Europe on the Brink
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Europe on the Brink

Debt Crisis and Dissent in the European Periphery

Tony Phillips, Tony Phillips

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eBook - ePub

Europe on the Brink

Debt Crisis and Dissent in the European Periphery

Tony Phillips, Tony Phillips

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About This Book

Europe is suffering from a bipolar economic disorder. Financial journalists divide the continent into two groups of nations - centre and periphery - not by geography but by credit rating. Europe on the Brink is a critical investigation of the root causes of this sovereign debt crisis, and the often misguided policy choices made to resolve it. Nobel Laureate Joseph Stiglitz, together with two other finance experts, compares debt contagion in Europe with regional financial crises elsewhere, while Roberto Lavagna, former economics minister in Argentina, provides a poignant comparative analysis with his own country's experience. Crucially and uniquely, Portuguese, Greek and Irish economists provide hard-hitting case studies from the perspective of the periphery. This much-needed book offers a heterodox economic perspective on the causes, symptoms and solutions of the biggest economic issue currently facing Europe.

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Publisher
Zed Books
Year
2014
ISBN
9781783602162
1 | THE GREAT RECESSION, SPILLOVER IN EUROPE, BANKING COLLAPSE IN IRELAND
Tony Phillips
Introduction
This chapter takes a look at the role of the private international financial sector in the European sovereign debt crisis. Traditional economic theory – the neoclassical (or neoliberal) schools – tends to underplay the role of the private sector in the creation of sovereign debt. In retrospect, neoclassical economic theory has had a difficult time keeping up with the changing realities of modern international finance: financial innovation, securitisation and the globalisation of government bond markets. Whether such blindsiding has been intentional or whether it is simply the result of an excessive belief in the mastery of the markets, a few key blind spots in the theory are evident and some of these are covered in this chapter. Unfortunately, due to the prevalence of neoclassical economic theory, these blind spots sometimes lead central bankers, finance ministers and other policy makers to prescribe policies, austerity for example, that serve to tackle only the symptoms rather than the root cause of the crisis.
This investigation proceeds by interpreting public sources, particularly the US Senate Banking Committee (SBC) and G-20 announcements, in an attempt to unscramble the concern about ‘spillover effects’ between the US and European economies. The analysis traverses a hidden virtual bridge of securitised debt crossing the Atlantic between Washington policy makers and New York financiers to their European equivalents. The policy perspective is both national and regional (covering the European Union or EU), while also providing a perspective on the globalised private financial sector.
This chapter analyses transatlantic influences that affect proposals for the resolution of the European sovereign debt crisis. I look at the interactions of the international private financial sector with democratic institutions both in the US and in Europe. The sovereign debt crisis in Europe is analysed from a variety of perspectives: financial innovation; government regulation; channels of international contagion via cross-border finance; and policy response. National policies are decided by politicians, but in close consultation with multilateral debt agencies and the private financial sector. In Europe, there are three multilaterals: the European Central Bank (ECB), the European Commission and the International Monetary Fund (IMF), collectively referred to as the Troika. Apart from examining the ineffective firewalls in place to prevent further contagion, I also look at proposals for loss sharing as a result of debt restructuring. In the financial world, this is called ‘burden sharing’. In practice, the burden is shared between the private and the public sector. If private debt is made public (or ‘socialised’), debt becomes a moral and a political issue. Former US President Harry Truman used the phrase: ‘The buck stops here.’ In the end, this is where the artificial world of finance meets the more concrete world of democratic decision making. Burden sharing is at the heart of the problem: the buck stops there.
Spillover
The United States has an ‘immense economic stake’ in Europe, noted Lael Brainard, Undersecretary for International Affairs in the US Treasury. It was 16 February 2012 and Ms Brainard, a Harvard economist, was giving evidence to the SBC hearing entitled ‘Examining the European Debt Crisis and its Implications’.1 The crisis in Europe had concerned the SBC for quite some time. Those responsible for the US financial system had concerns about their exposure to Europe or what they called the ‘spillover’ to the US economy.
The SBC is a forum where regulators from government agencies, especially the Federal Reserve (FED) and the US Treasury, face questions from senators representing US public concerns on finance. The SBC is only one of three such US government legislative forums, the other two being the House Financial Services Committee and the Senate Agriculture Committee, the latter having partial responsibility for the regulation of derivatives (more on this later).
