Dear Mr. Munchau,
Many thanks for all the insightful articles you write in FT every week.
In this weeks article, you mention that "Resolution of both the problems require a large fiscal transfer, not from Germany to Greece, but from German public sector to the German bank sector - in the form of new capital. The same would apply to France"
I thought, Capitalism means private business taking risks and if the risk fails then they go under. What is this back-hand solution of transferring funds from public sector to privately managed banks? Why not come to the point directly that the real solution lies not in the fund transfer where in good times the private bankers/share-holders/creditors enjoy and in bad times the public bails them out at the cost/gun-point of recession/depression/higher-taxes/fiscal cleaning etc., but the real solution is WHY NOT CALL THE BANKING SECTOR - A UTILITY SECTOR - AND NATIONALIZE IT!!!
Regards,
Pradeep Kabra
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Only a closer union can save the eurozone
By Wolfgang Münchau
Published: June 27 2010 19:52 in Financial Times
I was speaking recently to a group of investors who forced me – all but at gunpoint – to tell them how long I thought the euro would last. I normally prefer conditional forecasts but, in this case, I was asked to make an unqualified prediction. And so I yielded. My answer was that the eurozone would probably not survive the decade in its current form. As it turned out, I was the most optimistic person in the room, by far.
There are few people in Brussels – where I live and work – who would consider me an optimist. The point is not so much about how policymakers and investors relate to my predictions, but how the two groups relate to each other. They are worlds apart. Europe’s political classes still believe they are in control of the situation – and that a combination of austerity and financial repression will do the trick. Investors, meanwhile, do not understand how Greece, Spain and Germany can coexist in a monetary union.
I have noticed that whenever the European Council meets in Brussels, the European bond markets tend to slump with short delay. Yields are now close to the level they were at in early May, when the European Council set up the €440bn ($540bn, £360bn) European Financial Stability Facility and when the European Central Bank started to buy bonds. This crisis goes on and on.
The reason is that investors have lost confidence in the political economy of the eurozone. European politicians such as Wolfgang Schäuble, German finance minister, praise their own long-termism. But investors ask with some justification: what is long-termist about a bank bail-out without bank resolution? Or a sovereign bail-out without fiscal union?
I recently had an eye-opening experience appearing in the finance committee of the German Bundestag as a witness to testify on the proposed legislation to ban naked short sales. It turned out that the finance ministry could not produce the basic statistics on short selling, let alone provide even an anecdotal link between short selling and the bond crisis. I told the Bundestag that this cynical piece of legislation has contributed far more to the European bond market crisis than the naked short sales it purports to ban. Helmut Schmidt, the former German chancellor, said later that he almost died laughing when he heard about this legislation.
The proposed ban is the latest reminder that European Union members, and Germany in particular, have not learnt a single lesson from their serial communication failures during the crisis. In February, they made the mistake of announcing a political agreement on a Greek rescue package without backing it up for another three months. In May, they hailed the stability facility as a historic breakthrough in political governance; it then turned out to be little more than bail-out facility.
I only hope that they know what they did when they recently announced the publication of the stress tests for 25 banks. Once these are published, the markets will immediately demand to see the tests for all banks. Once that happens, in turn, governments will need to produce a convincing recapitalisation strategy. I fear, however, that they are once again committing themselves to going down a road without a map.
Without an endgame, this exercise will end in disaster. At some point the markets will realise that large parts of the German and French banking systems are insolvent, and that they are going to stay insolvent. You might think that Europe’s policy elites cannot be so stupid as to commit themselves to stress tests without a resolution strategy up their sleeves. But I am afraid they probably are. Europe’s political leaders and their economic advisers are, for the most part, financially illiterate.
Is there a way out? Yes there is, but the chance of a resolution to the crisis is starting to fade. The first step would have to be a serious attempt to resolve bank balance sheets. This is as much a German and French banking crisis as it is a Greek and Spanish debt crisis. You need to resolve both problems simultaneously. Resolution would require a large fiscal transfer, not from Germany to Greece, but from the German public sector to the German bank sector – in the form of new capital. The same would apply to France.
Beyond this restructuring, the eurozone will need to commit itself to a full-blown fiscal union and proper political institutions that give binding macroeconomic instructions to member states for budgetary policy, financial policy and structural policies. The public and private sector imbalances are so immense that they are not self-correcting. And you have to be very naive to think that peer pressure is going to resolve anything.
