THE "GRAND BARGAIN" IS JUST A START / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

The ‘grand bargain’ is just a start

By Martin Wolf

Published: March 29 2011 23:07

..

.
Will the eurozone survive its crisis? That was the question I raised three weeks ago. My answer was: yes. My argument was that economic self-interest and political will would combine to preserve the common currency, in spite of the difficulties.

.
Yet that raises a further question: have leaders now done enough to put the eurozone on a sound footing? The answer is: no. Progress has indeed been made.

.
But more will be needed, both intellectually and institutionally. Evidently, I am assuming that further shocks will compel further reforms. That is my judgment. It cannot be a certainty.

The euro is a unique project. For sovereign states to share a currency demands solidarity and discipline. The more diverse are the component economies and the more divergent is their performance, the greater is the need for solidarity and the smaller is its likely supply. So it has proved. I was one of the many who believed that a stronger political union and greater economic flexibility would be needed if the eurozone was to survive in the long run. Only in a crisis would it become clear whether the conditions for survival would be met. This crisis provides the test.

A fascinating speech by Lorenzo Bini Smaghi, a member of the executive board of the European Central Bank, makes the point. “Europe”, notes Mr Bini Smaghi, “is evolving, growing, continuing on its path of integration. This is not happening, however, according to some pre-defined, agreed plan, but rather in response to the challenges it faces, which in some cases are likely to endanger the very existence of the Union.” The current crisis is such a challenge. This might be called “the perils of Pauline” route to integration. It is hugely risky, but it has also worked, at least so far.

The response to the crisis is a superb example of the risks and rewards of this approach. The shock caught Europe unawared. Some had recognised the dangers created by huge internal imbalances and irresponsible lending to peripheral countries. Few realised this might interact with a global financial disaster to generate banking, sovereign debt and competitiveness crises inside the eurozone.

In response, leaders have innovated spectacularly. Within a year, they have approved a €110bn ($155bn) rescue package for Greece, in co-operation with the International Monetary Fund, endowed a new European financial stability facility with €440bn, decided to amend the treaty, to create a permanent rescue mechanism, amended the stability and growth pact, to enhance fiscal discipline, and created a new system of macroeconomic surveillance.

Germany has accepted ideas that its citizens abhor. Countries in difficulty have accepted austerity that their citizens abhor. We have seen much kicking and heard much screaming. But the show goes on.

Yet however far the eurozone may have come, it has not yet come far enough. There are three challenges.

First, the leaders have not created a regime capable of preventing and dealing with the potential crises.

True, important areas of agreement have been reached. One is the intention to monitor and promote competitiveness, particularly in labour markets. Without flexible labour markets, such a currency cannot work. Another is the focus on long-term fiscal sustainability. Yet another is the decision to legislate for banking resolution. Another is the plan to monitor debt of banks, households and non-financial companies.
.
Nevertheless, big holes remain. The most important hole in the plans for economic co-ordination is the unwillingness to recognise the link between the external surpluses of core countries and the financial fragility in the periphery. The focus remains overwhelmingly on fiscal indiscipline, which was not the cause of the crises in Ireland or Spain.
 .

.
Meanwhile, the biggest failing in the plan for a permanent European stability mechanism is that its resources – a total of €500bn – would be insufficient to manage liquidity crises in larger countries. Moreover, as my colleague Wolfgang Münchau has also noted, even this depends on resources from countries that may themselves need to be rescued.

Second, it is unclear whether the countries now in difficulty will be able to escape from their crises at manageable political cost. They have barely begun what is surely going to prove a long and painful process of adjustment. At present, Greece, Ireland and Portugal find access to financial markets prohibitively expensive. It is unclear when or how they can regain it. Yet they have no easy alternative to the slog. The countries in difficulty have large structural primary fiscal deficits (that is, before interest payments).
.
Thus, debt restructuring alone is no panacea. An additional question is whether those in trouble can regain competitiveness without making their euro-denominated debt yet more unmanageable. At present, the countries likely to adjust their way out of the mess seem to be Ireland and Spain. But further political and economic shocks are all too likely.

