Category: News and politics

Further thoughts on Free Speech

Why are Americans (in particular) so attached to free speech, even repugnant free speech? Why is the first item in our Bill of Rights (i.e. the First Amendment to our Constitution) devoted to its protection? Our strong defense of free speech rests largely, in my view, on three beliefs held by most Americans.

The first is that it is our right and our responsibility to decide for ourselves what to read, view or listen to. We turn to ourselves and our families first and to our communities and our government second and third for most things. No one is absolutely self-reliant (even Robinson Crusoe had his man Friday), but Americans have historically been more self-reliant than most any other people. We trust our own judgment more than that of a public morality police. Though we often turn to trusted advisors in our churches or communities for guidance, we choose whose guidance we respect. No one has a stronger interest in our getting it right than we do ourselves. I don’t buy the paternalistic argument of some “do gooders” that the poor or uneducated just don’t care.

The second belief, born of centuries of experience and accumulated evidence, is that government power is always in danger of being corrupted to the service of those in power if not carefully checked and balanced. If government had the power to control what we heard, it would, sooner or later, be abused. If government is able to filter what we see and hear, it will not be able to resist filtering out information inconvenient to or critical of itself.

The third belief is that competition in ideas and information as well as in the provision of goods and services will reward the truth and drive out falsehood. This issue of discovering the truth is complicated. These days anyone can say anything and post it on the Internet. However, it doesn’t generally take long for the truth to crowed out lies (the claims that Ambassador Stevens body had been sodomized or that American Embassy Marine guards did not have live ammunition come to mind). To the extent that we trust the statements of our government it is only because we know that we (and the press) are free to contradict it if we have contrary evidence.

Our strong defense of free speech does not obligate us to defend the content of that speech. The Turkish Prime Minister Recep Tayyip Erdogan said that “’both the mentality and the organization behind this movie and those perpetrating terrorist actions exploiting Islamic symbols and discourse’ were equally to be condemned.” (The Washington Post “Anti US fury widens in Muslim world” 15/9/2012). Secretary of State Hillary Clinton called the offending video “disgusting and reprehensible.” She was right to say so, though I found the film merely pathetic.  We defend the right of the cretins who made this film to make it and to show it where ever they can convince some company or person to do so while also defending our right to denounce it.

This brings us to the “Muslim” reaction to the film. Many Muslims around the world have complained loudly about pictures or films that denigrate Mohammed, as do many Christians when pictures or films denigrate Jesus. That is simply an exercise of free speech. But what about demonstrations at American Embassies? “The right of the people peaceably to assemble,” is merely one of the means of exercising free speech and is also protected by the First Amendment to our Constitution.

Attacking our Embassies and their officials and employees is quite another matter. Muslims are wrong to do this and their governments should not allow it. I hope that you stumbled at my broad brushed attribution of this violence to “Muslims”.  If you didn’t you should have. Muslims did not kill four Americans in Benghazi or set various American properties on fire in several countries. “It is no more accurate to condemn the Muslim world for the atrocities of a relative few than it is to indict America because one lowbrow decides to upload a lousy flick that nobody otherwise would watch or even know about.” (Kathleen Parker, “In Libya and America-imbeciles affecting foreign policy” 14/9/2012.) Individuals did these things, each with their own motives. What drew people to these demonstrations? Who are they and what are their goals? In Benghazi, the murderers may have been al-Qaeda linked. The attacks in Egypt were primarily lead by hard line Islamists groups against the somewhat more tolerant and moderate new government of the Muslim Brotherhood. (David Ignatius, “Cairo and Libya attacks point to radicals jockeying for power” The Washington Post 12/9/2012)

Not everyone in the world understands or accepts our strong commitment to free speech. Our self-interest calls for us to carefully explain to the rest of the world its value and importance for the kind of societies that respect individuals that we want to live in.

American Values and Foreign Policy

One of America’s values and traditions is standing together in the face of foreign attack or challenge. Presidential candidate Mitt Romney has violated that tradition by attacking the statements of the American Embassy in Egypt’s condemnation of an anti-Muslim film made in California: “The Embassy of the United States in Cairo condemns the continuing efforts by misguided individuals to hurt the religious feelings of Muslims — as we condemn efforts to offend believers of all religions.”

