Though I find it excruciatingly hard to agree with Nobel Laureate Joseph Stilgitz on anything, I can’t say he is wrong on his latest hunch.Â In his Project Syndicate column today, Mr. Whither Socialism suspects that perhaps the European Central Bank doesn’t have the “public’s” interest at heart in its attempt to resuscitate the Euronzone and guide Greece through what looks like an impending default.Â He writes:
The ECBâ€™s insistence on â€œvoluntaryâ€ restructuring â€“ that is, avoidance of a credit event â€“Â has placed the two sides at loggerheads. The irony is that the regulators have allowed the creation of this dysfunctional system.
The ECBâ€™s stance is peculiar. One would have hoped that the banks might have managed the default risk on the bonds in their portfolios by buying insurance. And, if they bought insurance, a regulator concerned with systemic stability would want to be sure that the insurer pays in the event of a loss. But the ECB wants the banks to suffer a 50% loss on their bond holdings, without insurance â€œbenefitsâ€ having to be paid.
There are three explanations for the ECBâ€™s position, none of which speaks well for the institution and its regulatory and supervisory conduct. The first explanation is that the banks have not, in fact, bought insurance, and some have taken speculative positions. The second is that the ECB knows that the financial system lacks transparency â€“ and knows that investors know that they cannot gauge the impact of an involuntary default, which could cause credit markets to freeze, reprising the aftermath of Lehman Brothersâ€™ collapse in September 2008. Finally, the ECB may be trying to protect the few banks that have written the insurance.
Surprisingly, Stiglitz recognizes the need for a “deep restructuring” of Greece’s debt; no doubt alluding to a hard default.Â Where he was making this call two years ago when the crisis started gaining steam in the home of democracy, no one can say.Â In reality, Stiglitz at first denied Greece would need a bailout and then became a supporter of the measure to prevent a default.Â So much for appraising the behavior of culpable political institutions.
As anybody who has looked into the history of central banking knows, these established systems of regulation are never the product of an altruistic political class but merely an implicit maneuver to cartelize the banking system in favor of banker elites.Â Like Hayek said, “Socialism has never and nowhere been at first a working-class movement.”
From the beginning of the Eurozone crisis, those who understood the symbiotic relation between central banks, their respective governments, and the financial institutions which fund the state, realized that the exercise in bailout futility, otherwise known as kicking the financial can, was done on part not to bailout countries such as Greece and Italy but to save the banks which hold large portions of their debt.Â In short, the governments weren’t being bailed out, the banks were.Â Stigliz finally seems to get it:
In fact, the ECB may be putting the interests of the few banks that have written credit-default swaps before those of Greece, Europeâ€™s taxpayers, and creditors who acted prudently and bought insurance.
Better late than never.
Despite his economic accolades, Stigliz may finally be grasping on to the true nature of central banking:
The final oddity of the ECBâ€™s stance concerns democratic governance. Deciding whether a credit event has occurred is left to a secret committee of the International Swaps and Derivatives Association, an industry group that has a vested interest in the outcome. If news reports are correct, some members of the committee have been using their position to promote more accommodative negotiating positions. But it seems unconscionable that the ECB would delegate to a secret committee of self-interested market participants the right to determine what is an acceptable debt restructuring.
News to the Columbia U. Professor, power centers attract powerful special interests.Â Angels don’t occupy public offices; those who take great pleasure in wielding coercive authority over their fellow man do.
Though Stiglitz believes the Eurozone crisis is a product of a lack of regulation (by easily bought bureaucrats, which he grudgingly admits), he is correct that a hard default is the correct path through the storm.Â If the EZ wants to retain any credibility of free market capitalism, losses must be taken by those who took the risk.Â Perpetuating moral hazards by papering over the bad decisions of market participants creates further disasters down the road.Â But with a hard default must come a triggering of credit default swaps which the ECB wants to prevent.Â Credit default swaps, for all their demonization by the anti-Wall Street crowd, are merely a means for investors to hedge themselves against potential default through risk assessment.Â Take away this function and the market will find inevitably find another way to protect itself against recklessly spending governments.Â For all the faith bestowed upon faceless regulators by those who wish the hand of government in every affair of life, these bureaucrats have specialized in always chasing the last market innovation.Â Despite increases in staff and funding, regulators simply don’t have the vast amount of knowledge to attempt to plan an economy.
The economic fact is that credit default swaps don’t cause fiscal destabilization.Â The profligate spending of governments and continual interest rate manipulations by central banks are what wreak havoc on normal working order.Â Markets are self correcting when left to their devices.Â An emboldened political and regulatory class that sees itself as omniscient in the face of the complex phenomena known as an economy only ever burdens this process.Â Allowing the triggering of credit default swaps, like the financial meltdown in the fall of 2008, won’t be the end of the world.Â Even Stiglitz recognizes this:
The one argument that seems â€“ at least superficially â€“ to put the public interest first is that an involuntary restructuring might lead to financial contagion, with large eurozone economies like Italy, Spain, and even France facing a sharp, and perhaps prohibitive, rise in borrowing costs. But that begs the question: why should an involuntary restructuring lead to worse contagion than a voluntary restructuring of comparable depth?
If an auto insurance company sees a large, but uncorrelated, jump in claims, the government shouldn’t step in to protect its losses by stopping a payout to insurance holders for the sake of financially saving the company.Â Those who insured themselves were acting prudently; why should they by punished?Â What kind of message does this send for future drivers?
Stiglitz naively believes that “democratic” institutions are too beholden to wealthy special interests.Â Until he realizes that institutions given monopolies on a specific industry or over force and legal arbitration themselves attract the most unscrupulous of men, he won’t see the true cause of societal impoverishment and decay.