William K. Black, Quito: July 6, 2015
If you want to know why economic policy has gone insane in the UK you simply have to read the work of the BBC’s “Economics editor,” Robert Peston. I showed one example of his failed effort to terrify the Greeks into voting “Yes” in favor of continuing the self-destructive policies that have forced Greece into worse-than-Great Depression levels of unemployment in my most recent column. Peston argued that the Greeks had to submit to the troika’s demands that it make these policies even more economically illiterate and self-destructive because the troika would otherwise ensure that Greece’s economy was “utterly crippled.” As you know, the EU stands for “ever closer union.”
But Peston has been moved to new depths of propaganda and rage by the Greek “No” vote. In his July 6, 2015 column entitled “Huge costs of Greece staying in or quitting the euro” he lies by commission and omission. I’ll begin with his deceptive description of the ECB, which provides a “target rich environment.”
As for the ECB, it does not wish to be seen as Greece’s Judge Dredd. It will take its lead from any statement by eurozone government heads on whether there is a realistic chance of a new deal to rescue the finances of the ailing Greek state.
This would be an excellent opportunity for the “Economics editor” of one of the world’s top publications to bring economic facts to bear. The ECB is the EU’s central bank. A key role of a central bank is to provide liquidity to its banks – which include the Greek banks. The ECB, in response to the Greeks daring to vote democratically on whether to succumb to the ECB’s blackmail, pulled the provision of liquidity to Greek banks. So, the principal starting point of any analysis of the ECB’s role is to know that they deliberately refused to meet their responsibility to provide liquidity to the banks in order to extort the Greeks to exacerbate policies that ensure that the troika will increase the harm to the Greek people and economy rather than “rescue the finances of the ailing Greek state.”
The “Judge Dredd” metaphor is a bit over the top. The troika’s policies are causing unnecessary deaths in the eurozone through suicides and degrading health care, particularly in Greece, but the ECB does not want to execute the Greek people – it wants them as low-wage laborers that can raise the profits of large EU corporations. The ECB wants to extort them to adopt three neoliberal policies that would greatly reward wealthy foreigners. The ECB wants the Greeks to continue to lower their wages, continue to gut their increasingly oxymoronic “safety net,” and sell Greek assets such as its islands and infrastructure at fire sale prices to wealthy foreigners. Forty-five percent 45% of Greek pensioners are in poverty – after receipt of their grossly inadequate pensions – and the troika is demanding further pension cuts. In the U.S., we call this “cat food” policies because prior to increases in Social Security support that occurred only a few decades ago many elderly Americans dependent on Social Security were in such deep poverty that they were reduced to eating cat food to survive. The troika openly endorses scandalous “cat food” policies.
But there is a more basic problem with Peston’s “Judge Dredd” metaphor – the Greek people are not vicious criminals leading a reign of terror worthy of execution. Indeed, the ordinary Greek citizen has committed no crimes or even done anything “immoral.” The only moral content to the Greek disaster is the indefensibly immoral treatment of the peoples of the EU by the troika’s leadership. (Ok, there is also a question of journalistic ethics, but no one is holding their breath waiting for that to reemerge.)
What Peston carefully hides from his readers is that this is simply another case of what we have seen tens of thousands of times in the last decade. A whole bunch of CEOs of EU banks (primarily German and French), solely on their own initiative, made enormous bad loans, mostly to private Greek banks that cater primarily to the wealthy.
These loans from foreign EU banks to Greek banks rarely took the form of insured deposits. (When we make a deposit in a bank we are making a loan to the bank.) Instead, the CEOs overwhelmingly chose to make uninsured and unsecured loans to Greek banks and companies. The CEOs made this decision for the reason they invariably make this decision – the quest to be made wealthier through higher yield. The riskier and the larger the loans they made to the Greek banks and companies, the higher interest rate the foreign EU banks charged, the higher the (fictional) “profits” they reported, and the higher the compensation the CEOs and officers of the foreign EU banks received.
I emphasize a critical point here that most banking “experts” ignore. It is common for the CEOs of the lenders to agree to lending terms in which the interest rate on the loan is higher than the banks’ typical yield on a loan – and for that “spread” still to be grotesquely inadequate relative to the true risks of making the loan. The resultant paradox is that the worse the underwriting (and underwriting is the first foundation of prudent, honest banking), the higher the (fictional) nominal yield, the higher the (falsely) reported profits, and the greater the bonuses to the elite bankers in the near term – and the greater the true losses that will only be recognized in the longer term.