Following news on September 11 of American casualties at an American consulate in Libya, Romney’s foreign policy advisers recommended that he speak out against the government’s apologies. He issued the following statement:

“I’m outraged by the attacks on American diplomatic missions in Libya and Egypt and by the death of an American consulate worker in Benghazi. It’s disgraceful that the Obama Administration’s first response was not to condemn attacks on our diplomatic missions, but to sympathize with those who waged the attacks.”

The next day Romney pressed his attack further, saying that, “I think it’s a terrible course for America to stand in apology for our values, that instead when our grounds are being attacked and being breached, that the first response of the United States must be outrage at the breach of the sovereignty of our nation. An apology for America’s values is never the right course.”

Romney was apparently not aware that the American Embassy’s statement on September 11 had been issued before the tragic death of Ambassador Stevens and three other Americans in Libya. Christopher Stevens was a fraternity brother of mine from the ATO house in Berkeley, though we were not there at the same time and I have never met him. President Obama in fact condemned the killings and according to the Washington Post: “unnamed White House officials told news outlets later Tuesday night that the [Egyptian] embassy statement did not reflect U.S. government views.” That is a pity because it does reflect American values and should reflect U.S. government policy.

Since neither Romney nor Obama seem to understand what American values are in this context, I am volunteering a refresher course.

We believe passionately in free speech and tolerance of the views of others. This is far from accepting anything someone might say. It is hardly the same thing as condoning insulting or ignorant things people sometimes say. Sam Bacile’s “The Muhammad Movie” is crude and disgusting. It deserves to be condemned and the Egyptian Embassy was quite right to apologize for it. Terry Jones, the hate mongering, Koran burning, so-called Christian minister in rural Florida has been promoting the film. Real Christians should condemn him, while at the same time acknowledge his right to state his twisted views.

Our values were reflected, for example, when many Christians complained that Andres Serrano had received $15,000 from the National Endowment for the Arts (a government agency) for his photograph of a crucifix submerged in a glass of urine without questioning the artists right (at his own expense) to do such things. Although the artwork was condemned by many as an affront to Christians, mobs did not storm the gallery that planned to show it nor the NEA. Secretary of State Hillary Clinton is one of the few to get the balance about right: http://www.washingtonpost.com/blogs/she-the-people/post/hillary-clinton-speaks-out-for-the-same-american-values-upheld-in-retracted-embassy-statement/2012/09/13/ccbf05f2-fdd6-11e1-b153-218509a954e1_blog.html

Standing together in the face of foreign attacks does not mean that we cannot or should not criticize foreign policies that we think do not service the best interests of our country.  But wise and thoughtful people know when the timing is right for such serious discussion. The present moment of grieving for our lost brothers and sisters is not a time for divisive political maneuvering. Romney’s foreign policy advisers have given him bad advise before (think Israel/Palestine. See my earlier blog: https://wcoats.wordpress.com/2012/08/05/romney-on-culture/). Romney should fire them.

Has the ECB provided the missing piece to resolve the EU debt crisis?

On September 6, Mario Draghi, president of the European Central Bank (ECB), announced that the ECB would engage in unlimited secondary market purchases of government bonds of member countries adhering to the policy conditions agreed to with the IMF and EU (and thus qualified to borrow from the European Financial Stabilization Fund – EFSF – or the European Stabilization Mechanism – ESM) to the extent needed to promote the efficient transmission of monetary policy throughout the Euro area. The over all liquidity impact of such purchases will be sterilized (offset by the sale of some other ECB assets), as needed, in order to preserve the ECB’s inflation objective of an inflation rate below but near 2% over the next two years. What does this add to the existing European tool kit and is it enough to resolve the EU debt crisis?

All responsible government officials recognize and accept that in the long run nations, like individuals, must live within their means (pay fully for what they consume). Their standard of living will depend on what they are able to produce (productivity).  Eliminating government deficits requires reducing government spending and/or increasing its tax revenue. Increasing the sustainable standard of living of its people (the level of consumption they can fully pay for with what they produce) requires liberalizing restrictions on labor and product markets and investment that will increase the productivity and thus output of workers and businesses. The debate is primarily over the optimal pace of introducing the measures needed to balance budgets and increase productivity and competitiveness.  This matters in that it takes time for the economy to adjust to reforms before it enjoys the benefits of more rapid growth. In the interim continuing but declining deficits must be financed either in the market (if market lenders have confidence in the effectiveness of the measures being taken), or by the IMF/EU/ECB until market confidence can be established.

