MONEY BACKSTAGE Mumbai, Monday, May 24, 2010

www.dnaindia.com
epaper.dnaindia.com 24
is that deeply troubled members of the
After months of Eurozone are trying to bail out each oth-
prevarication, panic is what er. The stronger countries’ balance
sheets are being contaminated by the
As Woody Allen once
observed: “More than any
drove the European Union to bailout process. It’s like sharing dirty
needles - we all end up HIV positive. other time in history,
assist Greece. Satyajit Das Do you see the PIIGS able to live with the mankind faces a crossroads.
stringent IMF criteria for bailout?
says the situation reminds One path leads to despair
Basically you can choose how you
and utter hopelessness. The
him of Mark Twain, who want to die. You can default and be os-
tracised from financial markets and re- other, to total extinction. Let
once said, “I wonder whether structure your economy. If Greece is un-
able to finance its debt or elects to de-
us pray we have the wisdom
the world is being run by fault and exit the euro, then Greece will to choose correctly.”
become isolated and enter a period of
smart people who are forced economic and financial decline.
putting us on, or by imbeciles The alternative is that you take the IMF
cure but the problems are probably in-
obligations in the future.
Given all this, what do you think is the fu-
who really mean it”. Das, an capable of solution and terminal. Tem-
porary emergency funding may help
ture of euro?
People are confusing the health of the
internationally renowned meet immediate liquidity needs but do Eurozone economies with the euro. The
not solve fundamental problems of ex- real problem is the Eurozone economies,
derivatives expert and the cessive debt and a weak economy. You particularly the weaker members who
author of Traders, Guns & must cut government expenditure and
raise taxes to reduce its stock of debt.
shouldn’t have been allowed to join the
monetary union in the first place. There
Money: Knowns and But the government is too large a part of
the economy and the suggested austeri-
is also a problem within the Eurozone
(similar to the China-US global imbal-
Unknowns in the Dazzling ty measures will put the economy into a ance) whereby Germany has financed
severe recession. In turn, this will drain European consumption to keep its ex-
World of Derivatives (2006, tax revenues making it difficult to re- port levels high. These problems need to
FT-Prentice Hall), spoke to duce the budget deficit. Most of these
has limited opportunity to grow or in-
be addressed, something which the cur-
rent plans neatly avoid addressing. The
Vivek Kaul last week. flate itself out of the problem. Without euro’s problem is slightly different.
the ability to devalue the currency, First, the effect of a Greek default via re-
Excerpts from the interview: Greece cannot address its fundamental denomination of its debt into new drach-
lack of competitiveness quickly. The ma (the Greece currency) would not af-
narrow economic base, primarily agri- fect the euro. Argentina and a whole host
How does a country as small as Greece

EU rescue is like sharing needles…

bring Europe to its knees?
Greece’s significance is not its eco-
nomic size. Greece has significant debts
(currently around €270 billion (113% of
GDP), which is projected to rise by 2014
to around €340 billion (150% of GDP)).
Much of this debt is owed to investors
outside Greece, mainly banks and in- of emerging market nations have de-

