The German Finance Minister Needs To Confront Investment Banks

By Simon Johnson

Wolfgang Schauble, German finance minister, has a surprisingly sensible op ed in today’s Financial Times.  As we suggested yesterday, first the relevant Europeans should decide if they want to keep the euro – more precisely, who stays in and who leaves the currency union – then policy must be adjusted accordingly.

Mr Schauble is obviously correct that existing economic self-policing mechanisms are badly broken; the eurozone can only survive if there are effective monitors and appropriate penalties for fiscal and financial transgression.  He is also right to fear that involving the IMF in Greece would necessarily give the Fund greater rights to kibbitz on European Central Bank monetary policy.  Given the fear and loathing expressed for the IMF’s “4 percent inflation solution” (or is it 6 percent?) in eurozone policy circles, you can see why this gives the Greek prime minister some bargaining power – the Germans will do whatever it takes to keep him away from the IMF in the short-term.

But Schauble misses (or holds back for now) on a potentially important point vis-a-vis investment banks.

He is tough, towards the end of his piece, on countries that “intentionally breached European economic and monetary law.”  But what about banks that aid and abet countries that are trying to break the rules?

Of course, governments can always massage their statistics unassisted.  But when international banks help countries to disguise their true debt levels, through off-balance sheet transactions, what is the difference between that and what Merrill Lynch did for Enron regarding “Nigerian oil barges” (and more)?

Technically, Greece’s (and potentially other country’s) debt deals may not have broken any laws – because the international space for these transactions is so anarchic.

But Mr Schauble would be well within his rights to call for rogue investment banks – i.e., those that help break European rules in any fashion – to be banned from the highly lucrative market for European government new issues.

Of course, if he is afraid to do this because the banks in question have great market power and a fearsome reputation for sharp elbows and exacting revenge, perhaps Mr. Schauble should consider referring the broader investment banking market (including over-the-counter derivatives) to the relevant anti-monopoly authorities within the European Commission.

34 thoughts on “The German Finance Minister Needs To Confront Investment Banks

  1. The German finance minister says “Greater calm is needed.” That is for sure (in light of the recent social unrest being reported). I would not be surprised if either Greece voluntarily or is indirectly nudged out of the euro zone, or at least the current crop of politicians may not be around by the next national elections.

  2. If Greece is dropped from the eurozone, would that mean they would have to recreate their own domestic currency? Wouldn’t a move like that ruin the sense of stability in Europe? That has to be more damaging to Europe’s economy and attractiveness to investors than a bit of inflation or direct debt payments by Germany, doesn’t it?

  3. “Mr Schauble is obviously correct that existing economic self-policing mechanisms are badly broken…”

    ANY self-policing mechanisms for any entity, from financial to personal, is unworkable. Self-regulation relies on both commitment and willpower, which inevitably flags in the face of reward. Allowing financial institutions to police and regulate themselves, just like polluting industries or dope addicts, is a recipe for repeated failure, invariably resulting in fallout which snares the innocent.

  4. SARose: “ANY self-policing mechanisms for any entity, from financial to personal, is unworkable.”

    Don’t the military do a good job of self-policing?

  5. A view from Europe: Now the rumorology has it that a 55 bn Euros bail-out could be in the works for Greece ???

    Your piece yesterday was great view of the current shameful state of European politics, Mr Schauble at the beginning of the week was advocating for the EMF, quickly rebuffed, it seems like they really want to wreck the ship recklessly, imho the solution of creating a “Euro-bond” to deck the ship would be the
    only one effective to prevent a “double-dip” and the
    blow up of the Eurozone

  6. Just to add that Mr Noyer ( Banque de France ) was
    nominated this week as new chairman of the B.I.S, a
    convenient way to keep the “cooking of the books ” at
    banks such as BNP-Paribas going

  7. I hate to subscribe to conspiracy theories; however, Greece’s acceleration of the financial collapse contagion in the EU is a great way to thwart the region’s productivity and shift some demand to the U.S.A.


  8. Military policing, is “Don’t embarass your superior.” Like military intelligence, an oxymoron. One reason we’re always at war.

