Tuesday, September 27, 2011

Can Liberia Stand on its Own?

Economist: Liberia’s Election: Hold Your Breath
UN: Upcoming Elections in Liberia Must be Peaceful, Free and Fair

Liberia, a country that was torn by civil war less than a decade ago, is anticipating holding only the second presidential election since the fighting ended. After years of dealing with riots, marauding gangs, and violence, Liberia now appears to be on a more stable path towards development. In recent years, violence has calmed and economic growth has taken hold. The IMF recently predicted Liberia’s economy would grow by 5.9% this year thanks, in part, to improving relations with foreign governments, who have forgiven $6 billion of Liberia’s debt and have aided Liberia’s reconstruction efforts.

Liberia has not solved all its problems, however. A recent ranking by Transparency International deemed Liberia the most corrupt country in the world. Rampant nepotism in government hiring and a corrupt police force are two prominent issues. The ranking came as a major blow to current president Ellen Johnson Sirleaf, Africa’s first female head of state, whose “zero tolerance” policy on corruption obviously has not been successful. 

The upcoming October elections are also gaining international importance. The United Nations (UN) currently has about eight thousand peacekeepers in Liberia through its Mission in Liberia (UNMIL). If the election proves to the international community that Liberia is more politically stable, the UN will withdraw its peacekeepers. UNMIL is set to end by the end of the year either way, which may leave the newly elected Liberian government responsible for maintaining a fragile peace. The country’s dependence on foreign aid and UN policing has led some observers to question whether Liberia will be able to stand on its own if and when the peacekeepers leave.

Finally, the election could have drastic consequences for the Liberian economy. If the election proves to foreign investors that the country is politically stable, foreign investment will likely begin flowing to the country. The withdrawal of the peacekeeping force may multiply any new investor confidence as well, unless investors believe the peacekeeping force is the only thing preventing Liberia from falling into another civil war. New foreign investment would spur economic growth and allow the country to become less dependent on foreign aid. Any economic growth should actually benefit Liberian citizens—not just the government—as new investment would create jobs in a country where 83% of adults are unemployed. In short, this seemingly commonplace election could be the first step toward major changes in Liberia.

Middle Eastern Governments Plan to Spend Huge Oil Profits on the Poor


Many oil-rich countries in the Middle East will see unprecedented profits thanks to high oil prices and have pledged to invest much of these profits in programs designed to alleviate poverty. Countries like Saudi Arabia, United Arab Emirates, Kuwait, and Qatar plan to spend billions on food aid, increasing civil servant salaries, and, to a lesser extent, on infrastructure improvements.

Substantial domestic investment is a new trend in the region, likely spurred by uprisings. In the past, many middle-eastern countries preferred to invest oil profits overseas. The recent political unrest throughout the region, however, has forced governments to pay more attention to the basic needs of their population. Citizens in Libya, Egypt, Tunisia, Bahrain, Syria, and Yemen have started protests and even civil wars against their current governments in the past several months. Many of these incidents resulted from citizens who feel their governments are oppressing them and neglecting their basic needs. In some countries, the uprisings have ousted long-standing leaders– a result none of the region’s leaders want to see in their own country.

Some experts feel the governments’ new investments are not the solution to these region’s problems. Much of the relief, such as food and cash handouts, will only have a short term effect. The governments are spending very little on projects that will support economic development in the long-term. Therefore, when the relief is gone, the poor will be in the same position they were before the handouts. Despite observers’ opinions that the countries should spend money on long-term investments that will support economic activity for years to come, citizens seem satisfied.

Regardless of the motivation for- or longevity of- the relief, increased domestic investment is a positive step for the Middle East. Oil wealth has been the source of some of the most dramatic inequality in the world as dictators and oil barons have kept oil profits for themselves for decades. The vast majority of the population lives in poverty. Unfortunately, many feel the financial disparity between the rich and the poor of these countries is just one characteristic of an oppressive culture in which citizens have little say in their government. The governments’ new domestic spending is the first sign of hope for the poor in these countries and may lead to increased political voice for the underrepresented group.

Monday, September 26, 2011

Italy Struggles to Calm Creditors’ Fears After Debt Downgrade

Guardian: Italy Downgrade Adds to Eurozone Contagion Fears
Spiegel: Belligerent Berlusconi Toys with Europe
Spiegel: Debt Downgrade
Telegraph: S&P Downgrades Italy: the full text
WSJ: Italy’s Frattini Sees Next Austerity Package Soon
WSJ: Italy Approves EUR54 Billion Austerity Plan

On Monday afternoon, credit ratings agency Standard & Poor’s (S&P) downgraded Italy’s credit one notch to A/A-1. The announcement came after S&P lowered its annual growth forecast for Italy to just 0.7% annually between 2011 and 2014, down from its earlier 1.3% prediction. The main reasons for the downgrade, according to S&P, is the political uncertainty regarding the country’s ability to deal with its economic challenges, especially finding a way to reduce its enormous public debt—currently at 120% of gross domestic product (GDP). S&P questions whether Italy’s plans to cut government spending and reach other fiscal targets will be as effective as the Italian government believes. S&P did not raise any concerns about Italy’s economic structure, external liquidity and investments, or the country’s monetary flexibility.

Italy is currently facing a fiscal deficit of 4% of GDP, an increase from just 1.5% in 2007. Although the government has attempted to limit spending, Italy’s exceedingly high public debt still accounts for 23% of all sovereign debt in the Eurozone. This immense debt burden has forced the Italian government to raise an equally large amount of capital by selling bonds (debt) on a regular basis to pay for its already-existing debts.

In an effort to tackle its increasing financial difficulties, the Italian government approved a €54 billion austerity package last week that increases taxes and cuts spending for the next three years. The package includes a 1% increase in the value-added tax (a European form of sales tax) which is expected to bring in €4.2 billion in new revenue per year. Additionally, observers expect the government to introduce a third round of austerity measures to Parliament within the next few weeks. The new legislation will likely aim to decrease the government’s medium-term debt by selling public property and privatizing some public services, although important businesses, such as oil and energy production and high-tech operations, are likely to remain under government control. The new measures are also aimed at promoting economic growth by attracting new foreign investments.

Many critics believe that Italy’s austerity plans will push the country into a recession by the end of the year as tax increases will reduce a major source of economic growth—domestic consumption—by taking money out of consumers’ hands. Thus, the country’s debt-to-GDP ratio will not decrease if a decrease in GDP accompanies any debt reduction the measures achieve. The only certain thing is that the Italian government has a difficult road ahead.

Mexico Decides to Stay the Financial Course

Bloomberg: Mexico Needs No Stimulus to Withstand U.S. Slowdown, Finance Minister Says
Bloomberg: Pemex Scrapping Peso Bond Sale Signals Deepening Slowdown: Mexico Credit
FT: Mexico Presents ‘Prudent’ Budget
Market News International: Repeat: Mexico: 2012 Budget Plan Cuts Deficit to 0.2%/GDP

Mexico’s proposed 2012 budget calls for fiscal policies designed to stimulate economic growth while reducing the country’s budget deficit. The Mexican government hopes the budget will attract foreign investors by showing economic stability at a time of global economic uncertainty. Former Finance Minister Ernesto Cordero, who stepped down to campaign for the presidency, explained that the budget adjusts for the global economic slowdown by increasing public spending “without putting fiscal sustainability at risk.”