WE’LL ALL END UP HIV+

vestors in other European countries. As
of June 2009, Greece owed $276 billion to
international banks, of which around
$254 billion was owed to European
banks with French, Swiss and German
banks having significant exposures. It is
risk of default on this debt that has
made it the centre of global concern.
What happens in Greece is unlikely to
stay in Greece creating new problems
for the fragile global banking. Greece is
also the ‘canary in the coal mine’. It is
pointing to very similar problems in
other countries - the PIGS (Portugal, Ire-
land, Greece and Spain) as well as some
eastern European countries. There are
also similar problems in the FIBS
(France, Italy, Britain and the US).
The problem is a large amount of
public debt, unsustainable budget
deficits and unfavourable current ac-
count deficits both in absolute terms
and relative to GDP. What Greece is
highlighting is that such debt is unsus-
tainable and investors will not continue
to finance it, certainly not at current
rates and perhaps not at all. It is a prob-
lem that was there all along.
What got the EU to act after months of
dilly-dallying?
In a single word, panic. The European
Union spent months prevaricating
about any sort of assistance for Greece.
Then, Wham, bam, thank you M’am,
and they said, we have €110 billion for
Greece. And then when that did not
work they come up with a €750 billion
package for all of Europe.
EU leaders and worthies convinced
themselves that the euro and therefore
the EU itself was under attack and at
risk of collapse. So they went “nuclear”
to salvage the situation, and try to stop
contagion.
It’s going to take a mira-
cle and those have always
been in short supply. The EU
rescue package has bought
some time but markets pres-
ent value-outcomes and they
have discounted the chances
of a successful adjustment. I
think they are correct.
Amusingly all constitutional con-
cerns about the legality of a bailout
were jettisoned with alarming speed.
The view was that it had all always been
possible under the “exceptional circum-
stances provision” (Article 122) to count-
er a systemic threat. One couldn’t help
but think of Mark Twain, who had said,
“I wonder whether the world is being
run by smart people who are putting us
on, or by imbeciles who really mean it”.
Do you think contagion was a given with-
out the nuclear option?
Contagion has already happened.
There are several channels of transmis-
sion. The first is other sovereigns. Oth-
er countries with similar economic
problems will inevitably be scrutinised
and targeted. Remember, when a sover-
eign runs into funding problems, it
means that banks and other borrowers
in that country are
also affected. For ex-
ample, Greek banks q&a
were unable to fund
themselves in the in- satyajit das
ternational markets.
The second is the banking system. If
Greece defaults or its debt falls sharply
in value then the losses affect the
lenders, wiping out capital. Given the
fragile condition of major banks global-
ly, this places pressure on their ability to
fund and lend, setting off a negative
feedback loop that we saw in the early
part of the global financial crisis. The
third is the generalisation of credit
problems. We have already seen funding
costs rise across the board. Inter-bank
markets are become more expensive
and losing liquidity creating liquidity
shortages.
Then these financial problems affect
the real economy - growth, jobs, invest-
ment etc. In turn, this feeds back into
the financial system and so on. The
process is difficult to control or manage.
Can you explain how exactly is the plan
supposed to work?
The fine points of the plan are still
sketchy. As I understand, Greece gets
€110 billion in emergency loans (€80 bil-
lion from Eurozone countries and €30
billion from the IMF). Then there is the
€750 billion Eurozone stabilisation fund,
the Greek deal is ex-poste part of. The
IMF would provide up to €250 billion of
the facility. The entire package requires
IMF participation, which limits the
amount of any bailout package and also
makes it conditional on meeting the
fund’s stringent economic prescrip-
tions. The package requires countries to
exhaust commercial debt market
sources prior to accessing the package.
The aid required “unanimous” agree-
ment among the EU members.
The European Central Bank (ECB) is
also providing support and has now re-
laxed its rules completely and will ac-
cept bonds as repo eligible irrespective
of rating. The ECB is also buying Euro-
zone sovereign bonds in the secondary
market. As of May 19, 2010, the ECB had
purchased bonds
worth around €16.5 bil-
lion, mainly of the
porcine variety.
In addition, the
ECB has been funding
banks such as those in Ireland and
Greece.. Greek banks account for 6.6%
of all ECB credit to financials while
holding only 1.6% of European Union
assets. Similarly, the Irish account for
12% while holding 5.24% of assets.
Also, because of the IMF involvement
and direct bilateral facilities, it is a glob-
al effort. The average American must be
a bit bemused to find that they are tip-
ping some $30+ billion into the hat to-
wards the rescue via the IMF. The whole
package is a mess. I think the EU and
ECB are hoping that the announcement
will suffice to bring stability to markets
and they won’t ever have to use it.
Will the plan work?
At best, the plan can provide tempo-
rary liquidity to cover immediate fi-
nancing needs. For example, the event
that crystallised Greece’s problem was
its need to repay maturing debt and also
issue bonds to finance its deficit. (Ger-
man chancellor) Angela Merkel had ad-
mitted as much.
But we don’t have a liquidity problem;
One couldn’t help but think of Mark Twain,
