UBS Interview promoting the modest Proposal
And the crisis sails on… (Anyone recall Fellini’s masterpiece “And the ship sails on”?). In todays post you can: (A) listen to a half-hour long radio interview on the euro crisis (interviewed by Doug Henwood, for the Behind the News program – it begins on the 27th minute), (B) watch an interview I gave to a leading Dutch TV station (on their main evening news program) and, lastly, (C) read the transcript of a conversation with analysts at UBS, one of Europe’s major banks (see text below or click here for the pdf of the UBS magazine intended for their clients).
- Dutch TV interview on the euro/Greek crisis
- Interview with Doug Henwood, 6th June 2011 (please jump to the 27th minute)
My interview with markets analysts of a major European bank follows:
Yanis Varoufakis, as a Professor at the University of Athens you are a government employee. What changed for you since the outbreak of the debt crisis about a year ago? My salary has declined by 28 percent. Besides this we now have to work in a University which feels impecunious. To give you an example, our adjunct lecturers are being paid something like €200 per semester for six hours of lecturing weekly. Now, the Ministry has asked us to fire them, on the basis that all temporary contracts must be discontinued. And this comes on top of a complete cessation of all appointments to permanent positions (an embargo that has been going on for at least a year now). In essence, the Universities are no longer able to reproduce themselves as communities of scholars.
Do all Greek employees have similar salary cuts like you? The salaries of all the public service employees have certainly been cut in a similar proportion. For most contract workers the situation is much worse because they lost their jobs. Looking at the private sector we see that unemployment has more than doubled within a year since the eruption of the debt crisis.
How is this situation reflected in daily life? Every single day you pass shops which have only very recently closed down. Close to my office, in fact two floors up in the same building, a soup kitchen has been doing brisk business for a number of years now. It is run by some evangelical, US-based, outfit. Before the crisis two groups of people flocked to receive their daily bread and soup: local drug addicts and refugees on their way establishing a foothold in the local labour market or on their way to Western Europe. Within eight months the number of Greeks using it has increased tremendously. People who, not long ago, had a job and an apartment or even a house. I know this because I occasionally chat with them. Once they lose their job and are evicted from their apartment, especially those lacking strong family support networks, they lose access to unemployment benefits and life gets intolerable very quickly. Lacking a fixed abode, a permanent address, they stand little chance of finding another job, of receiving benefits or retraining. It gets very hard to make a comeback into organized society.
The unemployment rate reached in March16.2% a record. 811000 Greek are unemployed, 40 percent more than a year ago. How likely is a popular uprising or revolt, if the austerity measures increase? I think we are already seeing signs of this. Every evening thousands gather at the Constitution Square in front of Parliament to demonstrate. They behave peacefully, but they are very passionate and united in their opposition to the government in particular and to the political system in general. They are opposing the way the government and Europe, not to mention the IMF, is dealing with the crisis. I spoke to government MPs and it is very clear to me that they are in complete disarray – the members of the governing socialist party in particular are at a loss on how to deal with this crisis themselves. Many are considering resigning their seats. One MP described her options as follows: “I have the impression the government gave me a gun, so that I can either shoot myself or give it back to them, so that they can shoot me.” Greek society is edging very quickly towards a situation of ungovernability. Very soon this government will not have the capacity to pass legislation; very soon its own MPs will be in open revolt.
This does not sound optimistic at all? No it does not. But then again every crisis is also a laboratory of the future. We do not know what will come out of it. Crises in the past have sometimes given rise to a better society, while on other occasions (like in the 1930s in Europe) the crisis led to the domination of society’s worst side: the rise of xenophobia, racism, fascism and a form of populism that creates circumstances of wholesale regression.
What will be the next decisive step, which will determine the direction of change? The Greek Prime Minister pushed the fiscal adjustment program, as he calls it, with budget cuts of €78bn through parliament. With this he hopes he can negotiate a new loan package inBrusselsin the range of €40bn to €90bn. On his triumphant return to Athens, he will address the Greek people saying. “I bought the nation an extension of at least one year’s worth, without which the state would be insolvent and unable to pay salaries and pensions.” Then he hopes that the heat of the summer, which is considerable inAthens, will see to it that the demonstrations wither as the demonstrators abandon the square for the beaches. This will reduce the pressure he is under till autumn.