I have elaborated these points in earlier blogs: “European debt crisis: causes and cures”; “Saving Italy and the euro”;   “Buying time for Italy”; and “Saving Greece-Austerity and/or Growth”.

Throughout the crisis Germany has demanded that Greece and other over indebted and uncompetitive countries undertake the needed corrective measures before being granted the financing needed for the transition back to normal market borrowing.  Events have proven Germany to be right as earlier “bailout” commitments have led to a suspension or slow down in policy reforms thus prolonging recovery.  For the same reason Germany has vigorously opposed (correctly in my view) the adoption of Eurobonds, which would allow Greece and others to borrow at the same interest rate as Germany and all other EU members. The moral hazard of bad fiscal behavior when market discipline of over borrowing is removed is a real and serious issue.

On the other hand, Germany is also pushing for Fiscal Union in order to gain better EU wide control over excessive national deficits. This may or may not be a good idea for Europe (I have my doubts) but it is certainly not, contrary to much opinion, essential for the viability of the Euro. The idea behind the German push for Fiscal Union stems from the markets’ failure to properly price the risk of lending to Greece, Portugal and some other overly indebted countries and Germany’s belief that the only way it can protect its tax payers from supporting inflated living standards to the South is by gaining control over their governments’ expenditures. Until the last few years, the governments of Greece and Portugal could borrow in the market at interest rates very close to the rates paid by the German government, which by the way has borrowed quite a lot itself (the ratio of German government debt to its GDP is currently above 81%). These governments spent and over promised future benefits recklessly on the (temporary) basis of relatively cheap debt financing in the market.

It is certainly a fair question to ask why the market failed in this regard and over lent to a number of governments that now have difficulty repaying. The expectation that Germany and other Northern EU countries would not allow the profligate southern ones to default made such lending seem risk free and the market priced it accordingly.  Fiscal Union and/or EU-wide fiscal rules are one way to limit such excessive borrowing and unfunded future promises. Improved market discipline of borrowing via more accurate risk premiums on market lending is another, and in my opinion, superior approach. Greece’s orderly default (75% haircut) on its publicly held debt and the current crisis have restored a large measure of market discipline to sovereign borrowing. Greece and Portugal do not need to borrow from the market for several more years as long as they implement and adhere to the reforms demanded by the IMF/EU/ECB. However, Spain and Italy closely watch the now far more sensitive interest rates demanded by the market when lending to them. Given the substantial outstanding debt of these countries, those interest rates can make the difference between the success or failure of reform efforts. Ireland, which has successfully, though painfully, implemented all of the conditions of the IMF et al “bailout,” is well on the way to full recovery and is now able to borrow again in the market at reasonable interest rates.

The missing piece in the EU/ECB tool kit to manage the ongoing debt crisis is the availability of sufficient temporary adjustment financing for larger countries such as Spain and Italy should markets loss confidence in one or both of them before their reforms have had time to bear fruit. The resources of the EFSF/ESM, still waiting for the German constitutional court’s approval, are not sufficient to finance stabilization programs with both countries. This leaves markets uneasy and volatile.  Market interest rates on ten-year Spanish government bonds have varied this year between under 5% to 7.6%. German government bond rates have varied between 1.24% and 1.85%.  Mario Draghi’s commitment of ECB funds to buy short-term sovereign debt (with maturities of up to three years) in secondary markets does not augment the resources available to the EFSF/ESM to finance adjustment programs with the IMF, but by buying such bonds in the secondary market should liquidity in a program country dry up, the ECB should be able to significantly reduce the prospects of what it considers unrealistically high risk premiums for such bonds. The ECB would only buy bonds of countries meeting the conditionality of an IMF supported adjustment program. Outright secondary market purchases are a standard and traditional liquidity management tool for central banks. What is unique in the European context is that open market purchases must be for the bonds of individual countries and the choice of countries matters. It is for others to determine whether, as Mr. Draghi claims, the new initiative is consistent with the ECB’s mandate.