who had said, “I wonder whether the world is
being run by smart people who are putting us
on, or by imbeciles who really mean it”.
we have a solvency problem. Most of
these countries have unsustainable lev-
els of debt. Beyond 2010, Greece needs to
refinance borrowings of around 7%-12%
of its gross domestic product (around €16
billion to €28 billion) each year till 2014.
There are significant maturing bor-
rowings in 2011 and 2012. In addition,
Greece is currently running a budget
deficit of over 12% that must be financed
using euros.
Greece’s total borrowing, currently
around €270 billion (113% of GDP), is
forecast to increase to around €340 bil-
lion (over 150% of GDP) by 2014.
It is highly unlikely that Greece can
avoid a debt restructuring. For countries
like Ireland, Spain and Portugal, as well
the others that will follow the same
route, the savage austerity measure re-
quired are unlikely to be palatable and
probably won’t work in any case.
It is useful to remember that Argenti-
na had a debt to GDP of around 60% and
a budget deficit of 6%. They tried to make
the adjustments necessary to halve both
and didn’t succeed. After a long-drawn
struggle between 1999 and 2001, they were
forced to reschedule their debt and have
still not quite made their way back to nor-
mality. Many countries we are talking
about are in a much worse position. It’s
going to take a miracle and those have al-
ways been in short supply. We have
bought some time but markets present
value outcomes and they have discount-
ed the chances of a successful adjust-
ment. I think they are correct.
How will EU finance the rescue effort
given that its member-states are heavily
indebted?
That’s the really funny part. We are
trying to solve a problem of too much
debt with more debt. What is also bizarre
culture, tourism and construction, fur-
ther limits options.
So essentially they have few options…
The level of indebtedness may al-
ready be too high. (Economists) Ken-
neth Rogoff and Carmen Reinhart, in
their survey of financial crises called
This Time It’s Different, argue that once
the debt of a country goes above 60-90%
of GDP, it acts to restrain growth.
Greece and some of the other countries’
high levels of debt mean that interest
payment now total around 5% of GDP
and are scheduled to rise over 8% by
GDP. Rising interest costs will only
worsen this problem. High levels of sov-
ereign debt are sustainable where three
conditions are met: First, the debt is de-
nominated in its own currency. It is
helpful if the currency is also a major
reserve currency, an advantage enjoyed
by the US dollar. Secondly, there is a
large domestic saving pool to finance
the borrowing, such as exists in Japan.
Finally, the country possesses a sound
and sustainable economic and industri-
al base. These countries do not meet any
of the above criteria.
There are no easy solutions…
There are no more easy solutions.
Take Ireland, which has already
implemented austerity measures. The
government debt as a percentage of
GDP has gone up to 64% from 43.9%.
The budget deficit as a percentage of
GDP has doubled to 14.13% from 7.3%.
The nominal GDP of the country has
fallen by 18%. Given many of these
countries have low growth, high unem-
ployment (Spain’s unemployment rate
is 20%), the likely social and political
consequences are extremely severe. I
am not sure that the cure is feasible or
will help make it easier to meet the debt
faulted on dollar debt with no impact on
the currency itself. In fact, cutting out
the unsustainable countries - those that
are unlikely to survive —- out of the
euro in a form of battlefield triage would
help the currency.
Germany has banned naked short-selling.
Are we going to see more clampdowns
from governments?
The short-selling ban is a poorly con-
ceived and politically-driven initiative.
First, it can’t possibly work as only Ger-
many has implemented it and other na-
tions are likely to be reluctant to follow.
Secondly, blaming ‘wolfpacks’ — by the
way, wolves are seriously endangered in
Europe and are protected — misses the
point that through their trading actions,
they are pointing out the blindingly ob-
vious: that these states are effectively
bankrupt and not in a position to repay
debt. They say about Shakespeare that
“they all quote him in the end”. When
things go wrong in the financial mar-
kets, everybody looking for a scapegoat
blames speculators and short-sellers.
Some statement about a worldwide con-
spiracy, probably with a Jewish taint,
can’t be far away.
Where do we go from here?
Frankly, things are fairly grim. The
world has too much debt. During the
first phase of the global financial crisis,
governments and regulators did not
want to acknowledge this and merely
transferred the debt from private-sector
balance sheets onto government bal-
ance sheets. The debt never went away
at all. Now, governments themselves are
in trouble, some no longer able to fi-
nance themselves. This means at best a
withdrawal of government support - or
lower spending and higher taxes —
which will reduce global demand and a
prolonged period of stagnation. At
worst, we could see a string of sovereign
debt rescheduling and a return to the
worst days of the credit crisis. It’s now
finely balanced. There is no political
will to tackle the deep-seated problems.
The electorate, which is poorly in-
formed, is unwilling to accept the ad-
justment and lower living standards
that will be necessary. As Woody Allen
once observed: “More than any other
time in history, mankind faces a cross-
roads. One path leads to despair and ut-
ter hopelessness. The other, to total ex-
tinction. Let us pray we have the wis-
dom to choose correctly.”