Mexico’s economy bounced back in 2010 after experiencing a deep recession the previous year. After recovering economically, Mexico wants to avoid resorting to excessive stimulus that increased debt in a number of other countries during the global financial crisis. Instead of increased borrowing, Mexico’s fiscal policy will concentrate on spending restraint in anticipation of a further economic slowdown to reduce the deficit to 0.2% of gross domestic product (GDP). The Mexican government, however, believes that the budget will stimulate growth despite any economic slowdown by increasing investment in Mexican industry and encouraging higher export volumes and consumption of Mexican goods.

Although Mexico is Latin America’s second-largest economy with growth that currently outpaces U.S. economic growth, it still lags behind other emerging markets. The Mexican government estimates that Mexico’s economy will grow by 4% this year, which is the second-lowest growth rate among Latin America’s major economies, ahead of only Venezuela. In 2012, the Mexican government expects Mexico’s growth rate to decrease by 0.5%. The United States’ economic crisis has affected Mexico’s growth dramatically as 80% of Mexican exports go to the U.S, and U.S. consumers are buying fewer Mexican goods. Critics fear that if the United States slips into a second recession, Mexico could see a drastic reduction in trade, tourism, and remittances, which would be disastrous for the country’s economy.

The Mexican Congress has until November 15 to approve the budget, which calls for 3.62 trillion pesos ($259 billion) in total spending—a 2.5% increase from 2011. The budget includes new investment in Pemex, the state-owned petroleum company that is also the second-largest non-publically listed company in the world. The budget also estimates 3.2 trillion pesos ($229 billion) in total revenue—a 3.8% increase from 2011. The government is counting on Pemex reversing its six-year decline in oil output to generate a 1.15 trillion pesos profit ($82 billion). The budget calculates revenue based on an average oil price of $84.90 per barrel in 2012, a 10.3% increase compared to 2011 when the price has averaged $65.40 per barrel.

The budget also includes a 3.3% increase on economic development spending and a 6.7% increase on social development spending over the 2011 budget, which includes 400 million pesos ($29 million) dedicated to health care, 56.5 billion pesos ($4 billion) for science and technology research and development, and 38 billion pesos ($2.7 billion) for roads and highways. By spending in these sectors, including its lucrative oil industry, the government hopes to boost growth for years to come without resorting to borrowing money that could increase the national deficit.

Portugal Expected To Receive €3.98 Billion Disbursement from IMF

BBC: Portugal Bail-out
CBS Money Watch: Portugal to get More Bail Out Funds
ECB: Statement by the European Commission, ECB and IMF on the first review mission to Portugal
IMF: IMF Completes First Review Under an EFF with Portugal
IMF: Executive Board Approves an €26 Billion Extended Arrangement for Portugal

On September 12, the Executive Board of the International Monetary Fund (IMF) completed the first review of Portugal’s performance under a three year, €78 billion, bailout agreement reached earlier this year. The successful completion of the review allows Portugal to immediately receive a €3.98 billion disbursement from the bailout fund, bringing total disbursements under the agreement to €10.43 billion.

One of the main reasons for Portugal’s financial trouble is that the country’s economy has not grown fast-enough to keep up with the government’s spending. As a result, the government has had to take on a great deal of debt to continue providing the services its citizens have come to expect. As the financial crisis worsened, interest rates on Portuguese bonds increased due to investors’ fears that Portugal was taking on too much debt, which made it more expensive for Portugal to continue borrowing money. Eventually, interest rates increased so much that Portugal needed external financial support to pay its debts—a bailout.

Under the bailout agreement, approved on May 20, 2011, the IMF and other European countries agreed to lend Portugal €78 billion on the condition that it make specific dramatic economic reforms within the next year and a half to address the country’s debt. The reforms, which include forcing banks to increase cash reserves and reducing government payroll costs, are meant to improve competitiveness and put Portugal’s economy on a path toward sustainable growth. In its first review of the country’s austerity program, the IMF stated that the country is on track to meet its fiscal target of reducing the budget deficit to 3% of gross domestic product (GDP) by 2013. The IMF also expects economic growth and inflation to remain in line with its conditions.

The review committee noted that Portuguese banks have been successful in increasing their capital (cash) reserves to meet the new capital adequacy requirements, and that the Portuguese government has made progress in strengthening its supervisory and regulatory framework over the financial sector. Nevertheless, the success of the IMF program is greatly dependent on the government’s ability to address another one of Portugal’s main problems—lack of competitiveness—by opening the economy to competition. To do so, the government has so far eliminated the special rights (shares) it holds in private companies to reduce government involvement in the private sector, which helps level the economic playing field. While the reforms appear promising so far, Portugal still faces more difficulties. The review committee made it clear that Portugal has not yet done enough to ensure the future stability of its debt.

Sunday, September 25, 2011

Historic U.N. Meeting Addresses the Global Impact of Non-Communicable Diseases

CNN: U.N. Adopts Political Declaration on Non-Communicable Diseases
Council on Foreign Relations: Global Action on Non-Communicable Disease
Reuters: UN Assembly Backs Steps to Fight Chronic Disease
UN: High-Level Meeting on Non-communicable Diseases

In a landmark United Nations (U.N.) summit, world leaders converged for the first ever high-level meeting to address non-communicable diseases (NCDs)—the leading cause of death across the globe. Non-communicable diseases, such as cancer or heart disease, are diseases that do not pass from one person to another. The General Assembly (GA) addressed prevention and control of four groups of NCDs: cancer, cardiovascular disease, chronic respiratory diseases and diabetes. This week’s session represents only the second time in U.N. history that a global health issue commanded the attention of the GA, after it addressed the global AIDS epidemic nearly ten years ago.

In addition to lost lives, the economic costs of NCDs add to their total impact. NCD’s kill more than 36 million people each year and the World Economic Forum estimates that NCDs will cost the global economy $47 trillion over the next 20 years. Though NCDs are increasing dramatically world-wide, most developing nations are ill-equipped to effectively deal with major health problems due to a lack of equipment, well-trained doctors, and medicines. This reality is especially problematic considering more than 80% of NCD deaths occur in low- and moderate-income nations. With the exception of Africa, NCDs cause more deaths and illness world-wide than communicable diseases like HIV and malaria that generally receive more attention from the international community. Even in developed nations, NCDs create a substantial drag on the economy and highlight the issue of unequal access to medical care.

To combat NCDs, member nations unanimously adopted a “political declaration” calling for implementation of collaborative efforts between governments and the private sector to reduce risk factors, such as obesity and tobacco and alcohol use. The declaration highlights the need for comprehensive health care, calls for assistance to developing countries, and mandates the coordination of local, national, and international efforts to promote healthier lifestyle choices. The broad language of the declaration also touches on key health issues such as breast feeding, cancer screenings, and medical research. The declaration calls on the World Health Organization to prepare global target goals and an international monitoring framework by the end of 2012.

