by Philip Whyte
The world economy is going through its greatest financial crisis since the 1930s Great Depression. Who – or what – is to blame for the credit crunch? And what are the lessons to be learned? The arguments are still filling newspaper column inches, but a consensus has yet to emerge.
Some observers have blamed central banks – particularly the US Federal Reserve under Alan Greenspan’s stewardship. The main charge against the Greenspan Fed is that it pursued an excessively loose monetary policy following the bursting of the ‘dotcom’ bubble in 2000. Persistently low US interest rates, it is argued, were the proximate cause of the housing market bubble whose bursting has resulted in the current credit crunch. Low real interest rates do seem to have been a contributory factor, but they cannot be the only explanation. Some countries with lower real interest rates than the US did not experience house price bubbles (eg Germany and Japan). And some countries with higher real interest rates than the US experienced even greater house price bubbles than the US (eg the UK).
A second explanation might be financial innovation – particularly securitisation, the practice of packaging loans as securities that can then be sold on and traded in the open market. Until recently, securitisation was often praised for spreading risk. The trouble is that it also seems to have ratcheted up the overall amount of risk in the system. Since the originators of loans did not bear the ultimate risk, securitisation gave them every incentive to generate fees without considering whether borrowers had any chance of repaying their loans. This process might have been mitigated if credit rating agencies had done their jobs. But whether because of negligence or conflicts of interest – they are paid by sellers, not buyers – credit rating agencies dished out investment grade ratings to poor quality securities.
Banks are never popular even at the best times. So it comes as no surprise that they have also been in the line of fire. The case against them is that they allowed their greed to get the better of their judgement – resulting in irresponsible behaviour. Some observers believe that banks’ recklessness was encouraged by compensation structures that reward short-term performance. Banks have already owned up to some mistakes. An interim report by the Institute of International Finance (IIF), an association of bankers, admitted that banks were guilty of a ‘decline in underwriting standards’; had been too reliant on inadequate ratings; and had had trouble identifying where exposures resided. Intriguingly, the IIF report also concluded that banks should reconsider incentives and compensation structures.
Perhaps the most satisfying explanation involves some combination of all these factors. The credit crunch did not result from any of these factors in isolation, but from the way in which they interacted. Credit growth, for example, would not have been so buoyant had real interest rates been higher. A backdrop of unprecedentedly cheap money almost certainly encouraged banks to under-price risk. Banks’ reckless behaviour may also have been encouraged by the actions of central banks, such as the Fed’s decision back in 1998 to rescue Long Term Capital Management (LTCM), a hedge fund. By signalling that irresponsible institutions and managers could count on being bailed out by public money, critics claim, the US Fed created ‘moral hazard’ – laying the foundations for subsequent excesses.
Recent events have not cast the financial sector in a good light. The IIF believes that a regulatory clampdown is unnecessary, and that banks can learn from their mistakes. This is wishful thinking. A regulatory clampdown now looks inevitable – on both sides of the Atlantic. At this point in the game, the key must be to ensure that changes in financial sector regulations are sensible, well-designed and proportionate to their objectives. But there may also be lessons for the monetary authorities. For much of the past decade, the conventional wisdom, particularly in the Anglo-Saxon world, was that central banks could (or should) not target asset prices. The time may have come to revisit the subject. Alan Greenspan remains to be convinced. But do not be surprised if you come across more column inches arguing in favour of the need for central banks to ‘lean against the wind’.
Philip Whyte is a senior research fellow at the Centre for European Reform.
Wednesday, April 23, 2008
Thursday, April 10, 2008
Turkey’s turmoil, the EU’s reaction
by Katinka Barysch
Political turmoil is nothing new in Turkey. After six years of unusual stability, tensions have mounted since early 2007. The army threatened to topple the AKP government in case it made Abdullah Gul president. Gul did become president, and the AKP emerged strengthened from an early election. Now the chief prosecutor has pushed a case in front of the constitutional court that threatens to ban the AKP because of its alleged anti-secular activities, most notably ending the ban on women wearing headscarves in universities.
So far, the EU has tried to stay out of Turkey’s battle between the mildly Islamist AKP and the increasingly desperate secular establishment. But last week Olli Rehn said that the court case was a mistake. Both he and Javier Solana have indicated that if the constitutional court banned the AKP, the accession negotiations would be off – or at least that is how the Turkish press have interpreted their statements.
A number of the people I spoke to during a Turkey visit last week were unhappy about the EU apparently taking sides. They say that Turkey’s West European friends underestimate the threat of creeping Islamisation. They worry about what Commission President Barroso will say when he arrives for his first official visit to Turkey this week.
The AKP and its supporters have a point when they say that this case is political and therefore merits a political response. They say that the 160-page indictment is based more on past statements by AKP politicians than on their actions. Yet not one of the 11 constitutional judges voted against accepting the case. To many, this indicates that the outcome is a foregone conclusion.
The AKP would not be the first party to be banned for allegedly violating the constitution: 24 have been shut down since the 1960s, including the AKP’s predecessors. But the circumstances have changed. The AKP has built up an impressive track record of reforms and modernisation during its seven years in office. It is popular enough to rule without a coalition partner. If it were closed down, it would reappear in a different guise and probably win another election. However, its top leadership, including Prime Minister Erdogan and President Gul, would most likely be banned from politics for years. For an organisation as hierarchical as the AKP this is hardly an acceptable outcome.