Third, the eurozone has failed to cut the Gordian knot connecting the fiscal to the financial crises. Today’s dominant opinion is that the senior creditors of banks must be made whole, while governments must avoid restructuring their debts.
This combination is a machine for loading the costs of past bad lending onto the taxpayers of countries whose private sectors borrowed excessively.

This is, alas, a “transfer union”. But those transfers occurred years ago, when these loans were made. It would be helpful – and honest – for the German government and the governments of other creditor countries to tell their people that they are rescuing their own savings in the guise of rescuing peripheral countries. The alternative is to write off loans and recapitalise their banks directly. To admit this would be to admit their policies have been at fault. That would surely be helpful.

Indeed, we can go further. An admission that mistakes have been made by both the virtuous and the sinners may be a necessary condition for sustaining the political will to strengthen the system.

Huge challenges remain ahead. It would be easier to believe they will be overcome if everybody confessed to their part in the mess. Those who lent so foolishly and those who borrowed so foolishly are implicated.

As Christine Lagarde, the French finance minister, has remarked, “it takes two to tango”. So it does. The eurozone’s tango is fiendishly complicated. But the dance goes on. It will continue to do so, provided the will to remain entwined survives.
.

Copyright The Financial Times Limited 2011

THE "GRAND BARGAIN" IS JUST A START / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

The ‘grand bargain’ is just a start

By Martin Wolf

Published: March 29 2011 23:07

..

.
Will the eurozone survive its crisis? That was the question I raised three weeks ago. My answer was: yes. My argument was that economic self-interest and political will would combine to preserve the common currency, in spite of the difficulties.

.
Yet that raises a further question: have leaders now done enough to put the eurozone on a sound footing? The answer is: no. Progress has indeed been made.

.
But more will be needed, both intellectually and institutionally. Evidently, I am assuming that further shocks will compel further reforms. That is my judgment. It cannot be a certainty.

The euro is a unique project. For sovereign states to share a currency demands solidarity and discipline. The more diverse are the component economies and the more divergent is their performance, the greater is the need for solidarity and the smaller is its likely supply. So it has proved. I was one of the many who believed that a stronger political union and greater economic flexibility would be needed if the eurozone was to survive in the long run. Only in a crisis would it become clear whether the conditions for survival would be met. This crisis provides the test.

A fascinating speech by Lorenzo Bini Smaghi, a member of the executive board of the European Central Bank, makes the point. “Europe”, notes Mr Bini Smaghi, “is evolving, growing, continuing on its path of integration. This is not happening, however, according to some pre-defined, agreed plan, but rather in response to the challenges it faces, which in some cases are likely to endanger the very existence of the Union.” The current crisis is such a challenge. This might be called “the perils of Pauline” route to integration. It is hugely risky, but it has also worked, at least so far.

The response to the crisis is a superb example of the risks and rewards of this approach. The shock caught Europe unawared. Some had recognised the dangers created by huge internal imbalances and irresponsible lending to peripheral countries. Few realised this might interact with a global financial disaster to generate banking, sovereign debt and competitiveness crises inside the eurozone.

In response, leaders have innovated spectacularly. Within a year, they have approved a €110bn ($155bn) rescue package for Greece, in co-operation with the International Monetary Fund, endowed a new European financial stability facility with €440bn, decided to amend the treaty, to create a permanent rescue mechanism, amended the stability and growth pact, to enhance fiscal discipline, and created a new system of macroeconomic surveillance.

Germany has accepted ideas that its citizens abhor. Countries in difficulty have accepted austerity that their citizens abhor. We have seen much kicking and heard much screaming. But the show goes on.

Yet however far the eurozone may have come, it has not yet come far enough. There are three challenges.

First, the leaders have not created a regime capable of preventing and dealing with the potential crises.

True, important areas of agreement have been reached. One is the intention to monitor and promote competitiveness, particularly in labour markets. Without flexible labour markets, such a currency cannot work. Another is the focus on long-term fiscal sustainability. Yet another is the decision to legislate for banking resolution. Another is the plan to monitor debt of banks, households and non-financial companies.
.
Nevertheless, big holes remain. The most important hole in the plans for economic co-ordination is the unwillingness to recognise the link between the external surpluses of core countries and the financial fragility in the periphery. The focus remains overwhelmingly on fiscal indiscipline, which was not the cause of the crises in Ireland or Spain.
 .

