Category Archives: political economy

A Back of the Envelope Bailout of the Bailout

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Let us say that Greece survives the EU’s assault on democracy (Brüderle’s “It’s a strange thing to do [hold a plebiscite],” for instance), and the Greeks proceed with their referendum on whether they want the latest bailout.  Say, further, that the Greeks reject the bailout.  Now accept, arguendo, that all of the dire things EU leadership claims will happen, do happen: there is a 90% write down of Greek sovereign debt; the Greeks leave, or are dismissed from, the euro zone, and perhaps from the EU altogether; and the Greeks go back to using (a now severely devalued) drachmas.  Beyond these, some are even claiming, apocalyptically, that the future of the euro and of the EU are at stake.

What will, in fact, happen from these desperate consequences, and how might they be mitigated?

Looking at these in reverse order, it’s possible to achieve some clarity.  Greece’s economy is 3% of the EU economy, even in good times.  Greece is one small nation of 27 nations in the EU and 17 in the euro zone—the subset of the EU that actually uses the euro as their common currency.  It just isn’t that big a player.  The threat, such as it is, comes from the large holdings of Greek sovereign debt that private banks, investors, national central banks, and the European Central Bank hold—a total of some €340 billion—and the threat from this sum comes from the fact that those who hold this debt hold it as a central part of their assets.  If the debt becomes worthless, these holders’ survival—at least that of the private banks and investors—becomes problematic.  I’ll address these debt holders in a bit, but it’s clear that the failure of the EU or the euro as a result of a Greek rejection of the latest bailout—of a Greek default—is nothing more than hysteria for political purposes.

On the matter of Greece leaving the euro zone—what the hey, Greece leaves the EU—some other things become apparent.  One is the nature of the downside of Greece leaving and striking out on its own.  I see little beyond the disruption of the leaving process itself.  Greece’s Mediterranean culture and its economic principles and imperatives (large government involvement in its people’s lives, early retirement ages, vast social programs paid for with high taxes, those taxes routinely evaded, the budget deficits associated with this (even if the taxes were paid)) made Greece a poor fit with the northern European EU (with its different work ethic, smaller government and fewer social services, and lower tax rates) from the start.  This nature of this mismatch has made for a large, continuous movement of northern European private and taxpayer money into Greece in the form of those loans, in the unrealistic expectation that they actually would be paid.  Or, maybe the expectation actually was that only the stream of interest income would last long enough for a profit.  With these differences in mindset and in government and economic goals, though, the Greeks could not, and cannot, compete in the EU, and so long-term servicing of Greek sovereign debt, including final repayment, has always been a chimera.  Larger than this, it simply has been a losing proposition all along to try to force inhomogeneous economies and cultures to integrate.  The Greeks are better off on the outside, on their own, and so is the EU.  I’ll come back to how the Greeks are better off, beyond this no longer having to take part in a losing game, in a bit.

As an aside, this same set of differences, with the possible exception of tax collectability, can be said to underlie the relationship of the other major Mediterranean economies (which are, incidentally, the rest of the PIGS: Portugal, Italy, and Spain) with the EU.  And the result of this may well be the same.

Now we come to that write down of Greek debt.  First, let’s put that debt into a perspective.  The banks (private and government, including Greek banks) hold around €340 billion, as I mentioned above.  This is against an EU economy with a GDP of some €12 trillion.  The loss of those €340 billion would be disruptive, to be sure, but it’s not catastrophic.  What exacerbates the problem is the key role many of those banks play in the national and EU economies.  The EU claims that there are around 95, or so, “systemically important” banks, and the EU claims further that these must be propped up virtually at all costs because of that perceived importance.  These are the banks whose reserves are required by the terms of the present bailout proposal to be increased to 9%, an increase intended to enable the banks to handle the disruption from the 50% write down of Greek debt that this bailout envisions.  Oh, yes, one more little fillip: it’s only the private banks that must suffer the 50% loss; the governments’ banks are to be kept whole.

Now let’s look at how this might be handled.  Assuming a bailout ever is appropriate, assuming that it ever is optimal to ignore moral hazard and morality in favor of short term convenience, I offer this solution, which has the advantage of at least being a better targeted, more efficient bailout.

