoid the mess. So I am also saying the the EU institutions (who were effectively in charge) cannot get off Scott free. Monetary policy was set in Frankfurt (and interest rates were set to meet Germany's needs and not those of Spain and Ireland). It was obvious that this was absolutely dangerous, and many economists were warning, but we were all ignored.
On the fiscal side, Spain repeatedly got a bill of good health (go through the reports), and no one was arguing that lending regulations (like loan to value guidlines) should be changed on an initiative from the Bank of Spain (which they could have done, but Frankfurt was silent), and the Commission was not pressing for a larger surplus (to drain demand). And obviously no one here in Spain would press for that, since they didn't understand the need, and everyone was too happy watching their home equity going up, or selling and building houses, or lending money on mortgages.
So what I am saying is that in the same way that the people who were running the banks need to shoulder their share of the responsibility for having millions of people ruined (this part is yet to come) so should those leading the political institutions who made the mess possible by, at best, their inaction.
So there is no way I think that Spain and Ireland can be expected to shoulder the burden of "cleaning up" the situation alone, although since I see you accept the pragmatics of the situation, I won't belabour this point.
Good luck,
Edward
Hi rytu
"Anyway, I was more interested in knowing your opinion in the previous post, where i reported the Carlo Pelanda's article"
Well look, I really am very loath to get into very complex issues where I have little expertise. I don't know how to resolve the toxic assets thing on a global scale.
As I keep stressing, I would try much more on the real economy side. I mean, we now know that the majority of the OECD economies cannot live from domestic demand duringt he coming years as they deleverage, regardless of wht is done on the toxic assets side. Until we have a turnround in global demand we will simply see the banks piling the money they take from the asset cleanout into their reserves with the central bank, or into buying all those nice crisp government bonds, but not into "risky" things like investing in new capacity.
The only place where people are still trying to build up capacity is China, and this is because they have an economy which is largely non responsive to market mechanisms, and they are piling up more capacity for exports, so this is only adding to the problem (not solving it), since it is adding to the short term capacity overhang.
I think we are not going to see serious attempts to solve the "who the hell are we all going to export to" problem till we have had two or three years of running up and down blind alleys (Geithner plans), we humans just seem to work like that.
But I think the time for thios debate will be when people are nearer being ready to listen, at the moment it is just a waste of breath. Solbes said in the parliament this week that he was more inclined to believe the Bernanke view that the recovery will come in 2010, then the Krugman one that Spain could be stuck in this for some years.
So you can see, it won't be till we get to 2011, and we are still stuck, that people will be ready to try new ideas. Again, the history of Japan makes this plain.
Basically, we are still trying ramp up liquidity, expand the money supply measures which already failed in the early 1930s. So there is a slow learning curve here. Still, we live in hope, becuase I suppose, it is all we have.
Also there are things in Carlo Pelanda that make me nervous. This for instance:
"it's not true it's impossible to evaluate the quantity of toxic assets that contaminate the balance sheets of european and american banks."
I don't believe this for a moment, since as I say, we have a huge machine producing new toxic assets with every week that passes, as formerly sound companies get driven into bankruptcy, and the debts become non performing.
Basically, look, I prefer careful detailed analysis of individual economies. That's why I refuse really to pronounce on the US, since I haven't made a study. I feel there are plenty of able economists working on the US, not so Spain.
Or Italy, for that matter. There is plenty of material on Italy on my Italian blog, and I've been at it for six years now. Could you point me to a study Pelanda has made as to why Italy is in the mess it is? This would make it easier for me to see where he is coming from.
Hello Richard,
"From personal experience, it is becoming increasingly clear how the high cost and hassle of laying off staff in Spain threatens to drive more companies to the wall than might be the case in countries with more 'flexible' and less costly labour regulations."
Well, obviously I agree with this. The labour laws ahve moved from being a job protection mechanism to a job destruction one.
But I would make a counple of points.
I the first place, economies in the south and east of europe are "flexible" in a way that some others aren't, in that the frontiers between the formal and informal sectors of the economy are very fluid.
So what I would expect to see across these two regions is more dramtic drops in formal GDP than is actually the case, as sections of the economy move back over again (in Spain's case undoing to some extent the gains of the Solchaga era, indeed curiously they hired Solchaga down in Argentina just before they went bust, since it is this dynamic which drives a state over the edge and into ruin).
So that is why my attention in Spain now is not focuesed on the banks, nor even on corporate bankruptcy, but on the fiscal crisis, which I imagine will get really really big after 2011, if there is no aid from the EU before.
Basically, a commentator called Eddy has a point on my latest post which is valid about the banks, but I would say that this isssue also extends to the state. Essentially the point of now return is reached as the state has to pay more in total for the whole debt (as refinancing of existing debt gets hit) than any extra revenue raised by selling more bonds as the spread on the debt rises. Basically there is a critical piont here, and the n you are done.
And notice that here, as in Greece etc, they are going for short term financing (which needs rolloevers) as the cost of financing debt goes up. This seems to me to be a classic symptom.
So obviously a lot of official companies will liquidate completely to avoid the "regulación de empleo" costs, but that won't stop them opening up again (in the same building even) and hiring people who are also being paid a subsidy from INEM. It isn't the point to condemn this, these companies will have no alternative.