.
Meanwhile, the biggest failing in the plan for a permanent European stability mechanism is that its resources – a total of €500bn – would be insufficient to manage liquidity crises in larger countries. Moreover, as my colleague Wolfgang Münchau has also noted, even this depends on resources from countries that may themselves need to be rescued.

Second, it is unclear whether the countries now in difficulty will be able to escape from their crises at manageable political cost. They have barely begun what is surely going to prove a long and painful process of adjustment. At present, Greece, Ireland and Portugal find access to financial markets prohibitively expensive. It is unclear when or how they can regain it. Yet they have no easy alternative to the slog. The countries in difficulty have large structural primary fiscal deficits (that is, before interest payments).
.
Thus, debt restructuring alone is no panacea. An additional question is whether those in trouble can regain competitiveness without making their euro-denominated debt yet more unmanageable. At present, the countries likely to adjust their way out of the mess seem to be Ireland and Spain. But further political and economic shocks are all too likely.

Third, the eurozone has failed to cut the Gordian knot connecting the fiscal to the financial crises. Today’s dominant opinion is that the senior creditors of banks must be made whole, while governments must avoid restructuring their debts.
This combination is a machine for loading the costs of past bad lending onto the taxpayers of countries whose private sectors borrowed excessively.

This is, alas, a “transfer union”. But those transfers occurred years ago, when these loans were made. It would be helpful – and honest – for the German government and the governments of other creditor countries to tell their people that they are rescuing their own savings in the guise of rescuing peripheral countries. The alternative is to write off loans and recapitalise their banks directly. To admit this would be to admit their policies have been at fault. That would surely be helpful.

Indeed, we can go further. An admission that mistakes have been made by both the virtuous and the sinners may be a necessary condition for sustaining the political will to strengthen the system.

Huge challenges remain ahead. It would be easier to believe they will be overcome if everybody confessed to their part in the mess. Those who lent so foolishly and those who borrowed so foolishly are implicated.

As Christine Lagarde, the French finance minister, has remarked, “it takes two to tango”. So it does. The eurozone’s tango is fiendishly complicated. But the dance goes on. It will continue to do so, provided the will to remain entwined survives.
.

Copyright The Financial Times Limited 2011

WHERE THE BAIL-OUT WENT WRONG / THE NEW YORK TIMES OP EDITORIAL ( A MUST READ )

March 29, 2011

Where the Bailout Went Wrong

By NEIL M. BAROFSKY

Washington

TWO and a half years ago, Congress passed the legislation that bailed out the country’s banks. The government has declared its mission accomplished, calling the program remarkably effective “by any objective measure.” On my last day as the special inspector general of the bailout program, I regret to say that I strongly disagree. The bank bailout, more formally called the Troubled Asset Relief Program, failed to meet some of its most important goals.


From the perspective of the largest financial institutions, the glowing assessment is warranted: billions of dollars in taxpayer money allowed institutions that were on the brink of collapse not only to survive but even to flourish. These banks now enjoy record profits and the seemingly permanent competitive advantage that accompanies being deemed “too big to fail.”


Though there is no question that the country benefited by avoiding a meltdown of the financial system, this cannot be the only yardstick by which TARP’s legacy is measured. The legislation that created TARP, the Emergency Economic Stabilization Act, had far broader goals, including protecting home values and preserving homeownership.


These Main Street-oriented goals were not, as the Treasury Department is now suggesting, mere window dressing that needed only to be taken “into account.” Rather, they were a central part of the compromise with reluctant members of Congress to cast a vote that in many cases proved to be political suicide.


The act’s emphasis on preserving homeownership was particularly vital to passage. Congress was told that TARP would be used to purchase up to $700 billion of mortgages, and, to obtain the necessary votes, Treasury promised that it would modify those mortgages to assist struggling homeowners. Indeed, the act expressly directs the department to do just that.


