By Simon Johnson
The eurozone financial situation continues to worsen. The latest idea from the eurogroup of finance ministers is apparently to have the European Central Bank make a massive loan to the International Monetary Fund, which would then turn around and lend to countries like Italy. This is a bizarre notion. If the IMF takes the credit risk of a mega-loan to Italy – e.g., an amount around the $600 billion mark, greater than the fund’s current lending capacity – this would represent an unprecedented and unacceptable risk to the IMF’s shareholders, including U.S. taxpayers. If the IMF does not take this credit risk, what’s the point? The ECB should provide financial support directly to Italy, if that is the goal.
But that goal increasingly seems both to be the only idea of officials and the last failed notion of a fading era. More bailouts and the reinforcement of moral hazard – protecting bankers and other creditors against the downside of their mistakes – is the last thing that the world’s financial system needs. Yet this is also the main idea of the Obama administration. Treasury Secretary Tim Geithner told the Fiscal Times this week that European leaders “are going to have to move more quickly to put in place a strong firewall to help protect countries that are undertaking reforms,” meaning more bailouts. And this week we learned more about the underhand and undemocratic ways in which the Federal Reserve saved big banks last time around. (You should read Ron Suskind’s book, Confidence Men: Wall Street, Washington, and the Education of a President, to understand Mr. Geithner’s philosophy of unconditional bailouts; remember that he was president of the New York Fed before become treasury secretary.)
Is there really no alternative to pouring good money after bad?
In a policy statement released this week, Governor Jon Huntsman articulates a coherent alternative approach to the financial sector, which begins with a diagnosis of our current problem: Too Big To Fail banks, Continue reading
Dominos
By James Kwak
So, as everyone knows, the ECB came out yesterday with its latest plan to stem the creeping European sovereign debt crisis. This one involves potentially unlimited ECB purchases of sovereign debt, so long as its maturity is less than three years (presumably so that the ECB can pull the plug within three years on non-complying governments) and the country in question agrees to comply with fiscal policy reforms (i.e., austerity).
I don’t have any particular ability to forecast whether this will succeed or fail. My inclination is that it will succeed for a while and then turn out to be insufficient, for the reasons that others have identified. Central bank bond-buying will enable governments to borrow money at manageable yields, so their national debt will not spiral out of control solely because of climbing interest rates. But to bring debt levels down will require actual economic growth, and more austerity—even if it isn’t quite as austere as that imposed on Greece in the past—will not generate growth. In addition, the ECB’s promise to “sterilize” its bond purchases—I believe by selling other assets to raise the cash for bond purchases, so the net effect will not be to create money—means that this is not a particularly expansionary form of monetary policy.
This is as good an occasion as any, however, to ask a question I’ve been wondering about for, oh, years now. Every discussion of the European crisis includes the following domino theory (although no one calls it that anymore, for reasons I’ll get back to): If Greece leaves the Eurozone, that proves that it is possible to leave the Eurozone—or, put another way, that the powers that be cannot keep the Eurozone intact. If people realize that it is possible, then bond markets will bet even more heavily against Spain and Italy, which will force them to leave the Eurozone, which would be terrible. Hence Greece cannot leave the Eurozone.
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Tagged euro, European crisis, eurozone