The next Euro-plan, sensible or senseless?


There are rumours in the Welt am Sonntag and the Wall Street Journal of another grand plan to save the Euro. The main outlines have already been foreshadowed in recent weeks by the main players (Draghi, van Rompuy, Barosso, Juncker): a re-focus on bailouts for banks, not governments, together with stronger central fiscal institutions that will control and perhaps even mandate national reforms and budgetary choices.

One can see where they are coming from: having figured out that several governments can’t possibly balance their own books and politically cannot afford to let their banks fail, the ECB and the European political elites have woken up to the fact that the banks need to be brought into the fold. Options include these banks being bought up by the ECB, given unlimited credit by the ECB, or be subjected to European financial institutions. At the same time, the need for growth means the European elite has finally woken up to the fact that Southern Europe is simply not politically able to push through major reforms and is now proposing central institutions that will do it for them. In exchange for this loss of sovereignty, they will get more cheap loans, perhaps even Eurobonds (essentially allowing Greeks and others to borrow as much as they want whilst the rest of Europe has to pay them back).

I have called for the buy-up of banks by the ECB in the past (see this previous post, this other one, yet another one, and the links from there to outside data) so am glad they are finally starting to wake up to this issue. Yet, what appears to be on the table now is worse than ‘muddling on as usual’: from what it sounds like, it is a recipe for the break-up of the European Union.

Let us first take the whole issue of bank-buyouts. At present, European banks have lots of toxic debts. Unlike US banks though, their toxic debt is to a large extent of an institutional nature: government bonds that wont be paid back and loans to other banks and major institutions that are also unsure. Hence the solvency of banks is more an issue of governments and institutions.

The problem banks in questions, particularly in Southern Europe, are furthermore joined at the hip with their political systems: they have bonds in their government debts because the same group runs the politics as the banks. The open financial flows between those governments and their banks hence means that helping one inevitably means taking on the problems of the other too.

So what you really want is a wholesale restructuring of these banks so that they do not lend vast amounts to local and national governments and instead get more focused on loans to entrepreneurs. Yet, those banks are permeated with political networks and hence one would have to have a large number of financially skilled monitors throughout these banks to prevent financial flows to political allies.

Is the ECB or the European Commission capable of affecting such a restructuring? Not on its own: it simply does not have the tens of thousands of financially skilled employees to do all the monitoring.

Who does have the manpower? The only group that comes close is in healthy banks in the rest of Europe and the rest of the world. Hence the only way in which banks would be properly restructured is if they are taken on as a project by major for-profit foreign financial institutions whose first concern will be all these ties to local government. Furthermore, because of the open financial flows between governments and their banks in the problem countries, for-profit foreigners would probably need to have control of all the banks in a country to prevent them being unfairly treated compared to other banks in that country.

Now, that makes it a very tough and big job: one conglomerate of foreign banks would have to ‘take on’ all Spanish banks, another would have to take on all Greek banks, etc. The ECB could indeed help organise this by buying up these banks, and then simply auction off all these banks to conglomerates (probably at a hefty negative price), but that in itself is a tough job.

Is this what is on the table? Not at all. The ECB has realised it doesn’t have the manpower to restructure these banks so is simply proposing to give these banks access to cheap loans whilst having a small but supposedly powerful financial institution monitor those banks.

Let us be clear about such a plan: it is ludicrous and naive. These banks are going to run rings round those few monitors and in a hundred and one ways are going to remain tied at the hip with their local politicians. Surplus money will flow (via bonds and loans) to those local politicians who will use it to prevent making tough choices and to pay off their own supporters.

The banking aspect of the plan will thus only further strengthen the political and economic paralysis of the problem countries, making the eventual crash even more spectacular. And financial markets will see it coming (though it might take them a few weeks to figure out what is really going on. There is always an initial rally after announcing the next counter-productive plan) and will continue the preparations for a financial collapse of Southern Europe.

Then the political aspect of the plan, which is to impose fiscal restraint and structural reforms on non-reforming countries via more stringent central institutions.

In the optimal scenario, Southern European politicians would be implementing true structural reforms to make their economies more competitive and thus have some hope of growth in the medium term. This includes allowing firms to more easily fire workers. It includes a massive reduction in the promised pensions (which are unaffordable). It includes the breaking up of a zillion local cartels, including those of the lawyers, the taxi drivers, the pharmacists, the teachers, the accountants, the medics, etc. It includes an opening up of the local financial markets to true foreign competition. It includes a radical trimming of the bureaucracy. It includes a reform of all the infrastructure and property institutions which are rife will corruption. It includes demolishing all the hidden subsidies to agriculture (which is one of the real reasons for why Spain has such high unemployment levels: they are keeping harvest labourers in unemployment benefits in the off-seasons). It includes complete welfare reforms, etc.

This kind of reform is not so much costly from a financial point of view, but takes an awful lot of political will. It needs an invigorated civil service and a sense of national crisis on the part of the populations. It needs the old guard to give the young and idealistically ambitious the power and the opportunity to reorganise things.

You should by now realise why this is not happening: the young and ambitious have fled Southern Europe and are now in the US, Australia, Northern Europe, or even in former colonies. The civil service in these countries is demoralised as their wages have been reduced and their pension prospects look bleaker, so the remaining civil servants (those who couldn’t get a decent job elsewhere) are mainly hanging on to what they have and in no way are prepared for the daring deep reforms needed. Similarly, those with remaining jobs and positions are those dependent on their political connections. Paralysis is deepening, not reducing.

And how is the new Europlan proposing to break this deadlock? By having a bunch of snot-nosed German, French, English, and other European civil servants come and tell the Southern Europeans what reforms to instigate, how much to cut pensions, etc.?

Why is this an act of utter lunacy? Well, just imagine what these local Southern European politicians are going to do the second after they have agreed to such a plan and hence got access to more cheap loans? They are going to complain and sabotage all those deeply unpopular reforms. And their populations will lap it up, becoming highly Euro-skeptic in a matter of months. They will quickly grasp onto the way out of such a self-esteem trap: take the money and simply not implement any real changes (there are hundred and one ways for national politicians to not actually implement laws or frustrate them), literally forcing the European institutions to realise that they cannot actually dictate anything, putting them the stark choice of either to keep bailing out or to be seen to stop the money tap.

Eventually, the money tap will indeed by stopped by which time the antipathy between the European countries will have become so high that most countries will simply take the hit, default, reintroduce their own currencies, and effectively leave the European Union.

As a passionate believer in the European project, it is simply heart-wrenching to see it destroyed by such political incompetency. It is not quite Versailles all over again, but one gets the same feeling of having to watch politicians make a complete balls-up of the situation. I can only hope that the usual inability to agree on anything in Europe will torpedo this plan.

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