Solution to the eurozone crisis: treat the people as the priority

New US unemployment figures are at a seven month low, adding to the view that the American economy is strengthening.

But in Europe the crisis is deepening.

As financial institutions in the eurozone search for new sources of finance to replace expiring debts (almost €2,000bn  is needed over the next five years), not only are outside lenders wary of getting involved, but even banks within the eurozone are wary of lending to each other, especially to the banks in southern Europe that need it most.

Difficulty brings innovation and many lenders are switching to ‘covered’ loans. These are secured against specific assets owned by the borrower. This seems like a safer option, but in the event of bankruptcy it means there are fewer remaining assets to share amongst the other lenders — so the risk for them increases, making the situation as a whole more unstable/bipolar.

The cost of borrowing from other (smaller) investors has also increased, so the banks find themselves moved towards three possible outcomes:

  1. Fear of a failure to find a solution leads to a run on the banks
    Deposits in Greece have already fallen by more than a third since 2009 (€50bn), leading to collapse of the banks and the economy.
  2. More funding is provided from a ‘higher’ source, such as the ECB
    But Germany is opposing this because of fears of hyper-inflation and associated collapse of asset values.
  3. Banks reduce the size of their balance sheets
    Selling off assets and their associated debts would lead to a ‘partial’ credit crunch/economic collapse, which will most affect those with the fewest assets and lowest credit ratings. This solution depends on buyers being found who would be willing to pay a ‘fair’ price for the assets, and who are willing to take the debts at any price.

Nevertheless the reality, as one ‘senior banker’ put it, is that “A bank is a highly leveraged entity. For every unit of equity you need six to eight units of debt. If you can’t get this the old business model just falls over.”

In that case, the time has come to find a new ‘business model’.

The markets agree: “Despite the European Union’s most strenuous efforts, it has not yet won back the confidence of the financial markets.

So it is not surprising to see that two of the German foreign minister’s recommended priorities for action are for systemic changes: Deepening European monetary union into a ‘stability union’; and Reforming and coordinating economic and financial policies. His third priority is to tackle the immediate crises of Greek [and Italian] government and banks. All three are “urgent” and essential.

Whether they will be sufficient to provide a ‘new business model’ remains to be seen. But if we focus for a moment on the third in the list we find that Italy’s new prime minister, Mario Monti, is planning to achieve this using a list of fairly conventional measures. He says he is “looking at” options including: a property tax; selling state assets; cutting pensions; easing taxes on businesses; cutting government; changing labour laws.

The problem is that Silvio Berlusconi on the one hand has already pledged his party will oppose a wealth tax. And students on the other are already marching in protest.

The need for change is still not accepted. And if this part of the change fails, the whole plan fails.

Michael Ignatieff offers some critical advice:

“convince your people that you are doing this not for the banks, not for Europe, not for the bond market, but for them, your fellow countrymen and women. Remember they, not the bond market or the European Union, have the ultimate power. If they believe you are on their side, you can succeed. If they believe you are not on their side, you will fail and they can make your country ungovernable.”

It is the failure by both bankers and government to focus on the people as their number one priority that has got us us into this mess. It is the demand to correct that failure that lies behind the Occupy movement.


In other news:

President Obama has stressed America’s commitment to the Pacific region, while Australia’s acceptance of a US military base on its soil could mean it finds itself squeezed in future between China (its main market) and America (its guarantor of security).

The World Bank has confirmed a $200m loan to Morocco, which it will now use to start building a large solar power plant, one of the largest of the 200 similar plants now planned or operating around the world. Total cost is around $1bn.

Fraud is once again an issue, this time in Formula One racing.

And against a background of significant over-capacity in shipping tankers, the General Maritime shipping company has filed for Chapter 11 bankruptcy.

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