But it has done little to abide by this legislative bargain. Almost immediately, as permitted by the broad language of the act, Treasury’s plan for TARP shifted from the purchase of mortgages to the infusion of hundreds of billions of dollars into the nation’s largest financial institutions, a shift that came with the express promise that it would restore lending.


Treasury, however, provided the money to banks with no effective policy or effort to compel the extension of credit. There were no strings attached: no requirement or even incentive to increase lending to home buyers, and against our strong recommendation, not even a request that banks report how they used TARP funds. It was only in April of last year, in response to recommendations from our office, that Treasury asked banks to provide that information, well after the largest banks had already repaid their loans. It was therefore no surprise that lending did not increase but rather continued to decline well into the recovery. (In my job as special inspector general I could not bring about the changes I thought were needed — I could only make recommendations to the Treasury Department.)


Meanwhile, the act’s goal of helping struggling homeowners was shelved until February 2009, when the Home Affordable Modification Program was announced with the promise to help up to four million families with mortgage modifications.


That program has been a colossal failure, with far fewer permanent modifications (540,000) than modifications that have failed and been canceled (over 800,000). This is the well-chronicled result of the rush to get the program started, major program design flaws like the failure to remedy mortgage servicers’ favoring of foreclosure over permanent modifications, and a refusal to hold those abysmally performing mortgage servicers accountable for their disregard of program guidelines. As the program flounders, foreclosures continue to mount, with 8 million to 13 million filings forecast over the program’s lifetime.


Treasury Secretary Timothy Geithner has acknowledged that the program “won’t come close” to fulfilling its original expectations, that its incentives are not “powerful enough” and that the mortgage servicers are “still doing a terribly inadequate job.” But Treasury officials refuse to address these shortfalls. Instead they continue to stubbornly maintain that the program is a success and needs no material change, effectively assuring that Treasury’s most specific Main Street promise will not be honored.


Finally, the country was assured that regulatory reform would address the threat to our financial system posed by large banks that have become effectively guaranteed by the government no matter how reckless their behavior. This promise also appears likely to go unfulfilled. The biggest banks are 20 percent larger than they were before the crisis and control a larger part of our economy than ever. They reasonably assume that the government will rescue them again, if necessary. Indeed, credit rating agencies incorporate future government bailouts into their assessments of the largest banks, exaggerating market distortions that provide them with an unfair advantage over smaller institutions, which continue to struggle.


Worse, Treasury apparently has chosen to ignore rather than support real efforts at reform, such as those advocated by Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, to simplify or shrink the most complex financial institutions.


In the final analysis, it has been Treasury’s broken promises that have turned TARP — which was instrumental in saving the financial system at a relatively modest cost to taxpayers — into a program commonly viewed as little more than a giveaway to Wall Street executives.


It wasn’t meant to be that. Indeed, Treasury’s mismanagement of TARP and its disregard for TARP’s Main Street goals — whether born of incompetence, timidity in the face of a crisis or a mindset too closely aligned with the banks it was supposed to rein in — may have so damaged the credibility of the government as a whole that future policy makers may be politically unable to take the necessary steps to save the system the next time a crisis arises. This avoidable political reality might just be TARP’s most lasting, and unfortunate, legacy.


Neil M. Barofsky was the special inspector general for the Troubled Asset Relief Program from 2008 until today.

WHERE THE BAIL-OUT WENT WRONG / THE NEW YORK TIMES OP EDITORIAL ( A MUST READ )

March 29, 2011

Where the Bailout Went Wrong

By NEIL M. BAROFSKY

Washington

TWO and a half years ago, Congress passed the legislation that bailed out the country’s banks. The government has declared its mission accomplished, calling the program remarkably effective “by any objective measure.” On my last day as the special inspector general of the bailout program, I regret to say that I strongly disagree. The bank bailout, more formally called the Troubled Asset Relief Program, failed to meet some of its most important goals.


From the perspective of the largest financial institutions, the glowing assessment is warranted: billions of dollars in taxpayer money allowed institutions that were on the brink of collapse not only to survive but even to flourish. These banks now enjoy record profits and the seemingly permanent competitive advantage that accompanies being deemed “too big to fail.”


