Will Eurozone Avert Implosion?

James Galbraith, professor of economics at the University of Texas at Austin wrote a brilliant article for Salon explaining the crisis in the eurozone:

The eurozone crisis is a bank crisis posing as a series of national debt crises and complicated by reactionary economic ideas, a defective financial architecture and a toxic political environment, especially in Germany, in France, in Italy and in Greece.

Like our own, the European banking crisis is the product of over-lending to weak borrowers, including for housing in Spain, commercial real estate in Ireland and the public sector (partly for infrastructure) in Greece. The European banks leveraged up to buy toxic American mortgages and when those collapsed they started dumping their weak sovereign bonds to buy strong ones, driving up yields and eventually forcing the whole European periphery into crisis. Greece was merely the first domino in the line.

In all such crises the banks’ first defense is to plead surprise – “no one could have known!” – and to blame their clients for recklessness and cheating. This is true but it obscures the fact that the bankers pushed the loans very hard while the fees were fat. The defense works better in Europe than in the U.S. because national boundaries separate creditors from debtors, binding the political leaders in German and France to their bankers and fostering a narrative of national-racism (“lazy Greeks,” “feckless Italians”) whose equivalent in post-civil rights America has been largely suppressed.

Underpinning banker power in Creditor Europe is a Calvinist sensibility that has turned surpluses into a sign of virtue and deficits into a mark of vice, while fetishizing deregulation, privatization and market-driven adjustment. The North Europeans have forgotten that economic integration always concentrates industry (and even agriculture) in the richer regions.

As this process unfolds the Germans reap the rents and lecture their newly indebted customers to cut wages, sell off assets, and give up their pensions, schools, universities, healthcare – much of which were second-rate to begin with. Recently the lectures have become orders, delivered by the IMF and ECB, demonstrating to Europe’s new debt peons that they no longer live in democratic states.

The U.S. advantage

The eurozone’s architecture makes things worse in two major ways. While the EU has long paid some compensation to its poorer regions, these structural funds were never adequate and are now blocked by unmeetable co-pay requirements. And the zone lacks the inter-regional redistribution channels to households that the U.S. has developed in Social Security, Medicare, Medicaid, federal government payrolls and military contracting among other things. Nor do German retirees settle in Greece or Portugal in large numbers as New Yorkers do in Florida or Michiganders in Texas.

Second, the ECB refuses to solve the crisis at a stroke, which it could do by buying up the weak countries’ bonds and refinancing them. The argument against this is called “moral hazard,” buttressed by old-fashioned inflation fears, but the real issue is that to do so would admit loss of control by creditors over the central bank. Actions parallel to those taken by the Federal Reserve – nationalizing the entire commercial paper market, for instance – would repel the ECB, even though it does buy up sovereign bonds when it has to. So instead the zone has gone about creating a gigantic toxic CDO called the European Financial Stability Fund, which may shortly be turned into an even more gigantic toxic CDS (like AIG, they will call it “insurance”). This may defer panic at most for a little while.

Technical solutions exist. The most-developed of these is the “Modest Proposal” of Yanis Varoufakis and Stuart Holland, widely backed by older political leaders in Europe. It would 1) convert the first 60 percent of GDP of every eurozone country’s debt to a common European bond, issued by the ECB; 2) recapitalize and Europeanize the banking system, breaking the hammerlock of national banks on national politicians; and 3) fund a New Deal-like program of investment projects through the European Investment Bank.

Variant proposals include Kunibert Raffer’s call for a sovereign insolvency regime modeled on the U.S. municipal bankruptcy statute, Thomas Palley’s proposal for a new “government banker” and Jan Toporowski’s proposal for a tax on bank balance sheets to retire excess public debt.

These are the best ideas and none of them will happen. Europe’s political classes exist these days in a vise forged by desperate bankers and angry voters, no less in Germany and France than in Greece or Italy. Discourse is sealed off from fresh ideas and political survival depends on kicking cans down roads so that the fact that this is a banking crisis does not have to be faced. The fate of the weak is at best incidental. Thus every meeting of finance ministers and prime ministers yields treacherous half-measures and legal evasions.

The latest example was the pretzel-logic that declared a 50 percent haircut on Greek debt to be “voluntary” so that it would not trigger default clauses on the CDS to which some American banks, in particular, might be exposed. When Timothy Geithner warned the Europeans of potential “catastrophe” last month one may reasonably infer he had this risk – and not the minor effect on our already disastrous jobs picture – in mind. But of course if the haircut can be declared voluntary, then CDS are not worth the storage space they occupy in bankers’ computers, and another prop to the rapidly failing market in sovereign debts falls to the ground.