Jamie Dimon, JPMorgan’s CEO, almost stated the fraud recipe correctly in his March 30, 2012 letter to shareholders: “Low-quality revenue is easy to produce, particularly in financial services. Poorly underwritten loans represent income today and losses tomorrow.”
The precise statement is that “poorly underwritten loans represent fictional income today because lenders engage in accounting fraud to avoid establishing the necessary allowance for loan and lease losses (ALLL) provision that would demonstrate that the loan was actually made at a loss.” Loss recognition can be (improperly) delayed for years, particularly under the fraud-friendly IFRS standards that EU banks successfully lobbied to create. IFRS bans the creation of the ALLL. To complete the logic loop, the unlawful (under GAAP) recognition of “income today” leads to a “sure thing” that will promptly make the controlling officers far wealthier.
“Liar’s” loans provide a good example of this seeming paradox that more Americans are familiar with. The typical “liar’s” loan borrower paid not only a higher stated interest rate, but also a hidden “yield spread premium” (YSP) that meant that the supposed base “market” interest rate that was the starting point was materially inflated over the actual market interest rate. The combination meant that bankers (falsely and criminally) reported substantially increased yields on their fraudulently originated liar’s loans and their fraudulent sales of those loans to the secondary market. These fraudulently “profits” produced very real bonuses. As large as the nominal premium yield was on liar’s loans (relative to honestly originated, prudent loans), however, it was fictional because of the massive losses inherent in the massive fraudulent origination of loans.
The way this paradox played out in Greece proved devastating. There was little realistic prospect of the Greek banks and companies being able to repay these loans to the foreign EU banks. Some of these foreign EU bank CEOs were merely incompetent and some were simply following the “recipe” for “accounting control fraud.”
Far fewer of these foreign bank loans went to the Greek government, but those loans compounded what prudent and honest bankers refer to as the (imprudent and dishonest foreign bankers’) “over exposure” to Greece. This is simply our old friend in banking – the need to diversify rather than concentrate risk. Diversification is the second of the two paramount requirements for sound and honest banking. The CEOs of the foreign EU banks that made the largest loans to Greek banks, corporations, and governmental entities violated both of the fundamental pillars of prudent and honest banking.
The neoliberal “modern finance” theories such as the “efficient market hypothesis” are premised on lenders providing “private market discipline.” That, in turn, is premised on the assumption that when lenders make bad loans (whether for reasons of fraud or incompetence) they will suffer the resultant losses rather than being bailed out. The troika, however, while purporting to be neoliberal, is actually an old-fashioned means of bailing out German and French banks that make bad loans. The troika, therefore, partially bailed out Greek banks to prevent their foreign EU bank creditors from suffering losses. The troika’s bailout was deliberately not made large enough to actually restore the Greek banks to solvency, much less health. The goal was simply to get them enough cash that they would continue to repay their primarily French and German bank creditors.
The proverbial bottom line is that the CEOs of the French and German banks, in their quest for personal wealth, caused “their” banks to make over $100 billion in bad loans primarily to Greek banks and corporations. In the normal business world, the French and German banks would have suffered severe losses. The troika, however, is run by and for the EU’s most powerful bankers, so the result instead was an EU bailout of (primarily) French and German banks.
If the CEOs of these largely French and German banks who made the massive bad loans to Greek entities had not been able to call on the troika as an extortionate debt collection agency and source of a partial bailout they would have done what normal creditors do every day when larger corporate borrowers are unable to repay the loan. They would have cut their losses by entering into a troubled debt restructuring (TDR). TDRs are not inevitable, but they are negotiated as a matter of routine in the commercial sphere when debts are unsustainable. But because the CEOs of the largely French and German banks can call on the troika to extort the Greeks and provide a partial bailout of the Greek banks’ debts to the foreign banks they have done so. The BBC presented a chart on the same day as Peston’s article showing that French and German banks have, through the bailout and troika’s extortion, largely eliminated their loss exposure to Greek bank debt.