For simplicity’s sake, and in keeping with the back of the envelope estimating of this proposal, let’s take a worst case condition: the Greek debt is written down 100%, not 90%.  The European Stability Fund Facility, set up explicitly for a Greek (and ensuing nation) bailout, has around €234 billion left after the last round of Greek bailout, and it’s capable of borrowing to a current maximum of €440 billion.  Private banks hold around €200 billion of that Greek debt, and the governmental banks hold the remaining roughly €140 billion.  Since Brussels has said that 9% reserves is sufficient to handle the 50% write down of Greek debt, it must be so.  This leaves €100 billion of losses from a complete Greek default to be covered (again, assuming a bailout is at all appropriate).  These “systemically important” banks can be made whole, then, for just €100 billion from the EFSF piggy bank, leaving €134 billion to cover the governmental banks’ complete loss of their €140 billion holdings.  That’s rounding error, but if Brussels’ accountants get too upset, the EFSF easily can tap its debt capacity to borrow an additional €6 billion to top up the bailout.  And with the EU leadership’s views of national taxpayers, it’ll be a simple matter to adjust the national subscriptions to recover the ECB, and the nations can simply ask their taxpayers to pay a tad more for their own national banks.  This bailout is a piece of cake.  And the object lessons here will instruct the rest of the PIGS.

But what of the Greeks, now that they’re on the outside looking in?  To be sure, they’re in for tough times, but the “austerity” measures the existing and EU-proposed bailouts were putting, and are going to put, on them will create the same tough times.  Only without the EU props, now the Greeks will be forced to learn to stand on their own.  They’ll be forced, both their government and themselves, to learn to live within their means.  A cash and carry economy will teach that.  The Greeks will find it hard, as all bankrupts do, to borrow; they’ll be forced to earn their way, and success will come slowly at first, but with each success, the next will come more easily.  Over time (and in less time than will seem possible in the days after the default), the Greeks will earn their way back to respectability.  Borrowing will become possible, albeit expensively so.  With continued prompt repayment, made possible from the lessons of earning one’s own way (of necessity, since there will be no outside help available), borrowing costs will come down to a normal range.  Their newfound understanding of their responsibilities will prevent them from over-borrowing for several generations, as happens with all bankrupts, as happened with the American society after the Great Depression (whose cause was different, but the lessons of work and frugality are the same).

And Bob’s your uncle.

The Bailout, Again

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I’ve disparaged in other posts the Greek people’s response to their economic crisis.  However, the decision of their Prime Minister, Giorgios Papandreou, to put the latest EU offer of a bailout to a plebiscite—to let those Greek people speak directly and for themselves on whether they think the bailout, or its terms, are suitable—has led to an interesting set of responses from the other governments of the Union, and from within the Greek government itself.

On the one hand, there is a great deal of legitimate frustration on the part of those governments over the decision for a plebiscite of the people who would be the “beneficiaries.”  Regardless of what we might think of the bailout itself, a lot of hard work and political capital, and yes, sacrifice and good faith, went into working out the parameters of this latest bailout, and filling in the details will take much more of the same.  On the other hand, how those governments are expressing their frustration says a very great deal about their views of democracy.

French President Nicolas Sarkozy insists, “Giving the people a say is always legitimate, but the solidarity of all countries of the eurozone cannot work unless each one consents to the necessary efforts….”  The Greeks really must have other nations’ permission to speak for themselves.  It’s a cute idea, though; thank you for playing.

Rainer Brüderle, a leader of the Free Democrats Party (part of Germany’s ruling coalition), says in all seriousness, “It’s a strange thing to do [hold a plebiscite], but all you can do is take precautionary steps in case there is a state insolvency in Greece.”  Indeed.  How alien a concept it is, this letting citizens speak and instruct their government.

The Swedish Foreign Minister, Carl Bildt, has Twittered,  “I truly fail to understand what Greece intends to have a referendum about. Are there any real options?”  Aside from the question of whether the Swede’s understanding is necessary to a Greek referendum, his professed inability to understand the matter says more about his understanding of the imperatives of democracy than it does about Papandreou’s decision to consult his employers.

