It is one thing to suspect that something is rotten in Denmark, quite another to have proof. Ever since Obama appointed his Rubinite economics team, it was blindingly obvious that he was aligning himself with Wall Street. The strength of the connection became even more evident in March 2009, when Team Obama embarked on its “stress test” charade and bank stock cheerleading. Rather than bring vested banking interests to heel, the administration instead chose to reconstitute, as much as possible, the very same industry whose reckless pursuit of profit had thrown the world economy off the cliff.
But now we see evidence in a new paper by the think tank Third Way of an even deeper commitment to pro-financier policies. The Democratic party has made clear that it supports institutionalized looting by banks, via the innocuous-seemeing device of rejecting the idea of writedowns on bonds they hold.
Policy advisors Lauren Oppenheimer and David Hollingsworth argue that point in the context of Greece, but the exact same logic would apply to banks anywhere. As Michael Hudson has warned:
…the war being waged against Greece by the European Central Bank (ECB) may best be seen as a dress rehearsal not only for the rest of Europe, but for what financial lobbyists would like to bring about in the United States.
And make no mistake about the role of Third Way. Third Way runs the policy apparatus of the Democratic Party. In Congress, staffers attend regular Third Way policy briefings, where the group hands out pre-packaged legislative amendments in legal form, generic press releases, polling around those policy ideas, and talking points. It’s a soup-to-nuts policy apparatus. Most of these ideas are harmless – like increased volunteerism – but some are not, like various tax proposals.
The group has enormous juice. On the Congressional side, it has six honorary Senate co-Chairs, and seven House-side co-Chairs. Jim Clyburn, a co-Chair, is in the House Democratic leadership. Two current cabinet members are former co-Chairs. Steny Hoyer, the House minority whip, held regular briefings for the freshmen member staff in the last Congress.
On the administration side, former Third Way board member Bill Daley is now White House chief of staff. Ron Klain, who was Biden’s Chief of Staff, is now with Third Way. The White House is pretty much full of Third Way-style apparatchiks.
Third Way also echoes, nearly entirely, the White House’s political line (though it is slightly ahead on gay rights). Here’s Third Way praising the Gang of 6 talks, opposing cut, cap, and balance, encouraging entitlement cuts, pushing various free trade agreements
Finally, most of the Board members are from the FIRE Sector (Wall Street and real estate), including the head of equity trading for Goldman Sachs and one of the heads of investment banking for Morgan Stanley.
It’s a highly optimized political operation for the White House and Congressional Democrats, with PR muscle, elite validators, access, and policy-making infrastructure.
This nine-page paper, Why Greece Matters, is lightweight, particularly for anyone who has kept up even minimally on the Eurozone mess. From the overview sent via e-mail:
As if DC policymakers don’t have enough to worry about with our own debt, we argue that the Greece bailout package announced last week may not stop the bleeding. And in our new memo, Why Greece Matters, we dissect and explain how a Greek default could affect the American economy—from Wall Street titans to widows on pensions—due to the interconnectedness of the global financial system.
A Greek default could lead to:
Stunning losses for European banks that hold Greek bonds;
A steep reduction in the value of the bonds of Ireland, Portugal, Spain, and Italy and exponentially increasing losses for the European banking sector;
Dissolution of the euro, the second most important world currency behind the dollar, with dire consequences for the world economy; and
Possible crippling losses for American financial institutions that lend to European banks, American exporters who rely on the European market, and anyone who holds a money market fund.
The tone is apocalyptic. And notice the failure to define what “default” means. Since it is never spelled out in the paper, a DC non-finance savvy reader would take it to mean “miss a bond payment”. But as anyone who has been paying attention knows, a good bit of effort was expended in the latest Greek package to devise a restructuring that did not constitute a default (technically a “credit event”) as defined for credit default swaps. Yet some commentators depict the latest rescue as a default, since banks will take an estimated 21% losses on Greek debt. Mirabile dictu, the world did not stop spinning.
Yet given the fulminating about the need to spare banks from taking meaningful hits, it’s not hard to see that a large writeoff would produce large losses to banks and hence would also be an outcome Third Way would see as detrimental.
The paper’s argument rests on two fallacies. First it that it would be very bad to have Greece fail because it would spread to other periphery countries. They are quite explicit about that they see the risk propagating, using metaphors like dominoes and mountaineers tethered together. Second is that “the Greece contagion could spread to Eurozone banks”. We’ll deal with them in order.
Like Tolstoy’s unhappy families, each of the so-called periphery countries that is at risk is for reasons specific to each county, not because the spectacle of Greece about to fall over suddenly produces Ebola-like financial hemorrhaging in its neighbors. The document never once acknowledges that the other periphery countries are independently at risk. They all have independent stresses that are coming to a head in a closely synchronized manner thanks to the impact of the global financial crisis. One connecting device of the oft-abused notion of “contagion” is the poor policy responses at the EU level. If the EU can’t come up with a workable remedy for Greece, which is badly impaired but not all that large, it is not going to be credible in dealing with Spain, Italy, or France. That too is absent from the Third Way account.
Marshall Auerback pointed out via e-mail:
The economies of Europe continue to look weaker.
Spanish real retail sales get worse and worse. In June they were down a huge -7% year on year versus -5% for the since November of 2010. Nobody is taking notice. Perhaps they are focusing too much on this debt ceiling crisis, which is a manufactured one, as opposed to Europe’s which is an institutional weakness of EMU.
Italian and Spanish sovereign interest rate spreads are resuming their rise. This is raising interest rates on some private borrowers, which could add to economic weakness. This should especially be the case for Spain where the ratio of private non-financial debt to GDP is exceedingly high and collateral values are gravely imperiled.