This past week I attended a meeting of the Mont Pelerin Society in Prague. Friedrich Hayek, Milton Friedman and a few other free market champions founded the MPS in 1946. Czech President Vaclav Klaus, also an MSP member, hosted this year’s meeting. President Klaus has opposed the Czech Republic’s adoption of the Euro. It has kept its own currency, which the Czech National Bank has managed very well under an “inflation targeting” policy regime. However, Spanish economist Jesus Huerta de Soto spoke at the meeting in defense of the single currency. He favors a return to the gold standard but convincingly argued that the monetary discipline on Spain provided by giving up its own currency to the Euro was a good second best.  The key to success or failure of the Euro for the overly indebted countries that use it is whether they reform deeply enough to live within their own means within a few years and to sufficiently improve their competitiveness with the rest of Europe and the rest of the world. Failure to do so will harm the defaulting country far more than it will harm the Euro.  I wish them well.

Romney on Culture

Mitt Romney is clearly an intelligent guy with an impressive business track record. This makes it all the more disturbing that while visiting Israel Romney felt called upon to blame the difference in living standards between Israel and the occupied West Bank and Gaza (WBG) on cultural differences. I will unpack the ignorance of this claim further on, but first, why did he do it?

We know that Romney is weak on foreign policy issues and regrettably influenced in this area by neocon advisors who tend to favor the one Israeli state solution to the Israeli/Palestinian problem favored by the Israeli right wing over American interests and policies. Since George W Bush American policy has explicitly supported a two state solution. Those unfamiliar with the history of these issues are urged to read my earlier blogs on the topic: “The View from the West Bank – a history of the conflict”, “Jerusalem in august 2006″, “Leaving Israel August 11 2006″. “The Invented Palestinians”.

The United States has a strong commitment to the military defense of Israel and it was appropriate for Romney to restate that commitment while visiting Israel. But it is neither in our national interest nor Israel’s to support or endorse every measure the current Israeli government might think up or take in relation to its neighbors. Israel’s well being depends on making a just peace with its neighbors and returning the West Bank and Gaza to the Palestinians that live there. This is well known and accepted by most Israeli’s but not, apparently, by Romney’s neocon advisors. Given Romney’s lack of understanding in these issue, wisdom would have called for him to remain silent on the issue. So why did he say it, then deny it and than say it again?

First, what did he actually say? According to the Associated Press (“Romney outrages Palestinians by saying Jewish culture helps make Israel more successful”) on July 30 Romney told a breakfast meeting with wealthy donors at the King David Hotel in Jerusalem:  “As you come here and you see the GDP per capita, for instance, in Israel which is about $21,000 dollars, and compare that with the GDP per capita just across the areas managed by the Palestinian Authority, which is more like $10,000 per capita, you notice such a dramatically stark difference in economic vitality…. And as I come here and I look out over this city and consider the accomplishments of the people of this nation, I recognize the power of at least culture and a few other things.”

Saeb Erekat, a top Palestinian official told the AP: “What is this man doing here? Yesterday, he destroyed negotiations by saying Jerusalem is the capital of Israel, and today he is saying Israeli culture is more advanced than Palestinian culture. Isn’t this racism?”

The next day in an interview with Fox News’ Carl Cameran in Poland, Romney denied that he has spoken of the role of culture in the differences in income between Israel and Palestine. (Cameron interview of Romney) It did not take long for Romney to correct this misstatement in a National Review article under his name, “Culture does matter-Mitt Romney”: “During my recent trip to Israel, I had suggested that the choices a society makes about its culture play a role in creating prosperity, and that the significant disparity between Israeli and Palestinian living standards was powerfully influenced by it. In some quarters, that comment became the subject of controversy.”

So why did he say it?  Sadly Tom Friedman probably has it right in his July 31 column in the New York Times: “Why not in Vegas”  “Since the whole trip was not about learning anything but about how to satisfy the political whims of the right-wing, super pro-Bibi Netanyahu, American Jewish casino magnate Sheldon Adelson, why didn’t they just do the whole thing in Las Vegas? I mean, it was all about money anyway — how much Romney would abase himself by saying whatever the Israeli right wanted to hear and how big a jackpot of donations Adelson would shower on the Romney campaign in return.”

So statesmanship, diplomacy, American national interest had nothing to do with it. So maybe Romney actually understood how stupid his comments were. But let me walk us through the facts.

First, Palestinians and non Arab Israelis are first cousins racially. So this can’t be what Romney had in mind. Religiously, Judaism, Christianity, and Islam, the three great monotheistic religions, with Islam the most recent in that evolutionary chain, all share cultures of individual responsibility and work ethic. So it is hard to see Romney’s point in this area. My point is not that culture is unimportant, though calling in “everything” is clearly wrong. My point is that anyone who knows anything about Israel and the WBG, knows that it does not apply there. A very informative and well worth reading criticism of Romney’s statement is in Fareed Zakaria’s Aug 2, Washington Post op-ed, “Capitalism not culture drives economies”.