The interests of the regulatory agencies do not necessarily coincide with the interests of the private financial sector that they regulate: banks, investment banks, securities and insurance providers, hedge funds, etc. In fact, the private financial industry lobbies the US senators hard to weaken or alter legislation designed to regulate the industry, and the industry is often successful at dodging the bullet. With the interests of the senators not necessarily coinciding with those of the agencies, this dynamic makes for interesting debates.
This chapter examines the links and dependencies between the European and US financial sectors, exploring how these relationships affect policy choices for dealing with the crisis within Europe. Private sector interests have a significant influence on European rescue plans, thereby affecting problem resolution. What we now call the European sovereign debt crisis or the Eurozone crisis is in fact a crisis that has had many names. It is by no means strictly European. In fact, it is simply the European face of a globally mobile investment crisis, one with extreme mobility between the United States and Europe. I shall explore various financial instruments and pertinent regulatory decisions that demonstrate this financial interdependence. Along with private and public debt (sovereign bonds), I also examine the role of unregulated derivatives, particularly credit default swaps (CDSs).
SBC debates
The televised SBC meetings, like those of the house committee hearings, provide a rare glimpse of the interplay between the financial markets, their regulatory agencies and elected government representatives. Using indirect language and codified in insider terminology, the hearings are the WikiLeaks diplomatic cables of the US financial sector. These debates are unfiltered primary sources, which sometimes provide pearls of information of surprising candour. Senate and house committee members are privy to global financial issues not in the public domain. They regularly speak to national and international stakeholders and governments around the world. US national financial policies (such as the new Dodd–Frank Reform Act) affect large-scale international investments and the markets in non-US securities, including European government bonds.
The two main agencies (the FED and Treasury) giving testimony in these forums are also directly responsible for the global currency of record, the United States dollar. The dollar plays many roles outside the US and permeates many markets: of particular international relevance are trades in financial services, trades in commodities (oil in particular), US share trading (private share trades and trades on listed exchanges) and trades in foreign shares listed on US exchanges (called alternative deposit receipts or ADRs) and, most importantly for countries with weaker national currencies, accumulation of foreign dollar reserves in the US used by national central banks to adjust the relative value of their currencies to the US dollar. Cash markets for illicit goods and certain military goods markets are also widely denominated in dollars. Also of geopolitical relevance is the competition between the US dollar and the euro as the world’s two principal reserve currencies. Sometimes the euro is referred to in the financial press as the ‘un-dollar’. For these and many other reasons, the decisions made by US federal agencies have global implications.
Senate and house regulatory committees have goals that are broadly aligned with the agencies, but conflicts occur and the committee hearings are a chance for the senate members to broach topics that they find interesting in an on-the-record setting. At the SBC hearings, agency representatives are literally on the spot to answer questions. They play a game of cat and mouse with committee members who ask difficult questions that, in certain cases, agency representatives would prefer not to answer in such a public forum.
SBC sessions have two stages. First, high-level agency executives present to the committee, then, after the speeches, the senators are offered five minutes each of question time. Some senators just applaud what they have heard, using their time to thank agency representatives; others take their jobs more seriously and get right down to brass tacks. This chapter focuses on public evidence of important links between the European and the US financial sectors and their relevance to options to resolve the European sovereign debt crisis. Laws governing investor privacy in unregulated financial markets mean that investigations like this one are highly reliant on secondary public sources. The committee hearings are therefore very valuable for the insight they provide into the financial agencies, rating agencies and banks and their interactions with the legislatures.
SBC questions on the European crisis Treasury Undersecretary Brainard was asked about the exposure of the US financial system to the EU’s sovereign debt crisis. Ms Brainard categorised exposure in four segments: direct and indirect exposures to both the EU ‘periphery’ and the EU ‘core’.2 The word ‘periphery’ is an investment term for Portugal, Italy, Ireland, Greece and Spain, sometimes referred to in the financial press as the ‘PIIGS’. The term ‘core’ refers to the financial power of Germany, France and the UK, along with some smaller players such as Belgium, the Netherlands, Sweden, Finland and Austria, and non-European Commission financial players such as Switzerland. When speaking about US spillover, the most important Eurozone nations in the European core are Germany and France.
