The Europe debate

By Felix Salmon
April 10, 2012
Munk Debate looks set to be simply depressing.

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Remember the Krugman vs Summers debate last year? That was fun, in its own way. But this year’s Munk Debate looks set to be simply depressing. The invitation has the details: the motion is “be it resolved that the European experiment has failed”. And I’m reasonably confident that the “pro” side — Niall Ferguson and Josef Joffe — is going to win.

That’s partly because Ferguson has the public-speaking chops to dismantle his meeker opponents, Peter Mandelson and Daniel Cohn-Bendit. Ferguson is likely to go strongly for the jugular, while Mandelson and Cohn-Bendit will noodle around ineffectually, hedging their conclusions and sacrificing rhetorical dominance for the sake of intellectual honesty.

You can see this, already, in the invite. Each speaker is introduced with a one-liner; Ferguson says that Europe is conducting “an experiment in the impossible”, while Mandelson says that Europe is, um, “getting there” and that the world is “very impatient”. Cohn-Bendit is weaker still: his quote, “We need a true democratic process for the renewal of Europe, in which the European Parliament has to play a central role,” seems to imply that Europe really is doomed, since there’s no way that the European Parliament is going to play a central role in anything, except perhaps an expenses scandal.

It wasn’t all that long ago that public intellectuals could make a coherent case that European union, both political and monetary, was and would be a great success story. In the wake of Greece’s default, however, and credible beliefs that Portugal is likely to follow suit, disillusionment and pessimism is the order of the day. The era of great European statesmen is over; in their place, we have David Cameron.

I was a believer in the European experiment; indeed, I thought it had a kind of grand historical inevitability to it, and that a strong whole could be made up of vibrant and disparate parts. And from a big-picture historical perspective, Europe is indeed a success: a bloody and war-torn continent has transformed itself into a political union where it’s unthinkable and impossible for one member state to invade another. But if by “the European experiment” we mean the euro, that’s been a disaster, and virtually everybody in Europe would have been better off had it never existed.

In this, curiously, the broad European population was much more prescient than the educated and political elites, who in large part imposed the euro on their unthankful and unwilling countries. Mandelson is a key member of that elite, and he was wrong about the euro and about the advisability of the UK joining it. It’s going to be very hard indeed for him to persuade an audience of Canadians that this time he’s right. Or, for that matter, that they should in any way welcome the prospect of a monetary union with Iceland.


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Fox, not name calling, just pointing out that if we aren’t in it together, we stand alone; Neanderthals were supposedly just as intelligent (if not more so) than Homo sapiens and were certainly stronger but lived alone. The strongest dominated their territory, the weak died out. Yet where are they now? Homo sapiens’ love of the group over that of the individual ensured they survived and the individually stronger Neanderthals died out.

As I keep saying, it isn’t a matter of things just being black and white; when multiple factors are involved, multiple players are both strong and weak at the same time, and the other players may need them for their own survival at a later time so just letting them fall is not always a good solution. Plus a lot depends on whether we are talking about corporates or individuals.

The US has a history of favouring the corporation, in Europe we favour the individual. This is clear when you look at the different responses to the housing bubble (which didn’t really exist for most of Europe, mostly the UK and Spain). In the UK, nobody ended up homeless, in the US thousands did.

Posted by FifthDecade | Report as abusive

@TFF – you wrote – “The other answer (the path they are currently on) involves … feeding the banks cheap cash and waiting until they recapitalize themselves through their profits.* And that isn’t a terrible solution either.”

It’s a terribly unjust solution, TFF. Taxpayers are “gifting” those profits that dribble-in over time to banks, and getting zip in return; while the same crew of criminals keeps lining their pockets from the booty, like Blanstein’s $12Mil last year. That doesn’t happen under Northern Rock. The current process serves to drag-out the resolution of the housing matter for possibly decades – that’s not really a good thing, even if it’s paper-over by fictitious accounting on bank balance sheet. It does, however, have one irresistible virtue compared to Northern Rock – the criminals on the Street love it. What else matters?