If Romney had driven the short, but time consuming, distance from Jerusalem to the temporary Palestinian capital in Ramallah, he would have seen some of the physical evidence of how Israel is choking the economies of the occupied, land locked West Bank and the blockaded Gaza Strip (high concrete walls cutting through Palestinian farms, check points blocking the movement of people and commerce, illegal Israeli settlement on Palestinian lands, etc.). I would have thought that a man of Romney’s intelligence would chose to remain silent on these deeply explosive issues until he could consult a more balanced group of foreign policy experts. Sadly he seems to have put politics above national interest.

Spain’s Financial Crisis: First Principles

Europe’s debt crisis has many contributing elements: bloated government bureaucracies, unaffordable social welfare programs, and productivity stifling labor and commercial laws.  However, none is as central as the condition and behavior of those European banks that overlent to and undercharged many European governments, and whose potential insolvency should one or more European governments default (as Greece has already to some extent) has dominated the EU’s slow, halting approach to dealing with it. Focusing on the case of Spain, the following note illustrates the importance for the future of Europe’s financial markets of resolving the banking sector’s problems properly.

Overview

In some respects the financial and debt situation of Spain is similar to that of the U.S.[1] Its central government debt is less than the U.S.’ and Germany’s (68%, 103%, and 83% respectively). This year its public sector deficit is expected to be 5.9% (8.5% last year), less than the U.S. at 7.6%, but more than Germany’s at 1.3%. Its total debt (public and private) to foreigners (external debt) is less as well (84%, 103%, and 142% respectively). Spain’s housing bubble and subsequent collapse were average. The decline in Spain’s real housing prices from their peak in 2007 of about 20% was about the same as the UK’s and the Euro zone’s and less than in Ireland and the U.S.

To over simplify, what sets Spain apart is a) its lack of competitiveness (its current account deficit with the rest of the world relative to GDP was 9.6% in 2008 and is currently almost 3% while the Euro area as a whole is balanced – i.e., 0); b) the heavy reliance of its banks on borrowed funds (its loan to deposit ratio is about 150% compared with 80% for U.S. banks; and c) its banks’ large exposure to the real estate and construction sectors (56.5% compared to 30% for U.S. banks). In addition, Spanish and European banks in general operate on much less capital than do American banks. Going into the recent financial crisis—2007—the ratio of total European bank assets to capital—i.e., the leverage ratio—averaged around 30, while for American banks it averaged around 13 (i.e. capital gearing ratios of 3.3% and 7.7% respectively).

Spain was confident that it could make sufficient budgetary and policy adjustments to convince markets that it was still safe to lend to while gradually winding down excess spending and liberalizing rigid labor and product markets (its no bailout strategy). But after four years of inadequate measures Spanish voters ousted the Socialist Party and gave the center right party of Mariano Rajoy a solid majority in Parliament with a mandate to move more aggressively. Prime Minister Rajoy’s reform program has been a mixed bag (see “Spain’s Economic Reforms: A Mixed Bag”). The central government’s spending and deficit are falling rapidly, though excessive regional government spending remains a problem. Labor market reform has been quite quick and strong and is already producing improvements in competitiveness. However, Spain has fallen back into recession and unemployment is the highest in Europe at over 24%.  (see Rajoy government reform program)

Spain’s Banks

Spain’s primary vulnerability comes from its banks. In fact, a central feature of the European debt crisis is the relatively large exposure of European banks, including German banks, to the sovereign debts of Greece, Portugal, Ireland, Italy, Spain, etc. If depositors think that their deposits are at risk, they will move them. If they think all banks in Spain suffer this risk, they will move them out of Spain to other banks that accept Euros. If depositors withdraw their deposits too rapidly (i.e., bank runs) then even solvent, well capitalized banks can have trouble liquidating assets fast enough to fund the withdrawals. The total deposits of Greek banks have fallen from € 245 billion at the end of 2009 to € 175 billion at the end of April 2012. However, Spanish banks’ deposits have not begun to decline until very recently.

