Goldman Sachs Rakes In Profit in Credit Crisis

Published: November 19, 2007

For more than three months, as turmoil in the credit market has swept wildly through Wall Street, one mighty investment bank after another has been brought to its knees, leveled by multibillion-dollar blows to their bottom lines.
Skip to next paragraph
Michelle V. Agins/The New York Times

Lloyd C. Blankfein, chairman of Goldman Sachs, said the firm would not take any write-downs related to the mortgage crisis.

And then there is Goldman Sachs.

Rarely on Wall Street, where money travels in herds, has one firm gotten it so right when nearly everyone else was getting it so wrong. So far, three banking chief executives have been forced to resign after the debacle, and the pay for nearly all the survivors is expected to be cut deeply.

But for Goldman’s chief executive, Lloyd C. Blankfein, this is turning out to be a very good year. He will surely earn more than the $54.3 million he made last year. If he gets a 20 percent raise — in line with the growth of Goldman’s compensation pool — he will take home at least $65 million. Some expect his pay, which is directly tied to the firm’s performance, to climb as high as $75 million.

Goldman’s good fortune cannot be explained by luck alone. Late last year, as the markets roared along, David A. Viniar, Goldman’s chief financial officer, called a “mortgage risk” meeting in his meticulous 30th-floor office in Lower Manhattan.

At that point, the holdings of Goldman’s mortgage desk were down somewhat, but the notoriously nervous Mr. Viniar was worried about bigger problems. After reviewing the full portfolio with other executives, his message was clear: the bank should reduce its stockpile of mortgages and mortgage-related securities and buy expensive insurance as protection against further losses, a person briefed on the meeting said.

With its mix of swagger and contrary thinking, it was just the kind of bet that has long defined Goldman’s hard-nosed, go-it-alone style.

Most of the firm’s competitors, meanwhile, with the exception of the more specialized Lehman Brothers, appeared to barrel headlong into the mortgage markets. They kept packaging and trading complex securities for high fees without protecting themselves against the positions they were buying.

Even Goldman, which saw the problems coming, continued to package risky mortgages to sell to investors. Some of those investors took losses on those securities, while Goldman’s hedges were profitable.

When the credit markets seized up in late July, Goldman was in the enviable position of having offloaded the toxic products that Merrill Lynch, Citigroup, UBS, Bear Stearns and Morgan Stanley, among others, had kept buying.

“If you look at their profitability through a period of intense credit and mortgage market turmoil,” said Guy Moszkowski, an analyst at Merrill Lynch who covers the investment banks, “you’d have to give them an A-plus.”

This contrast in performance has been hard for competitors to swallow. The bank that seems to have a hand in so many deals and products and regions made more money in the boom and, at least so far, has managed to keep making money through the bust.

In turn, Goldman’s stock has significantly outperformed its peers. At the end of last week it was up about 13 percent for the year, compared with a drop of almost 14 percent for the XBD, the broker-dealer index that includes the leading Wall Street banks. Merrill Lynch, Bear Stearns and Citigroup are down almost 40 percent this year.

Goldman’s secret sauce, say executives, analysts and historians, is high-octane business acumen, tempered with paranoia and institutionally encouraged — though not always observed — humility.

“There is no mystery, or secret handshake,” said Stephen Friedman, a former co-chairman and now a Goldman director. “We did a lot of work to build a culture here in the 1980s, and now people are playing on the balls of their feet. We just have a damn good talent pool.”

That pool has allowed Goldman to extend its reach across Wall Street and beyond.

Last week, John A. Thain, a former Goldman co-president, accepted the top position at Merrill Lynch, while a fellow Goldman alumnus, Duncan L. Niederauer, took Mr. Thain’s job running the New York Stock Exchange. Another fellow veteran trader, Daniel Och, took his $30 billion hedge fund public.

Meanwhile, two Goldman managing directors helped bring Alex Rodriguez back to the Yankees, a deal that could enhance the value of Goldman’s 40 percent stake in the YES cable network — which it is trying to sell — while also pleasing Yankee fans. The symmetry was perfect: like the Yankees, Goldman, more than any other bank on Wall Street, is both hated and revered.

Robert E. Rubin, a former Goldman head, is the new chairman of Citigroup. In Washington, another former chief, Henry M. Paulson Jr., is the Treasury secretary, having been recruited by Joshua B. Bolten, the White House chief of staff and yet another former Goldman executive.

The heads of the Canadian and Italian central banks are Goldman alumni. The World Bank president, Robert B. Zoellick, is another. Jon S. Corzine, once a co-chairman, is the governor of New Jersey. And in academia, Robert S. Kaplan, a former vice chairman, has just been picked as the interim head of Harvard University’s $35 billion endowment.

Since going public in 1999, Goldman has been the No. 1 mergers and acquisitions adviser, globally and in the United States, with two exceptions: in 2005 it came in second in the United States rankings, and in 2000 it lost the top spot globally. In both instances, Morgan Stanley took the lead, according to Dealogic.

Obama 'very concerned' about Greek debt crisis

(AFP) – 2 days ago

WASHINGTON — US President Barack Obama said in an interview released Saturday that he was "very concerned" about the Greek debt crisis and its impact on European economies.

"I am very concerned about what's happening in Europe," Obama told Russia's Channel Rossiya in an interview conducted at the White House on Thursday.

"But I think it is an issue that the Europeans recognize is very serious."

Fears in past months that Greece would be unable to maintain debt payments sent its borrowing costs soaring, sapped the euro and put the spotlight on other weak European economies.

"If we can stabilize Europe that will be good for the United States," Obama said.

His remarks came ahead of an imminent and unprecedented bailout from the European and the International Monetary Fund worth 140 billion dollars badly needed by debt-hit Athens.

