17 September 2011

Immoral Hazard


I think it is important to repeat J. M. Keynes' criticism of the Treaty of Versailles (1919) and I will repeat some things I said elsewhere.

"It is an extraordinary fact that the fundamental economic problems of a Europe starving and disintegrating before their eyes, was the one question in which it was impossible to arouse the interest of the Four. Reparation was their main excursion into the economic field, and they settled it as a problem of theology, of polities, of electoral chicane, from every point of view except that of the economic future of the States whose destiny they were handling” Ch VI, The Economic Consequences of the Peace, (1919). J M Keynes.

Europeans are busy arguing over who has the best work ethnics. Some governments take advantage of others in the EC as their citizens are lazy. More formally, they call it a problem of moral hazard. So lets have a look at this.

Moral hazard applies when one side of the market has more information than the other and takes advantage this. Now let me give you two bits of information.

1) Zoi Georganta is a board member of the Greek Statistics Authority (ELSTAT) and professor of Econometrics (University of Macedonia). She claims that Greece’s budget deficit underwent a upward revision in 2009 to 15.4% instead of 12.6% just to force Greece to take the harsh austerity measures. (Read more) It was the announcement of these Greek Statistics that started the Greek debt crisis.

2) Barroso (European Commission President) was invited by Spiros Latsis (a student friend at the LSE) to be a guest on his yacht a month before the Commission approved €10.3 million Greek state aid for Latsis' shipping company. (Read more).  Spiro Latsis manages a family fortune that includes more than 40% in EFG Eurobank Ergasias, the Greek part his Swiss EFG Group and more than 30% in Hellenic Petroleum via his ownership of Paneuropean Oil and Industrial Holdings S.A. Latsis group also controls PrivatAir, Lamda Development, a major real estate group based in Athens etc.

Ok I don't know what lies behind these stories but I just use them to set the scene for the following question.  Who has more information in the risk and bond markets? The buyers or sellers?  I believe that moral argument applies to the buyers of these financial assets.  

Here's an interesting  extract from ' London Banker' blog (23rd June)

If protecting bondholders from bad debt really is the primary objective of the supervisors, then the supervisors have become the problem. Capitalism does not work when capitalists are shielded from the economic risks that they freely undertake for profit when they enter into private contracts for debt finance. If bondholders know that they can get the ECB and the FSA to tilt the field in their direction, they have no incentive to balance yield against risk. They should just go for yield wherever they find it, and trust the ECB and FSA to ensure that they get their money whatever happens to the company, the depositor, the employee or the taxpayer who foots the ultimate bill for their yield.

..... If the officials have decided that the bondholders always win, then the rest of us will always lose. And once the rest of us - the companies, depositors, employees and taxpayers - remember that we have political power, then we will change the system.

This is what we are seeing in Greece on the streets. The Greek people have realised that the government works for the bondholders; the ECB works for the bondholders; the IMF works for the bondholders. They now understand what was not clear before: No one works for the people.

'Too big to fail' means that higher 'risk' debts have been accumulated higher than what should have occurred. It has caused financial bubbles and instability. Deficit countries are paying for this failure in the market through austerity measure. Surplus countries have paid for this by foregoing real wage increases (that produced the surplus) and will pay for financial mismanagement in their taxes.

Attempts to prevent defaults means that the buyers of risk have passed on the losses to the sellers. Deficit countries are then force to impose the losses on their population (those who can't move funds to Swiss bank accounts) through austerity measures. Democratic controls are removed and the representatives of the creditors run the economy. This is in effect a form of dictatorship.

Mediaeval Times

As long as interest payments on government bonds remain greater than the rate of investment (and economic growth) the country is enslaved to meet impossible debt repayments. Debt is paid from future earnings. When undertaking debts there is the presumption that there will be future streams of income to service the debt. The Greek economy is collapsing. So where are the future streams of income that can service the debt?  Whatever happened to that Marshall plan for Greece announced in July?

Greece continues on its road to serfdom. The latest desperate tax, the 'property' tax, obliges those to pay if electricity bill is in their name, is a feudal tax on the space we live. For many poor Greeks, who struggle to pass this bill on to their landlord, the lights will go out.

How much revenue will such taxes raise? Taxes not based on the ability to pay are self defeating.  We have seen austerity measures reduce GDP, savage the tax base, destroy small businesses, reduce overall tax receipts, miss budget targets and calls for more rounds this austerity spiral. Increasing taxes while reducing everybody's ability to pay them will eventually lead to a breakdown in the tax system.

Even the new tax on eating out might fail to increase tax revenues. If Greeks' appetite for eating out falls (%) more than the increase (%) in tax, then tax revenues will fall. Add to this the number of restaurants that will close down, or refuse to pay, and it is easy to see how this particular tax target will be missed.

These taxes only exist to buy time for the Troikai. It cannot get the Greek economy out off its downward spiral of austerity. There is no prospect of real investment or economic growth and the only motive of the measures is to keep the European Banking Sector happy. Greece is insolvent and is being asset stripped.  Its not profitable, unable to make its debt payments and so it is more profitable to liquidate it.

This insane policy, applied repeatedly to Greece for 18 months, is now being applied to all Euro budget deficit countries. Europeans are still failing to under the causes.  Government budget deficits are the symptom not the cause. Spain and Ireland were in a budget surplus, unlike Germany, before the 2007-8 global financial crisis.  They have in common unsustainable trading deficits with their Euro partners and no tools (exchange rates or a monetary policy) to restore competitiveness.  Greece has been trapped by reckless activities and exposure of the European Banking system and a religious worship of the Euro with calls for punishment by its leaders.  

Greece faces mass destruction from a Vietnam 'destroy the village, to save it' economic policy.  Its needs to force the issue by saying it is not going to borrow more money that it simply can't pay back. 

If the Euro auto-pilot can't be switch off, the passengers will at some point say 'lets roll' and take over the cockpit. Alternatively, they may fight each other and bring down the whole Euro project that way.



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