Though there is no question that the country benefited by avoiding a meltdown of the financial system, this cannot be the only yardstick by which TARP’s legacy is measured. The legislation that created TARP, the Emergency Economic Stabilization Act, had far broader goals, including protecting home values and preserving homeownership.


These Main Street-oriented goals were not, as the Treasury Department is now suggesting, mere window dressing that needed only to be taken “into account.” Rather, they were a central part of the compromise with reluctant members of Congress to cast a vote that in many cases proved to be political suicide.


The act’s emphasis on preserving homeownership was particularly vital to passage. Congress was told that TARP would be used to purchase up to $700 billion of mortgages, and, to obtain the necessary votes, Treasury promised that it would modify those mortgages to assist struggling homeowners. Indeed, the act expressly directs the department to do just that.


But it has done little to abide by this legislative bargain. Almost immediately, as permitted by the broad language of the act, Treasury’s plan for TARP shifted from the purchase of mortgages to the infusion of hundreds of billions of dollars into the nation’s largest financial institutions, a shift that came with the express promise that it would restore lending.


Treasury, however, provided the money to banks with no effective policy or effort to compel the extension of credit. There were no strings attached: no requirement or even incentive to increase lending to home buyers, and against our strong recommendation, not even a request that banks report how they used TARP funds. It was only in April of last year, in response to recommendations from our office, that Treasury asked banks to provide that information, well after the largest banks had already repaid their loans. It was therefore no surprise that lending did not increase but rather continued to decline well into the recovery. (In my job as special inspector general I could not bring about the changes I thought were needed — I could only make recommendations to the Treasury Department.)


Meanwhile, the act’s goal of helping struggling homeowners was shelved until February 2009, when the Home Affordable Modification Program was announced with the promise to help up to four million families with mortgage modifications.


That program has been a colossal failure, with far fewer permanent modifications (540,000) than modifications that have failed and been canceled (over 800,000). This is the well-chronicled result of the rush to get the program started, major program design flaws like the failure to remedy mortgage servicers’ favoring of foreclosure over permanent modifications, and a refusal to hold those abysmally performing mortgage servicers accountable for their disregard of program guidelines. As the program flounders, foreclosures continue to mount, with 8 million to 13 million filings forecast over the program’s lifetime.


Treasury Secretary Timothy Geithner has acknowledged that the program “won’t come close” to fulfilling its original expectations, that its incentives are not “powerful enough” and that the mortgage servicers are “still doing a terribly inadequate job.” But Treasury officials refuse to address these shortfalls. Instead they continue to stubbornly maintain that the program is a success and needs no material change, effectively assuring that Treasury’s most specific Main Street promise will not be honored.


Finally, the country was assured that regulatory reform would address the threat to our financial system posed by large banks that have become effectively guaranteed by the government no matter how reckless their behavior. This promise also appears likely to go unfulfilled. The biggest banks are 20 percent larger than they were before the crisis and control a larger part of our economy than ever. They reasonably assume that the government will rescue them again, if necessary. Indeed, credit rating agencies incorporate future government bailouts into their assessments of the largest banks, exaggerating market distortions that provide them with an unfair advantage over smaller institutions, which continue to struggle.


Worse, Treasury apparently has chosen to ignore rather than support real efforts at reform, such as those advocated by Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, to simplify or shrink the most complex financial institutions.


In the final analysis, it has been Treasury’s broken promises that have turned TARP — which was instrumental in saving the financial system at a relatively modest cost to taxpayers — into a program commonly viewed as little more than a giveaway to Wall Street executives.


It wasn’t meant to be that. Indeed, Treasury’s mismanagement of TARP and its disregard for TARP’s Main Street goals — whether born of incompetence, timidity in the face of a crisis or a mindset too closely aligned with the banks it was supposed to rein in — may have so damaged the credibility of the government as a whole that future policy makers may be politically unable to take the necessary steps to save the system the next time a crisis arises. This avoidable political reality might just be TARP’s most lasting, and unfortunate, legacy.


Neil M. Barofsky was the special inspector general for the Troubled Asset Relief Program from 2008 until today.