Countries limit the risk of deposit runs by explicitly insuring bank deposits up to a limit and/or by standing ready to intervene (bailout) failing banks. In Spain, all deposits are insured up to € 100,000 per depositor. If governments guarantee all deposits as a result of a comment to bail out insolvent banks, deposit insurance is redundant and not needed. Even a full deposit guarantee provides some market discipline of bank behavior if the regulator intervenes promptly when a bank becomes insolvent, because shareholders lose all of their investment in the bank. Market discipline is strengthened further if bank bondholders also incur losses when the assets of an intervened bank are not sufficient to cover their repayment.

The Importance of Bank Capital

Without deposit insurance or government deposit guarantees, their bank’s capital is the primary protection for depositors against the risk of loss.  If depositors think that their bank’s capital is too low to cover potential losses, they will move their deposits to safer banks. Unfortunately, the value of a bank’s capital cannot be known with certainty. Economic capital (net worth) is the difference between the value of assets and the value of liabilities. A large share of banks’ assets is loans. The value of a loan is less than its face (book) value if it is not repaid fully or on time. It is impossible to know for sure which loans are “good” and which are doubtful and how doubtful they might be in the future.

Minimizing the risk of deposit runs via capital adequacy consists of three elements:

  1. The level of capital banks are required to hold in normal times (dynamic or cyclically adjusted capital requirements deserve more serious attention) must be sufficient to absorb possible losses. Higher capital requirements provide more deposit protection.
  2. The rules for valuing assets and thus capital must reflect their real value as best as possible. Most bank loans have no secondary market from which to measure their value. Thus bank regulators have established rules of thumb for estimating the probable loss in value for loans that are not performing or are at risk of falling into arrears and potentially defaulting. Banks are required to provision (write down capital) to cover such probable losses. This is the equivalent of “marking to market” the probable value of loans that have no market. Loan valuation and loan loss provisions need to realistically reflect and cover the most likely repayment outcomes.
  3. Depositors must have confidence in the adequacy of the first two measures and the faithfulness with which banks apply them. This is the issue of transparency. The recent deployment of stress tests, when properly explained (especially when undertaken by third parties, such as the IMF), is meant to reduce the uncertainty surrounding the adequacy of measured capital.

The risks to Spanish bank depositors come primarily from three sources:

  1. The potential losses from loans to Spain’s now busted housing and construction markets and from holdings of sovereign debt of Greece are uncertain and have almost certainly been underestimated and under provisioned in the past. Significant exposure to Spanish sovereign debt is now becoming an issue as well. Capital injections are needed just to keep actual capital at currently reported levels. Higher levels of capital are needed to compensate depositors for the uncertainty of the actual level of capital.
  2. The ability of Spain to honor its deposit insurance commitments or its implicit commitments to cover deposits in the event of an intervention are increasingly in doubt because the ability of the Spanish government to borrow additional amounts to cover such commitments is in doubt.
  3. The ability of banks to fund their loans from non-deposit sources or to fund deposit withdrawals even if they are well capitalized are in doubt in current market conditions. This is a liquidity problem, not a solvency problem, and should be handled by the provision of central bank liquidity.

Spanish banks fund a large part of their loans with relatively short-term borrowed money rather than deposits. Access to such funds has become difficult and expensive. From the beginning of central banking, a core function of central banks has been to provide banks with the liquidity they need in such circumstances. The long-established principle is that the central bank should provide illiquid but solvent banks with all the liquidity they need (generally by lending to them against good collateral), but should not lend to insolvent banks (banks lacking sufficient good assets to cover their deposit and other liabilities). The ECB’s three-year Long Term Refinancing Operation is addressing banks’ liquidity problem (#3).

But even without deposit runs (or walks), Spanish and other European banks (especially) need to reduce the extent to which they lend long-term on the basis of short-term borrowed funds. They can only do so by reducing lending until their deposits finance a larger share of it and/or by increasing capital. The bank deleveraging now underway around the world is an important source of reduced bank lending and the slow pace of recovery (see Carmen M. Reinhart & Kenneth S. Rogoff, “This Time is Different: Eight Centuries of Financial Folly”).

Spanish banks were better capitalized than most at the onset of the international financial crisis but more recently have been overwhelmed by the magnitude of the collapse of Spain’s housing and construction markets. The government (previous and current) has taken measures to address banking sector weaknesses but always a bit behind the curve.  Seven failing cajas (regional savings banks heavily exposed to real estate) were merged in 2010 to form Bankia making it Spain’s fourth largest bank. In May the bank was largely nationalized (costing the Spanish government around 20 billion Euros to date) and trading of its shares was suspended on May 25, 2012. Deposit insurance was established then raised. Government guarantees of senior bank bond holdings were introduced (October 2008).