The practical effect of a U.N. political declaration elevates NCD’s on the global health agenda and provides the basis for governmental action at national and global levels. Private and public funding for such initiatives will likely increase as collective awareness rises. The declaration will be part of the U.N.’s permanent record delineating global development priorities and will provide a foundation for further collaborative efforts among member nations. By recognizing the impact of NCDs and addressing root causes, the measures proposed by the U.N. seek to limit the negative effect of NCDs on social and economic development worldwide.

Sunday, September 18, 2011

China’s New Marriage Law Interpretation: One Step Forward or Two Steps Back?


On August 13, China’s Supreme People’s Court changed its interpretation of China’s marriage law and shattered China’s traditional notion of marriage. Before the ruling, divorced couples split their property evenly, unless either had committed bigamy, domestic violence, abandoned the family, or lived with a lover for more than three months. Under the new interpretation, the person whose name is on the deed will receive the property. The ruling has the potential to have an enormous effect on gender-based wealth-distribution in the country, as Chinese tradition dictates that the groom-to-be should provide housing for the couple. Because the man has to bring property to the marriage, his name is already on the deed. Unless he agrees to add his new wife’s name to the deed, he will now receive the property if they divorce.

The Supreme People’s Court’s ruling came in response to Chinese women’s growing emphasis on material wealth in choosing a husband. Real estate prices have risen 500% since 2000 in some parts of China, which has made it more difficult for young men to afford housing and become truly eligible bachelors. Many observers speculate that the increased importance of finances in courtships led to a recent dramatic increase in divorces, as women have been more willing to marry the few men that actually own property regardless of whether those men will make good husbands. The new interpretation is supposed to encourage women to seek husbands based on love, not money, and thus preserve what the Court sees as an important cultural value.

Not surprisingly, the reaction to the Court’s ruling has been mixed. After the ruling, many couples have taken measures to add the woman’s name to property titles. Some observers say that the move is proof that the ruling encourages marital equality while also encouraging women’s financial independence. Many women’s rights groups, however, say that the ruling is a huge hit to gender equality. Marriage experts believe that the ruling will do little to change the tradition of keeping deeds in the man’s name, meaning the investment the wife makes in the marital home – whether monetary or otherwise – will be valueless if the couple divorces. Some critics have even gone so far as to suggest that the ruling strips women of their right to divorce their husbands, as they would risk losing everything. At the same time, the threat of the wife being left penniless after a divorce may be unsettling enough to cause marital problems even among otherwise happily married couples.

Only time will tell what effect the Supreme People’s Court’s ruling will have on gender equality in China. Real estate experts in the country have noted an increase in the number of women buying homes, a trend that suggests the ruling has increased women’s desire to be financially independent. Because women will often receive no assets after a divorce, the ruling may encourage more women to enter the workforce as a way of ensuring their own financial stability. If that were the case, these newly employed women could become a new class of consumers that could help China grow economically by increasing domestic consumption and demand for goods – a change the government thinks is necessary to help China move away from its dependence on exports. Needless to say, the ruling’s effects could go far beyond the divorce rate.

Cutting Interest Rates in Brazil

BBC: Brazil in Surprise Interest Rate Cut to 12%
Forbes: Brazil Lowers Interest Rates, but Risks Remain
MarketWatch: Brazil Stocks Hurt by Greek, Inflation Worries

Valor Econômico: Banco Central quis evitar ‘overdose’ na desaceleração
WSJ: Brazil’s Bank-Rate Boomerang
WSJ: Brazil’s Currency Unlikely to See Respite After Rate Cut
WSJ: Brazil Rate Cut Could Start Broad Anti-Recession Drive

This past week, Brazil’s Central Bank cut its benchmark interest rate—SELIC—to 12% from 12.5% to protect Brazil’s economy against the continuing effects of the global financial crisis. The Central Bank claims that a drop in trade or foreign investment could occur at any time and that decreasing interest rates makes economic sense as the global and Brazilian economies are slowing down. Cutting interest rates makes credit cheaper for both consumers and businesses who can then spend more money to drive economic expansion. At 12%, however, Brazil’s interest rate is still among the highest in the world.

Some analysts feel that the Bank is acting prematurely to guard against a global economic slow-down when it should be more concerned with domestic inflation. Although Brazil’s growth is slowing, it is still growing more rapidly than most other countries. Therefore, experts are concerned that Brazil acted to address a situation that does not reflect its economic reality. Brazil’s fast growth has pushed inflation to 6.9%, above the Bank’s target of 6.5%. Analysts predict that inflation will continue to rise and may reach 11% by 2012. However, the Bank believes that inflation will decrease as a natural side effect of slowing economic growth.

The Bank’s decision came on the heels of the Finance Ministry announcing a need for fiscal restraint, which prompted many critics to speculate that the government influenced the Bank’s decision, compromising its independence. One of the government’s main goals is to reduce the national debt. Lowering the amount of interest it pays on government bonds (Letras Financeiras do Tesouro or LFTs) would help accomplish this goal. The interest rate the Brazilian government has to pay on the bonds it issues is tied to the SELIC. Foreign investors fear that the Bank may sacrifice financially sound policies in favor of politically motivated strategies that may damage the economy. If investors lose confidence in the Bank’s independence, they may refuse to invest in Brazil, which would be devastating for the country as it needs foreign investment to finance infrastructure improvements ahead of the 2014 World Cup and 2016 Olympic Games.

The cuts have already had an impact on the market, although not for the better. Finance and real estate companies that depend on high interest rates to make a profit saw their stock prices fall after the announcement. Some economists believe that cutting interest rates will not solve Brazil’s economic problems. Cutting interest rates by only 0.5% will not substantially impact the the government’s debt payments. Furthermore, cutting interest rates poses the risk of increasing inflation. Though the increased spending—spurred by lower interest rates—may drive economic expansion, it may also increase inflation if production cannot keep up with the new demand. Since the Central Bank’s main task is to control inflation, it is easy to question whether the Bank has lost sight of its objective.

Friday, September 16, 2011

South Sudan: The Budding Country's Current Problems

Economist: Sudan, Old and New: Bloody Omens
NYT: Amid Fighting, South Sudan Plans New Capital
NYT: Former Territory Inciting Violence at Border, Sudan Tells the UN
NYT: Sudan Attacks Disputed Border State
Washington Post: Assistant Peacekeeping Chief says Sudan Government, Rebel Forced Pulling out of Abyei

The world’s newest country, South Sudan, is only two months old and is already facing a host of problems. Continuing armed conflict in border regions, a tenuous oil agreement with Sudan, and internal conflicts all pose significant threats to the young nation’s development. The new government must address these threats to establish an environment where economic activity can flourish.

Though South Sudan is now officially independent, armed conflict in the Blue Nile State, a region along the disputed border between Sudan and South Sudan, has not yet fully subsided. The Sudan People’s Liberation Movement-North (SPLMN) has refused to stop fighting after it fought for South Sudan’s independence only to end up on the wrong side of the new border. The rebel group is currently fighting the Sudanese government for control of the Abyei region, a stretch of land located in the Blue Nile State.