Even from within Greece’s own government, we have a lack of clarity.  “I never expected Papandreou to take such a dangerous and frivolous decision,” huffed Dora Bakoyannis, an independent member of the Greek Parliament.  In the birthplace of democracy, it’s a frivolous thing to have the government’s employers speak up and tell their government what it must do.

Socialist deputy Hara Kefalidou wrote to Papandreou this, among other things: “I cannot back a referendum which is a subterfuge by a government that appears unwilling to govern.”  Letting her constituents, and the constituents of the rest of the government, speak is mere subterfuge, and not democracy in action.  And a government which fulfills this duty is unwilling to govern.  This is interesting….

Even support for the decision to hold a plebiscite is founded, not on recognition of the fundamental tenets of democracy, but on the purely utilitarian grounds of its political practicality: a successful outcome would silence, once and for all, opposition to the bailout in Greece.

Another, ulterior, motive for the EU leadership’s crocodile tears seems apparent.  “While Greece is threatening a vote, nobody will ever give Europe the resources for the enhanced [EFSF],” said Jan Poser, Bank Sarasin’s chief economist.  Those uppity Greeks are going to cause an embarrassment for the EU at this week’s G-20 summit. The EU members had intended to beat the wallets of the other members, especially China and Brazil,  for funding to bail out the now over-committed EFSF, so that it could bailout Greece, and then Portugal, and then Spain, and then Italy, and….  However, with those Greeks so rudely planning to speak for themselves, it seems there will be great difficulty getting anyone from outside the EU to support these efforts.

Apparently, the European view of democracy is that the citizenry very democratically vote politicians into their government, and then the citizens are to shut up, sit down, and let their government speak for them.  But when governments speak for the people, with no obligation to heed those people, governments instead speak in the people’s place.  And the people have ceased to have a voice in their own governance.

No.  Let the Greek citizens speak through their ballot box.  They’ve been speaking in the streets for months, and they’ve been studiously ignored.  It isn’t government’s role to protect people from themselves (leaving aside the minor fact that it has yet to be established that a popular decision to reject the bailout is something from which protection is warranted).  Especially when government does such a terrible job in the attempt.  And putting off the default will only make it worse when it happens.

Supports and Consequences

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Rep. Collin Peterson (D, MN) has proposed a Dairy Market Stabilization Program to replace existing Dairy Product Price Support and Milk Income Loss Contract Programs, but the debates surrounding the proposal misses a key point.

“The Dairy Market Stabilization Program [proposed by Peterson] is specifically designed to increase milk prices,” the Consumer Federation of America says.  “As milk and dairy prices increase, low-income consumers are hit especially hard.”  National Taxpayers Union, Americans for Tax Reform, and Citizens Against Government Waste warn of other results.  Artificially propping up milk prices “will ratchet up budgetary pressures on the government’s food and nutrition programs.”  Further, the DMSP, if passed, would empower government to limit how much milk is to be produced given falling profits; this is intended to strengthen a “safety net” for a government-favored group.

While these are valid arguments; they don’t go far enough.  The key point is the long list of unintended consequences of this sort of program and of subsidies in general.  One narrow consequence has to do with this: the CBO estimates that the DMSP would save us taxpayers $167 million over five years.  How much would we save if we didn’t have any of these three subsidies?

Another consequence comes from this effort to “help strengthen a vulnerable dairy sector.”  Dairy wouldn’t be a vulnerable sector except that government subsidies have protected it from the strengthening and hardening that competition produces.  The sector is soft and “vulnerable” as a direct result of its having become dependent on government for its “protected” profits and its protection from the risk of failure.

This stems from another unintended consequence.  The bailouts of 2008 and 2009 have simply fostered an environment wherein everyone feels entitled to a bailout; no one should have to suffer the consequences of their own decision-making, or even of plain bad luck (and note carefully that a hand up is not a bailout).  All of us are entitled, goes the new plaint, to having taxpayers indemnify us from life.  However, something that was a mistake the first time is not made correct by repeating it.  It remains a mistake.