OBTW: Just because banks write-down underwater loans to FMV doesn’t necessarily mean the borrowers get a principal write-down too. The two matters are completely separate.

@5thDecade – You see it as a matter of the strong helping the weak – sorry, but IMO you miss the point. It’s actually a matter of the innocent having their pockets picked (again) for the benefit of the guilty. I don’t like that – neither do substantially all of the “innocent” Neanderthals.

Posted by MrRFox | Report as abusive

@FifthDecade, “In the UK, nobody ended up homeless, in the US thousands did.”

Really? Not impossible, but I haven’t seen that reported. How long did they remain homeless? Why were they not helped by the social safety net? Being foreclosed on is very different from “ending up homeless”.

@MrRFox, you make a good point about the ridiculous Wall Street bonuses (other executive-level corporate compensation is also through the roof). Otherwise, I’m not certain that dragging out the resolution is worse than a sudden shock.

“Just because banks write-down underwater loans to FMV doesn’t necessarily mean the borrowers get a principal write-down too.”

Ah. Wasn’t sure what you meant by that. In essence, the present policy allows the banks to continue operating with reduced equity levels rather than forcing a recapitalization. It dampens lending activity, encouraging the banks to shrink their books while they rebuild equity through profits, but is that really a bad thing?

The low interest rates, which are at the heart of the banking subsidy, have a variety of other effects:
* They are propping up housing values at some 20% (or more) above normal levels.
* They permit massive deficit spending for fiscal stimulus, without the crushing interest payments that would normally accompany such a policy (for now).
* The 75% of the mortgages which AREN’T underwater can be refinanced at interest rates under 4%.

Could argue that the “economy recovery” we saw last year was largely due to the low interest rates. It isn’t a complete recovery (several key aspects are missing) and there is a good chance it will fall flat in the next few months, but it isn’t quite as lopsided as what you describe.

Moreover, this solution promises to whallop the banks TWICE. Once the economic picture recovers, rates will rise and the loan margins will be squeezed. There is always a price to pay — and banking is not likely to be a healthy investment for at least another decade. (Think I owned shares in a bank for just one month out of the last two years.)

Posted by TFF | Report as abusive

@TFF – you wrote -”…the present policy allows the banks to continue operating with reduced equity levels rather than forcing a recapitalization.” Yes, they are allowed to carry performing loans (even in non-recourse jurisdictions) at historical cost even though the value of the securing property is far lower. This polite fiction all comes to an end if there are strategic defaults or any other acts that require reality to be recognized by auditors. Until then, it’s Fantasy Time.

TFF, you also wrote – “… encouraging the banks to shrink their books while they rebuild equity through profits, but is that really a bad thing?” Yes, because those bank profits are actually gifts from taxpayers. Under Northern Rock, the taxpayers also pay, but they own the banks when they do. That’s more fair, isn’t it?

Dragging-out the resolution is how the Japs did it – and are still doing it. Want to follow in their economic footsteps?

Bottom Line – banks must be recaped – by taxpayers, one way or the other. Shall we make them gifts, or declare them insolvent and take them over and own them when we recap them?

Posted by MrRFox | Report as abusive

@MrRFox, I’m not convinced all of the banks are (at this point) in QUITE as bad shape as you suggest. WFC and JPM in particular seem to be solvent, if not as profitable as they were before the crash. Then again, I’m not convinced of that assessment either. “Opaque”, to put it mildly. Or “Fantasy”, if I’m overestimating them.

Is Northern Rock the ONLY bank in the UK? The US already rescued/recapitalized AIG (which you objected to as a bailout?!?), Citigroup, and Fannie/Freddie. They forced Wachovia and WaMu into receivership. How many other banks did you want the Feds to take over? All of them?

There are some significant differences between the US and Japan — both political and demographic. The demographic differences are perhaps the most significant. “Dragging things out” simply gives you a chance to grow out of the problem. Japan’s demographics made growth impossible, thus extending the process.