Obviously, as money becomes scarcer we shoudl also expect to see a growth in "trueque" (or barter) as some self employed activities move out of the formal cash sector.
So if Spain already has an informal sector of about 20% (or one fifth of the labour force, you didn't really think all those people in the unemployment numbers weren't working did you Hynek??) this could easily start to head up to 30% with the predictable consequences.
All this follows from people being perfectly rational in their decision taking at the individual level, but the sum total of such individual rationality spelling disaster for the collective.
What I can't understand is why the people in Madrid are just sitting back and watching this happen.
"large and growing 'black' or 'grey' informal markets that encourage some people to define themselves as jobless "
This is pretty much the point. And several million migrants who will be willing to accept low salary irregular jobs rather than starve, which locals queue up at the INEM offices.
"In my experience, I would also add endemic corruption and nepotism to the list. I would argue that this 'cheat's economy' undermines competition, thereby weakening a key driver of innovation, investment, higher productivity and so on along the line of reasoning to a dampening of endogenous growth. For example,I have recently been made aware of a large and growing publicly owned enterprise that is widely believed to ask potential employees to show their political party membership card at the outset of selection interviews. It is referred to by those in the know as 'the vote machine'."
Well quite. But what you need to think about here Richard, is the regional dimension. Some parts of Spain subsideise others. That is what the debate about the Catalan Statute is all about really. But my impression is that if you press too hard on this topic you will blow Spain wide apart, since the differences are huge, and we are talking like something comparable to Bavaria vs the old DDR.
"The knee-jerk, begging-bowl response of local communities that expect the public purse to provide everything reminds me of the United Kingdom in the 1970s and much of the 1980s before it got weaned off Mother State's milk."
As I say, this isn't the situation everywhere. Cerainly it doesn't seem to fit my impression of what I can see here in Barcelona, where the policy seems to have been over the last decade "if it moves, outsource it". And since the public sector has been heaviliy underfunded (maybe nearly 50% of both the health and eductation sectors run on some form of private funding) there isn't that much "nanny's milk" going the rounds.
That doesn't mean to say that private sector money (namely builders and developers) haven't been helping bloat municipal balance sheets here as everywhere else during the last decade.
And it doesn't mean that there isn't a lot of civil servant fat at all the varous levels of the administration, but here we don't really have a "rentier" economy.
The thing is, Richard, as I say, you press this button too hard, and there simply is no "Spanish economy" since there is no Spain.
Incidentally Richard, if we think about how this crisis works, the causal chain seems to goe like this:
Financial Crisis -> Real Economy Crisis -> Political Crisis
Of course, then you need to build in all the circular, self reinforcing, feedback arrows.
What is amazing me at the moment about Eastern Europe is how quickly we have gone from one end of the chain to the other.
I would now expect this process to spread to Southern Europe (we have already seen some inkling in Greece).
Basically, the crisis to date has been extremely unfair in a country like Spain, since the private sector has carried most of the burden. This is now about to change as pressure of govt finance grows.
Then - as we are seeing in the East - the loyalty of all those who thought they were protected by the government starts to weaken, and then political instability sets in.
Since there is no one, absolutely no one, here in Spain, who is even talking the same langauge as the crisis, you can see the hopes of any kind of short term solution are as near to zero as you can get.
Dear Edward,
you can delete (or shorten) this post because it contains mainly some technical feedback and I do not think that it could be of interest to your readers.
"Hello Steve, [explaining why the EU is partly responsible for the situation in Spain]"
Ok, I got it, it was a little bit to easy to only blame the Spaniards. During the last ten years I was visiting Spain approx. every 3 months, not for vacation instead well integrated into every-day-family-life. And it was unbelievable for me to see every time more building sites...
About the europoean solution, it will be hard for the governing parties to sell this to the people. I can imagine anti-european politicians showing pictures form Seseña and asking why european tax-payers should pay for that excess...
"[...]So what I am saying is that in the same way that the people who were running the banks need to shoulder their share of the responsibility for having millions of people ruined (this part is yet to come)"
I know at least about 3 couples which will belong to those millions. maybe some more. ;-(
Ok, some minor design issues about your page (but do worry about that, only if you redesign you page someday):
1. Printing articles larger than one page with Firerfox destroys the layout and are unreadable. This problems does not occur with IE or Thunderbird.
2. It would be very nice to have an RSS-Feed with the comments.
3. You can see the time when comments have been written but the date is missing.
Thank you very much for the blog and keep up the good work.
Steve
Hello Steve,
Well I'm leaving your technical comments, since others may find them useful. There isn't much I can do about the print format I don't think, but at least the info about IE and Thunderbird is useful. I use both Firefox Thunderbird and IE, indifferently, but I never print anything out :).
Actually there is an RSS feed for comments, here it is, and the link is at the bottom of every post (or should be). Also, the date stamp should show (at least on the RSS feed), it does on mine.
On the substantive issue:
"About the europoean solution, it will be hard for the governing parties to sell this to the people."
Well, I agree, but the problems looming in the UK may temper attitudes a bit here. I don't know enough about what is actually happening in the UK, but what I do know makes me pretty worried. I mean, if we llosely divide Europe between the countries who borrowed to much (Spain and Ireland) and the countries who leant too much (Germany and Austria), then the UK does seem to be in the rather unique situation of having both borrowed and leant too much.
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