As time passed, depositors have only become more concerned about the safety of their deposits. In an effort to finally get ahead of the curve, the authorities have increased the provisions required against weak and doubtful loans and other assets, and initiated third-party stress tests of its banks. The IMF’s recent Financial Sector Stability Assessment found Spain’s large internationally active banks to be well capitalized and able to absorb the new capital strengthening requirements. However, its former savings banks and some of its medium and small private sector banks are more vulnerable and will need capital injections from the government to cover insured or guaranteed deposits. Because of its own financing difficulties, the government of Spain has turned to the EU to backstop its ability to recapitalize (replace capital lost by or potentially lost by defaulting loans) those of its banks with inadequate capital. For this purpose the EU has committed €100 billion.

The Way Forward

Deposit runs on Spanish banks (including the drying up of wholesale funding) can be prevented only by convincing depositors that their money is safe, i.e. that their banks have sufficient capital to cover any losses. This requires honest accounting and full implementation of the indicated provisioning, and adequate capital; or creditable government guarantees.

For the future health of Spanish banks, it is important that Spain’s banking interventions preserve the intended discipline of excessive risk taking that results from imposing losses on shareholders and senior bond holders while honoring its commitments to protect depositors. Thus liquidity support should only be given to solvent banks. Nonperforming loans should be properly provisioned. Banks that are critically undercapitalized and are unable to raise their own capital to required levels within a reasonable period should be intervened. Intervened banks should be resolved according to the least cost principle (least cost to the tax payer). Shareholders and senior bondholders should be wiped out before government money is injected to cover other liabilities. Viable banks should be continued and sold to new owners within a reasonable period of time. Non-viable banks should be wound down (liquidated) paying off all insured or guaranteed depositors with the help of public funds as needed.

In requesting EU financial assistance, Spain is committed to abiding by EU rules on state aid to banks. However, emergency responses to a financial crisis much too often produce the foundation of moral hazard and excessive risk taking that creates the next crises delaying true and long-lasting resolution. More market discipline of risk taking needs to be reintroduced via a sound bank resolution policy. Spain will contribute to the future soundness and vitality of its banking sector and that of all of Europe if it adheres to the above principles as it “cleans up” its financial sector.

[1] The International Monetary Fund’s “Financial Sector Stability Assessment”  provides an excellent summary as of May 2012.

The Hutchinson Lecture at the Universtiy of Delaware

Tuesday (April 17) I spent an enjoyable day in Newark, Delaware as the guest of the Economics Department of the University of Delaware. My afternoon, more technical, lecture to the graduate students and faculty covered my proposal for the reform of the international monetary system: http://works.bepress.com/warren_coats/25/

My evening lecture, this year’s Hutchinson Lecture, is reviewed here by the U. of Delaware newspaper (in which there is also a link providing background on the Hutchinson Lecture): http://www.udel.edu/udaily/2012/apr/HutchinsonLecture042012.html.

The War on Drugs

Like most of our elected wars, the war on drugs is producing more costs than benefits. In the United States, those drugs that were around for the last one to two hundred years have been legal at times and illegal at other times. There was no significant difference in the recorded use of these drugs when they were legal and when they were not (the data has to be rather sketchy, however). So there has been no measurable benefit.

The costs of outlawing drugs, however, have been enormous. The large expenditures on police, armies, courts, jails are nothing compared with the costs to society (on both sides of our Southern border) of creating the large criminal industry that grows, refines, transports, and markets these drugs and the lawlessness that accompanies it. Over the last thirty years 50,000 deaths have been attributed to drug related violence in Mexico alone. The Presidents of Colombia, Guatemala and Mexico are all now calling for a reconsideration of this war as an effective approach to dealing with the harm of some of these drugs.

http://www.washingtonpost.com/world/the_americas/latin-american-countries-pursue-alternatives-to-us-drug-war/2012/04/10/gIQAFPEe7S_story.html

As George Will puts it:  http://www.washingtonpost.com/opinions/should-the-us-legalize-hard-drugs/2012/04/11/gIQAX95QBT_story.html?wprss=rss_todays-opeds

Another good article in the Washington Post: http://www.washingtonpost.com/opinions/from-latin-america-a-new-strategy-in-the-war-on-drugs/2012/04/12/gIQAowenDT_story.html

Marijuana should be regulated like tobacco and cocaine and opium should be regulated like alcohol. We seem to be moving in the right direction on this issue but too slowly.