Posted by TFF | Report as abusive

@EverybodyWhoMisses-”ASliceofLimeInTheSo da” –

Everything becomes easy once you arrive at a straight answer to this -

“Bottom Line – banks must be recaped – by taxpayers, one way or the other. Shall we make them gifts, or declare them insolvent and take them over and own them when we recap them?”

It requires only a one-word answer – gifts or takeover?

What’s it to be?

Posted by MrRFox | Report as abusive

@MrRFox, the answer to your question is “that is a false dichotomy”.

Banking, like most businesses, is inherently profitable. Instead of spending taxpayer money on gifts, or spending taxpayer money on takeovers, why not force the banks to recapitalize themselves from future profits? Make them plow 5-10 years of earnings into repairing their balance sheets.

The other half of this approach is flooding the markets with cash to stabilize housing values (at perhaps a 20% higher level than they would naturally sink to) and to keep other businesses working while the banks slowly fix themselves.

I truly don’t understand how you can on the one hand complain about AIG being “bailed out” and on the other hand suggest that the Feds take over every single major bank in the country. If you aren’t happy with X, then why do you think you would be happy with 10X?

Finally, I suspect that most of the banks have successfully repaired their capitalization already. You worry that the mortgages are being carried on the books for more than the present value of the property, but as long as the mortgages are being repaid they ARE worth more than the present value of the property. Moreover, I suspect the overhang is less than the capital on hand. Most of the banks were probably insolvent in 2009, but I doubt that is true today. And those that are still in trouble will lose business and shrink into semi-oblivion over the next decade.

Posted by TFF | Report as abusive

@TFF – Cool, then there’s no need to do anything at all, is there?

Posted by MrRFox | Report as abusive

@MrRFox, the problem was created ten years ago and the decisions on the resolution were made four years ago. The implications of those decisions will continue for another 5-7 years. But no, further action is not called for at this point. We are not on the brink of financial collapse, we are simply in the middle of a long and agonizing recession/recovery.

The best and bravest action at this point is to take no action at all. Stop interfering with the natural course of events and let the markets work to restore equilibrium. Even if that is painful.

Posted by TFF | Report as abusive

@TFF – you wrote – “we are simply in the middle of a long and agonizing recession/recovery.* The best and bravest action at this point is to take no action at all.

Look at LadyG’s example, above. Thousands, maybe millions, are locked-in to underwater situations – they can’t sell, can’t re-fi, can’t stop paying on a mortgage that makes no financial sense and can’t afford to keep throwing money away by continuing to pay. Eventually, they all need to make the “pro move” and do what LadyG did – dump the losing trade. The longer we drag that out the worse the damage will be for everyone involved.

You say banks are so flush they could write-down all underwater loans and still survive. Hope you’re right – pretty sure you’re not. Damn sure the GSEs couldn’t do that.

Posted by MrRFox | Report as abusive

@MrRFox, not every household with an underwater mortgage is in a bad situation. They are merely paying what they agreed to pay seven years ago. As long as they don’t lose their job and don’t need to move, they are fine. Remember that whether a mortgage is underwater or not, if you make the payments for 30 consecutive years then you own your home free and clear. This is how our parents/grandparents lived.

That isn’t to say their situation might not be improved — and I’m open to ideas like LadyG’s — but I would strongly favor proposals that limit the hit to the public purse.

I didn’t say that ALL the banks are financially healthy, I said that MOST of the banks (the major ones at least) have repaired their balance sheets. Consider Wells Fargo, for example, the leading residential lender. Their combined residential first mortgage and home equity portfolios total around $330B. Their Tier 1 equity is around $100B. Do you truly believe they would need to write off a third of their residential book just to get down to market value on the properties?!? (And they have segregated roughly $100B of assets that are higher risk, with the intention of running off that portfolio. Doing so quite successfully thus far.) Please don’t exaggerate the problem!

