James Pethokoukis

Politics and policy from inside Washington

5 EU options for Greece, inspired by Lehman

May 21, 2010 14:48 UTC

Don Rissmiller of Strategas looks at how the lessons of the US financial crisis could instruct policy responses for the EU and its Greece problem:

1) The TARP-like option: this is essentially spending government money to buy bad debt, and the European bailout packages have moved in this direction. The political challenge
was always getting money authorized to help those that appeared to be spending beyond their means. This still appears to be where we are now in the EU, despite some progress
with the German vote.

2) The PPIP-like option: the challenge with spending government money in the U.S. was that the authorization process was burdensome. Hence, the next suggestion was a ”public private investment program” (PPIP). The challenge with PPIP (it never got off the ground) was how to get banks to sell assets in an illiquid market, which presumably would not be as large an issue with government debt. But the key features of the program – including non-recourse leverage and a sharing of profits – were indeed well thought out. No European option of this sort appears on the table currently, however.

3) The Monetization option: When the Fed finally started participating with “all available tools”, including buying mortgage securities, the U.S. market stabilized. This is certainly a politically tough option for the ECB. Should it come to it, however, the option of doing nothing certainly seems like a much worse policy mistake.

4) Cutting Spending: Greece already appears to have lost some sovereignty, as the Lisbon treaty has required sharp adjustments. These cuts can be some of the most politically challenging items, though as the governor of NJ has demonstrated, they are not impossible.

5) Europe Bank Guarantees: the risk of a “run on the bank” seems to be creating additional uncertainty, though the amount of deposits that would have to be guaranteed would presumably be quite large. The FDIC guarantee plan in the U.S. could provide some guidance for Europe, however.

And Larry Kudlow also has some thoughts on that last option of Rissmiller’s:

So it’s my contention that the Europeans must now embark on a similar program. The EU/IMF rescue plan, which consists of $1 trillion in loans and loan guarantees for government sovereign debt, must be expanded to include a blanket loan guarantee for all European bank debt, short term and long term. A Europe-wide, centralized, deposit-guarantee system should also be developed. Right now bank deposits are insured by individual countries, like Greece. This is not credible. (Hat tip to investor David Kotok for this deposit-guarantee thought.)

A loan-guarantee program to backstop the banks in Europe and sovereign debt will put an end to this crazy Greek drama that is pulling down markets everywhere and threatening the economic recovery. As a free-market advocate, I don’t like this sort of government intervention. But we’re talking emergency here. Systemic global emergency. … These bank-loan guarantees would be temporary, perhaps a year in length. And they would buy time for the essential budget restructuring necessary to slash spending and curb the welfare-state excesses in southern Europe, or perhaps all of Europe. These government-shrinking steps will free up private-sector resources to spur growth.

Wall Street scores a win on financial reform … for now

May 21, 2010 14:43 UTC

A sigh of relief is due on Wall Street. The procedural finale for the U.S. Senate’s debate on financial reform came just in time for the big banks. The bill just kept getting tougher as the talk dragged on. But it could have been worse. While banks’ future activities and profitability may get pinched, their core business model appears intact. In the end, Wall Street got nicked, not nuked. Some observations:

1) Wall Street should thank the White House. Had President Barack Obama prioritized bank reform over healthcare at the height of the crisis, the biggest players might have been broken up, hard caps placed on balance sheets, and banking and investing operations separated. More recently, the Securities and Exchange Commission’s lawsuit against Goldman Sachs in April helped re-energize advocates for such changes.

2) Nothing radical here. While the Senate and House bills still need to be blended, it’s safe to say the most radical ideas have fallen by the wayside. A “systemic risk council” of federal regulators will recommend new capital and leverage rules to the Federal Reserve, which will be the most influential bank regulator. The Federal Deposit Insurance Corporation will have the power to wind down any failing large, systemically interconnected institution.

In addition, large, complex financial firms will have to submit plans for their rapid and orderly shutdown should they go under. And for the first time the derivatives that are currently traded privately will mostly be forced to go through clearing houses and in some cases trade on exchanges. Bank lobbyists have defended their corner: it’s not the regulatory reign of terror their clients’ most vociferous critics wanted. But it’s hardly a “light touch” regime, either, and it does involve real changes. Caveat: This assumes the Blanche Lincoln provision on derivatives is softened or stripped in the conference committee.

3) Too Big To Fail is still a problem. As long as regulators and politicians have vast amounts of discretion, a financial crisis will make bailouts an irresistible temptation. The way around this is either breaking up the banks or creating hard, market-based triggers for either regulatory action or a resolution process. Neither is in the bill.

4) Wall Street’s has an enduring PR problem. Yes, big banks are unpopular. But it has gotten so bad that they may not be able to so easily counter their image issues with campaign cash. Getting Wall Street money now has a stigma attached to it like oil and tobacco money. Candidates like Meg Whitman in California and John Kasich are getting hammered for their Wall Street ties. The industry’s continued unpopularity will no doubt spawn further attempts to tax, regulate and restrict the sector.

5) Bernanke trimphant. The Federal Reserve has to be pretty satisfied. It did not lose its role as regulator; in fact, it’s been strengthened. And the central banks was also able to fend off attempts to make it more transparent.  The downside:  The GOP (see Rand Paul)  has soured on the Fed in a big way, particularly at the grassroots. Further economic woes will lead to more calls to change its form and function.