The plan is to privatize government assets and to buy back debt… Yes, but in my estimation this will be insignificant vis-a-vis the debt to GDP ratio and its explosive path.Greeceis in meltdown. Just look at its share market, its real estate market, or any other market. So it is not a very good idea to try to sell off the few remaining assets the Greek state has in a falling (and indeed failing) market. The revenues from this fire sale will be low. The strategy to buy back debt with these lowly revenues is a highly questionable strategy, especially in view of the realistic prospect of a future haircut.
You have another approach. You suggest that the ECB should buy €133bn, which corresponds to 40% of the Greek debt, and issue its own euro bond to much lower interest rates. With this Greece would have to pay much lower interest rate, because the ECB’s credit rating is much higher than the one of Greece. Do you believe this would resolve the problem? Yes I do. But, and let me be clear on this, the proposal you are referring to (we refer to it as the Modest Proposal) is not merely a proposal for resolving the Greek crisis. It is, rather, a proposal for ending the eurosystem’s crisis and, indeed, for redesigning the euro’s architecture. I strongly believe this is the only alternative to avoid the breakdown of the euro. The wayGreeceis going, along with the rest of the periphery, the whole euro system will collapse with it. I see no end in sight of this domino effect. The Greek situation will worsen, the loansGreecewill get will be wasted on repayments that resemble a Sisyphean task: in short, the debt to GDP ratio will keep rising. At some point Germany will cease financing the Greek state. Then the immanent default will push Greek banks into bankruptcy. In turn this will lead to a whole cascade throughoutEurope. Eurozone banks will begin to feel the strain, the spreads of Spanish sovereign bonds will exceed 8%, 9% or even 10% andSpainwill prove, as they say, too big to save.Germanywill not pick up the huge bill to save, singlehandedly, the whole euro-system and will rather choose to bail itself out (by reconstructing its own currency). This is my prediction, assuming that Europe continues to walk on the present path.
What is the alternative? The problem is that we have three crises going on at once. We have the banking sector crisis, we have the sovereign debt crisis and a crisis of severe under investment in the majority of the eurozone countries. We need to address these three issues at once. Because trying to resolve one leads to the worsening of the situation in one of the other two realms. It is a little like the mythical Hydra: Unless you cut off all its heads at once, and you attack them one at a time, they will grow back more menacing than before.
How do you want to do that? Starting with the banks – the EU has no policy to deal with the banking crisis, because the surplus countries’ governments refuse to acknowledge that there is a banking crisis and that many banks are insolvent. To strengthen the banks they have to be recapitalized, something that existing shareholders of course reject and struggle against. For this reason, they must be forced to accept recapitalization so that they stop operating like Japanese style zombie banks totally dependent on the ECB for their liquidity. This recapitalization could be effected by the European Financial Stability Fund (EFSF) which will take shares from these banks, in exchange. Instead of throwing good money after bad by lending toGreece,Portugaland others, the EFSF should use its funds to recapitalize the banks, cleanse them in a short space of time and, soon after, sell the shares it holds (at a profit even). This would energize the banks, strengthen the financial system and cost the European tax payer absolutely nothing.