The proverbial “bottom line” is that the troika has never sought to “rescue the finances of the ailing Greek state.” The troika’s paramount goal, which it has achieved, was to “rescue the finances of” the (originally) largely French and German banks’ who made over $100 billion in bad loans to (primarily) Greek banks and corporations, but also Greek government entities.
The BBC Sponsors a Myth about Ireland that Reverses Reality
Having gotten the basics of banking and the crisis wrong, Peston now careens into a whole passel of new lies.
So the fate of Greece lies firmly where it always did, in the lap of the German Chancellor, Angela Merkel and her fellow heads of government.
And here is the horrendous analysis of costs that they need to make.
They can allow themselves to be humiliated and write-off up to half of the €200bn odd of bailout finance they’ve provided to Greece since its debacle crystallised at the end of 2009 – and thereby provide a sounder financial basis for Greece remaining in the euro.
That would be viewed as the equivalent of a plate of cold sick by the administrations of Portugal and Ireland, inter alia, who were never offered such absolution for their spendthrift and reckless ways. And many German voters would fail to understand why Mrs Merkel was apparently throwing a jumbo jet of good money after bad.
Note that the BBC’s “Economics editor” has implicitly conceded that the issue isn’t economics, but the political survival of European heads of state who have inflicted the catastrophically harmful policies of austerity and refusal to do TDRs on the peoples of Europe. The new Greek government must not succeed in showing the eurozone a more humane and economically literate way forward, for if it does so the politicians in other nations who gratuitously caused such great suffering through economic malpractice and their ideological assault on eurozone workers would be instantly discredited and would soon lose power. These leaders cannot admit what economists have been overwhelmingly saying since 2008 about the self-destructive nature of austerity as a response to a Great Recession, for if they do so they will be “humiliated” politically.
But note that Peston invents a myth about Ireland. Peston claims that the leaders of Ireland were “never offered such absolution for their spendthrift and reckless ways.” What that means is that the troika never offered Ireland debt forgiveness for what Peston claims were its “spendthrift and reckless” debt levels. “Reckless” (or criminal, pursuant to the “recipe” for “accounting control fraud”) is an apt word to discuss the behavior of the Irish bankers and the CEOs of the overwhelmingly foreign EU banks that lent scores of billions of dollars to those Irish bankers on an unsecured and uninsured basis in order to book a higher (fictional) profits and “earn” higher bonuses.
Inconvenient Admissions about Ireland from the Troika
The Irish government was the triumphant poster child of neoliberal policy prior to the crisis. I explained in a prior article four years ago that ECB President Jean-Claude Trichet came to Ireland and claimed in his May 31, 2004 speech in Dublin that new EU entrants should use Ireland as their model. Here are the relevant excerpts. Note that rather than being “reckless” in its debt levels even at the time Trichet spoke during the raging twin Irish real estate bubbles (housing and commercial), Trichet stressed that Ireland was the very model of the opposite policy.
Trichet cited Ireland as his definitive proof of the correctness of the two main point of his talk. The substance of these points is a staple of the stump speech of every Republican candidate for the presidency in the U.S. The first priority is to deregulate.
“[O]one has to consider the astonishing experience of Ireland, which recovered from poor economic and fiscal conditions in the mid-1980s to an impressive pace of economic activity and sound fiscal position in no more than a decade. In addition to a favourable macroeconomic environment and the benefits derived from participation in the European Union, the economic recovery was grounded on far-reaching home made structural reforms in the labour, capital and product markets.”
The second priority is to cut government spending. Ireland has done both and is the Celtic Tiger because it has followed both policies.
“In this respect, the dramatic acceleration of output in Ireland in the post 1987 period can be associated with a vigorous and successful project of fiscal consolidation starting in 1987. This programme was based on tight expenditure control via subsidy cuts, social security reform and a streamlining of the public sector and control of public expenditure.
Ireland’s experience … clearly shows how policies geared to fiscal consolidation do not necessarily entail contractionary effects on real aggregate demand and economic activity. [I]in spite of the tightening policies undertaken, the rate of growth showed a significant increase in relation to previous years. [S]ignificant budget consolidation based on spending reduction enhanced the long term fiscal sustainability and increased the policy credibility of a more favourable tax regime.