The GSEs are not banks. Nor are they private companies. In fact they are an example of what you are (foolishly) recommending for the entire system! The Treasury recapitalized the GSEs, and took on the (ongoing) losses at great taxpayer expense. Are you holding the GSEs up as a shining light for what our financial system should look like?

Posted by TFF | Report as abusive

@TFF – you wrote -

“…not every household with an underwater mortgage is in a bad situation.”

Suggest you ask LadyG about that – she’s been there. They are locked-in – they cannot sell the home, probably cannot relocate to take a new and better job, cannot refinance, must make payments for the life of the loan that exceed those based on the current FMV of the home lest they see their credit ratings destroyed.

Seems like “a bad situation” to me. Bet big money LadyG wasn’t happy being in it – perhaps she’ll tell us how allegedly “not bad” it was. She eventually threw in the towel – bet she wishes she’d done it sooner. Eventually, most all upside-down borrowers will reach the same conclusion, and more foreclosures will drive prices down further, and deeper bank balance sheet hits will result.

When disaster has struck, there’s nothing to be gained by pretending that it hasn’t. Dragging things out and hoping for a miracle to make all the pain go away isn’t a responsible policy approach IMO. Nor is it fair to drag things out and recap the banks by gifts of taxpayer funds that dribble-in over time, as is happening now; while entrenched managements that caused the whole mess continue to milk the system – and continue to finance both political parties.

Anyway, we’re both repeating ourselves now, so I’ll sign-out here.

OBTW: You’re not Japanese, are you?

Posted by MrRFox | Report as abusive

@MrRFox, please try to read a little more precisely… Twice in two posts you’ve modified a qualifier. Either you are doing so intentionally (which makes you a dishonest liar) or you are doing so carelessly (which makes you a fool). Your pick.

When I said “most of the banks have successfully repaired their capitalization already”, I meant precisely that. I didn’t mean “all of the banks and the GSEs to boot”.

When I said “not every household with an underwater mortgage is in a bad situation”, I meant precisely that. If I had meant, “no underwater mortgage is ever a problem” then I would have said so.

It is **VERY** annoying to hold discussions with liars/idiots who continually twist your words. If you persist in that behavior, I’ll leave you to “discuss” yourself off in a corner.

To answer your point, the degree to which being underwater is bad depends on three factors.
(1) How affordable was your original deal?
(2) How badly do you need to move?
(3) How far are you underwater?

If the original deal was affordable, then continuing an underwater mortgage isn’t substantially worse than renting. If you don’t need to relocate, then that isn’t an issue FOR YOU. And if you are $30k underwater then you have less to gain from shedding the obligation than if you are $500k underwater.

Most of the underwater mortgages are not seriously troubled and will eventually be repaid (unless the market takes another jag downwards which might or might not happen). Those which are most seriously underwater will (or should) eventually default, but I’ve never denied that.

It isn’t as bad (not yet at least) as some would have you believe. Obama’s recent plan for refinancing might have helped 3M to 4M households. That is a big number (and LadyG might have been among them), but it is still a small fraction of the total households in the country.

You still haven’t told me whether or not you approve of the (taxpayer funded) Fannie/Freddie takeover, or the (taxpayer funded) AIG takeover. I’ve seen you criticize each on occasion, but then you are proposing that the taxpayers fund a similar recapitalization of the ENTIRE financial system. Seems expensive to me, not to mention presently unnecessary. (If you were going to do that, it should have been done in 2008-2009, not 2012.)

Posted by TFF | Report as abusive

“You still haven’t told me whether or not you approve of the (taxpayer funded) Fannie/Freddie takeover,” (TFF)

It had to be done, but should only have been done in conjunction with applying the Northern Rock Solution to all other insolvent banks. That would have been the least unfair way to have handled it.

“or the (taxpayer funded) AIG takeover…”

Paying AIG’s counterparties 100% was criminal – an AIG default on CDSs in conjunction with the general MBS crisis meant substantially all of them were insolvent. They all should have been Northern Rocked.

