Friday, 10 October 2008

An opportunity in disguise

The monetary and financial crisis now entrenched in the global marketplace has already metastasised into a stock market crisis as investor confidence has fallen (the Dow Industrial Average slipped below 9,000 points as this edition went to press, shedding a third of its value since January). A business crisis is expected as consumer confidence fails, and eventually a fiscal crisis as jobs are lost, business profits fall and interest rates rise. Not only will state revenues fall, but governments will also have to borrow more to finance social policy and business bailouts.

A recession is now seen by most analysts as inevitable, with pessimists predicting it will last until 2012 (see our coverage of the Central and Eastern European Banking Conference on page 20). The crisis is even being seen by some as the end of the era of Monetarism - the economic principle that a healthy money supply ensures a healthy economy.

That is because a healthy money supply helped create an oversupply of cheap credit, resulting in bad loans. Those were re-sold as paper of questionable worth, making such inroads into the portfolios of investment banks that they collapsed when borrowers defaulted and their main collateral - their homes - fell too far in value to cover their debts.

This overextension of credit was undoubtedly the result of greed on the part of the retail banks; but there was also greed among investment banks, whose giddying failure to assess risk on the paper they were buying is only gradually coming to light.

In one of the most revealing testaments so far, a risk manager wrote in The Economist on August 9: "We trusted the rating agencies... the reputation of outside bond ratings was so high, that if the risk department had ever assigned a lower rating, our judgement would have been immediately questioned." Worse, the trading desks saw risk assessors as an albatross. "Most of the time the business line would simply not take no for an answer."

Undoubtedly, there was also greed on the part of many consumers, who kept refinancing their mortgages to live beyond their means. Even governments were seduced. Greece's finance ministry sold two structured bonds to pension funds that were diabolically difficult to evaluate, and marked a departure from the classic, fixed-return bond public treasuries usually issue. The findings of two reports on those bond issues have been buried through extraordinary political manoeuvring.

Both bankers and consumers have sought government protection. As a result, national economies around the world have swung impressively into statist mode. There is no more talk of privatisation, deregulation or liberalisation - the catchwords of the past decade in the European Union. Even in America, free marketeers are singing a different tune.

Republican US Senator John McCain, who just a few weeks ago told voters that the American economy was sound, has upped the ante on his Democratic opponent for the presidency by advocating a state buyout of troubled mortgages rather than just troubled institutions. The US Federal Reserve has already spent hundreds of billions of dollars propping up major US lenders, and the taxpayer has been asked for $700 billion more. National bailout plans have followed in Spain, Britain and France. Ireland and Greece became the first European Union members last week to guarantee bank deposits.

The main vulnerability of the Greek position is not overexposure to bad paper, but the fact that consumers, banks and the state itself are over-borrowed. In the game of financial musical chairs, borrowers have been left standing.

Households and businesses borrowing on floating interest rates will pay more to service their debt, estimated at just under 200bn euros. And the signs already are that they are defaulting at higher rates. Non-performing loans rose this year, particularly for households.

Moody's and Standard and Poor's, the ratings agencies, downgraded three of Greece's biggest high street banks on October 7 because of their high ratio of loans to deposits. The government has guaranteed deposits to 100,000 euros, but that may not deter many account holders from stuffing money into the mattress.

Servicing their public debt will also cost the Greeks about 1.4 billion euros more than planned this year and next. That effectively swallows the extra cash Finance Minister George Alogoskoufis hopes to raise in 2009 through unpopular tax hikes announced in late August. Put differently, it is as if the Greek taxpayer had another two Olympic Airlines to support (the national carrier is estimated to cost about a million euros a day).

There is a silver lining, however. As the frenzy of consumerism that has gripped Greece since the deregulation of banking in the 1990s dies down, in line with the rest of the world, we are likely to see a drop in the price of oil. That will have a cooling effect on inflation, which in our country has remained above the eurozone average. It will also have a beneficial effect on the environment, which has suffered from a depletion of primary resources and production of greenhouse gases.

Lean times could help sort out the wheat from the chaff in the public and the private sectors. As voters and consumers focus on what is truly important to them, there is less room for flim flam. Now is the time to trim 1.2 billion euros the taxpayer spends each year propping up state enterprises bloated with political appointees. Now is the time to scrutinise public procurements and lower the debt, which sucks up all tax revenue from individuals and businesses each year.

The lack of competitiveness in the private sector also needs to be addressed. In the oligopoly that is Greece, the many can no longer afford to overpay to enrich the few, and in areas such as refined petrol, banking services and dairy products, to name a few, they have been overpaying egregiously.

But not all of these benefits will come by themselves. The political barometer needs to set to Transparency, Accountability and Meritocracy, the goddesses Greece now needs more than ever.

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