  9. Considering that German banks hold a big share of Greek bonds one could wonder if those banks have done any due diligence on the country before investing in it… Bankers cannot do their job properly and then they turn to governments for help. The Ponzi scheme continues…

  10. Thought the Lehman 105 Repo news was interesting today. The article on the BBC site said Lehman got a legal opinion from a London law firm that helped them hide borrowing transactions and the legal opinion was one they could not get from a US law firm due to tighter laws, rules, regs in the US. What was most interesting was the implications to the bigger picture of global finance.

    Time and time again news articles point out how large financial corporations shift their operations from country to country to take advantage of weaker legal, accounting and regulatory frameworks. Until there is a global financial framework about what is allowed along with serioius penalties for breaking rules, regs, laws, etc. then global financial corporations will just dance from country to country to game the system. CEO’s playing the role of modern day Nero’s fiddling from country to country while the global economy burns.

    Along these lines it’s also entertaining to see large global financial corp’s threaten to move their operations from country to country as a threat to prevent tougher rules, regs, laws, etc. Economic blackmail played out at the highest level. As I recall that was a tactic used by some large financial corps. when Great Britain was considering new taxes on their bonus structures.

    Until Europe and the US unite to regulate large financial corps. they will never be able to control the levels of risk that these large financial corps take leaving the global economy holding it’s collective breath for the next global economic meltdown.

  11. Keep in mind what actually happens in a 105 % Repo. Lehman “sold” $105 of asset to receive $100 of cash. Thus, they would be expected to book a loss of $5. Presumably, the asset is bought back at $100 less any discount for interest. If the asset is worth $105 at the end of the transaction, Lehman would book the gain back of $5. Presumably, E&Y did not object to the foregoing general outline. If the accounting pronouncements anticipate such a result E&Y had no reason to object. Mighty thin it seems. But the tenor of accounting rules has been to try to eliminate discretion for a very long time. OK, elimination of discretion works two ways. After all, one uses rules to achieve an unintended result of the rule. Our system is adversarial. The other side of a rule interaction does the same just as Mr. Valukas is trying to do in his report. He spent $38 million to secure a much greater return to the bankrupt estate. He is charged with that duty. Mr. Valukas gambled $38 million of Lehman Estate funds to put together his report. What could be more adversarial. He wants to collect a lot of D&O insurance or he wasted a lot of money.

    In the end survival requires creative uses of discretion in any business. Fuld claims he had no knowledge of the 105 Repo transaction and I suspect he was telling the truth. I have seen similar ignorances among big wigs for most of my adult life. As a tax manager, I had to understand the business as well as the real doers in the business and ran into the ignorant big wig quite often doing deals. The general rule. After all, these people tend to crow ” Just give me the bottom line”. This is illustrated a number of times in Andrew Ross Sorkin’s Too Big To Fail.

    The big ” investment banks” got careless using Repos. Look at drunks who drive for a very long time before being arrested.

  12. Few would argue with Herr Schauble’s call to arms – since no one else seems to have the remotest idea of how to tackle the problems of deeply indebted Eurozone members. There is however some flawed logic here: it is not Greece that is at the crossroads, but the Eurozone itself- especially Germany as the largest economy – whose policy of export led growth and modest domestic demand have contributed to the internal EU imbalances. Greeks of course hold a far better hand of cards than appreciated- they can collpase this € construct through contagion, which Eurocrats were very slow to pick up on. Trumpeting the “anchor of stability” that the € has been through this crisis rings pretty hollow too. Creating an EMF would take time and that commodity is not on their side. No one would dispute that some mechanism is required to allow inter-country fiscal adjustment. Fair enough but if that really means a new treaty to endorse harmonised taxtion and subsuming national Teasuries to Eurozone administrations then you are looking at real political union. This is regrettably fantasy at the momemnt, as the tortured process of passage of the Lisbon treaty testified. These countries are wildly different in culture, economic capacity, and it is just totally impractical, the EMF is an thinly veiled mechanism for avoiding the embarassment of an IMF inspired fix for a € member or members that could not be fixed by the institutions set up to run the currency. Nice idea but hidden agendas abound in the fractious Eurozone

  13. Abolish the Euro. Let the drachma float (might get a dollar for 5,000 of them). What’s the problem? They’d be paying pensions in worthless drachmas, but Greece would have a hell of an export advantage. And who wouldn’t want to see the Acropolis on $5/day? Tourism would explode. Greeks would be somewhat poorer, but that’s how it works. Until you get things working again.