” you are proposing that the taxpayers fund a similar recapitalization of the ENTIRE financial system. Seems expensive to me, not to mention presently unnecessary…”

Taxpayers are doing that right now – gifting money to banks to repair their balance sheets – IMO that’s improper. The money very likely must come from taxpayers or the Fed; that being the case, the taxpayers should own the institutions when the taxpayers recap them – that’s what Northern Rock accomplishes. The money works out the same either way, but your way – the wait-it-out method – amounts to taxpayers making gifts to private institutions. I don’t like that – you seem to. Cool – that’s also why they make chocolate and vanilla both. GFYS

Posted by MrRFox | Report as abusive

Thanks for the answers, MrRFox. I wouldn’t have objected to that solution back in 2008 — just seems a little late at this point. The price tag would have been HUGE, but not necessarily any worse than a decade of deficit spending.

But I disagree that the present solution represents a gift from taxpayers to the banks. Most of the funding for the losses is coming from the banks’ earnings, and most of what you see as a gift will be clawed back when interest rates rise in a few years.

QE isn’t strictly fair (as you have pointed out). It is hard on those who hold monetary assets, good for those with monetary liabilities. The banks are in both games, so I would guess it does more to shift profits than create them? Overall, QE is good for borrowers (and with an $11T federal debt we are all borrowers) and bad for lenders (such as China).

In conclusion, I think I’m with you on the solution — nationalize banks and boot the bums — but not on the timing. We’ve already committed to the present course of action, and barring another 20%+ drop in real estate prices there is simply no excuse for nationalizing most of the banks at this point.

Posted by TFF | Report as abusive

There are three sources of new capital for banks – profits and government money have been mentioned already (although if the second is a loan it isn’t really a capital injection). UBS, the biggest of the Swiss banks diluted shareholder holdings by taking in new capital from new shareholders.

Fox, I’m not sure your constant chatter about “the Northern Rock Solution” conveys much understanding of what this actually is… perhaps you could explain what you think it means? In any case, Northern Rock was not a big bank, that would be LloydsTSB and RBS.

@TFF I don’t call people living in gymnasiums and halls in dormitory style conditions as being ‘homed’. I could also add that those people in the UK who lost their houses do not suffer any difference in medical care compared to their previous position, neither timewise nor qualitywise.

Posted by FifthDecade | Report as abusive

@FifthDecade, like I said, I haven’t seen this supposed epidemic reported. Can you offer a link? I’m puzzled why foreclosure would leave them in such dire straits. Perhaps the people you are describing also lost their jobs?

For the most part, foreclosure is a middle class disease. The poor were never able to buy in the first place.

Posted by TFF | Report as abusive

Part of the sub-prime problem was that the poor WERE in fact sold houses, financial ‘experts’ walked into their homes and told them they COULD afford to buy that dream house, even though some of them were on benefits and had no deposits. Just look at Cleveland. Innocent people were sold loans that should never have been given to them, but the lenders didn’t care as they passed the loans on up through the repackaging ladder.

Here’s a link to the web version of the News Report Paul Mason did for BBC’s Newsnight program: a-14296682

This link illustrates my point of how the US thinks less of the individual than does Europe, although the US system does allow companies to push totally unsuitable products by those who think of themselves more highly than they think of their victims. This might only be a small number of the total cases, but the fact remains it is allowed, it happened, and in Europe there are regulations and safety nets that respect the individual, and control companies more tightly.

Posted by FifthDecade | Report as abusive

Agreed, Fifth, that was PART of the subprime problem. Only the tip of the iceberg, though.

That Paul Mason report cites legitimate suffering, but consider the cause? Unemployment, divorce, unemployment. You can add medical bills to that list if you like. This story, at least, didn’t blame any of it on foreclosure. Rather, it is part and parcel of the greater recession/depression.

Europe definitely embraces a greater degree of socialism than the US — that is both your strength and your weakness.

Posted by TFF | Report as abusive

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