There is no point in beating about the bush and issuing polite calls for the creation of independent fiscal councils or other paraphernalia. This is not the time for a debate on second-order reforms. I am aware that, at a time of rising nationalism and regionalism throughout the EU, there is no consensus for such sweeping reforms. But that is the choice the EU’s citizens and their political leaders will have to make – a choice between reverting to dysfunctional and, as it transpires, insolvent nation states, or jumping to a political and economic union.
munchau@eurointelligence.com
---------------------------------------------
Monday 28 June 2010
Thursday 3 June 2010
Re: Bankers have been sold short by market distortions
I feel sorry for Mr. Rajan for writing this article. I thought he is an intellectual. But as often with intellectuals, they get carried away by their knowledge to such an extent that they cannot differentiate between woods and the trees any more.
Coming back to this article, apart from the pretty naive generalisations and assumptions he makes, the awful thing is 'to justify' bankers action to the level of empathy vis-a-vis the regulatory & policy forces unleashed.
An example of a naive generalisations or assumption:
'But short-sellers perform a valuable social function by depriving poorly managed companies of resources they will waste'
I'm sure Mr. Rajan is aware that Short-Sellers don't even own the shares of the company they are shorting. How could they? Then, if they don't hold the shares ie., they are not investors. If they are not investors how are they depriving poorly managed companies of resources they will waste?
I'm sure an investor is smart enough to sell the shares if he feels the management is not up to the task. He or We don't need a short-seller to guide us!!!
Agreed about the regulatory and policy inconsistencies. But that can be discussed as a separate article instead of juxtaposing it with bankers behaviour.
Regards,
Pradeep Kabra
Bankers have been sold short by market distortions
By Raghuram Rajan
Published: June 2 2010 22:37 in Financial Times
Bankers must be heaving a sigh of relief as the shenanigans of the offshore drilling industry have pushed them to the edge of the radar screen of those targeting corporate greed. But it is unlikely their respite will be for long. Inquiries under way are bound to unearth more instances of ethically, and even legally, challenged bankers. When overlaid on images of bankers hankering after their outlandish bonuses soon after being bailed out with public money, the public picture of an industry motivated only by money and without any sense of the larger consequences of its actions will be reinforced. How do we instill more social values in the industry? Or is banker greed mostly good?
Most people do not work for money alone; a primary motivation for many is the knowledge that their work makes the world a better place. Bankers are no different, but their work differs from most other professions in two important ways. First, a broker who sells bonds issued by an electric power project is merely a cog in a gigantic machine, who never sees the plant she helped build. Second, the most direct measure of her contribution is the money she makes for her firm. This is where both the merits of the arm’s-length financial system and its costs arise.
Take for instance a trader who sells short the stock of a company he feels is being mismanaged. He does not see the workers who lose their jobs or the hardship that unemployment causes their families. But short sellers perform a valuable social function by depriving poorly managed companies of resources they will waste. A company whose stock price tanks will not be able to raise financing easily and could be forced to close down.
The trader does not cause the company to go out of business. If he is wrong and the company is well managed, other traders will take the opposite side, buy shares, push up the share price, and make the short seller lose money. It is typically only when the short seller’s opinions come to be widely shared, and company management is truly awful, that the share price tanks. Mismanagement is the source of the company’s troubles; the trader merely holds up a mirror to reflect it.
The best measure of the trader’s value to society is whether he made money from the trade: that indicates he was right to short the firm and that society will benefit from his actions. This is why free-market capitalism works and why bankers usually do good even as they do very well for themselves.
However, when the discipline of markets breaks down, as it sometimes does, the finely incentivised financial system can derail quickly and cause immense damage. The very anonymity of money then makes it a poor mechanism for guiding financiers’ activities toward socially desirable ends. Did the mortgage broker make his fees by offering a variety of sensible options to the professional couple who were looking to upgrade their house, or did he do so by urging an elderly couple to refinance into a mortgage they could not afford? When the broker’s loans are scrutinised by sensible banks that refuse to refinance shaky mortgages, there is a market check on his behaviour that forces him to focus on persuading the professional couple instead of deluding the elderly one. When the market is willing to buy any loan he makes, however, he leans towards easy pickings.