Regarding Ireland, the budget deficit was reduced from 10.1 % of GDP in 1986 to 1.7 % in 1989, while the debt ratio declined from 113 % of GDP to 100.4 % of GDP; over the same period GDP growth accelerated from 0.3 % to 6.2 %; the overall consolidation effort, as measured through the structural fiscal balance, amounted to 5.1% of GDP over these three years. In the years afterwards, Ireland continued to enjoy high rates of GDP growth and kept large structural fiscal surpluses (almost always above 5 % of GDP), thus allowing for a steady and rapid decline of the debt ratio (which reached 32.4 % of GDP in 2003).
The Irish and Danish experience brings evidence that expansionary expectation effects may dominate on the contractionary effects of a fiscal consolidation. In both cases there is a considerable evidence that the consumer boom was prompted by the wealth effects of cuts in public spending, as a signal of lower future taxes, concomitantly to the wealth effects implied by the fall in interest rates. On the supply side, a low tax environment has underpinned the pick up in economic activity in Ireland.”
His substantive introduction was that all was mostly well. “Economic and Monetary Union has been highly successful in fostering macroeconomic stability in Europe.” The euro and financial integration were unambiguously stabilizing.
“Finally much progress has been achieved in capital market reforms, not least due to the introduction of the euro. But the further integration of national capital markets towards a truly European financial market could make an even more important contribution to safeguarding against country-specific shocks. It would also result in greater availability of risk capital – particularly for innovative enterprises – and, more generally, in a reduction in financing costs for productive investments. Structural reforms in capital markets should aim to allow a more effective allocation of savings toward the most rewarding investment opportunities. Further efforts should also be made to promote foreign investment in the euro area in order to attract additional capital and promote a greater transfer of technology.”
The EU Growth and Stability Pact prevented contagion within the EU: “fiscal discipline prevents spill-over effects from one country to another in the form of higher interest rates.”
Note that Trichet framed lower interest rates as unambiguously favorable – they would prompt greater productive investments. Freer capital flows would move investable funds to their most productive uses. Indeed, he repeated this point for emphasis:
“Beyond these economic underpinnings, other considerations are worth mentioning: a fiscal policy set according to rules adds to macroeconomic stability by providing agents with expectations of a predictable economic environment; this reduces uncertainty and promotes longer term decision making, notably investment decisions, and economic growth; in addition, sound fiscal policies contribute to lower risk premia on long term interest rates and thus support more favourable financing conditions….”
Regulation played no favorable role. Trichet only non-hostile reference to it was extremely vague: “Moreover, Ireland developed a transparent regulatory framework.” In reality, Ireland had an opaque, wholly ineffective anti-regulatory framework for financial regulation.
In addition to his ode to Ireland’s deregulation and financial miracle, Trichet provided an ode to the euro.
“Moving to the second topic of my speech, i.e. fiscal policies, let me stress that we Europeans have been very bold in creating a single currency in the absence of a political federation, a federal government and a federal budget at the euro area level. Some observers were indeed arguing that without a federal budget of some significance the policy mix would be very erratic, depending on the random behaviour of the different national fiscal policies of the member countries. They were also arguing that without a federal budget it would be impossible to weather, with the help of the fiscal channel, asymmetric shocks hitting one particular member economy. In this respect, the very existence of the Stability and Growth Pact actually allows to refute these two arguments: first, the Maastricht Treaty and the Pact provide a mutual surveillance by the “peers”- i.e the Ministers of Finance – of national fiscal policies; second, by calling upon Member States to maintain their budget close to balance or in surplus over the medium term, the Pact allows the automatic stabilisers to play in full in countries facing an economic downturn, without breaching the 3 % ceiling for the deficit.”
“Bold” is one word to describe creating the euro without creating the conditions vital for weaker EU members to escape simultaneously from a sovereign debt crisis and a severe recession. Other, blunter terms come to mind. Each of the safeguards he asserted has failed in this crisis.
But Trichet had a fallback position – cut taxes and the national deficits and cause a supply-side boom. He used the term “fiscal consolidation” as a euphemism for a wave of budget cuts, particularly in entitlements such as care for retirees.
“Some people argue that fiscal consolidation is detrimental to demand and economic activity. I would maintain that wealth and expectational effects of well-designed consolidation programmes might very much reduce and possibly even outweigh the traditional Keynesian multiplier effects of fiscal policy on demand and activity. If fiscal consolidation is perceived by the private sector as a credible sign that public spending will be permanently lower in future years, households will revise upwards their expected permanent income in anticipation of lower future taxes. Therefore, current and planned consumption will also increase.