The Trayvon Martin Tragedy continues

The Trayvon Martin – George Zimmerman story has a way to run.  Every day seems to bring something new. Last week’s doctoring of audio tapes between Zimmerman and the 911 dispatcher aired by NBC (http://www.washingtonpost.com/blogs/erik-wemple/post/nbc-to-do-internal-investigation-on-zimmerman-segment/2012/03/31/gIQAc4HhnS_blog.html?hpid=z6 ) are now under internal investigation by NBC (a once reputable news source).

Yesterday David Franke passed along the following article by friend Walter Williams and his own observations that:

“Walter Williams is SO good!

“Right now we are witnessing the biggest lynch mob in the U.S. since the heyday of the Ku Klux Klan.  I refer to the mob out to lynch that “white” hispanic, Zimmerman.  This is a lynch mob made up of “black leaders” and MSNBC white-as-white-bread liberals.

“I have no idea whether Zimmerman is guilty or not, but I am willing to wait and let the police and courts and lawyers on both sides—and a jury, no doubt–go through the process of determining that.  And then, based on the evidence, I might venture whether I agree or disagree with the jury and the authorities.

“Not this lynch mob, however.  They KNOW who is guilty, and don’t confuse them with any facts or due process. “

http://www.lewrockwell.com/williams-w/w-williams117.html

The Trayvon Martin Tragedy

The shooting death of an unarmed black boy, Trayvon Martin, in the Florida town of Sanford, by a white Hispanic neighborhood watch volunteer, George Zimmerman, has raised many questions and issues. The positive side of this tragedy for me is that almost everyone wants to know the truth of what happened and to proceed from there. Moreover, our system of justice has procedures and mechanisms that maximize the prospects of uncovering and sorting out the truth from what is still a very confused mix of partial facts and assertions by interested parties (the friends and parents of Trayvon and of George).

When Trayvon’s death first rose to national attention, everyone’s initial reaction was colored by his or her personal biases (“priors”). If you are black, you initially and immediately accepted the outrage of Trayvon’s parents at the failure of the police to arrest the shooter of their unarmed son. If you are one of George’s friends you immediately accepted George’s claim of self-defense (the somewhat later revealed claim that he had been attached and beaten by Trayvon and fired in self-defense).

For most of the rest of us, the fact that Trayvon’s pictures depict him as a handsome, smiling, friendly youth (looking, as President Obama ill advisedly claimed, much like his own son would if he had one), while Zimmerman’s pictures depict him as, well, more or less the opposite, activated a bias toward beauty.  Because Russian President Putin (and even more so outgoing President Medvedev) is handsome and fit, we assume he must be a better guy than fat and ugly Nikita Khrushchev (I just reviewed Khrushchev’s picture for the first time in many years and he actually isn’t THAT ugly). Because Israel’s Prime Minister, Benjamin Netanyahu, is handsome and speaks excellent American English, we assume that he must be right and good for Israel (despite all the evident to the contrary).

These are natural biases. We shouldn’t pretend that they don’t exist. What is important is that we can move beyond them when faced with contrary evidence. As allegations from each side of the Stanford tragedy (everyone agrees that it was a tragedy) along with bits of actual evidence accumulate, what seemed clear in the beginning to each of us (depending on where we started – i.e., our biases) becomes less clear. Trayvon’s past is not spotless. Did Zimmerman have blood on his cloths from being beaten by Trayvon as he claims (a surveillance video when he was taken into custody suggests not)? Whose voice was it shouting on the 911 recording (not Zimmerman’s according to two unofficial expert analyses)? ETC. ETC. With the passage of time and the collection of and vetting of more facts, the truth should clarify and emerge.

The positive side of the sad story is that virtually everyone outside of the immediate families genuinely wants to know the truth of what really happened. Hometown power figures have always been more able to bend our rules and procedures of justice to their interests than others but not without limit. Those limits in many ways have grown tighter. In this case, a southern town is bending over backward (after a slow start) to be and to appear to be fair. I suspect it would have been different fifty or a hundred years ago. Public opinion (i.e., our priors –biases), an important foundation of our conception of justice, has changed for the better.

I have no doubt that we will eventually know the truth of that night as fully as it is possible to know it.