Yet another consequence is that ratcheting up of budgetary pressures on the government’s food and nutrition programs that was warned of above.  The NTU, ATR, and CAGW are right as far as they go, but they miss the larger point, one hinted at by the CFA: the subsidies, including other subsidies that would be cascade victims of particular subsidies’ budget pressure, all drive up—by design—prices that consumers, including poor consumers, must pay.  (And so we have food stamp programs, and other food and nutrition programs, to help those poorer consumers pay those artificially inflated prices….)

There’s another unintended consequence.  Consumers—taxpayers—in return for our tax money being taken away from us to pay these supports, have even more of our money taken away from us by our having to pay those artificially high prices that are the goal of these supports.  We’re forced to pay twice for the same milk.

There’s the unintended consequence of the moral hazard involved.  Industries that are protected from failure, government-favored small businesses that are protected from failure, have no incentive to control their own costs, have no incentive actually to compete.  They get high prices (which we must pay, both through those high prices and through the epicycles of subsidies on top of subsidies to prop up those prices and then to help others pay those propped up prices), and they have high costs with which to “justify” those high prices.  This is related to those original mistakes of the 2008 and 2009 bailouts.  How can a businessman, or an investor in that business, or a lender to that business, assess his risk accurately when there is no downside from risk?  Another aspect of the moral hazard question is this: one justification for the supports is that dairy farmers would go out of business without them.  But if they can’t compete, why should they be in business?  Why does any particular business or industry have an inherent right to exist, regardless of market competition forces?  Who decides which business or industry should be artificially continued?

Finally, here is a consequence almost as bad as the moral hazard one, a consequence with more concrete and immediate impact on our pocketbooks.  Supporters of the DMSP worry that were there a repeat of 2009’s economic dislocation (we’re out of that one?), a repeat of the problem of falling milk prices coupled with abruptly rising input prices, “I fear we could lose half our dairies,” as Congressman Peterson puts it.  But why did those input prices rise?  One (but not the only) reason is ethanol subsidies.  These diverted food corn away from the dairy herds (and other cattle herds, and people): nearly 30% of corn went to fuel production in 2009; that expanded to 35% in 2010.  The effect from seemingly unrelated subsidies on those input prices for milk production is apparent.  This diversion, in cascading unintended consequence, reduced our supply of food, raised the price of that food that we must pay, and drove cost increases in those food stamp subsidies.

Who is Serious about Solutions?

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Let’s look at the offers.  The Democratic Party Senate hasn’t offered a budget in nearly three years.  The last budget proposal proposed by President Obama, last winter, was laughed out of the Senate 97-0.  Not even the do-nothing Democrats took it seriously.

On the other hand, the newly elected Republican House of Representatives, flush with modern Conservatives, passed a budget largely developed by Budget Committee Chairman Paul Ryan (R, WI) in their first month in office.  It’s lain dormant in that Democrat’s Senate, where the Senate Majority Leader, Harry Reid (D, NV), has steadfastly refused even to let it come to the floor for debate, much less be voted up or down—or a counter proposal made.

What have the President and his fellow ProgressivesDemocrats offered in response?  Straw men attempting to deflect the discussion away from the issues: “We should not be in a race to the bottom where we take pride in having the cheapest labor and the most polluted air and the least protected consumers,” President Obama said from the campaign trail at a recent San Francisco fund raiser.  Of course, modern Conservatives, and Republicans, agree with him.  Who, indeed, has proposed such a thing?  This is simply an attempt to change the subject, driven by the fact that the Obama team has nothing to offer beyond their mantra of more spendinginvestment and more taxes.

Another straw man is this chestnut: “Despite what some Republicans have argued, I believe that we have to ask the wealthiest Americans and biggest corporations to pay their fair share by giving up tax breaks and special deductions.”  He doesn’t consider that the top 10% paying 70% of the nation’s income taxes to be their fair share.  He also carefully elides the fact that his proposals go far beyond eliminating deductions and loopholes—they include outright rate increases.  He does consider the bottom 50% paying 3% to be paying their fair share.