IN TERMS OF SCOPE OR AMBITION OF US LAWMAKERS’ ACTIVITY, THE LAST 16 MONTHS HAVE NO OTHER PARALLEL

Setting a progressive agenda that rivals the New Deal, no less

With the US Senate’s passage of finan- Federal Reserve, which did not distin-
cial regulation, Congress and the White guish itself during the housing bubble. Momentous moves Reagan thrust in some important ways.
Although the Reagan administration did
changes. This would hurt financial
firms’ ability to act as a middleman,
House have completed 16 months of ac- Already, though, one downside to the First came a stimulus bill that, while not shrink the size of the federal gov- much as Expedia and other travel Web
tivity that rival any other since the New legislative spurt does seem clear. By fo- aimed mainly at ending a deep reces- ernment, it changed the ways that Wash- sites have hurt travel agents.
Deal in scope or ambition. Like the Rea- cusing on long-term problems, Obama sion, also set out to remake the ington collected and spent its money, by For all these differences, though,
gan Revolution or Lyndon Johnson’s and the Democrats have given less than nation’s educational system and vastly reducing taxes on the affluent, cutting there are also ways that Obama and to-
Great Society, the new progressive peri- their full attention to the economy’s cur- expand scientific research some social programs and increasing day’s Democrats have accepted, and are
od has the makings of a generational rent weakness and turned off a good Then President Barack Obama signed military spending. even furthering, the Reagan project.
shift in how Washington operates. number of voters. a healthcare bill that was the biggest These policies ended up magnifying in- They are not trying to raise tax rates on
First came a stimulus bill that, while After months of discussion, and with expansion of the safety net in 40 years come inequality, which was already ris- the affluent to anywhere near their pre-
aimed mainly at ending the unemployment And now Congress is in the final ing for other reasons. Since 1980, median 1981 levels. Their health bill tried creat-
a deep recession, also rate hovering near a stages of a bill that would tighten Wall household income has risen only 30 per- ed new private insurance markets, not
set out to remake the na- 27-year high, Democra- Street’s rules and probably shrink its cent, adjusted for inflation, while average expand Medicare.
tion’s educational sys- tic leaders said Thurs- profit margins incomes at the top have tripled or quadru- Most striking, the administration is
tem and vastly expand day they had finally pled. Every major piece of the Obama trying to improve public education by in-
scientific research. reached agreement on agenda is meant, in part, to push back troducing more market competition.
Then President Barack comment a bill that would send I’d have told you it was going to fizzle achievements. And given the difficulty against inequality. Government may Even with those bubbles, the nation’s
Obama signed a health- David Leonhardt aid to states and take into virtually nothing,” said Theda of getting anything done under the grid- grow, but the bigger change will be how economic output expanded only 20%
care bill that was the other steps to increase Skocpol, the Harvard political scientist. lock of Congress, it’s pretty surprising.” the government is spending its money. from 2000 through 2009. In the 1980s, it
biggest expansion of the safety net in 40 job growth. Congress plans to vote on the “Now it could easily be one of the pivotal The last 16 months seem most similar The health bill expanded insurance grew 35%, and in the 1990s, it grew 37%.
