The ECB have issued a legal opinion on Credit Institutions (Stabilisation) Bill 2010 (documents here). One highlight: “these emergency powers interfere significantly with the property rights of institutions’ shareholders and creditors. Thus it is important for any regime to properly balance these fundamental rights with the general interest in the financial system’s stability.”
Category: Banking Crisis
Colm has an article in today’s Sunday Independent which is well worth reading.
The Irish Central Bank has developed a new data series that shows the consolidated foreign claims of the six domestically-active banks headquartered in Ireland (ie it does not include the activities of the affiliates of UK banks in Ireland and it corresponds to the list of ‘guaranteed’ banks).
This note clarifies the vast differences between these claims and those reported in the BIS database.
A few weeks back, Harvard’s David Laibson gave a fascinating keynote lecture at the Geary Institute’s Economics and Psychology Conference. A key theme was the way people form expectations when macroeconomic time series have what he calls “hump-shaped dynamics”. These dynamics and their implications for expectations are described in a recent paper for the Journal of Economic Perspectives:
Many macroeconomic time series have long‐horizon hump‐shaped dynamics – processes that show momentum in the short run and some degree of mean reversion in the long run. Such dynamics will generally not be captured by simple growth‐regressions. Hence, agents with natural expectations will make approximately accurate forecasts at short horizons, but poor forecasts at long horizons, because the economy has more long‐run mean reversion than the agents impute from their intuitive models. In other words, agents with natural expectations will overestimate the long‐term persistence of good news or bad news.
David explained how even a skilled econometrician facing relatively short time series will tend to miss the longer-term mean reversion. The difficulty of seeing the mean reversion can mislead us into believing that a string of good draws on the fundamentals reflects a permanent improvement – with Ireland’s property bubble a good candidate. But equally a string of bad news can lead us to excessive pessimism – Wolfgang Munchau’s expectation that Ireland’s nominal growth will not exceed 1 percent for a decade comes to mind as a possible example.
We have certainly experienced a string of bad news on both economic growth and fiscal cost of the banking losses. Just as during the boom, extrapolation has led to extreme expectations about the economy and solvency. Of course, this pessimism could turn out to be justified. But it is no harm to remember that mean reversion works both ways.
Today’s Q3 growth numbers can be considered mildly good news. It is still too early to tell if we will be “bumping along the bottom” for some time or have “turned the corner”. (See here for graphs of real and nominal GDP/GNP based on today’s release.) For a mild antidote to the competition for who can come up with the biggest number for the banking losses, it is worth taking a look at Ronan Lyons’ analysis of potential mortgage-related losses.
All countries have choices — even our own, despite assertions to the contrary — but some countries have more choices than others.
Faced with solvency problems around the European periphery, and quite possibly in core banks as well, and also with the underlying reality of intra-Eurozone imbalances, how should Germany react?
Continuing to do as little as possible, and hoping that we can all muddle through, is one option. This risks destroying the euro.
Having the ECB step in via some sort of overt or covert QE is another.
Moving towards fiscal burden-sharing, implying deeper Eurozone integration, is another.
And a big-bang approach to restructuring debts in Europe is another.
In my view some combination of the last three options is probably optimal, if you want to keep the euro. But none of these options are particularly attractive, one assumes, from a German perspective. German industry would be a major loser if the Euro collapsed. The ECB option could undermine the credibility of the euro as a strong currency. Burden-sharing is going to cost the German taxpayer money. And as for the collective restructuring option, Germany is a creditor country.
Today’s article in the FT by Frank-Walter Steinmeier and Peer Steinbrück is a good contribution, from a pro-EU-integration perspective, that can help us see how one section of the German political spectrum views these trade-offs. They are attached to EMU, and so rule out doing nothing. Nor do they like the prospect of the ECB becoming ‘Europe’s “bad bank”‘, a nice political turn of phrase. Unlike Merkel, however, they understand that ruling out these two options has logical implications, pushing the burden of adjustment onto the other two options. For Steinmeier and Steinbrück, this means haircuts for the periphery and the introduction of Eurobonds:
In the case of Ireland, abolishing full state guarantees for private banks would allow their debt to be cut off at the root of the problem, while also letting private investors take their fair share of the burden. A new European framework for bankruptcies of financial institutions should support this.
There are conditions of course:
empowering European institutions to establish tighter controls over fiscal and economic stability, alongside common minimum standards on wage and welfare policies, as well as capital and corporate taxation. In short: we need European government bonds, but we must put an end to beggar-thy-neighbour policies and harmful tax competition within the eurozone too.
It is perfectly understandable that this would be the German position, and anyone who thinks these issues are going to go away is living in cloud cuckoo land. (What our position should be if presented with such a bargain is an interesting question: plenty of costs and benefits on both sides to be considered, which is why God gave economists two hands.)
On the other hand, the Steinmeier-Steinbrück reforms would probably require a new Treaty. Anyone on the Continent who thinks that there is a hope of getting a referendum passed in Ireland, so long as the ECB and EC continue to rule out burden-sharing with senior bondholders, is probably also living in cloud cuckoo land. Time is running out as regards the remaining unguaranteed debt: federalist Europeans should logically be arguing for this issue to be dealt with, satisfactorily, as quickly as possible.