On the other hand, President Obama did offer, last month, a $447 billion Jobs Bill, and he insisted “Pass this bill now.”  Never minding that the proposal had little that would generate jobs, but it did have considerable spending and the requisite tax increase, Senate Minority Leader Mitch McConnell (R, KY) agreed that it should be debated and voted on, and he attempted to honor Obama’s “request.”  The White House, though, promptly objected, claiming that an actual vote was just a “political stunt,” followed by Reid refusing to allow the vote.  Only later did Reid bring the bill to the floor, and it was promptly voted down, with Democrats agreeing with the Republicans that the bill was a bad idea.

The Democrats also insist, especially in the aftermath of their “Jobs” Bill failure, that the Republicans are the Party of No, and they have no ideas—only obstruction.  But this ignores the fact that the (Republican) House of Representatives has already passed at least seven jobs and jobs-related bills, of which exactly zero have been taken up by Reid’s Democratic Party Senate.  This also ignores the fact mentioned above that that same Senate hasn’t even troubled itself to propose any kind of budget, much less one that might do some jobs creation good.

And there’s the simply inane.  We have Reid, in a speech on the Senate floor saying with an absolutely straight face, “it’s very clear that private sector jobs are doing just fine. It’s the public sector jobs where we’ve lost huge numbers.”  Reid said this after the August jobs report had come in with zero private sector jobs created for that month, and with a national unemployment rate over 9% and 14 million Americans without any employment, much less in the private sector.  Additionally, from the start the Obama administration has been more interested in fixing blame (it’s all Bush’s fault, even now, three years later) than they have been in fixing the problem.

And there are the plain ad hominem attacks, which aside from their dishonesty, simply demonstrate the lack of solutions, the absence even of ideas.  For instance, members of the Congressional Black Caucus have called black conservatives like Herman Cain and Allen West (R, FL) oreos, they have accused the Tea Party of being racist, and one member consistently referred to the Tea Partiers as tea baggers. And there’s the plain race-baiting of the Progressives: Rep Elijah Cummings (D, MD) said in a recent Press Pass interview, “I think when [Tea Party members] can vote for a Herman Cain and hear him say the things that he says they feel like, ‘Well, you know, I can, I support this guy and… so it shows that I’m not racist and I’m supportive.'”

In sum, one of these groups emphasizes class warfare divisiveness and evasion of the problems facing us, and the other group offers unification and solutions.  For one group, it’s the rich vs. the rest of us.  Only the definition of “rich” floats at convenience: it’s those who make more than $250 thousand one day, it’s the fat cat millionaires and billionaires another.  For another group, it’s a matter of all of us being in this together, with solutions that affect all of us and that benefit us all.  One example of this is in Ryan’s speech on “Saving The American Idea” at The Heritage Foundation: “Rather than raising taxes and making it more difficult for Americans to become wealthy, let’s lower the amount of government spending the wealthy now receive[,]” and “…true sources of inequity in this country – corporate welfare that enriches the powerful, and empty promises that betray the powerless.”  And this is that budget bill and those jobs bills that have been passed out of the House of Representatives and that the Senate refuses to consider.

Chinese Danegeld

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Once you pay the Danegeld, you never get rid of the Dane, goes the saying.  It’s appropriate that this European saying, originating in an ancient attempt to buy off (Danish) Vikings—which, of course, kept the Vikings coming—is being demonstrated today in Europe.

In the aftermath of the European Union’s massive bailout of the Greeks on the backs of European taxpayers and banks, EU leadership is going hat in hand to China asking for funding for the European Financial Stability Fund (EFSF).  China is insisting, though, on far more than just the usual concrete guarantees of a decent return that any investor will demand of a potential business partner who is unreliable.  China is demanding a muzzle on European speech.  If China agrees to participate, apparently, the EU must, in return, abjectly surrender its right to criticize Chinese manipulative monetary policy.

It remains to be seen whether the EU will knuckle under on this.  However, their respect for free speech never has been strong.  Just ask Geert Wilders, the Dutch Parliamentarian who was hailed into court over a four-year period for the heinous crime of criticizing Muslims, and in the height of irony, banned for several months from entry into Great Britain, his presence representing a “threat to one of the fundamental interests of [British] society.”

The Chinese are demonstrating yet another price, an unintended price, of bail outs.  And what price will they demand next?