While the South Sudanese government denies any involvement with the rebels, the Sudanese government insists that the rebels are too well armed and trained not to have external help. The Sudanese government insists that it has evidence that links the South Sudanese government to the rebels. With this alleged proof, the Sudanese government has lodged a complaint with the United Nations Security Council against the South Sudanese government for violating the countries’ peace treaties..

The countries’ most important short-term economic project is an agreement to pump South Sudan’s oil to the Red Sea through a pipeline that would go through Sudan. The South Sudanese government has already threatened to end the agreement and build its own pipeline in response to Sudan’s accusations regarding its support of the SPLMN. Such a move would be disastrous for Sudan as it would deprive the country of billions of dollars in transit fees that it desperately needs to help rebuild after years of civil war.

South Sudan also must address internal conflicts in its southern state of Jonglei. Violent conflicts between two ethnic groups, the Murle and the Lou Nuer, have escalated of late. The Murle recently killed six hundred Lou Nuer after a dispute over cattle raids. The Lou Nuer had previously killed four hundred Murle and taken twenty five thousand cattle, which young men of both ethnic groups use for marriage dowries. The central government has struggled to stop the violence as poor infrastructure prevents authorities from reaching the rural area in time to prevent the disputes from turning deadly. Even when law enforcement authorities arrive, they are often ill-equipped to counter the large, violent crowds they encounter.

South Sudan must address these and other issues to ensure economic growth and political stability. Foreign investors are not likely to invest in a country they fear will be unable to protect their investments from armed conflicts. South Sudan must also find a way to profit from its oil wealth and use the revenue to build infrastructure and create new economic opportunities for its citizens. Creating stability after the long civil war will be difficult, but it is the only way for South Sudan to reach its potential.

Uncertainty in the U.S. Employment Situation Continues


NYT: Bank of America Confirms Plans to Eliminate 30,000 Jobs

NYT: Bigger Economic Role For Washington

U.S. Dept. of Labor: Employment Situation Summary

U.S. Postal Service: News Release

WSJ: GOP Balks At Taxes TO Finance Jobs Plan

WSJ: Post Office History For Sale

Since 2007, Congress has passed three stimulus bills aimed at reviving the ailing economy: a $158 billion tax cut package in 2008, a $787 billion stimulus plan in 2009 and a tax cut and unemployment fund extension plan in 2010. While these packages have forestalled major job cuts, none of these measures have been successful in appreciably reducing the unemployment rate, which remains persistently high at 9.1%. In response, President Obama unveiled a $447 billion job creation bill that was quickly met by partisan opposition and more job losses.

Several major U.S. employers recently announced plans to layoff significant numbers of workers. Bank of America announced a plan to cut 30,000 jobs over the next “few years” as part of a $5 billion cost savings initiative. After cutting 30,000 jobs in 2010, the U.S. Postal Service eliminated an additional 7,500 positions last month in an effort to chip away at its $9 billion debt. The book retailer Borders cut 10,700 jobs and pharmaceutical giant Merck eliminated 13,000 positions. Even the U.S. Army has had to cut back—earlier this year it announced plans to eliminate 8,700 positions.

The continuing economic slowdown has forced companies to search for creative ways to save money while trying to preserve as many jobs as possible. For example, the U.S. Postal Service is redefining large aspects of its business model. It is reducing its overhead expenses by selling its real estate in favor of operating out of third-party retail locations like grocery stores and pharmacies. Similarly, Bank of America views its short-term workforce reductions as necessary to ensuring long term-growth and workforce stability.

President Obama’s plan calls for the creation of new jobs and a reordering of fiscal priorities to help get the U.S. economy back on track. During periods of high unemployment the demand for consumer goods and services declines as fewer people have extra money to spend, production slows due to the decreased demand, and businesses ultimately lose money, which forces them to cut jobs to save money and reinforce the negative economic cycle. President Obama believes that the government can break the cycle by spending money to spur consumption and thereby force companies to increase production, which theoretically requires those companies to hire new workers who become new consumers that spend money and establish a positive cycle of growth. Economists estimate that President Obama’s plan could add 100,000 to 150,000 jobs per month over the next year to lower the unemployment rate by a full point. Opposition to Obama’s plan is rooted in the belief that the government has already tried similar stimulus measures with little success. Notwithstanding the partisan political debate over Obama’s Job Act, many economists believe that stimulus packages and further intervention from the Federal Reserve are ultimately necessary to prevent the economy from falling back into a recession.

Thursday, September 15, 2011

China in Win-Win Position as Europe Nears Collapse


The urgent need of a growing number of European countries has put China in a position to gain financially and politically. Chinese Premier Wen Jiabao and National Development and Reform Commission Vice Chairman Zhang Xiaogiang recently stated that China is open to buying bonds from European nations facing sovereign debt crises including Italy, Spain, Greece, and Portugal. Zhang believes that increased global coordination is necessary to prevent the global economy from sinking into a second recession. Nevertheless, China urged the U.S., Europe, and Japan to address their debt and deficit problems instead of relying on China to bail them out.

Each day Europe looks closer to needing external financial support. Greece is nearing default. French banks have invested heavily in Greece, meaning if Greece defaults, France’s banks will face catastrophic losses. Ireland, Portugal, Italy, and Spain are all facing debt crises thanks, in part, to their close financial ties with Greece and each other. Without corrective action, the debt crisis is likely to spread to other European countries. A large scale European default would devastate Europe’s trade partners, specifically China, which is one of the EU’s largest trading partners. China can help Europe avoid such a doomsday scenario by buying bonds from countries in need, thereby providing them with the cash they need to continue to pay their debts.

Though helping Europe during its economic struggles is China’s main objective, China itself could benefit economically from buying European bonds. China’s economy has grown by an average of nine percent per year since 2008 in the face of a global recession. Growth is good, but some economists believe that China is growing too quickly. By buying European bonds, China could slow its domestic growth by investing its excess capital (money) overseas instead of using it to push domestic growth. Slowing growth would relieve some of the inflationary pressure that threatens China’s entire economy by making its exports more expensive and, therefore, less competitive globally. The shift could delay China’s goal of transitioning from an export-based economy to a more sustainable economy based on domestic consumption, but only temporarily.

Buying European bonds may also help increase China’s exports by opening new markets. In return for its support of Europe, China wants the European Union (EU) to recognize China as a “market economy” immediately. Currently, China is classified as a “non-market economy” under the World Trade Organization’s definition, which has significant trade and legal implications under WTO rules. The WTO defines market economies as economies in which prices are determined by the forces of supply and demand. Because the EU does not recognize China as a market economy, WTO rules allow EU countries to place tariffs on Chinese goods, nearly doubling the cost of those goods and making them less competitive in the EU. The tariffs allow the EU to protect its own industries that would not otherwise be able to compete with China’s low production costs. The WTO will require all member countries to recognize China as a market economy by 2016, so the EU’s refusal would only serve to delay the inevitable. However, if the EU agrees to China’s demand, the cost of China’s exports to the EU would fall overnight, likely resulting in increased export revenue. With such large potential benefits, it is easy to understand why China is open to the idea of helping Europe.