In addition, fiscal consolidation might improve long-term financing conditions by way of less demand on the savings pool (reducing crowding out) and lower risk premia on government paper. Hence, wealth effects prompted by lower nominal and real interest rates would support larger consumption. Furthermore, following more favourable financing conditions, private investment is also likely to increase.
The case for expansionary effects on the supply side, via an improved competitiveness of the economy, is also important. If fiscal consolidation can induce moderating effects on wage demand, relative unit labour costs might decrease, with positive medium-term effects on real GDP growth through a greater competitiveness of the productive sector. Such effects are buoyed if lower expected tax rates and more efficient public expenditure enhance the working incentives and the investment environment.”
If the Tea Party knew Trichet better they wouldn’t be so dismissive of the French. He didn’t use the rising tide metaphor, but he got the substance of the message – deregulation makes “everybody” better off.
“The successful implementation of structural economic and fiscal reforms requires significant and tireless efforts of explanation, pedagogy and adequate public communication. Over time, everybody will benefit from more growth, employment and opportunities. These gains from reform are often overlooked in the public debate. In fact, there is a formidable challenge to gain the support of public opinion for implementing structural reforms.”
Trichet finished off with another swing at Keynes, using Ricardo as his hurley.
“What are the implications in the current economic environment? Fiscal imbalances are quite significant in a number of EU countries with deficits and public debt ratios being too high. For these countries, there are solid economic reasons to argue that credible fiscal consolidation would boost growth in net terms, the so-called “Ricardian” effect being more important than the “Keynisian” effect. Reducing such imbalances is likely to have positive expectational effects of a more favourable tax regime and better financing conditions in the future.
Moreover, we would probably all agree that tax and spending ratios in some countries are too high and unfavourable for investment and economic dynamism. Expenditure-based fiscal consolidation and reform that would credibly reduce disincentives to work, invest and innovate could have significant confidence effects even in the short run.”
Cato’s Ode to Ireland’s Neoliberal Policies
In a 2007 article entitled “It’s Not Luck” – written after the Irish property bubble had begun to collapse – Cato (a neoliberal cult posing as a “think tank”) praised Ireland and Iceland as proving the wisdom of Cato’s support for large tax and public spending cuts.
“Iceland’s economic renaissance is an impressive story. [S]upply-side reforms, along with … privatization and deregulation, have yielded predictable results. Incomes are rising, unemployment is almost nonexistent, and the government is collecting more revenue from a larger tax base.”
Cato described Ireland (in 2007) as an unqualified success as a result of tax and government spending cuts.
“[Ireland] boasts the fourth highest gross domestic product per capita in the world. In the mid-1980s, Ireland was a backwater with an average income level 30 percent below that of the European Union. Today, Irish incomes are 40 percent above the EU average.
Was this dramatic change the luck of the Irish? Not at all. It resulted from a series of hard-headed decisions that shifted Ireland from big government stagnation to free market growth.”
Cato (2007) argued that austerity was an essential policy for prosperity.
“After years of high inflation, double-digit unemployment rates, and soaring government debt that topped 100 percent of GDP, Irish policymakers began to cut spending in the late 1980s in a desperate bid to recover financial stability.” Cato 2007
Cato (2007) singled out Ireland’s savage cuts in corporate taxes as “the key” to its success.
“Ireland has steadily reduced its tax rates. The top individual income tax rate was cut from 65 percent in 1985 to 42 percent today. The capital gains tax rate was cut from 40 to 20 percent in 1999.”
However, the key to Ireland’s success has been its excellent tax climate for business.”
“In 1980, Ireland established a corporate tax rate for manufacturing of just 10 percent. That low rate was subsequently extended to high-technology, financial services, and other industries. More recently, Ireland established a flat 12.5 percent tax rate on all corporations — one of the lowest rates in the world, and just one-third of the U.S. rate.”
Cato (2007) specifically endorsed Ireland’s business tax cuts for sparking an international “race to the bottom” of corporate income taxation.