The second channel of contagion is the interconnectedness of the banks. As this blogger and many other commentators have pointed out, the most important corrective measure that needed to take place in the wake of the global financial crisis was to reduce the tight coupling among major financial firms. Right now, the banking system is like a badly designed power grid, where a bolt of lightning hitting a single transformer takes down not just a neighborhood but half the country. The Third Way paper, by contrast, tries to have its cake and eat it too on this point. It gives the tight coupling prominent play, not in its discussion of the origins of the Greek mess but in its urgent call to spare the banks any pain, predictably invoking the Lehman trope and arguing for another bailout. And the bailout metaphor is well chosen. The failure to fix the defective architecture of the financial system means these rescues are tantamount to bailing out a leaky boat. A full bore effort is unlikely to keep it afloat.
It’s critical to understand the real vectors of contagion if you are to propose sound remedies. But if the aim is to product bank-supporting propaganda, plausible-sounding stories within hailing distance of reality work just fine.
But let’s examine the core foundational argument in more detail, “”the Greece contagion could spread to Eurozone banks”. There’s a huge lie misapprehension here. The pretense is that the banks are sound. They aren’t.
The authorities are playing Schrodinger’s banks. They want to preserve the notion that we really don’t know whether the major financial firms are alive or dead. As long as we keep the quantum uncertainty game going and don’t open the box the stress tests are an effort to discredit critics who manage to pry the top open and peek), the banks remain in an indeterminate state and the authorities can carry on as if they are really alive. In fact, based on the decay rules established for this game, informed observers know well that if the box were opened, the banks are pretty certain to be dead.
To put this in simpler terms: experts were predicting losses of 50% to 75% when the first iteration of the Greek crisis hit in May 2010. Some are now predicting 90%. The latest rescue took a major step forward, in that it substantially reduced interest rates and pushed maturities out. But if you take the most recent projections of Greek indebtedness, and apply the effective writedowns contained in the latest package, you still have a debt to GDP ratio in excess of 150% for 2012, when a year ago, the IMF forecast that it would never breach 144%. Virtually all experts agree that more aggressive writedowns now would lead to lower losses later, but the political incentives are to delay the day of reckoning as long as possible.
And where has Third Way been? The authors honestly seem to believe that if Greece is bailed out, all will be well. As we noted above, the paper presents the odd notion that if Greece were saved, the Eurozone can soldier on, and it fails to mention some obvious suspects, namely Belgium and Cyprus, as among the walking wounded. There have been a gazillion charts generated in the last year of which countries’ banks are exposed to the debt of various sovereigns. And all the arrows point to one conclusion: the effort to shield the banks from taking losses in the crisis has simply imperiled Eurozone states (the core will not escape the damage to the periphery), and will inevitably redound to the banks.
Pretending a better bailout is the answer is just plain naive unless you start considering much more radical measures, namely having the ECB step up in a much bigger manner than before and abandon austerian policies. The latest estimates are that the rescue costs are two to three times the size of the facilities now authorized. But most observers believe that the ECB’s Bundesbank reflexes and other impediments like the parliaments of countries like Finland and the Netherlands and the German constitutional court will block this path.
Why is the Third Way position tantamount to endorsing institutionalized looting? Consider the definition in the classic George Akerlof and Paul Romer paper (emphasis ours):
. . . an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations. Bankruptcy for profit occurs most commonly when a government guarantees a firm’s debt obligations. The most obvious such guarantee is deposit insurance, but governments also implicitly or explicitly guarantee the policies of insurance companies, the pension obligations of private firms, virtually all the obligations of large banks, student loans, mortgage finance of subsidized housing, and the general obligations of large or influential firms. . . .
If so, the normal economics of maximizing economic value is replaced by the topsy-turvy economics of maximizing current extractable value, which tends to drive the firm’s economic net worth deeply negative. Once owners have decided that they can extract more from a firm by maximizing their present take, any action that allows them to extract more currently will be attractive—even if it causes a large reduction in the true economic net worth of the firm). . . .
Notice the Third Way script is a refinement of the process. We no longer bother with the actual stage of bankruptcy; that would be too messy and would embarrass too many powerful people. We now have a drip feed running directly from governments to banks via various hidden subsidies (super cheap interest rates being the biggest one of late) and the official “no more Lehmans” policy stressed in this paper.
“Bondholders can’t take losses” is now an explicit part of the “preserve the zombie banks” strategy. This is utterly ridiculous, since bonds are risk capital. Even before the crisis hit, economists like Nouriel Roubini were advocating wiping out bank equity and forcible conversion of some bank debt to equity as the remedy. Instead, the authorities are committing themselves to what will be at best a Japan trajectory of near zero growth (and unlike many European countries and the US, Japan has the social cohesion to carry this off with some grace). It assures high unemployment and low wage growth and is a very costly way to stabilize French and German banks. At this juncture, it would be better to write off the dud loans held by Eurobanks and thus re-capitalize them by using the currency-issuing power of the ECB and abandoning the Orwellianly-named Stability and Growth Pact. The other option is, contra the Third Way’s alarmism, to let the eurozone fracture into two or three more economically homogenous groups.
As we’ve said before, saving a banking system does not mean preserving individual firms in their current form or coddling diseased managements. Failed banks should be resolved and their executives should be replaced by more realistically paid and publicly-focused professionals and their operations reoriented to public purpose. The ECB clearly has the financial capacity to do but the banks in the US and their Democratic party mouthpieces at the Third Way want to make sure ideas like that never get a hearing.
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