Germany Makes Contingency Plans in Case of Greek Default

Guardian: Greece on Verge of Default as Doubt Grows Over €8bn Bailout
NYT: German Leader Faces Key Choices on Rescuing Euro
Spiegel: Germany Plans for Possible Greek Default

This week, German Finance Minister, Wolfgang Schauble, gave Greece a loud and clear message that it needs to be more aggressive in implementing its program of spending cuts and tax increases if it wishes to avoid a default. Schauble stated that unless Greece follows through with the austerity measures, the International Monetary Fund (IMF), European Commission, and European Central Bank (ECB) may refuse to release the sixth €8 billion installment of their joint rescue package. Without the aid, Greece will not be able to make interest payments on its outstanding bonds and will, therefore, default.

In view of a possible Greek default, German officials are preparing plans to limit the resulting damage. If Greece defaults on its debts, the ECB, other European Union countries and banks, insurance companies, and financial institutions throughout Europe that have lent money to Greece will suffer large losses. The primary goal of the German plan is to protect the Eurozone from such a large disruption.

The German plan has two major aspects. First, it calls for the use of “preventive” credit lines, whereby the European Financial Stability Facility (EFSF) would loan funds to financially weak countries, such as Italy or Spain, in the even that private investors stop lending to those countries after a Greek default. Those countries would then use the money to pay their own debts to avoid defaulting themselves. The second aspect is to have someone (the details are not yet finalized as to whom) provide cash injections to banks to help cover any losses they may face. Taken together, the two instruments would protect both countries and their banking sectors from the spillover effects of the default.

Furthermore, the German plan would make it possible for Greek banks to receive aid even after creditors stop giving money to the Greek government. Without special aid, the Greek banking sector would suffer significantly if the government defaults on its debts, because the banks hold a large portion of Greece’s bonds (its debt). This if of major concern because, as the global financial crisis showed, banks are deeply interconnected across national borders. Thus, allowing Greece’s major banks to fail would risk dragging down other banks across the Eurozone, putting additional strain on an already weak region.

Tuesday, September 13, 2011

Spain’s Economic Woes Lead to Historic Reforms

Economist: The Golden Amendment
Economist: Spain’s Economy: A balancing Act
El País: Congress Passes Constitutional Reform on Deficit in Historic Vote
Time: Spain Caps Its Debt
CIA World Factbook: Spain’s Economy

Last Wednesday, Spanish lawmakers overwhelmingly passed a constitutional amendment (referred to as the “golden rule”) aimed at placing a cap on the country’s future deficits. The legislation came in response to statements by German Chancellor Angela Merkel and French President Nicolas Sarkozy who jointly demanded that all Eurozone countries who wish to receive bailouts pass such “golden rules,” though Spain is only the second country to do so (Germany is the other). Although Spain has not yet needed a bailout, the global financial crisis hit the country’s economy hard. Currently the country has an unemployment rate of 20.89% and a budget deficit of 9.2% of its gross domestic product (GDP)-- more than three-times the Euro-zone limit.

The Spanish Senate approved the amendment just eight days after the lower house first started debating the rule. Such urgency was meant to send a strong message to the world that Spain would not need a bailout. The “golden rule” does not set a specific target cap on the country’s future deficits, but merely requires the legislature to pass a law setting what the actual deficit cap will be. An accompanying law, set to take effect by June 30, 2012, will set the actual deficit cap at 0.4% of annual GDP starting in the year 2020. Under the constitutional change, every level of the government – national, regional, and municipal – must limit its budget deficit to the set cap, except following natural disasters, recessions, or other extraordinary emergencies. Even in those situations, the lower house of parliament must approve any additional deficit. The constitutional reform also requires Spain to reduce its total accumulated debt, the results of many years of deficits, to within the European Union limit of 60% of GDP. The “golden rule” amendment will become part of Spain’s constitution unless 10 percent of either house of parliament votes to hold a referendum on it in the next 15 days.

It is difficult to predict how the amendment will affect the country in the short-run since it will not take effect until 2020. Spain’s finance minister, Elena Salgado, stated that, in the mean time, the government will continue working towards its goal of reducing the deficit to 6% of GDP by the end of this year, and to 4.4% of GDP by the end of 2012. With experts predicting the Spanish economy will grow by only 1.3% this year, it will be difficult for Spain to meet these targets, but Spain has no other choice if it wishes to avoid economic ruin.

The Cost of Educational Reform in Chile

El Chileno: A partir de hoy a las 10 horas: Reunión del ejecutivo con estudiantes
FT: Business Braced for Chile Tax Rise
MercoPress: Chilean Students Will Assess Piñera Road Map for Education Reform Before Next Meeting
The Nation: Demanding Economic and Educational Reform in Chile
Santiago Times: Chilean Students Set to Reject Government’s Proposed Working Groups

For over three months, Chilean president Sebastián Piñera has stood firm against students, educators, and parents seeking university-level educational reform in Chile. Although Chile has the highest per capita income in Latin America, it also has the most uneven socioeconomic distribution thanks, in part, to its dysfunctional private educational system. Because of the high cost of private education and high interest rates on education loans, many Chileans have been unable to afford an education, and others who have pursued their education have had to take on enormous amounts of debt. Even those students who can pay for a private education are not necessarily getting their money’s worth. The quality of Chile’s educational system is low, due partly to corrupt school administrators at direct-grant schools (private institutions that receive some state funding) pocketing and misusing state funds. To address these disparities in access and quality, protestors are demanding that the state provide “free and equal quality education for all.”

President Piñera’s approval rating has steadily declined as he has continued his resistance to educational reform. Just last week, he finally agreed to hold talks with the student protestors, a move some observers speculate was motivated by a desire to improve his popularity for the upcoming election cycle. President Piñera has offered to increase grants and decrease the interest rate on student loans to help students pay the costs of private universities, but he has adamantly refused to provide free education for all Chileans. Commentators have observed that President Piñera is a free-market conservative who believes that the government should not interfere in relations between buyers and sellers. He does not view education as a right to which all Chileans are entitled, but rather as a good that private vendors sell to those who can afford to pay the price.

In all likelihood, President Piñera will compromise by proposing initiatives that support a “mixed” educational system of public and private institutions. However, financing public education would require a redistribution of resources, including potentially investing profits from direct-grant schools into public education. The government fears that such redistribution would encourage waste as it fears that state-funded institutions are more likely to misuse public funds than are private institutions.

In addition to redistributing current profits, the Chilean government must also find new sources of revenue to pay for any new educational programs. New taxes are the most obvious potential source for funds, but the Chilean mining industry (the nation’s largest industry) worries that it will bear the brunt of the cost. After last year’s increase in mining royalties, mining companies currently pay about $11 billion in taxes, which is a quarter of the government’s total revenue. However, Chile still taxes mining companies at a lower rate than many other countries. Neighboring Peru, for example, imposed a new mining royalty last month that will add an additional $1.1 billion in costs to mining companies each year. Mining companies in Chile hope to avoid a similar fate.