When asked about exposure of the US financial system to the European periphery, Ms Brainard rated US exposure as ‘quite modest’. While from a US perspective this is good news, it also implies that the periphery can expect little direct help from the US, as we will see confirmed in the case study on the Irish ‘rescue’ below. So, if exposure to the European periphery in crisis is ‘quite modest’, why would US senators be interested in a crisis in the periphery?
Ms Brainard gave us a small hint: she noted that the Treasury’s focus was on ‘indirect exposure to the European core’. She argued that possible contagion from the EU periphery to the EU core would imply financial exposure in the US too, or, as Ms Brainard put it, if this were to happen then ‘The spillover to our economy matters ...’
Timothy Geithner3 backed up his undersecretary’s assertions on the vulnerability of the US financial system to the core in written testimony to the House Committee on Financial Services. He characterised the risks of spillover in much the same way as Ms Brainard had done:
Our financial system has relatively little exposure to the five European economies at the heart of the crisis, but we have significant financial and economic ties to Germany and France and the continent as a whole.4
Again Geithner reaffirmed his support for the IMF in its role in the crisis, adding that it was good for Europe but also good for the US as its solutions helped to limit damage to the US economy.
The IMF has also played an important role in Europe. The IMF has provided advice on the design of reforms, a framework for public monitoring of progress, and support for programs in Greece, Ireland, and Portugal in partnership with Europe, which has assumed the majority of the burden. These actions have helped limit the damage from the crisis to the United States and to economies around the world.
I will come back to direct and indirect exposure when discussing derivatives later.
Who regulates global finance?
Revolving-door policies between banks and large private financial groups and government agencies blur allegiances between the private and public sectors. This blurring of lines between the regulator and the regulated is referred to as regulatory capture. The European Shadow Financial Regulatory Committee has the following to say on regulatory capture:
It is a common phenomenon in all areas of regulation that regulators become ‘captured’ by the industry they regulate, meaning that they take on the objectives of management in the firms they regulate. They may thereby lose sight of the ultimate objectives of regulation.
Regulatory capture is particularly serious in industries such as banking where there is a conflict of interest between the firms’ objectives (to maximise profits) and the objectives of the regulation (to provide consumer protection and maintain systemic stability) (Benink and Schmidt 2004: 186).
Regulatory capture occurs to some extent in all nations, but in the US it is particularly important due to the relative size of the US financial services sector and the prevalence of the US financial industry in global finance. Because of links with financial centres in Europe, US regulatory capture matters to European nations too.
Global investment banks, some of the largest of which are based in the US, commonly hire senior agency staff or offer them boardroom seats when they complete their term in government. Many agency staff are sourced for their private sector experience and often return to private practice afterwards.
A model for such revolving-door policies was Robert Rubin, who in his early career worked at international law firm Cleary Gottlieb Steen & Hamilton.5 This firm is best known internationally for sovereign bond litigation. Mr Rubin then moved on to Goldman Sachs, where he became chief executive officer (CEO) and vice-chairman of the board. From there he accepted an invitation from President Clinton to become US Secretary of the Treasury during the neoliberal hiatus in the 1990s, with Alan Greenspan heading up the FED.
Alan Greenspan was sympathetic to free market capitalism and to ideas popularised by the writer Ayn Rand, whom Greenspan knew personally. Ms Rand was one of the philosophical linchpins used by neoclassical economists to argue for minimal government intervention in the private markets (deregulation). In congressional testimony on the 2007–08 global financial crisis, Greenspan conceded that he had made an error on regulation and had put too much faith in the self-correcting power of the free markets.
Rubin’s period as Secretary of the Treasury was characterised by deregulation, and especially by resistance to controls on key financial derivatives products and the 1999 repeal of the Glass–Steagall Act. Robert Rubin, supported by Greenspan, also actively opposed giving the Commodity Futures Trading Commission (CFTC), an independent regulatory agency, oversight of over-the-counter (OTC) credit derivatives. Instead, he promoted deregulation policies leading to the Commodity Futures Modernization Act of 2000, which officially ensured the deregulation of OTC derivatives. Many cite such deregulatory changes as contributing to subsequent financial crises. The fact that the European Securities and Markets Authority (ESMA) has banned certain derivative contracts on sovereign debt shows that it also believes that unregulated derivatives have a negative influence in the current Eur...

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