  14. There’s a way in which we could replace ‘self-regulation’ by ‘self-organization’ (or at least homeostasis). In which case it’s not simply politically correct but correct in the broader sense.

    That’s not what you meant but it pays to be careful.

  15. Actually I believe that in addition to Germany and France’s being Greece’s two largest creditors, Germany and France (or the banks thereof) are also the largest holders of credit default swaps against Greece.

    They’re trying to hedge their bets (and minimize their losses in the event of a default). But the more they buy CDSes the harder things become for Greece. Kind of, um, ironic.

    I think much of the speculative component of a bubble needs a fundamental story on which to piggyback itself. So the fundamental story here would be a) Germany and France’s being Greece’s largest creditors then b) Germany and France buy CDSes to protect themselves.

    c) is when vampire squids hop on the bandwagon (sorry for the not quite mixing of metaphors).

    I could go into my division of the 2008 oil price spike into fundamental story and speculative parasites, but enough already.

  16. Sure investigating the possibility of civil and criminal liability for the big investment banks involved in shady transactions is a good idea but so far governments have been reluctant to do it. There have been a number of cases from Enron to Parmalatte where banks appear to have engaged in illegal activity but government does very little.

  17. It’s not enough that our bloated military has engendered a never ending wave of state and non-state sponsored terrorists, but now our investment bankers are threatening the world’s financial stability by engaging in the same deception and obfuscation vis a vis foreign treasuries that it foisted upon our own citizens. And one might ask why greed is in the list of the seven deadly sins — not now, it has become more than obvious.

  18. Simon: This is great information and perhaps a model for the types of new questions and directives that need to be raised and pushed forward. The media “acceptable market rhetoric” is not only stale byt mis directed. The deeper questions are not even being raised. Perhaps it takes the direct approach of the Germans to break the ice, but I am sure glad your leading it into our mainstream!

  19. “…perhaps Mr. Schauble should consider referring the broader investment banking market (including over-the-counter derivatives) to the relevant anti-monopoly authorities within the European Commission.”

    Do you think that would work? Would doing so change the business practices of huge banking firms like Goldman Sachs? And how would Germany and the rest of the Eurozone get the U.S. on board?

  20. Mr. M, there are two sides to the riddle, and since debts are in euro’s, the de-euronization of one side of this ledger will simply result in massive increases in interest payments, leading to a debt default. The key question for Greece will become how to finance it’s huge and ever growing deficits…. there are no easy answers..thats why you aren’t hearing any.

  21. If this story was coming out of an Asian finance minister, I would give it some respect, but for European officials to be frustrated by the actions of big global financial players, when Frankfurt, London and Paris based organizations have been vying with NY at the heart and soul of the game.

    Remember the Asian financial crises, Ruble crises, LTCM etc. all these events featured all the usual suspects from those four centers of global finance. And, wasn’t the whole CDO game at AIG built around regulatory arbitrage for the European banks who are behemoths of global finance….but now that Greece and the Euro is on the menu…HOUSTON WE’VE GOT A PROBLEM!!!! give me a break…

    I think Observer hit it on the head

  22. Gracious! How is Greece going to be “thrown out” of
    the Euro system? Will all passengers on all flights,
    trains, boats to Greece be searched and Euros
    confiscated. Will Greece be invaded and all Euros
    taken from the populace? will whatever printing/
    coining facilities exist in Greece be bombed?

    I suppose it is thinkable that a country now presently
    on the Euro could reinstate some kind of original
    currency and hope that Gresham’s law would work in
    its favor(e.g. that the new home currency is _worse_
    than the Euro!!!!)

    Also, while I’m still seized by a fit of practicality,
    why would taking Greece off the Euro — even supposing
    it to be possible — help the problems of Greek

    Best wishes to all,

    Alan McConnell in Silver Spring MD

  23. There is no way “confronting the investment banks” with Schäuble. The “man at work” here is imho Jörg Asmussen wich I think is not likely to do so.