Student activists and other concerned citizens feel that President Piñera’s proposed measures do not go far enough to remedy educational disparity in Chile. Therefore, student leaders have openly rejected the president’s offer to work together with the government to achieve reform. Critics believe that without more input from students and educators, governmental reform will preserve the inequalities of privatized education in Chile and continue to encourage profiteering by direct-grant schools. Despite President Piñera’s attempt to address the students’ concerns, his efforts may be too little, too late as far as his own re-election is concerned. Unless President Piñera and the activists agree on educational reform, educational disparity in Chile will continue to affect its development.

New Japanese Prime Minister Faces Daunting Task Taking on Japan's Financial Recovery


In August, Japan elected Yoshihiko Noda as its sixth different prime minister in five years. Noda faces the difficult task of lowering the value of the nation’s currency, the yen, and addressing a host of other issues, such as political unrest and earthquake recovery. The yen has appreciated four percent in the last three months. Noda, a former finance minister, must intervene to reduce the value of the yen to prevent it from having a negative effect on Japan’s export. An overly strong currency makes Japanese goods more expensive for other countries to buy. Those other countries are, therefore, likely to find cheaper suppliers of the same goods elsewhere, which leads to a decrease in the total goods Japan exports. Because Japan’s economy depends heavily on revenues from exports, any decrease in exports has a large, negative effect on the country’s entire economy.

For Prime Minister Noda, controlling the value of the yen will not be easy. During his time as finance minister, Noda unsuccessfully attempted to prevent the yen from appreciating by selling the yen on international markets. Leaders from around the world are anxiously waiting to see if Noda can solve Japan’s problems, as Japan’s economy, the third largest economy globally, affects regional and global economic networks.

The yen’s value is not Japan’s only economic problem. Japan’s economy has suffered in the aftermath of the massive earthquake and tsunami that hit this past March. Noda, therefore, must also continue reconstruction efforts, while at the same time attempting to reduce Japan’s already large public debt. Japan’s debt is currently 200% of its gross domestic product, the highest percentage of any country. This means that simply making interest payments on the debt consumes a large portion of Japan’s budget. Japan’s aging population will also put a growing strain on the country’s debt. In the coming years, more and more Japanese citizens will retire and, therefore, will stop contributing as much to the government in taxes, while drawing more money from the government in the form of retirement and healthcare benefits.

Noda must address all of these problems while operating in a political system that is in disarray. Previous prime ministers have not lasted long in the post, as they failed to deliver the changes the electorate demands. In spite of the electorate’s agreement that the country needs to change course, the two political parties have been unable to compromise as infighting within each party has grown. Such infighting may greatly inhibit Noda’s effectiveness. Nevertheless, Noda can be sure that his own tenure will be short if he fails to offer effective solutions to Japan’s problems.

Famine in Somalia

BBC: Somalia Famine: U.N. Warns of 750,000 Deaths
Economist: Chronicle of a Famine Foretold
Economist: Famine and Fighting
FT: Somali Militants Reject Famine Claim
FT: Somalia Famine Puts Spotlight on Country's Misrule
FT: U.N. Declares Famine in Rebel-Held Somalia
NYT: Somalia
NYT: U.N. Officials Say Famine is Widening in Somalia

For the last several months, Somalia has been suffering from an extreme famine. The United Nations (UN) issued a statement last week stating that the famine has spread to a sixth region. The UN has warned that the famine could spread to put 750,000 lives at risk. Tens of thousands of Somalis have died in the last two months as the famine has spread due to a continuing drought. The UN declares famine in a region when thirty percent of children in the region are malnourished, twenty percent of the population is without food, and two of every ten thousand adults, or four of every ten thousand children, die each day.

Experts say that the drought plaguing Somalia, Kenya, and Ethiopia is not the only cause of the famine, though it has played a large role as Somalia’s agricultural production has fallen by seventy-five percent. The central government collapsed in 1991, and no effective government has come to power since. This political upheaval has contributed to many economic crises, including the current famine. In addition, the lack of a centralized police power has led many farmers to abandon their trade as thieves increasingly take crops before the farmers can sell them for a profit. Foreign producers are also wary of sending goods to Somalia as the fear of having pirates seize a shipment has made doing business with Somalia too risky for many to handle.

Another side effect of Somalia’s lack of a central government—and major contributor to the famine—has been that al-Shabaab (a militant Islamic group with connections to al-Qaeda that the U.S. government characterizes as a terrorist organization) has taken-over Southern Somalia. Al-Shabaab has banned most foreign organizations from providing aid in the territories it controls. The group claims that the UN and United States are exaggerating the extent of the famine as propaganda to turn Somalis against the Islamic government. Even without the ban, many aid-giving countries are hesitant to send supplies for fear that al-Shabaab would use them for its own purposes, perhaps even to commit terrorist acts.

Many non-governmental organizations (NGOs) are also hesitant to send personnel to Somalia. Al-Shabaab has been responsible for several kidnappings and deaths of NGO workers. A group of aid organizations that is still dedicated to helping Somalis have stated that it needs $300 million to be able to provide any significant relief. Because it does not appear likely that $300 million dollars will flow into Somalia any time soon, the Somali people may be left to die. Only time will tell if either nature or human politics will change in time to prevent more unnecessary deaths.

U.S. Sues Big Banks Over $196 Billion in High-Risk Home Loans

Fannie Mae
Federal Housing Financial Agency
FT: Banks Sued Over Mortgage Deals
Freddie Mac
NYT: Federal Regulators Sue Big Banks Over Mortgages
WSJ: U.S. Sues Big Banks Over Home Mortgages

Last Friday, the U.S. Federal Housing Finance Agency (FHFA) filed lawsuits against 17 of the world’s largest banks, alleging that they failed to disclose the high-risk nature of some of the home loans contained in $196 billion worth of mortgage-backed securities (MBS) they sold to Fannie Mae and Freddie Mac. The U.S. Congress established Fannie Mae and Freddie Mac (known as government-sponsored entities, or GSEs) to provide liquidity and stability to the U.S. housing market. As the largest source of home financing in the U.S., Fannie Mae and Freddie Mac play an integral role in ensuring that the average American can secure a home loan.

Although Fannie and Freddie do not lend money directly to homeowners, they are the largest purchasers of home loans from banks and other financial institutions that create the mortgages. Thus, they are able to influence what loans the banks issue based on what loans they (Fannie and Freddie) will purchase. The GSEs “securitize” many of the loans they purchase by bundling several loans together and selling them as one financial instrument called a mortgage-backed security or MBS. They also purchased MBSs from banks.

The FHFA lawsuits accuse the banks of making “materially false statements” about how risky the home loans were that the banks securitized and sold to the GSEs to mislead the GSEs into buying these unsafe investments. After the collapse of the U.S. mortgage market in 2008, Fannie Mae and Freddie Mac were left holding billions of dollars of home loans and MBSs that became worthless as homeowners defaulted at an unprecedented pace. Since then, the U.S. Treasury has spent $141 billion taxpayer dollars keeping the GSEs afloat as part of an ongoing effort to stimulate the U.S. housing market. Since 2008, the FHFA has been responsible for overseeing the preservation and conservation of Fannie’s and Freddie’s assets on behalf of U.S. taxpayers. The FHFA filed the lawsuit in keeping with this role.