What would happen to the debt, under your proposal, if the EFSF deals with the banks, as opposed to the debt problem that it was set up to address? The debt crisis cannot be dealt with by means of loans, from the EFSF or from anyone else. Insolvency problems cannot be solved by pouring (expensive) liquidity on them. Here is our proposal of what ought to be done: The debt of the member countries should be divided into theMaastrichtcompliant part, which is up to 60% of GDP and the rest, which is above this limit. The first part, which is Maastrich compliant, should be then transferred to the ECB. What does this mean? It means that the ECB does not buy the bonds of the member-states but, instead, takes these bonds on its books and undertakes to service them on condition that the member-states repay the ECB, to the full, but in the long run. For that purpose, the ECB opens a debit account for each participating member-state (our idea is that participation in this debt-transfer or debt-conversion scheme is purely voluntary and open to all member-states; Germany included). And how does the ECB service the member-state bonds that have been transferred to it? Not by printing money but, rather, by issuing Eurobonds (guaranteed by the ECB itself, as opposed to by the triple-A member states) which are then floated in the international money markets. The ECB, with its solid reputation, would be able to borrow at no more than 3%. In turn, the member-states will begin repaying their debt to the ECB over a period equal to the maturity of the ECB eurobonds and at an interest rate just above that of the ECB’s eurobonds. Thus the aggregate European debt will deflate. Immediately the spreads withinEuropewill shrink considerably. Even basketcaseGreecewill be able to roll over its remaining bonds at no more than 6% (compared to the 15+% the markets demand of it now). The debt crisis would be over.
Also for Greece? ActuallyGreecewould still have a problem, because Greece’s debt exceeds 155% of GDP.Greecewould need additional medicine, which could come in a particular way. Most of the Greek debt is in the hand of Greek banks, which are effectively bankrupt. They will have to be heavily recapitalized through the EFSF and supported further by the ECB’s liquidity. Here is how this could happen: When Greek bonds that the Greek banks hold, previously transferred onto the ECB’s books, mature, the Greek banks will go to the ECB (like all bondholders) to cash them in. At that point, the ECB can say to them: Unlike other bond holders, you are being kept alive by our extraordinary liquidity provisions. To continue the latter, you must adhere to the following two conditions. First, you must accept more capital from the EFSF (in exchange for another swathe of your shares) and, secondly, you will swap all the remaining Greek bonds you hold (and which were not part of the tranche transfer to the ECB) for new ones of a fraction of the older ones’ value and with much longer maturity. This would amount to a haircut, but a very selective haircut and only for formerly bankrupt banks. (Note that the credit rating agencies cannot see this as a credit event because, in effect, it constitutes no more than a concession by a bankrupt firm so that it can be bailed out.) Coming to the third point – the dearth of investment throughout much of the eurozone: Europe, and especially the periphery, need more investment to become competitive with other regions and continents and, of course, to exit the crisis through strong growth. This is where the European Investment Bank (EIB) can come in and play a decisive role. Note that, compared to the World Bank, the EIB has double the capacity to finance investment projects. The major problem, which ties the EIB’s hands at the moment, and stops it from aiding Europe to get out of this crisis, is the stipulation on its charter that 50% of every investment project must be financed by the member country, where it will be invested. However, the member states in the periphery can not finance anything right now. This problem could be solved by putting to good use the debit account that each member-state will by now have with the ECB (see above, in the context of the partial debt transfer to the ECB). How? The ECB would co-finance these projects by (a) additional issues of eurobonds and (b) by charging them to the debit account of the country in which the project is to be realized. This small change would unleash the investment powers of the EIB and re-energize the European economy.