years. And now Congress is in the final bill next week. But some of the money periods in domestic policy.” But, Skocpol in scope to three other periods in the last coverage largely for middle-class and Will this new progressive project suc-
stages of a bill that would tighten Wall will not be spent for months and may not added, “It will depend on what happens 80 years. After World War II, the federal poor families and paid some of the bill ceed? There are any number of uncer-
Street’s rules and probably shrink its be enough to affect voters’ attitudes be- in the next two elections.” government helped build the modern by taxing households making more than tainties: whether enough charter schools
profit margins. fore November’s midterm elections. The recent period surely will not middle class with the GI Bill, housing $250,000 a year. Attached to the final will succeed, whether the new health in-
If there is a theme to all this, it has Still, the turnabout since January 20 match the impact of the New Deal. Noth- subsidies, the highway system and in- health bill were also education provi- surance markets will function well,
been to try to lift economic growth while — the first anniversary of Obama’s in- ing is likely to, notes David Kennedy, a centives for employers to offer health in- sions that cut subsidies to banks making whether the Fed will learn to become an
also reducing income inequality. Growth auguration and the day after Scott Pulitzer Prize-winning historian, be- surance. The 1960s — mostly under John- student loans, and used much of the effective regulator of Wall Street.
in the decade that just ended was the Brown, a Republican, won a Senate seat cause the New Deal created much of the son, but also Richard Nixon — brought money for college financial aid instead. Some of those questions won’t be re-
slowest in the post-World War II era, in liberal Massachusetts — has been re- modern American government. “These civil rights legislation, Medicare, Medic- The financial regulation bill, mean- solved for years. But one issue should
while inequality has been rising for markable. Then, commentators pro- are not as dramatic as the foundational aid and environmental laws. Then Rea- while, would take several steps likely to become clear much sooner. Reagan,
most of the last 35 years. nounced the Obama presidency nearly moments,” Kennedy said, “but they’re gan ushered in a period that continued, reduce Wall Street’s profits —- and Wall Johnson and Franklin D Roosevelt ce-
It is far too early to know if these efforts dead. Today, he looks more like a liberal significant changes.” more or less, until 2008: tax cuts, less reg- Street has created more multimillion- mented their changes by retaining
will work. Their success depends enor- answer to Ronald Reagan. Alan Brinkley, a historian of the De- ulation and other attempts to unleash the aires in recent decades than any other enough allies in Congress and serving
mously on execution and, in the case of fi- “If you’d asked me about this admin- pression, added: “This is not the New competitive forces of the market. industry. To take one example, certain more than four years in the White
nancial regulation, specifically on the istration after Scott Brown was elected, Deal, but it’s a significant series of Obama has been trying to reverse the trades would be forced onto open ex- House. Obama has yet to do so. NYT

Printed and published by Kamal Jain on behalf of Diligent Media Corporation Ltd. Printed at EL-201 MIDC TTC Industrial Area, Mahape, Navi Mumbai 400705 Phone No. 39802200 and published at 1st Floor Oasis Complex, Lower Parel, Mumbai 400013 Phone- 43888888 Editor: R. Jagannathan. Reg No.-MAHENG/2006/18434