“The Irish model of rock-bottom business taxation has been hugely influential. In recent years, corporate tax rates have been slashed across Europe. [T]he average rate in the EU has fallen from 38 percent in 1996 to 26 percent in 2006.
Inspired by the Celtic Tiger, many Eastern European nations have … installed both low corporate taxes and simple, flat-rate taxes on individuals.”
Cato (2007) took a much more radical position than the Washington Consensus, which had admitted that governments should spend on education, health, and infrastructure. Cato took the position that Ireland had proved that there was no particular reason for a Nation to educate its workers because it could import skilled workers that other nations had paid to educate.
“It’s become fashionable to argue that increased government spending on education is the key to success for countries like Ireland. I’m skeptical. For one thing, booming economies today can attract high-skill workers from global labor markets. In Ireland, brain drain has been replaced by brain gain as smart people from across Europe are drawn into the country’s growing industries.”
Cato (2007) bemoaned the failure of the United States to copy Ireland’s policy of slashing business taxation despite the “competition spurred by globalization.”
“Economic growth is spurred by attracting entrepreneurs and investment capital. Countries do that by establishing the rule of law, stable money, open borders, and low taxes. Let’s call these the ‘rainbow’ factors, since Irish legend says that there is a pot of gold at the end of the rainbow.
The good news is that with the competition spurred by globalization, the leprechauns are on the defensive. As more countries follow the path of the trailbrazing Irish, the relationships between the rainbow factors and growth become ever more clear.”
Peston Doesn’t Want You to Recall How Ireland’s Debt Load Became Immense
The Irish government committed one of the most destructive “own goals” in history when in response to its banking crisis and fraud epidemics it decided to bail out the EU creditor banks that had made massive bad loans to the worst Irish banks that were rapidly collapsing due to scores of billions of dollars in losses on their real estate loans. Again, the key is to understand that the CEOs of the foreign EU banks that funded the massive expansion of the failing Irish banks did so largely by deliberately making vast amounts of unsecured and uninsured loans to the worst Irish banks that had no ability to repay those loans. Again, the reason the CEOs did this was to be able to (improperly) report higher profits and secure larger bonuses that would make them wealthier. The CEOs of the foreign EU banks that provided the loans that funded the massive growth of the worst Irish banks consciously chose to cause “their” banks to chase greater yield in a manner that exposed the banks to immense losses should the worst Irish banks fail catastrophically. The probability that the worst Irish banks would fail catastrophically was extremely high because they followed the accounting control fraud “recipe” in their lending and because they grew so rapidly that they hyper-inflated the twin Irish real estate bubbles (relative to GDP) more than any developed nation.
As the worst Irish banks were, inevitably, suffering catastrophic failures, however, the Irish government adopted the economically insane policy (see my testimony before the Irish parliamentary inquiry commission) of providing those banks’ largely foreign EU bank creditors an unlimited guarantee against loss. The Irish government had zero legal or moral responsibility to bail out bank creditors who knowingly chose to receive a (nominally) higher yield in return for assuming the risk of enormous losses should the worst Irish banks that they chose to lend to fail. The Irish government’s attempted bailout of foreign EU bank creditors instantly transformed a banking crisis into a debt crisis of crippling proportions. There was no way that the Irish government could pay those debts to the foreign EU bank creditors. That, in turn, would have forced the foreign EU banks to recognize massive losses that would have made clear that the foreign EU banks had deeply inadequate capital or were even insolvent. The troika, therefore, announced a bailout of Ireland that was a thinly veiled means of bailing out the large EU banks that had made the terrible loans to the worst Irish banks.
So, if the BBC wishes to use the word “reckless” to describe Ireland’s debt, it can only mean (logically) that Ireland acted in a “reckless” manner when it gratuitously sought to bail out foreign EU banks. But that is not, of course, how Peston used the term. He is well aware of the facts I have spelled out. He consciously sought to mislead his readers into believing that Ireland caused itself a debt crisis because it took on “reckless” amounts of public debt in order to fund the safety net.
Peston is simply the latest proof of the adage that lies beget lies. Which raises a key question: why is the BBC deceiving its readers about Greece and Ireland and their bank creditors? Remember, the norm is that banks should suffer severe losses when they lend fraudulently or incompetently. Why in the case of the EU is it considered outrageous that creditors will suffer losses when they knowingly make loans to borrowers who are very likely to default?