On Sunday, the IMF's governing body will to vote on Greece's request for a 40-billion-dollar loan from the world lending institution.

Obama commended Greece for its proposed "very difficult measures" of some 30 billion euros (38 billion dollars) in tax hikes and spending cuts.

But Greece was still plagued by concern that the draconian austerity measures could plunge the recession-hit Greek economy into deeper trouble, dampen productive initiative and create cracks in social cohesion.

Washington has strongly backed the bailout for Greece, saying it has the potential to help restore stability to the country, and the global financial community.

Three general strikes have been held in the last three months against the government's economic policies, and a senior member of Greece's main union warned its members to be prepare for another.

Obama pointed to the Greek crisis and the impact it has had on world markets as one of the "real threats" to US well-being.

Panic swept US markets on Thursday as the Dow Jones Industrial Average plunged nearly 1,000 points, a record intra-day drop, before recouping more than half those losses.

It remains unclear whether the sudden sell-off was the result of fears over the Greek debt crisis, mistaken trade transactions or technical error.

Greece's total debt stands at nearly 300 billion euros and there is growing concern that the government will face severe difficulty in implementing the harsh cuts with the economy set to shrink by four percent this year.

The parliament in Athens has become a focal point for successive street protests. Violence erupted on the sidelines of a massive demonstration on Wednesday and clashes between young protesters and police also broke out Thursday as the chamber approved the austerity plan.

Copyright © 2010 AFP. All rights reserved. More »

Korea holding breath over Greek debt crisis

By Kang Seung-woo
Staff reporter

The financial malaise created by the debt crisis in Greece has swept through the global financial market, renewing fears that the world will go through another economic meltdown akin to the one triggered by the collapse of Lehman Brothers.

It still remains to be seen whether it is the harbinger of another financial storm that will travel across the globe or only one of the passing economic hiccups that lie in the path to the full recovery of the global economy.

However, one thing that is obvious is that Europe's debt fiasco is a double-edged sword in regards to Korea. It will have a negative impact on the local economy in the short term as the turmoil is expected to destabilize the financial market and delay the complete recovery.

The other side of the coin is that depending on how to cope with it, South Korea will be able to strengthen its position in the global community by capitalizing on the fall of Europe, which has shared the global economy with the U.S. over the past few decades.

Contagion of fears

Korean policymakers have been on alert over the fallout from Europe's debt problems as fears of another crisis have sent foreign investors scrambling for the exits from Korea, sending the local financial markets into a tailspin.

Foreign investors cashed out a record amount of money from Seoul's stock market Friday, pulling down the KOSPI index by 2.21 percent. Foreigners sold 1.24 trillion won worth of shares, which was the highest selling by overseas investors in the history of Seoul's main bourse.

Since Thursday, foreign selling at the KOSPI market has amounted to almost 2 trillion won ($1.75 billion). The main stock index closed at 1,647.50, down 5.4 percent from a week ago. The won also fell 1.24 percent to close at 1,155.40 won.

Despite the market crash caused by the sudden shockwave from the Greek fiscal woes, policymakers and analysts expect that the impact will be limited as its economy has very low exposure to Europe both in terms of debts and trade.

The Ministry of Strategy and Finance emphasized Friday that there is a remote chance of the current European trouble turning into a second global financial crisis, and made it clear that the aftermath of the fiscal problem is limited.

``There is a low possibility for another global financial crisis to happen and that is what the International Monetary Fund (IMF) asserted,'' said Yoon Jong-won, director general of the Economic Policy Bureau.

``South Korea's investment in Europe accounts for two percent overall and the exports to Europe takes up 10 percent of total exports. As for Southern Europe, its investment in Korea is not that high for the whole of Europe. Nonetheless, we are on alert for the current situation and will come up with solutions considering all possible options.''

Economists are doubtful about whether the European economy will get worse after the Greek fallout spreads to neighboring nations.

``If the current fiscal crisis continues, South Korea will be in jeopardy, but I do not think it will,'' said Hwang In-seong, vice president of Samsung Economic Research Institute."

Not as severe as Great Recession

``Given that the extent of Greece's crisis is already known and it is limited to Southern Europe, it is not the same case as the Lehman Brothers, and there will not be as big of an impact.

``If an EU-level support package is implemented, the crisis will get better. It will not linger too long.''

Lee Chang-seon, managing director of the financial research department at LG Economic Research Institute, was on the same lines on the issue.

``It depends on how much further this issue progresses. If it just ends in Greece and Portugal, it will be okay because of the low interaction with them, but if it reaches Spain, it can be a problem due to its size," he said. The Spanish economy is the euro zone's fourth-largest.

In addition, if the crisis hit Spain, concerns will rise and foreign investment be withdrawn, which is likely to stir the local financial market.

``Fortunately, the United States and European countries are taking the situation seriously and are trying to hammer it out, so there will be no contagion to the vicinity,'' he added.

Meanwhile, financial regulators - the Financial Services Commission (FSC) and Financial Supervisory Service (FSS) - said Friday that it would closely monitor market development and set up an emergency council to monitor financial firms' foreign currency positions and their overseas funding capability, as well as the potential of capital flight.

``In preparation for the possibility of the current jitters diffusing into the entire European region, the FSC has decided to ratchet up monitoring of the financial market and European funds' in- and outflows,'' the top financial watchdog said in a statement.

Zero sum game

Following the Wall Street crisis, U.S. hegemony has been gradually eclipsed by the rise of new economic powers such as China, Brazil and India. The debt crisis in Europe is expected to speed up the ongoing power shift that is moving the center of global politics and economics toward the East from the West, as the current crisis is slowing Europe's recovery more than in other parts of the world.