The controversial lawsuits are the most sweeping governmental action aimed at holding the banks accountable for their role in the financial crisis. In their defense, the banks point to Fannie Mae’s and Freddie Mac’s formidable roles as “major players” in the mortgage market as they purchased, packaged and sold billions of dollars worth of mortgage securities. In July of 2008, just prior to the U.S. government taking control of Fannie and Freddie, the portfolios each GSE held were worth $758 and $798 billion respectively. The banks claim that Fannie and Freddie were, therefore, shrewd and sophisticated market participants with detailed knowledge of the home loans and securities they purchased. Because Fannie and Freddie knew so much about the home mortgage business, the banks argue, the government should not blame the banks for the GSEs’ investing mistakes.

The banks claim that, even if they are at fault, the lawsuits will do more harm than good. After spending the past three years rebalancing their business to address the massive losses they suffered during the financial crisis, the banks fear that the lawsuit creates enormous potential liabilities and uncertainty that threaten their stability. Of the seventeen banks named in the lawsuit, Deutsche Bank, Credit Suisse Holdings USA, Goldman Sachs and Morgan Stanley sold $10 billion or more each in MBSs containing questionable home loans to Fannie and Freddie. J.P. Morgan Chase and Royal Bank of Scotland Group sold over $30 billion each, and the beleaguered Bank of America’s total exceeds $57 billion due to its acquisitions of Countrywide and Merrill Lynch/First Franklin Financial. Although the lawsuit does not specify how much the government hopes to recoup in damages, prior settlements of similar lawsuits indicate that the government could recoup twenty percent (nearly $40 billion) of the total securities sold to the GSEs.

Government critics point to high U.S. unemployment rates, the declining stock market, including the rapid devaluation of bank stocks since the lawsuits were filed, and broad consumer concerns as an indication that the timing and potential consequences of the lawsuit could be bad news for the economy. Bank critics claim that the U.S. government needs to hold the banks accountable for their past reckless practices to prevent future misdeeds. Irrespective of the merits of the lawsuits, the litigation may take years and cost the banks and taxpayers millions of dollars in legal expenses. Most of the banks were in settlement negotiations with the regulators prior to the filing of the lawsuits and observers expect those negotiations to continue.

Sunday, September 11, 2011

IMF Lowers its Prediction for Debt-ridden Ireland's Economic Growth

Belfast Telegraph: Noonan Plays Down Budget Fears
Bloomberg: IMF to Cut Irish Growth Forecasts as Outlook Worsens for Trading Partners
The Independent: Enda Kenny Elected Taoiseach
Irish Times: IMF Says Irish Economy to Grow
Reuters UK: IMF Cuts Irish Outlook, Urges More Asset Sales
WSJ: IMF Urges Flexibility for Ireland

Although the International Monetary Fund (IMF) forecasts Ireland’s economy to grow in 2011 for the first time in three years, it lowered its prediction for Ireland’s 2011 growth from 0.6% to 0.4%, and 2012 growth from 1.9% to 1.5%. This unwelcome news is due, in part, to the weakening economies of Ireland’s main trading partners (the Eurozone countries, United States, and United Kingdom), but also to fears that Ireland may suffer negative side effects if Greece has to restructure its debt.

The IMF has been monitoring Ireland since November 2010, when a banking crisis compelled Ireland to ask the IMF and the European Union (EU) for assistance. In exchange for an €85 billion ($114 billion) bailout, Ireland agreed to recapitalize its banks and introduce government austerity measures (a mix of spending cuts and higher taxes). These measures were aimed at reducing Ireland’s budget deficit to less than 3% of gross domestic product (GDP) by 2015.

There have been significant political and economic changes in Ireland since the EU/IMF bailout. In a March 2011 election, Prime Minister Brian Cowen of the Fianna Fail party lost his position to a coalition government led by Enda Kenny of the Fine Gael party. Prime Minister Kenny has continued Ireland’s austerity programs and the IMF reports that Ireland is on target to meet the fund’s 2011 deficit target of 10.5% of GDP. In July, Ireland’s progress in implementing austerity measures led Eurozone leaders to cut the interest rate Ireland pays on its bailout loans. Furthermore, Ireland has seen a rise in its exports (and, therefore, its export revenue), although the IMF cautions the increased exports could be temporary due to recent declines in new export orders.

Even with lower deficits, higher growth rates, and increased exports, the IMF warns that Ireland and the Eurozone still need to do more to restore investors’ confidence in Ireland. The IMF suggests Ireland consider selling €5 billion in assets to raise more funds (potentially the country’s stakes in the airline Aer Lingus and several energy firms), and recommends that Eurozone leaders consider making the European Financial Stabilization Fund (EFSF) more flexible to address future financial risks.

Despite the IMF’s and Eurozone’s attempts to rescue Ireland from its debt crisis, Ireland’s low economic growth and large, persisting deficit are still daunting problems. Finance Minister Michael Noonan recently admitted that future deficit-reductions may require “rather difficult policy decisions.” For a Prime Minister attempting to fix a struggling economy while promising no new taxes or cuts to social welfare programs, these will be difficult policy decisions indeed.

Sunday, September 04, 2011

Gold Miners' Strike in South Africa

BBC: South Africa's Gold Miners Begin Strike Over Pay
Bloomberg: Mine Nationalization in South Africa is a Concern
Financial Times: South African Gold Miners Strike
Financial Times: Strikes Spread in South Africa's Mining Sector
Main & Guardian: Talks Aim to End SA Coal, Gold Sector
MarketWatch: Miners End South Africa Gold Strikes with Wage Deal

South Africa, Africa’s largest economy, has recently faced a series of strikes in its mining sector. In late July, gold miners began a strike after the National Union of Mineworkers (NUM) rejected an offer of a seven to nine percent wage increase from mining companies, including AngloGold Ashanti, Gold Fields, and Harmony. Though the national inflation rate is around five percent, the NUM had been asking for a fourteen percent increase in wages. The NUM justified the high demand by arguing that workers should have “something to show” for the dangerous work they do.

Strikes have plagued South Africa’s mining sector lately, with coal and diamond miners staging separate strikes as well. While admitting that workers deserve decent wages to support themselves and their families, mining companies are concerned about their own ability to compete globally. Increased labor costs, along with rising energy prices, and threats of nationalization have dented the mining sector’s profits in recent months by increasing production costs and scaring off investors. However, mining companies understand that retaining an already-trained workforce is important to maintaining high productivity levels. Large wage increases could, therefore, be in the companies’ best interests in the long run.

Many observers believe the root cause of the strikes is much deeper than a simple desire for higher wages in the face of a higher cost-of-living. Some believe that mounting frustrations about social and economic inequality are pushing the working class to demand a larger share of national wealth. Racial undertones accentuate South Africa’s inequality. Only seventeen years removed from government-approved segregation, whites still own most mines, while the vast majority of mine workers are black.

After almost a month of striking, the NUM and the gold-mining companies reached a two-year agreement to get the miners back to work. The agreement includes an eight percent increase each year. The NUM also successfully lobbied for a provision guaranteeing it the right to re-negotiate a higher wage increase if the rate of inflation rises. Economists estimate that the gold miners’ strike alone resulted in $200 million in lost revenue for the mining sector, which will likely have a negative impact on South African economic growth for the year. South Africa can only hope that such costly strikes become less common as it continues to develop.

