Whom the Gods Would Destroy
-Edward Hugh (Don’t Shoot the Messenger)
As I keep stressing, these days I have no central Euro scenario. There are only tail scenarios, where the debt crisis veers in either one direction or the other in a way which makes the eventual outcome very hard to foresee. In the case of the full banking, political and fiscal union scenario the efficient causes which could make it happen are obvious: just keep the participants looking down into the abyss often enough and long enough. In the case of complete breakup things are rather different, since it is hard to concretize what would actually bring it about, although the risk is evident, and indeed in many ways it seems a more probable endpoint than the alternative.
The conclusion I have come to is that it is political risk and the destabilizing of Europe’s democratic systems, where we need to look, which is why I have spent some time this weekend thinking about Romania.
According to Princeton Professor Kim Lane Scheppele:
“A political crisis has gripped Romania as its left-leaning prime minister, Victor Ponta, slashes and burns his way through constitutional institutions in an effort to eliminate his political competition. In the last few days, Ponta and his center-left Social Liberal Union (USL) party have sacked the speakers of both chambers of parliament, fired the ombudsman, threatened the constitutional court judges with impeachment and prohibited the constitutional court from reviewing acts of parliament – all with the aim of making it easier for Ponta to remove President Traian Basescu from office. They hope to accomplish that by week’s end”.
Well, in fact just yesterday President Basescu’s opponents did achieve that last objective, since he finally was suspended from office in a majority vote by the two chambers of the country’s Parliament. The suspension is to last for 30 days, during which time a referendum on his future is to be held.
As Lane Scheppele points out, it is hardly coincidental that the country has been stuck (Spain style) in the aftermath of a steep recession, and despite having received an initial 20 billion euro EU/IMF rescue program in 2009 followed by a further 5 billion in 2011 the economy still struggles to find air. The country’s economy plunged by 6.6% in 2009, recovered slightly in 2010/11, and then sank back into recession in the last quarter of last year. GDP is still below the pre crisis peak – at levels first seen towards the end of 2008 and moving backwards in time.
Ponta himself came to power in May after President Basescu asked him to form a new government following the ousting of the three-month-old cabinet of Mihai-Razvan Ungureanu on April 27 in a no-confidence motion held after widespread popular protests rocked the country.
One of the new Prime Minister’s first moves was to indicate his intention to restore 25% public sector wage cuts introduced under pressure from the IMF in 2010. Romania’s run into the 2009 collapse was very much characterized by unsustainably strong public sector wage increases and very high inflation. The IMF warned on July 2nd that delays in program implementation by the government were “sending a poor signal of Romania’s commitment to structural reforms and undermining its growth potential”.
This connection between political instability and IMF programs in the East is becoming habitual. We have seen it in Ukraine, and we have seen it in Hungary. There is obviously something deeply wrong with the way these programs are designed, since none of them (including Latvia) could be claimed to have achieved its objectives. We can only hope that what we have seen in the East will not now spread to the South, though I can’t say I am especially convinced it won’t.
Who Wants Regulatory Reforms?
-Ed Dolan (Ed Dolan’s Econ Blog)
We all know that unreliable ratings were one of the contributing causes to the financial crash. Still, it is nice to see the juicy specifics, like those in a New York Times article by Gretchen Morgenson last week:
- When the primary analyst at S&P notified Morgan Stanley that a certain issue would most likely receive a BBB rating, not the A grade that the firm had wanted, the agency received a blistering e-mail from a Morgan Stanley executive. S&P subsequently raised the grade to A.
- In the case of one structured product, an S&P analyst wrote “I had difficulties explaining ‘HOW’ we got to those numbers since there is no science behind it,” while the lead analyst at Moody’s for the same product noted there was “no actual data backing the current model assumptions.”
- A former S&P managing director wrote, “I don’t want to miss one deal because of our model assumptions either. Is there any possibility of ‘tweaking’ the default table to get all of this so that we don’t have to compromise?”
Presumably this kind of thing was common knowledge in the months leading up to the crash. Why, then, was there widespread failure of market discipline? We know that there was a built-in conflict of interest stemming from the fact that raters were paid by issuers. In theory, though, raters’ temptation to fudge the numbers was supposed to be curbed by the fear that their ratings would lose credibility with investors. Why would issuers bother to pay for ratings that were known to lack credibility?
The answer, it seems, lay in excessive regulatory reliance on ratings, which gave investors an incentive to buy products that were overrated. Instead of investors acting as a check on the conflict of interest between raters and issuers, all three parties were pulling the same oar. No wonder the system failed.
Some regulatory reformers have tried to address the problem, but it is not clear the attempted reforms will really bite. It is hard to reform a corrupt system that the supposed victims support as enthusiastically as do the perps.
Markets getting ahead of the Central Bank of Turkey
-Emre Deliveli (The Kapalı Çarşı: Emre Deliveli’s blog on the Turkish economy)
In my latest Hurriyet Daily News column, I discuss the factors behind the sharp drop in Turkish government bond rates last week, and whether that trend will continue, accompanied by some lira weakness.
Click to enlarge.
I argue that the better-than-expected inflation print and the Central Bank’s easing of the effective policy rate were the main reasons behind the sharp fall in the benchmark. But the key question is whether this trend will continue. Markets certainly seem to be thinking so, but I beg to disagree.
First, while the Bank is supporting growth, the latest data do not point to very weak growth (although the data are painting a mixed picture, as I argue in a recent post and addendum to the column). Second, the Bank has noted it cares about inflation, and rightly so: Core inflation, despite the recent downward trend, is still high; inflation expectations are still above the 5 percent target and the positive June figure is mainly because of temporary factors, as the Bank has underlined as well. Finally, unless capital flows improve drastically, it will be tough for the Bank to lower rates aggressively without hurting market sentiment and putting pressure on the lira.
Of course, the obvious question then is why the Bank lowered its funding rate so much this past week? Because “the time was right”. Here’s economist Murat Üçer in a blog post I designed as an addendum to the HDN column: “when times are ‘good’, i.e. when it is up to the Bank to choose its monetary policy stance, policy is likely to be accommodative, with the liquidity being provided at a rate as low as feasible – albeit, cautiously so. When times are ‘bad’, i.e. when monetary policy is constrained by lack of inflows and F/X market pressures emerge as a result, the Bank moves to a high rate/tight liquidity regime, out of choice, in order to curb further lira weakness”.
This is why Turkish monetary policy is hard to predict, but you still should not expect aggressive easing even in good times because of the macro picture I outlined.