The German economy contracted by five percent last year and Britain also posted a negative growth of 4.9 percent, along with Greece at minus two percent and Spain at minus 3.6 percent with the United States at minus 2.4 percent last year.

In contrast, major Asian economies enjoyed robust growth despite the economic crisis. The Chinese economy jumped by 8.7 percent last year and soared 11.9 in the Jan.-to-March period from a year ago. Korea, which recorded a 0.2 percent growth in 2009, surged 7.8 percent in the first three months of 2010.

As a result, the region is expected to play a more important role in the world economy in the post-crisis era.

``The Asian markets will attract more attention than before. Asian nations, such as China and India, have tallied solid growth rates, so neighborhoods are enjoying the side-effects,'' Lee said

``Asian bonds draw interest because they are seen as safe assets thanks to a sound financial and economic status,'' he added.

Hwang also predicts a brighter prospect on the Asian market.

``In terms of money flows, Asia has more potential because its economy is now considered more resilient,'' he said.

Analysts advise Korean policymakers to put their heads together to become a winner in the post-crisis era. They suggested a two-pronged approach ― an internal and external move.

Internally, Korea should make an all-out effort to fix the nation's fiscal balance sheet to head off a debt crisis. Externally, it is urgent to sharpen the competitive edge of local exporters by diversifying export destinations and boosting research & development, they said.
May 10, 2010, 5:01 pm
Europe’s Debt Crisis: Your Questions Answered
Open Market

7:29 p.m. | Updated

On Sunday we invited your questions about the Greek debt crisis and its potential effects on markets and governments in the rest of Europe and beyond. Even as questions were being sent, the European Union moved to provide a huge rescue package intended as a “shock and awe” commitment to prevent the crisis from spreading. Markets reacted favorably, but many questions remain.

To address them, Economix invited three panelists to respond to selected questions. They are Simon Johnson, the former chief economist at the International Monetary Fund, an author of “13 Bankers: The Wall Street Takeover and the Next Financial Meltdown,” and a Daily Economist here at Economix; Carmen M. Reinhart, an economic historian at the University of Maryland whose recent book, “This Time Is Different,” chronicles 800 years’ worth of debt crises and sovereign defaults; and Yves Smith, the financial analyst behind the “Naked Capitalism” blog and “ECONned,” who heads Aurora Advisors, a management consulting firm specializing in corporate finance advisory and financial services.

Initial answers follow, with more responses to be added later today and Tuesday.

How does a country the size of Greece possess the ability to send shock waves throughout the world? — Paul, Seoul

Carmen M. Reinhart: Thailand has an even smaller gross domestic product (G.D.P.) than Greece. But in 1997, Thai financial problems were the epicenter of an Asian crisis in which currencies and equity prices plummeted in that region. Indonesia ended up defaulting, while Korea and Thailand avoided the same fate only through adjustments and international support. Asian economies posted output losses of 10 to 20 percent.

Companies and markets are interconnected, facilitating cross-border contagion.

First, many governments have common lenders, including big international banks and hedge funds. A large loss in one national market lowers the total amount of capital they can commit. Often they pull back across a broad front.

Second, concerns about debt sustainability in one country acts as a wake-up call to investors, who scour their holdings for risks posed by other economies in similar circumstances. When they look hard enough, they usually find cause for concern, triggering a withdrawal of funds. Citizens of Greece and Japan may speak different languages, but a worried portfolio manager hears only that both countries have ongoing budget deficits and a large outstanding stock of debt. Indeed, those inclined to be nervous about government finances do not have to look beyond the borders of Europe. Ireland, Portugal and Spain are running large budget deficits in proportion to their respective G.D.P.’s.

Third, Greece casts a long shadow on the European continent because 15 other countries share a common currency with it, the euro. Greece’s debt problems have raised a question that European officials thought had been buried with the introduction of the single currency in 1999: Will the euro survive? For an international investor, this means that the price of any European asset should incorporate some compensation for currency risk.

Simon Johnson: The impact of the Greek crisis has to do largely with expectations about what will happen in the rest of the euro zone. If you look at the map of who owes money to whom within the euro zone, you will see that Greece is fairly small in the overall picture — and mostly it owes money to German and French banks, which are backed by their governments (in one form or another).

But Portugal owes a great deal to Spain — and Spain, in turn, owes a great deal to France and Germany. And if you really want to scare yourself (or a European policy maker), look at how much Italy owes to its neighbors — or just add up all these numbers and think about dealing with it all at once.

Financial market confidence in Portugal, Spain, and the other weaker euro zone countries remains fragile. A primary goal of the financial support package put in place this weekend was to slow things down — allowing Portugal, in particular, a chance to differentiate itself from Greece. The potential for uncontrolled contagion needs to be taken off the table.

Yves Smith: If Greece had been truly an isolated actor, it would be unlikely to have had this sort of impact. However, two factors were at work. First, Greek government debt is held, to a significant degree, by French, German and other European banks. A Standard & Poor’s report, issued before the weekend’s measures were announced, suggested that not only might there be a loss or restructuring, which was increasingly expected, but the losses would be larger than most investors anticipated (30 to 50 percent). Since European banks are widely believed to have written off less of their toxic debt from the credit crisis than American banks, they are seen as vulnerable to shocks. Ironically, any lending under new facilities would be senior to the existing debt, which means if they merely delay rather than prevent default, the losses to the current bondholders would actually be greater.