Europe’s Necessary Steps Towards Economic Recovery

FT: Lagarde Capital Call Surprises Regulators
FT: Lagarde’s Ugly Truth on Debt
IMF: “Global Risks Are Rising, But There Is a Path to Recovery”: Remarks by Christine Lagarde at Jackson Hole
WSJ: Central Bankers Worry Economy Still in Peril

Last week, the Managing Director of the International Monetary Fund (IMF), Christine Lagarde, called on European governments to take action to remove the cloud of uncertainty hovering over the region’s governments and financial institutions as it struggles to recover from the global financial crisis. In an effort to promote strong, sustainable, and balanced growth, Ms. Lagarde proposed a three-step plan she believes will restore confidence in the European Union and put it on the road to recovery.

According to Lagarde, the first step is to lower government debts to sustainable levels. Containing growing costs for government programs, such as pensions and healthcare, is key to ensuring that governments will not have to continue adding to their debt to pay for such programs. Reducing spending on programs that already exist also helps free up money that governments can use in the short-run to support jobs and growth. Lagarde insisted, however, that cutting spending alone will not be enough to stabilize government debt in the region. European countries must also find a way to raise more money. She encouraged the European Central Bank (ECB) and Eurozone countries to continue their financial support of the countries in crisis.

The second step to sustainable growth is to strengthen Europe’s financial institutions. To do so, banks need to raise more capital (i.e., cash), which will enable them to increase lending to spur economic activity and survive any further losses they may incur. According to Lagarde, banks should seek capital from private sources first, and only seek public funding if absolutely necessary. If the use of public funds is unavoidable, Largarde suggested that the European Financial Stability Fund or another European-wide funding mechanism could make direct capital injections into the region’s weakest banks.

The last step of Lagarde’s vision for Europe’s economic recovery is to develop a common vision for the European Union’s future. The current crisis has exposed serious flaws in the architecture of the European Union that threaten the entire integration project. Therefore, it is important for European leaders to agree on how to prevent and address economic downturns in the future. Failure to do so could expose the EU to a repeat of the problems it is currently facing.

Friday, September 02, 2011

Understanding the Second Greek Bailout and the Effect of Finland’s Cash Demand

The Australian: Fresh Fears of Greek Default as Finns Hold Out in Collateral Dispute
Bloomberg: Finland is Negotiating Greek Collateral Model, Demands Remain ‘Absolute’
Ekathimerini: Barroso Sees Progress Over Collateral Deal Row
FT: Greco-Finnish Deal Reopens Bail-Out Debate
Helsinki Times: Finland’s Demands for Greek Collateral Cause Fear and Confusion
WSJ: Rescue Fund Hits Snags in Germany and Finland

In May of 2010, the International Monetary Fund (IMF) and several members of the European Union (EU) provided Greece with approximately €110 billion ($150 billion) to prevent Greece from defaulting on its debt. This first bailout was intended to satisfy Greece’s financial obligations while the country implemented measures to reduce the country’s debt and improve the country’s long-term financial stability. Unfortunately, the first bailout failed to solve the country’s debt problems, forcing EU countries and the IMF to provide Greece with another €109 billion bailout.

Finland is among the countries providing funds for the second Greek bailout. Because of voter backlash against bailouts, Finland demanded that Greece provide it with cash as collateral for any funds it contributes to the bailout. The collateral would serve to offset Finland’s potential losses if Greece fails to repay the bailout money. To satisfy Finland’s demands, the two countries reached an agreement under which Greece will provide Finland approximately €500 million ($680 million.) cash as collateral. In return, Finland will contribute approximately €1.5 billion ($2.05 billion) to the bailout.

Greece’s agreement with Finland has spurred criticism from other EU countries. Austria and the Netherlands (which, like Finland, have AAA credit ratings—the highest possible) are now demanding collateral before they will supply additional bailout funds to Greece. Other EU countries are concerned that these collateral demands will force Greece to use large portions of its bailout money as collateral instead of using the funds to address its debt. The idea that some, but not all, EU countries could demand collateral is also counter to the basic EU principle of equal treatment of member nations.

The IMF also opposes Finland’s collateral demand. The IMF currently enjoys status of preferred creditor, which ensures that borrowing countries will repay IMF loans before paying other creditors. If Greece were to default on its loans, the collateral Finland holds would allow it to recoup its losses before the IMF.

Despite the small uproar, Finnish Prime Minister Jyrki Katainen is adamant that Finland will not drop its demand for collateral and believes the other countries will approve the deal soon, a sentiment the president of the European Commission (the executive body of the EU) shares. If other EU countries do not approve of the deal, Finland may refuse to participate in a bailout, jeopardizing the entire Greek rescue effort. With no bailout, Greece may have no other choice than to default on its debt, which could have disastrous effects on the entire global economy.

Banks Reach Deal with New York Regulators to End Controversial Mortgage Lending Practices

Economist: A Call to Arms
IMF: "Global Risks Are Rising, But There is a Path to Recovery;" Remarks at Jackson Hole
Miami Herald: Goldman to Stop Controversial Mortgage Practices
SEC: SEC Addressing Misconduct That Led To Or Arose From the Financial Crisis
WSJ: Banks, State Reach a Deal

Last week, IMF Managing Director Christine LaGarde issued a global call to action for a “broad rebalancing of fiscal priorities.” LaGarde specifically challenged the U.S. to take aggressive action to deal with the ongoing foreclosure crisis. New York regulators and three financial institutions, including Goldman Sachs, reached a deal this week that appears to be a timely response and offers far reaching regulatory implications.

Prior to LaGarde’s call, the U.S. had already implemented various measures at the state and federal levels to address the spiraling housing market and reduce the foreclosure rate. Such programs generally focused on lowering homeowner’s interest rates, reducing the overall amount homeowners owe on their mortgages, and extending payment options. So far, none of these measures have been successful in fixing the housing market’s troubles. The New York agreement is the latest attempt at finding a solution.

Major U.S. banks, including Goldman Sachs and the five largest U.S. mortgage banks (J.P. Morgan, Bank of America, Citigroup, Wells Fargo, and Ally Financial) are facing regulatory inquiries regarding allegedly improper mortgage procedures they used prior to and after the financial crisis. This week’s agreement with Wall Street powerhouse Goldman Sachs and two smaller mortgage banks sets an example for addressing these procedures. The deal requires the financial firms involved to reduce mortgage payments for some homeowners, put an end to the so-called “robo-signing” of mortgage documents (illegally signing documents without having a qualified employee review them first), and conduct internal reviews of all previously processed loans to identify additional instances of robo-signing. The banks will have to reinstate or compensate borrowers whose property the banks improperly foreclosed through robo-signing.

The agreement promises to have far reaching implications as New York regulators are responsible for supervising nearly two-thirds of all U.S. mortgage servicing firms--many of which face allegations similar to those lodged against Goldman Sachs. The clear message of the agreement is that regulators will hold banks accountable for their actions and do what is necessary to help those who suffered as a result of the illegal mortgage practices.