  24. I am confused: When your next door neighbor can’t pay his bills, does that mean you have to pay his bills for him instead of letting him dig himself out of his own situation? Will it help if he switches to his own currency, “Neighbor Bucks”, or is that just trying to avoid dealing with the underlying problems?

    All these assumptions that just because the Germans share their currency with the Greeks means that they must pay the Greeks’ bills strikes me as nonsense. Certain institutions in charge of economic management may be very embarrassed by the naked unfolding of a sovereign default, but it must be allowed to happen when the sovereign nation doesn’t pay its bills.

    If that results in losses for German banks and bankers who loaned large proportions of their capital carelessly to Greek debtors, then that is the right outcome. In the future, German bankers will be more careful. If you don’t accept this outcome, then you are simply saying that sovereign lending should be unmanaged and unlimited.

  25. Nassim Taleb wrote on Twitter 7:13 AM Mar 9th via web

    “The differences between Goldman Sachs & the mafia: GS has a better legal-regulatory expertise; but the mafia understands public opinion.”

  26. I was astonished by the article, not because it was not right, but because I have rarely lately read something sounding so very German. “Achtung! Some very strict Euro condizionalities seem on their way!

    If we did not have a crisis before we most definitely must have one now as the room for middle-of the road adjustments seems to have disappeared. The Euro will either shoot up like a DM, or dissolve like an Argentinean peso. What will the markets believe?

    Whatever, if I was a Greek living in Greece I would probably start packing!

  27. PatR wrote:

    “I am confused: When your next door neighbor can’t pay his bills, does that mean you have to pay his bills for him instead of letting him dig himself out of his own situation?”

    March 13, 2010 – Toronto Star – excerpts

    Germany seeks to oust debt-flouting EU states

    Finance minister’s idea rebuked as `radical step’

    “While saying his proposals were not specifically geared to Greece, Schaeuble offered backing for an EU emergency lending mechanism that would reduce the risk of defaults. He opposed euro members appealing to the IMF.

    “Strict conditions and a prohibitive price tag must be attached so that aid is only drawn in the case of emergencies that present a threat to the financial stability of the whole euro area,” Schaeuble wrote.

    Countries that repeatedly breach the deficit limit of 3 per cent of gross domestic product should be denied EU “cohesion funds” for economic development and barred from voting on euro-region policies, Schaeuble said.”

  28. I am confused: When your next door neighbor can’t pay his bills, does that mean you have to pay his bills for him instead of letting him dig himself out of his own situation?

    You don´t “have to”. But the question is if you loose more money yourself then it would cost to help the neighbour out.

    And – one of the Banks lending Money is the Hypo Real Estate (10 bn) wich is (after a “rescue”) owned by the state. An who rescued the Bank? Jörg Asmussen. There will be a bad bank for the HRE but it is not known if the 10bn für Greece and the 21bn for Spain are included.
    And this is not the only Bank wich would cause (monetary and political) trouble for the gouvernment in case of not helping Greece.


  29. And compound the above with the fact that, courtesy of the financial regulators, banks hold little or no capital at all against these sovereign exposures… and surprisingly few seem to find this an extraordinary way of our bank regulators betting our banks. Can you imagine how much bank-equity has to be found in order to come up with some more reasonable to the eyes leverage?

    Bank capital-requirement on sovereign risks.

    Rating AAA to AA- = Cap-Req of 0%
    Rating A+ to A- = Cap-Req of 1.6%
    Rating BBB+ to BBB- = Cap-Req of 4%
    Rating BB+ to BB- = Cap-Req of 8%
    Rating Under B- = Cap-Req of 12%
    Unrated = Cap-Req of 8%

    Our financial regulators went mad! Imagine if the banker gave some surely modest loans to a BB+ rated sovereign at most certainly a very interest rate spread then it was required to hold 8 percent in equity but, if it was a copious loan to an AA- sovereign on which the bank was making an extremely low spread, it is allowed to do that with zero bank equity.

    If we do not free ourselves completely from this unfortunate regulatory mindset we are doomed.

    For a starter the German Finance Minister should be asking his own colleagues… how on earth did you allow our German Banks lend to Greece with no capital at all?

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