Second is the question of contagion. Recall that Thailand, an even smaller economy, set off a crisis that took down virtually all emerging markets when it devalued the baht in 1997 because it changed investor sentiments. The other so-called PIIGS (Portugal, Italy, Ireland and Spain) face or, in Ireland’s case, are in the midst of European Union-mandated fiscal deficit cuts. All these countries have private debt hangovers, too. Unless a country can engineer a very large increase in exports, which usually happens by depreciating its currency, trying to reduce public- and private-sector debt at the same time results in a big economic contraction. That’s happening now in Ireland, where nominal G.D.P. has fallen over 18 percent. A fall of that magnitude makes it even harder to pay off existing debt.

That situation meant two things. One was that the economic pressures on these European Union members, as their downturns deepened, would lead them to exit the euro (so they could devalue their economies to spur a recovery). The second was that the shock waves, both to the European banks, and via a euro zone recession, would have an impact on other economies.

What will it take to contain the debt crisis in Greece (and in the other southern European nations in question) to a sufficient degree to restore confidence in the financial markets? — kenger, Tennessee

Yves Smith: The measures taken thus far are not a remedy and will merely postpone the inevitable. Absent deep structural changes, the euro zone authorities can only placate the market on a short-term basis. Too many diverse economies are bound together, with no fiscal budget mechanism to provide a buffer. To contain the problem, we would need to see an enormous devaluation against the dollar and/or much greater demand from Germany. The fact that all of the euro zone is engaging in budget austerity means that all countries are reducing demand, which in the end is likely to lead to a down spiral, and actually increase deficits as incomes fall.

It’s in theory possible for the euro zone to achieve the needed political integration and become a sort of United States of Europe that its creators envisaged, but unrest in Germany and Greece suggests that this is unlikely. So concerns of the sort we saw over the last two weeks are likely to keep dogging the weaker euro zone economies and the European Union as a whole unless the euro zone members show commitment and progress toward strengthening fiscal arrangements. Incremental responses under extreme market pressure will not do the trick.

Carmen M. Reinhart: The best defense against contagion is not to be vulnerable in the first place. Specifically, not having: a high level of public or private debt, a large current account deficit (borrowing from the rest of the world); and domestic financial institutions that are exposed to toxic assets (in this case Greek government debt). Unfortunately, few European countries meet all three criteria (see also answer to question 1, above).

The large E.U./I.M.F. package put together over the weekend is intended to send a strong signal that the European Union is committed to go to great lengths to avoid a breakdown of the euro experiment. It is intended to provide broad-based coverage beyond Greece, as in the spirit of the TARP legislation in the fall of 2009. As with the United States bailout package, an important feature of the plan of action is to have the European Central Bank continue to treat Greek bonds as if the rating agency downgrades had never taken place. This is the kind of “forbearance” shown to toxic assets when the United States decided to require bank to mark-to-market their asset portfolio. This initiative can buy time for policy makers in other countries that have come under duress (notably Portugal, Spain and Ireland) to implement difficult austerity measures and (hopefully) move toward a broader and deeper restructuring of private debts-notably those of financial institutions. It does not change Greece’s (nor anyone else’s) levels of outstanding debts and their even more worrisome profile in the period ahead.

Is a restructuring of Greek sovereign debt inevitable? What would restructuring entail? Does the current E.U. plan envision restructuring? Is the current plan more concerned re the health of certain European banks than Greece? — kathaa, West Bloomfield, Mich.

Yves Smith: Yes, it is inevitable. The Greek austerity program is the most daunting in modern times. Argentina defaulted under a much less demanding program. The Greek population also appears to understand intuitively the record of Latin American austerity programs, that they are a transfer from the public to the banks, and they do not appear willing to make the depth of sacrifice demanded of them. Many experts believe the euro zone is wasting valuable firepower and credibility on Greece, when it would have done better to restructure Greece now and use any backstop funds for the other euro zone members under stress.

Simon Johnson: Greece has serious fiscal problems, and it will be hard for it to avoid restructuring its debt. Think about it this way. Under the I.M.F. program completed over the weekend, Greece needs to grow out of its debt problem soon. Greece’s debt/G.D.P. ratio will be a debilitating 145 percent of G.D.P. at the end of 2011. If we put more realistic growth figures into the I.M.F. forecast for Greece’s economy, e.g., with G.D.P. declining 12 percent between now and the end of next year, then the debt/G.D.P. ratio may reach 155 percent. At these levels, with a 5 percent real interest rate and no growth, the country needs a primary surplus (i.e., budget surplus without interest payments) at 8 percent of G.D.P. to keep the debt/G.D.P. ratio stable. This is a huge and painful fiscal adjustment.

The politics of such implied budget surpluses remain brutal. Since most Greek debt is held abroad, roughly 80 percent of the budget savings the Greek government makes goes directly to German, French and other foreign debt holders (mostly banks). If growth turns out poorly, will the Greeks be prepared for ever tougher austerity to pay the Germans? Even if everything goes well, Greek citizens seem unlikely to welcome this version of their “new normal.”

The European Union officially does not want Greece to restructure its debt — the fear is that this would also cause problems for Portugal, Spain and other countries. But if the situation more broadly stabilizes, particularly if Portugal shows progress toward containing its own fiscal dangers, then Greece will most likely move toward restructuring. If this is handled in a cooperative manner, with the help of other European Union countries and the I.M.F., it need not be disruptive to global financial markets.

Carmen M. Reinhart: It may not be inevitable, but it certainly seems probable. The need for fiscal austerity in Greece is not an artificial imposition by the I.M.F. and big governments of the European Union. It is an arithmetic reality once investors have woken up to the dubious prospects for repayment by a government living well beyond its means. This lesson might be news to governments in advanced economies since World War II, but it has been a fact of life for emerging market countries.

But fiscal austerity does not often have an immediate payoff. Such restraint, especially when significant in size and sudden in its enactment, almost surely contracts economic activity. This trims tax collection and increases unemployment and welfare benefits, working to scale back any progress in reducing the deficit. Even if new borrowing is reduced or eliminated, it takes time to whittle down a large outstanding stock of debt relative to income. Investors do not always have the patience to look past the immediate to that brighter future.

