29 June 2011

Christine Lagarde, IMF and the Question of Bailout

As predicted, Christine Lagarde was appointed the new Managing Director of IMF. As I said before, I like the idea of a woman finally running the Fund. It is a huge leap forward and I firmly believe gender should be given as prominent a role as Europe vs emerging markets criterion in selecting candidates.

Moreover, by all accounts, Mme Lagarde is a very competent and hard working woman and she would be an excellent IMF Chief.

Having said that, I have to reiterate that I am not as sanguine about her purported mission to solve the lingering Eurozone crisis. My educated guess is that she will push the recent Sarkozy plan to roll over Greek loans for a period of 30 years and will play a major role in convincing the rating agencies that this should not be viewed as a technical default.

The idea itself is fine as far as it goes. My problem with it is the framework upon which it rests. Capitalism is about risks and rewards, we are told. But the question is that is it still the case?

If you remember, during the so called housing bubble, banks made risky and fraudulent bets, entered into unethical arrangements with rating agencies to hide the problem, and paid themselves huge bonuses for those returns. When the big Casino closed, they asked to be bailed out by the tax payers.

In the Greek case, banks made risky bets, worked behind the scenes to hide the size and nature of the debt and made huge returns ("The deal, Mr. Alogoskoufis argued, would saddle the government with big payments to Goldman until 2019"). And when it became clear that Greece could not pay these gigantic sums, banks came running to the tax payers and are asking them to cover their losses. This is what the new roll over deal means. As BBC's Economics Editor Stephanie Flanders put it:
 But as a matter of simple arithmetic, if the banks don't lose and Greece gains, there must be an additional subsidy in there somewhere from eurozone governments, either in the "high-quality assets" provided as a back up or, possibly, the promise of preferential treatment for these new bonds in the event of a default.
Which is another way of saying that some assets backed by European taxpayers will be used as collateral in the process. Since it is extremely unlikely that the austerity measures that are strangling the Greek economy will result in some kind of growth any time soon, Greece will still default. At that point, the banks will still get their money through whatever collateral is being proposed behind the scenes. So, it is a bailout for the banks, not for Greece and it is done on the backs of European taxpayers.

Which brings me back to the new framework of capitalism: In this new order, with dramatic returns and incredible executive pay levels, risks that make these things possible are public but the rewards that stem from these risks are private.

We provide the collateral for the risky behavior and they collect the rewards. If something goes wrong (as is likely with risky ventures) we are holding the bag and we make sure that they still get rewarded.

I am continually amazed that no one seems to be bothered by this.

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