Friday, July 01, 2011

Greek debt crisis: risk for the euro, risks for the EU - but how much risk for the creditor banks?

Joschka Fischer, the former German Foreign Minister and former Green Party leader, has long been a hardline "pro-Europe" figure, meaning he very much supported the EU and its development into a more politically integrated union. His profession of dismay at the state of the EU doesn't represent "crocodile tears." He sees it a genuine problem for peace and democracy. And a major failure of German leadership. The Greek debt crisis is currently the Damocles sword hanging over the Union. In Does Europe Have a Death Wish? Project Syndicate 06/27/2011, he writes:

The crisis was always about much more than Greece: a disorderly insolvency there would threaten to pull other economies on the EU's southern periphery, including some very big ones, into the fiscal abyss, along with major European banks and insurers. That could plunge the global economy into another financial crisis, delivering a shock equivalent to the autumn of 2008. It would also mean a eurozone failure that would not leave the Common Market unharmed.

For the first time in its history, the very continuance of the European project is at stake. And yet the behavior of the EU and its most important member states has been irresolute and dithering, owing to national egotism and a breathtaking absence of leadership.
And he makes a central point that should be emphasized in every news article on the topic of the Greek crisis right now, though it isn't (my emphasis):

Everyone knows that Greece will be unable to work its way out of crisis without massive debt relief. The only question is whether the country’s debt restructuring will be orderly and controlled or chaotic and contagious.
And that debt relief will have to include writeoffs of some significant portion of the Greek debt, meaning the creditors will have to recognize that portion as uncollectable.

It's not entirely clear what Fischer is suggesting here:

It is certainly right, in principle, to argue that the banks should participate in financing the resolution of the debt crisis. But it makes little sense to insist on it as long as losses by banks that remain "too big to fail" could trigger a renewed financial crisis. Any chance to make this work would have required overhauling the financial system early in 2009, but that opportunity was largely wasted.
I read this as his saying that recognizing reality and writing off the bad debts from Greece would put some major financial European financial institutions underwater, i.e., bankrupt. And that he doesn't trust the current governments of France and Germany to handle it in a sensible way.

Simon Johnson (Europe's Naked Banks Project Syndicate 06/24/2011) describes the political situation on covering banks' bad debts this way:

Big European banks will not actually default on their debts – the governments of Germany, France, and Italy have made it clear that their banks are too big to fail. And Germany and France – though perhaps not Italy – have enough fiscal firepower to support their banks as needed.

But no European politician would really want to put serious money on the line for the likes of Deutsche Bank or BNP Paribas; governments will not force recapitalization using public funds. Nor do politicians care to order banks to raise more capital from private sources – this would be too embarrassing for all involved, because it would expose the full extent of the folly so far.
But whether the banks are forced to eat their actual bad debts, the governments are going to wind up paying a significant portion of the bill for the cleanup. And in fact what they are doing now to stave off default by Greece is shifting more and more of the downside risk to governments and the European Central Bank, also a governmental institution of the EU, and offering only upside opportunity to private banks. Stefan Kaiser lays this out in more detail in Wen die Griechen-Rettung reich macht Spiegel Online 07.01.2011. This explains the core idea:

Da ist zunächst einmal die schöngerechnete Summe von 3,2 Milliarden Euro. Von wirklich privaten Gläubigern, die man eigentlich rannehmen wollte, kommt davon höchstens die Hälfte. Den Rest steuert der Staat bei.

  • 1,2 Milliarden Euro sollen die sogenannten Bad Banks tragen, also Abwicklungsanstalten der WestLB und Hypo Real Estate (HRE) . Beide Institute gehören ohnehin dem Staat, und für die Verluste ihrer Bad Banks kommt der Steuerzahler auf.
  • Die restlichen zwei Milliarden Euro teilen sich die deutschen Geschäftsbanken und die Versicherer. Doch auch hier kommt längst nicht alles Geld aus privaten Kassen. Bei den Banken etwa gehören die staatliche Landesbank Baden-Württemberg (LBBW) und die immer noch teilverstaatlichte Commerzbank zu den größten Zahlern.
  • Wirklich private Beiträge in relevanter Höhe dürften nur die Deutsche Bank , die DZ Bank sowie die Versicherungskonzerne Allianz und Munich Re leisten.
Without translating it word by word, is that German banks will be contribute €3.2 billion (euros) to the next European rescue package for Greece. But of that amount, €1.2 billion will be from the German government's "bad bank" accounts, consisting of bad loans from WestLB and Hypo Real Estate that the government is resolving. Of the private bank and insurance company participants on the other €2.0 billion, some of that is from banks partly owned by the government, including Landesbank Baden-Württemberg and Commerzbank.

None of the "participation" is in the form of forgiveness of portions of the debt principal. It takes the form of agreeing to roll over the debt on maturity to new debt. But even for the purely private participants, that new debt is a sweetheart deal. The banks are effectively insured by the government from losses. But if the loans pay off at a higher rate than currently expected, the banks get the profit. This is yet another example of how governments regarding banks as too big to fail creates "moral hazard," further encouraging private banks to take bad risks.

This is the opposite of a what a democratic institution like the EU should be doing: imposing brutal cuts on the Greek people and spending the public funds of other EU countries in rescue actions that hold private creditors harmless and saddle the public with their losses. Fischer is right. The handling of the current debt crisis has been a horrible failure of European leadership.

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