The problem for Greece is compounded by the common currency. From Greece’s perspective, its goods and services are uncompetitive on world markets. But many of its most important trading partners share the euro, so there is no scope for a change in an exchange rate’s value to improve competitiveness with them. Moreover, the value of the euro, which matters for the rest of Greece’s trading partners, is set on continental considerations, not for one country alone. Thus, the only way Greece can improve its competitiveness is through a compression in domestic prices and costs.

Cutting government wages can restore competitiveness only gradually. Similarly, improvements in productivity take time. Most importantly, deflation (or a general decline in prices might help competitiveness, but it also lowers nominal G.D.P., making the burden of debt higher and less sustainable. If the goal is to reduce the ratio of debt to G.D.P., it will take price increases, not declines, and higher economic growth, not lower.

Of course, the ratio of debt to income could be trimmed by cutting the amount of debt, but that is an option that officials dare not mention. After all, restructuring of outstanding obligations is nothing less than a partial default.

It is also no panacea. Argentina’s economy contracted 20 percent in 2001 after its default, as it was shut out of international markets for a time. But when debt dynamics turn as adverse as they currently appear in Greece, authorities do not have any good options. History suggests that as other alternatives are exhausted, governments come to recognize that restructuring may be the lesser of the remaining multiple evils.

Fiscal adjustment is not impossible. The list of countries that opted for austerity in the face of market pressures and succeeded includes Mexico in 1995, Korea in 1998, Turkey in 2001, and Brazil in 2002. They paid a price in terms of lost output, but by communicating a credible commitment to a sustainable budget path, market access was restored relatively quickly and growth rebounded. But those countries all started with debt loads significantly below Greece’s and relied on significant exchange rate depreciation to gain an edge on international competitiveness.

The current E.U. plan does not envision restructuring; restructuring remains a taboo subject in official circles. Restructuring can be extremely disorderly, or it can be made less so (an under-the-rug restructuring) — if, for instance, French, German and other banks holding Greek debts are offered support from their governments if the interest rates on Greek debts are trimmed and maturities lengthened. Officials, of course, deny such a scenario to be possible — which, of course, means nothing.

The current plan is about saving the E.U., not about saving Greece per se. This includes reducing speculation about the demise of the euro as well as concerns about what a Greek default could do to financial institutions in France and elsewhere. This is understandable. The sharp easing in monetary policy in the summer of 1982 in the United States, for example, was not about helping Mexico and other emerging markets cope with default but about softening the blow for American banks that had high exposure to the newly (or nearly) defaulted sovereign loans.

What is the future of the euro? It seems plain that the current structure, with a common currency, common regulatory regime, but separate sovereign governments, cannot continue as it currently exists. … Should the nations of Europe go their separate ways? — stevieray, New Jersey

Simon Johnson: The euro zone does not look viable in its current form. The basic premise was to unify monetary policy (i.e., one currency, under the European Central Bank) while keeping fiscal policy completely separate — and constrained only by broad and vague promises. This arrangement has completely broken down.

Either the Europeans now go their own ways or — more likely — a core group moves toward greater integration, including integration of fiscal policy. But it seems unlikely that this new core will include Greece, and the thinking in financial markets is that Portugal and some others (Spain? Ireland?) will also be excluded. The “out” countries would presumably leave the euro or, if they refuse, the “in” countries could leave to set up their own bloc.

Either way, it will be messy — but more about the need for convergence in economic policy than any issues of more general culture. The need for a more integrated or complete political union remains more open; this seems less likely, even for countries that essentially share the same fiscal policy going forward.

How is the state of California any different than Greece? — CraigA, Los Angeles

Simon Johnson: Greece has been able to issue a great deal of debt — and run a big budget deficit — because European banks did not think it was dangerous to lend to a euro zone member country. This expectation has now been validated in large part by the bailout measures put in place over the weekend.

In contrast, the federal government does not stand behind California — at least, that is what most people think. This puts more of a limit on what California can borrow. California can still have a fiscal crisis, but this will have different consequences from what is happening in Greece — and (hopefully) will not, even in a very negative scenario, contribute to financial contagion.
Greece: The start of a systemic crisis of the Eurozone?

Paul De Grauwe
15 December 2009

Is the Greek crisis the beginning of a deeper sovereign debt crisis that could destabilise the Eurozone? This column argues the Eurozone is no closer to a debt crisis than the US, but some members are getting close. EU governments could bailout Greece and, to avoid having to do so, they should clarify their stance on the matter.

The Greek crisis has led to fears that this is only the beginning of a deeper sovereign debt crisis that could ultimately destabilise the Eurozone. Are these fears exaggerated? How to deal with these problems? These are some of the questions many observers have been asking themselves.
Origins of the present crisis

It is useful to start out with the origins of the present crisis. Figure 1 provides a useful way to organise our thoughts. It shows the average yearly changes (in percent of GDP) of private and public debt in the Eurozone.

The period 1999-2009 has been organised in periods of booms and busts: the boom years were 1999-2001 and 2005-07; the bust years were 2002-04 and 2008-09.

One observes a number of remarkable patterns.

* First, private debt increases much more than public debt throughout the whole period (compare the left hand axis with the right hand axis).
* Second, during boom years private debt increases spectacularly.

The latest boom period of 2005-07 stands out with yearly additions to private debt amounting on average to 35 percentage points of GDP.

* During these boom periods, public debt growth drops to 1 to 2 percentage points of GDP. The opposite occurs during bust years. Private debt growth slows down and public debt growth accelerates.