Political fragility also explains the fury in France and Germany when George Papandreou [the calmest man in Europe, by the way, having been born and raised in Minnesota] sought to cut the knot of his rebellious ministers, irresponsible opposition and angry public by putting the latest austerity package to a vote. God help the bankers! The move was fatal to Papandreou in short order, and Greece will now be turned over to a junta of creditors’ deputies if such can be found willing to take the job. It won’t be anyone who wants to continue to live in Greece afterward.

Greece and Ireland are being destroyed. Portugal and Spain are in limbo, and the crisis shifts to Italy – truly too big to fail – which is being put into an IMF-dictated receivership as I write. Meanwhile France struggles to delay the (inevitable) downgrade of its AAA rating by cutting every social and investment program.

If there were an easy exit from the Euro, Greece would be gone already. But Greece is not Argentina with soybeans and oil for the Chinese market, and legally exit from the Euro means leaving the European Union. It’s a choice only Germany can make. For the others, the choice is between cancer and heart attack, barring a transformation in Northern Europe that not even Socialist victories in the next round of French and German elections would bring.

So the cauldrons bubble. Debtor Europe is sliding toward social breakdown, financial panic and ultimately to emigration, once again, as the way out, for some. Yet – and here is another difference with the United States – people there have not entirely forgotten how to fight back. Marches, demonstrations, strikes and general strikes are on the rise. We are at the point where political structures offer no hope, and the baton stands to pass, quite soon, to the hand of resistance. It may not be capable of much – but we shall see.

Indeed, the cauldrons bubble but US citizens are waking up. Henry Blodget wrote a comment showing charts on why the "Occupy Wall Street" protests are gaining momentum. People are outraged, realizing that bailouts are all about bailing out banksters who made stupid loans.

To add to this public outrage, banks that have been bailed out want to continue doling out ridiculous bonuses. Bloomberg reports that in the U.K., Prime Minister David Cameron said he can stop Royal Bank of Scotland Group Plc (RBS) from paying a reported 500 million pounds ($800 million) in bonuses to investment bankers this year but he doesn't want to wager war on banks:

“We can stop the 500 million, yes, absolutely,” Cameron said in an interview on BBC Radio 2. “That is not the agreed figure. That’s a proposal I’ve read about in the newspapers.” The Sunday Times reported the 500 million-pound figure on Nov. 6.

RBS was rescued by the U.K. government in 2008 and is now 83 percent state-owned. Lloyds Banking Group Plc (LLOY), which was rescued at the same time, is 41 percent state-owned. The government has tried to manage both at arm’s length, with a view to privatizing them again when the market recovers. The issue of large bonus payments to traders at bailed-out banks has strained that policy.

The bank cut the amount it set aside for bonuses last year at its investment-banking unit by 27 percent to less than 950 million pounds as part of an agreement with the government. RBS posted a net loss for the first nine months of the year of 199 million pounds, compared with a 1.14 billion-pound loss for the same period a year earlier.

The prime minister said he didn’t want to “spend the next six months simply having a war of words, a great big fight, with the banks about everything” and instead wanted to push them to lend money and help the economy recover.

“The real need in our economy is to get growth,” Cameron said. “You can’t do that if your entire life is spent at war with the banks.”

The British Bankers’ Association said Nov. 9 that lending to companies was 11 percent ahead of a target agreed with the government in February known as Project Merlin.

RBS said it had no comment on Cameron’s statement.

No comment? No surprise. The banksters have no shame. And while I'm tough on bankers, the reality is that greed has run amok in corporate America where top executive compensation has reached epic proportions. It's these shenanigans that are outraging citizens around the world and political leaders better wake up and smell the coffee or face the wrath of angry voters. Finally, let me leave you with a must watch interview with Yanis Varoufakis, professor of economics at University of Athens and author of The Global Minotaur: America, The True Origins of the Financial Crisis and the Future of the World Economy.

As I wrote in my comment on why Merkel's gambit may backfire, unless Germany steps up to plate, this eurozone crisis will worsen and bring about a global depression. Listening to Yanis Varoufakis should convince you that the last agreement in Brussels is not enough to put the eurozone as a system back on track. Love his quote: "To err is of course human. But to mess things up spectacularly, we need an elite." Watch the interview below and listen to the truth on Greece and eurozone crisis (H/T Protagon blog).