Why has your idea not been realized by now? Three reasons: The first I refer to as institutional inertia (or conservatism). Many colleagues and politicians protest that the Central Bank cannot play the role we suggest it ought to. That it is not its business to issue bonds and partake of fiscal policy. That this is the job of some pan-European Treasury. My reaction to this objection is that the ECB is a unique central bank in that it has not counterpart in some Federal European Treasury. This, in fact, is a major cause of the current euro crisis. There are two things Europe can do in response: One is to create the missing Union Treasury (with powers to tax, borrow and spend). [Alas, there is no way that Europeans will agree to this (within a decade or so) and, in any, case such a development requires a radical change in Europe’s Treaties and institutions (a political and logistical nightmare).] But there is another way: the one we are suggesting. The ECB’s exceptionalism (the lack of a Treasury counterpart) can be addressed by means of the small innovation we are suggesting – allowing the ECB to issue eurobonds etc. etc. The fact that no other Central Bank does this is neither here nor there. [In fact, as Professor Sinn has made clear, the ECB is presently forced to run fiscal policy by having, for instance, the German Central Bank finance, indirectly, the Greek state!] Europe embarked on a unique course when it decided to bind its economies monetarily, but not fiscally. It must now innovate again, doing something that has never tried before it order to save the currency union it created only a decade ago. The second reason is what I call coordination failure: When I speak to politicians (outside of Greece) they all tell me the same thing. If the finance minister ofSpain or ofItaly would support openly this idea, the spreads of this particular country would go through the roof, because the money markets would consider this statement as a sign of weakness. Similarly with bankers: If a banker comes out openly in favor of this plan, the shares of his bank will go through the floor, because the financial market will assume that the bank is facing difficulties. This is, what we call, a typical coordination failure: All would be better off if a common decision could be reached and announced at once, yet no one dares propose it individually. It is a clear case of the lack of political leadership and coordination at the centre of Europe. The third reason is the political value of the surplus countries’ exit option: Presently, the German Chancellor enjoys a fantastic degree of authority (within the European Council) courtesy of the fact that everyone knows that the surplus countries (Germany, Austria, Finland and the Netherlands) are the only ones that can get out of the euro, if they wish (despite the hefty costs that such an exit will bring to them). This exit option boosts Mrs Merkel’s bargaining power, and her power to set Europe’s agenda, no end. By agreeing with our proposals (e.g. the creation of common debt via the issue of eurobonds) Germany is, in essence, giving up its exit option, and with it its extraordinary political privilege. It is, in this sense, understandable that the surplus countries are reluctant to adopt this proposal. [In contrast, Greece and the other debt stricken countries cannot get out of the Euro, because announcing that they want to get out would lead to a massive outflow of capital. And ifGreece would try to get out,Ireland would have to introduce capital controls, a measure, which is not compliant with a monetaryUnion. The situation would be different, ifGermany announced, it intended to get out. Then there would be a capital inflow. So this situation increasesGermany’s influence and power within the EU. If our plan was to be accepted,Germany would lose this exit option because once you have common debt, which would be the case when the ECB issues eurobonds, you cannot assign a particular portion of the debt to a single euro member state. It is the reason why California could never leave the ‘dollar zone’.]
But it should be possible to overcome this failure? Yes. When the Crisis reaches the stage when the euro is at a critical juncture, and Europe must choose between something like our proposals and disintegration, I trust and hope that the current impasse will be overcome. But even then, the only way to implement proposals like the ones presented here would be to announce this plan in a coordinated way by the EU, the ECB and the major European banks. Then the spreads would go down instantly and all shares would rise. Unfortunately Europe is cacophonous. In the United States President Obama, Fed-Chairman Bernanke and Secretary of the Treasury Geithner get together on a Sunday afternoon and announce their plan a few hours later, before the markets open inAsia. This is not possible inEurope.
Getting back to the situation as it is now. Do you think that a default will be avoided? There is no way a Greek default can be avoided. It is only a question of how it will be referred to (Europe is now busily inventing new euphemisms for default). My models (simulations based on macroeconometric models that are in turn based on reasonable and uncontroversial assumptions) show that in the best of all cases (i.e. even if the recession ends this year and then growth of 1% is established next year and then 1,5% from then on; even if the privatization program yields €15bn this year, €15bn next year and €10bn in 2013 an again €10bn in 2014; even if all public spending is curtailed according to plan – which is, in truth, ‘science fiction’ scenario) the debt to GDP ratio will begin to rise fast after 2017, eventually topping 200%. So, unless some comprehensive solution is applied (and we have proposed just one such solution),Greecewill have to default, with all this means for the rest of the eurosystem.
What will be the most likely outcome? It is very hard to say, because one has to predict how politicians will decide. I believe they will try to buy time muddling through and in about one year there will be a major haircut of Greek, Irish and Portuguese debt. Whether this strategy will avert a cascade of failures that leads to the eurosystem’s disintegration is a matter of personal judgment. My expectation is that Europe will be forced to change track, if it wants to salvage the euro project.