Again the last period of bust (2008-09) stands out. Public debt increases by 10 percentage points of GDP per year, mirroring the spectacular increase of private debt during the boom years (but note that the surge of public debt during the bust years of 2008-09 are dwarfed by the private debt surge during the preceding boom years).

Figure 1

Source: ECB, Quarterly Euro Area Accounts. Note: 2009 is until second quarter

The following picture emerges. During boom years the private sector adds a lot of debt. This was spectacularly so during the boom of 2005-07. Then the bust comes and the governments pick up the pieces. They do this in two ways.

* First, as the economy is driven into a recession, government revenues decline and social spending increases.
* Second as part of the private debt is implicitly guaranteed by the government (bank debt in particular) the government is forced to issue its own debt to rescue private institutions.

Thus the driving force of the cyclical behaviour of government debt is the boom and bust character of private debt. This feature is particularly pronounced during the last boom-bust cycle that led to unsustainable private debt growth forcing governments to add large amounts to its own debt.1
Is the public debt sustainable?

Financial markets now ask the question of whether the addition of government debt is sustainable. Clearly the rate of increase of the last two years is unsustainable. But with Eurozone government debt standing at 85% of GDP at the end of 2009, the Eurozone is miles away from a possible debt crisis.

Things are different in some individual countries, in Greece in particular, a country with a weak political system that has been adding government debt at a much higher rate than the rest of the Eurozone and that in addition has a debt level exceeding 100% of GDP. So, while the Eurozone as a whole is no closer to a debt crisis than is the US, some of its member states have been moving closer to such a crisis.

Is it conceivable that a debt crisis in one member country of the Eurozone triggers a more general crisis involving other Eurozone countries? My answer is that yes, it is conceivable, but that it can easily be avoided.2
A debt crisis is conceivable

Let’s start with the first part of the answer: It is conceivable. Financial markets are nervous and the most nervous actors in the financial markets are the rating agencies. One thing one can say about these institutions is that they systematically fail to see crises come. And after the crisis erupts, they systematically overreact thereby intensifying it.

This was the case two years ago when the rating agencies were completely caught off guard by the credit crisis. It was again the case during the last few weeks. Only after Dubai postponed the repayment of its bonds and we had all read about it in the FT, did the rating agencies realise there was a crisis and did they downgrade Dubai’s bonds.
Credit rating agencies playing catch-up

Having failed so miserably in forecasting a sovereign debt crisis, they went on a frantic search for possible other sovereign bond crises. They found Greece, and other Eurozone countries with high budget deficits, and started the process of downgrading. This in turn led to a significant increase in government bond rates in countries “visited” by the agencies.
Add to this that the ECB is still using the ratings produced by the same agencies to accept or refuse collateral presented by banks in the Eurozone, and one can see that all the elements are in place to transform a local crisis into a crisis for the system as a whole.
A systemic crisis can be avoided

It does not have to be that way, however. A systemic crisis can be avoided. Let’s start with Greece again. Although an outright default by the Greek government remains a remote possibility it is good to think through what the other Eurozone countries can and will do in that case. They can easily bail out Greece. It does not cost them that much. In the unlikely event that Greece defaults on the full amount of its outstanding debt, a bail-out by the other Eurozone governments would add about 3% to these governments’ debt – a small number compared to the amounts added to save the banks during the financial crisis.
A Eurozone bailout is likely

The other Eurozone governments are also very likely to bail out Greece out of pure self-interest. There are two reasons for this.

* First, a significant part of Greek bonds are held by financial institutions in Eurozone countries.

These institutions are likely to pressure their governments to come to their rescue.

* Second, and more importantly, a failure to bail out Greece would trigger contagious effects in sovereign bond markets of the Eurozone. Investors having lost a lot of money holding Greek bonds would likely dump government bonds of countries, like Spain, Ireland, Portugal, Belgium that they perceive to have similar budgetary problems.

The local sovereign debt crisis would trigger an avalanche of other sovereign debt crises. I conclude that the Eurozone governments are condemned to intervene and to rescue the government of a member country hit by a sovereign debt crisis.
Are bailouts illegal?

It is sometimes said that bail-outs in the Eurozone are illegal because the Treaty says so (see Wyplosz 2009 on this). But this is a misreading of the Treaty. The no-bail-out clause only says that the EU shall not be liable for the debt of governments, i.e. the governments of the Union cannot be forced to bail out a member state. But this does not exclude that the governments of the EU freely decide to provide financial assistance to one of the member states. In fact this is explicitly laid down in Article 100, section 2.3

Eurozone governments have the legal capacity to bail out other governments, and in my opinion they are very likely to do so in the Eurozone if the need arises.

Financial markets today do not seem to believe this conclusion. If they did, they would not price the risk of Greek government bonds 250 basis points higher than the risk of German government bonds. The scepticism of the financial markets has much to do with the poor communication by the EU-authorities that have given conflicting signals about their readiness to give financial support to Greece if a sovereign debt crisis were to erupt.

All this leads to the conclusion that the Eurozone governments should make clear where they stand on this issue. Not doing so implies that each time one member country gets into financial problems the future of the system is put into doubt.

Reinhart, C., and Rogoff, K., (2009), This Time is Different: Eight Centuries of Financial Folly, Princeton University Press, 496pp.
Eichengreen, B., (2007), The euro: love it or leave it?, VoxEU.org, 19 November.
Wyplosz, C., (2009), Bailouts: the next step up?, VoxEU.org, 21 February.

1 For a fascinating historic analysis of public and private debt see Reinhart and Rogoff(2009).
2 See also Eichengreen(2007) on this issue.
3 Here is the text: “Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, acting by a qualified majority on a proposal from the Commission, may grant, under certain conditions, Community financial assistance to the Member State concerned”.