The key then to understanding the recent crisis is to see why markets offered inordinate rewards for poor and risky decisions. Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet. Chastise the banker who hankers after his bonus, but also pity him for he is looking for his primary measure of self-worth to be restored. Rather than attempting to instill social purpose in him, however, it is probably more useful for society to target the forces that distorted the market.
The writer is professor of finance at the Booth School and author of Fault Lines: How Hidden Fractures still Threaten the World Economy
Coming back to this article, apart from the pretty naive generalisations and assumptions he makes, the awful thing is 'to justify' bankers action to the level of empathy vis-a-vis the regulatory & policy forces unleashed.
An example of a naive generalisations or assumption:
'But short-sellers perform a valuable social function by depriving poorly managed companies of resources they will waste'
I'm sure Mr. Rajan is aware that Short-Sellers don't even own the shares of the company they are shorting. How could they? Then, if they don't hold the shares ie., they are not investors. If they are not investors how are they depriving poorly managed companies of resources they will waste?
I'm sure an investor is smart enough to sell the shares if he feels the management is not up to the task. He or We don't need a short-seller to guide us!!!
Agreed about the regulatory and policy inconsistencies. But that can be discussed as a separate article instead of juxtaposing it with bankers behaviour.
Regards,
Pradeep Kabra
Bankers have been sold short by market distortions
By Raghuram Rajan
Published: June 2 2010 22:37 in Financial Times
Bankers must be heaving a sigh of relief as the shenanigans of the offshore drilling industry have pushed them to the edge of the radar screen of those targeting corporate greed. But it is unlikely their respite will be for long. Inquiries under way are bound to unearth more instances of ethically, and even legally, challenged bankers. When overlaid on images of bankers hankering after their outlandish bonuses soon after being bailed out with public money, the public picture of an industry motivated only by money and without any sense of the larger consequences of its actions will be reinforced. How do we instill more social values in the industry? Or is banker greed mostly good?
Most people do not work for money alone; a primary motivation for many is the knowledge that their work makes the world a better place. Bankers are no different, but their work differs from most other professions in two important ways. First, a broker who sells bonds issued by an electric power project is merely a cog in a gigantic machine, who never sees the plant she helped build. Second, the most direct measure of her contribution is the money she makes for her firm. This is where both the merits of the arm’s-length financial system and its costs arise.
Take for instance a trader who sells short the stock of a company he feels is being mismanaged. He does not see the workers who lose their jobs or the hardship that unemployment causes their families. But short sellers perform a valuable social function by depriving poorly managed companies of resources they will waste. A company whose stock price tanks will not be able to raise financing easily and could be forced to close down.
The trader does not cause the company to go out of business. If he is wrong and the company is well managed, other traders will take the opposite side, buy shares, push up the share price, and make the short seller lose money. It is typically only when the short seller’s opinions come to be widely shared, and company management is truly awful, that the share price tanks. Mismanagement is the source of the company’s troubles; the trader merely holds up a mirror to reflect it.
The best measure of the trader’s value to society is whether he made money from the trade: that indicates he was right to short the firm and that society will benefit from his actions. This is why free-market capitalism works and why bankers usually do good even as they do very well for themselves.
However, when the discipline of markets breaks down, as it sometimes does, the finely incentivised financial system can derail quickly and cause immense damage. The very anonymity of money then makes it a poor mechanism for guiding financiers’ activities toward socially desirable ends. Did the mortgage broker make his fees by offering a variety of sensible options to the professional couple who were looking to upgrade their house, or did he do so by urging an elderly couple to refinance into a mortgage they could not afford? When the broker’s loans are scrutinised by sensible banks that refuse to refinance shaky mortgages, there is a market check on his behaviour that forces him to focus on persuading the professional couple instead of deluding the elderly one. When the market is willing to buy any loan he makes, however, he leans towards easy pickings.
The key then to understanding the recent crisis is to see why markets offered inordinate rewards for poor and risky decisions. Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet. Chastise the banker who hankers after his bonus, but also pity him for he is looking for his primary measure of self-worth to be restored. Rather than attempting to instill social purpose in him, however, it is probably more useful for society to target the forces that distorted the market.
The writer is professor of finance at the Booth School and author of Fault Lines: How Hidden Fractures still Threaten the World Economy
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