This article may be reproduced with appropriate attribution. See Copyright (below).

Topics: Europe's nations and regions

* eurozone
* Greece
* sovereign debt

Paul De Grauwe
Professor of international economics, University of Leuven, member of the Group of Economic Policy Analysis, advising the EU Commission President Manuel Barroso, and former member of the Belgian parliament.
Bookmark this: del.icio.us | Digg it | Tailrank | Reddit | Newsvine | Furl | Connotea | Technorati
Print this | Email this | Republish this | 9989 reads
Comments (2) | Login to post comments
Are bailouts illegal?
On January 5th, 2010 T. Saarenheimo says:

In quoting the Treaty's no-bailout clause, Professor de Grauwe omits a critical piece. The Treaty says that the Community or a member state "shall not be liable or assume the commitments" of any EU government body [Art 103 of the Nice Treaty, emphasis added]. Hence, not only can member states not be forced to bail out another member state, they are not allowed to do so, except when acting jointy under the exception of Art 100. Even then, getting a qualified majority in the Council in favour of the required interpretation that Greece's fiscal difficulties are due to "natural disasters or exceptional occurrences beyond its control" constitutes no small legal/political hurdle.

* Login or register to post comments

A dissenting view
On December 19th, 2009 mario.nuti says:

For an alternative view, looking at European bail-outs as unaffordable, probably illegal, and necessarily highly conditional, see http://dmarionuti.blogspot.com/2009/12/european-bail-outs-unaffordable-i..., with an exchange of comments with Paul de Grauwe.
D. Mario Nuti
Blog "Transition" http://dmarionuti.blogspot.com/

* Login or register to post comments

Η αισιόδοξη πλευρά της χρεοκοπίας


του Γιάνη Βαρουφάκη

Για μέρες τώρα βαραίνουμε τις ψυχές μας με μια μόνιμη αγωνία: Θα χρεοκοπήσει το κράτος μας; Ε, λοιπόν, ήρθε η ώρα να αγκαλιάσουμε αυτό που φοβόμαστε. Αν οι φίλοι μας οι Γερμανοί δεν έχουν πρόβλημα να χρεοκοπήσουμε, καιρός είναι να το κάνουμε. Χωρίς δεύτερη κουβέντα. Όχι ως διαπραγματευτική μπλόφα και ούτε μόνο γιατί το χειρότερο που μπορεί να μας συμβεί είναι να χρεοκοπήσουμε σε ένα χρόνο (βλ. το προηγούμενο άρθρο μου Το Πρώτο Τάνγκο στην Ευρωζώνη) αλλά επειδή ήρθε η ώρα να στρέψουμε το βλέμμα στην αισιόδοξη πλευρά της χρεοκοπίας.

Υπάρχει τέτοια πλευρά; Και βέβαια υπάρχει. Σε σχέση με χώρες όπως η γνωστή τρόικα Πορτογαλία, Ισπανία και Ιρλανδία, αλλά και η Βρετανία και το Βέλγιο, το σύνολο του χρέους μας (δημοσίου και ιδιωτικού) είναι το μικρότερο. Πως αυτό; Επειδή οι έλληνες, ως άτομα αλλά και ως ιδιωτικός τομέας, χρωστάμε πολύ λιγότερα εκείνων. Ακόμα και οι αντιπαθέστατες τράπεζές μας έχουν ένα μεγάλο συγκριτικό πλεονέκτημα: Πάνω από 150 δις πραγματικών καταθέσεων! Μιλάμε για άνω του μισού ΑΕΠ σε καταθέσεις, κάτι για το οποίο οι περισσότεροι εταίροι μας θα σκότωναν να το έχουν, που λέει ο λόγος. Αν μάλιστα προσθέσετε και όλα τα χρήματα ελλήνων που βρίσκονται στο εξωτερικό, θα δείτε ότι οι έλληνες δεν είμαστε και τόσο φτωχοί κατά μέσον όρο, κι ας έχουμε το μεγαλύτερο ποσοστό φτώχειας στην Ευρώπη (με εξαίρεση την Λεττονία).

Ως πολίτες είμαστε ελάχιστα χρεωμένοι σε σχέση με πολλούς από τους επικριτές μας στις Λόνδρες, στα Παρίσια και στις Νέες Υόρκες. Αυτό βέβαια δεν σημαίνει ότι είμαστε λευκές περιστερές. Για δεκαετίες φορτώναμε το δημόσιο με τόσο μεγάλο χρέος που το βλέπουμε πλέον να βουλιάζει μπροστά στα μάτια μας. Εδώ όμως που φτάσαμε, δεν μπορούμε να κάνουμε τίποτα. Ακόμα και να αποφασίσουμε σύσσωμοι (ΣΕΒ και ΓΣΕΕ, γιάπηδες και στελέχη του ΠΑΜΕ, αστοί των βορείων προαστίων και αναρχικοί της Πλατείας Εξαρχείων) να δώσουμε ό,τι έχουμε και δεν έχουμε στο κράτος, δεν αρκεί. Αν μάλιστα το παρακάνουμε στην αλληλεγγύη προς το δημόσιο, η 'γενναιοδωρία' μας αυτή θα στεγνώσει την κυκλική ροή του πλούτου από το οποίο εξαρτάται το δημόσιο για τα έσοδά του το 2011, το 2012 κ.ο.κ.

Ποια είναι λοιπόν τα χαρμόσυνα νέα; Ότι μια πτώχευση θα αποδειχθεί σχετικά ανώδυνη. Ο λόγος διττός: Πρώτον, δεν είμαστε κατά μέσον όρο ούτε οι φτωχότεροι ούτε οι πιο υπερχρεωμένοι. Δεύτερον, όσον αφορά τα χρέη του δημοσίου, αυτά βαραίνουν εμάς, ως άτομα, πολύ λιγότερο από όσο βαραίνουν τους ξένους.
Κάντε την σύγκριση με την Ιαπωνία, το χρέος της οποίας ανήκει σε Ιάπωνες σε ποσοστό 95%. Αν το Ιαπωνικό κράτος αναγκαστεί στην πτώχευση, η καταστροφή της χώρας θα είναι ολική. Κάτι τέτοιο δεν ισχύει για εμάς, καθώς μας ανήκει (δηλαδή στις δικές μας τράπεζες) μόνο το 25% του δημόσιου χρέους μας. Έτσι λοιπόν, δεδομένου ότι η πτώχευση του δημοσίου διαγράφεται ως αναπόφευκτη (εκτός αν πανικοβληθούν οι εταίροι μας αρκετά και το συνδράμουν για χρόνια πολλά, οπότε έχει καλώς), το κόστος της στάσης πληρωμών δεν θα το υποστούμε μόνοι μας.

Μα αν το δημόσιο κηρύξει στάση πληρωμών, τι θα γίνει την επόμενη μέρα; Πως θα ξανα-δανειστεί; Πράγματι, το κράτος θα στριμωχθεί. Για κάμποσο καιρό το δημόσιο θα πρέπει απλώς να ξοδεύει όσα μαζεύει από φόρους. Και γιατί είναι κακό αυτό; Να μάθει επί τέλους, αφού θα έχει ανακουφιστεί από το νταλκά των τοκοχρεολυσίων, να ζει με αυτά που εισπράττει. Π.χ. να καταγγείλει όλες τις εξοπλιστικές συμβάσεις, να συμπιέσει τους ανώτερους μισθούς (τον δικό μου συμπεριλαμβανομένου) τόσο που να καλύπτει τις δαπάνες του από τους φόρους που εισπράττει κλπ.

Οι τράπεζές μας; Θα υποφέρουν, είναι αλήθεια - δεδομένου ότι ακόμα και το 25% του δημόσιου χρέους που διαθέτουν θα παγώσει. Ναι, αλλά μην ξεχνάμε ότι το έχουν ήδη διαθέσει στην ΕΚΤ ως ενέχυρο για ζεστό χρήμα που έχουν ήδη πάρει. Και ότι έχουν πρόσβαση στις τεράστιες, κατά κεφαλήν, αποταμιεύσεις μας. Για να μην προσθέσω ότι απολαμβάνουν εγκληματικά υψηλά ποσοστά κέρδους τόσα χρόνια. Όπως το κράτος μας, έτσι κι αυτές να μάθουν να ζουν λιτά και με σύνεση όπως κάνουν χρόνια τώρα οι εργαζόμενοι των 700 ευρώ.

Επί πλέον, ο αποκλεισμός του κράτους μας από τις χρηματαγορές δεν θα διαρκέσει πολύ. Αν κηρύξει στάση πληρωμών, και ισοσκελίσει τον προϋπολογισμό του, δεν θα περάσει πολύ καιρός που παλιοί δανειστές θα αποδεχθούν νέους όρους αποπληρωμής ενός ποσοστού των περασμένων δανεικών και νέοι υποψήφιοι δανειστές (μπορεί και οι ίδιοι με τους παλιούς) θα σχηματίσουν ουρά έξω από το Υπουργείο Οικονομίας να το δανείσουν! Βλέπετε, το χρέος μας θα έχει μειωθεί τόσο που θα αποτελούμε εξαιρετική επένδυση. Έτσι είναι το κεφάλαιο - όταν οσφραίνεται ένα επικερδές deal δεν σέβεται ούτε τον εαυτό του.

Σε τελική ανάλυση, είναι λάθος μας να φοβόμαστε τόσο πολύ την στάση πληρωμών του ελληνικού δημοσίου. Άλλοι πρέπει να φοβούνται μια τέτοια εξέλιξη περισσότερο από εμάς:

• η κυβέρνηση της κας Μέρκελ η οποία θα πρέπει να διασώσει τις Γερμανικές τράπεζες που θα κλονιστούν από μια δική μας στάση πληρωμών

• η Ευρωπαϊκή Επιτροπή που θα πρέπει να δει τι θα κάνει με μία χώρα-μέλος την οποία δεν μπορεί να αποβάλει από την ΕΕ αλλά η οποία τελεί υπό πτώχευση

• οι κυβερνήσεις όλων των άλλων χωρών (πλην ίσως της Ολλανδίας και της Αυστρίας) που θα τρέμουν για το ποιος θα είναι ο επόμενος στόχος των αγορών (των οποίων η όρεξη θα έχει ανοίξει από την 'επιτυχημένη' επίθεση στο χρέος της Ελλάδας)

• οι κυβερνήσεις των ΗΠΑ και της Βρετανίας (χωρών με συνολικό χρέος πάνω από 400%)

• όλοι όσοι έχουν επενδύσει στο ευρώ, είτε σε περιουσιακά στοιχεία είτε ως μέσο συναλλαγής.

Στάση πληρωμών λοιπόν!
Με χαμόγελο και αισιοδοξία!

(Και ξέρετε ποιο είναι το ωραίο; Ότι αν πειθόμασταν να απελευθερωθούμε από τον φόβο της πτώχευσης, οι φίλοι μας οι Γερμανοί θα έσπευδαν την ίδια στιγμή να την αποσοβήσουν...)

*Ο Γιάνης Βαρουφάκης διδάσκει οικονομική θεωρία και πολιτική οικονομία στο Τμήμα Οικονομικών Επιστημών του Πανεπιστημίου Αθηνών