Instead, the government is thinking about pushing through a constitutional amendment that would make it harder to ban political parties. AKP leaders refer to the Council of Europe, which has said that only parties that support violence should be outlawed. The AKP does not have quite enough votes in parliament to change the constitution. It would need some support from the opposition, which would come at a hefty price. Alternatively, the AKP could put any amendment to a referendum, which it would presumably win.
Such a strategy may work, in the sense that it would prevent a ‘judicial coup’ against the government. But it would hardly assuage the concerns of those who suspect the AKP of using democracy as a means to pursue a hidden agenda of Islamisation.
That is why the European Stability Initiative – in a scary report about Turkey’s ‘deep state’ released last week – is calling on the government not to amend the old constitution but adopt an entirely new, more modern one. The ESI is right that a move to make it harder to ban parties would be more acceptable if it was part of a wider reform package.
It is also true that Turkey needs a new constitution: the current one dates back to the last military coup in 1982. However, the draft that legal experts wrote for the AKP last year has disappeared from view. Promises of a nation-wide debate have so far remained unfulfilled. Instead, the AKP has started doing constitutional change ‘a la carte’, especially by ending the headscarf ban. That was a mistake. But a constitution that was hastily adopted in an attempt to ensure the AKP’s political survival would lack legitimacy. Turkey first needs a wider debate about individual rights and a suitable systems of checks and balances. Constitutional change is simply too important for the future stability of Turkey to be rushed (see also
More than just a debate about the headscarf, article by Katinka Barysch, Financial Times, 7 November 2007).
There are other steps the AKP can take to bolster its reformist credentials; and it is taking some already. Erdogan now talks more about the government’s commitment to EU accession than he has done in a long time. After years of delay, a group of MPs has finally submitted amendments to the controversial article 301, under which the likes of Orhan Pamuk have been prosecuted. There is much more that the AKP could do, from liberalising rules for other religions to promoting women’s rights and making it easier for smaller parties get funding and parliamentary representation.
Barroso and other EU politicians should explain to Turkey that, unfortunately, the EU cannot offer an easy way out of the current dilemma. But that whatever the AKP decides to do would be more acceptable if the AKP restarted the modernisation and EU accession efforts that it has been neglecting over the last two years.
Katinka Barysch is deputy director of the Centre for European Reform.
Political turmoil is nothing new in Turkey. After six years of unusual stability, tensions have mounted since early 2007. The army threatened to topple the AKP government in case it made Abdullah Gul president. Gul did become president, and the AKP emerged strengthened from an early election. Now the chief prosecutor has pushed a case in front of the constitutional court that threatens to ban the AKP because of its alleged anti-secular activities, most notably ending the ban on women wearing headscarves in universities.
So far, the EU has tried to stay out of Turkey’s battle between the mildly Islamist AKP and the increasingly desperate secular establishment. But last week Olli Rehn said that the court case was a mistake. Both he and Javier Solana have indicated that if the constitutional court banned the AKP, the accession negotiations would be off – or at least that is how the Turkish press have interpreted their statements.
A number of the people I spoke to during a Turkey visit last week were unhappy about the EU apparently taking sides. They say that Turkey’s West European friends underestimate the threat of creeping Islamisation. They worry about what Commission President Barroso will say when he arrives for his first official visit to Turkey this week.
The AKP and its supporters have a point when they say that this case is political and therefore merits a political response. They say that the 160-page indictment is based more on past statements by AKP politicians than on their actions. Yet not one of the 11 constitutional judges voted against accepting the case. To many, this indicates that the outcome is a foregone conclusion.
The AKP would not be the first party to be banned for allegedly violating the constitution: 24 have been shut down since the 1960s, including the AKP’s predecessors. But the circumstances have changed. The AKP has built up an impressive track record of reforms and modernisation during its seven years in office. It is popular enough to rule without a coalition partner. If it were closed down, it would reappear in a different guise and probably win another election. However, its top leadership, including Prime Minister Erdogan and President Gul, would most likely be banned from politics for years. For an organisation as hierarchical as the AKP this is hardly an acceptable outcome.
Instead, the government is thinking about pushing through a constitutional amendment that would make it harder to ban political parties. AKP leaders refer to the Council of Europe, which has said that only parties that support violence should be outlawed. The AKP does not have quite enough votes in parliament to change the constitution. It would need some support from the opposition, which would come at a hefty price. Alternatively, the AKP could put any amendment to a referendum, which it would presumably win.
Such a strategy may work, in the sense that it would prevent a ‘judicial coup’ against the government. But it would hardly assuage the concerns of those who suspect the AKP of using democracy as a means to pursue a hidden agenda of Islamisation.
That is why the European Stability Initiative – in a scary report about Turkey’s ‘deep state’ released last week – is calling on the government not to amend the old constitution but adopt an entirely new, more modern one. The ESI is right that a move to make it harder to ban parties would be more acceptable if it was part of a wider reform package.
It is also true that Turkey needs a new constitution: the current one dates back to the last military coup in 1982. However, the draft that legal experts wrote for the AKP last year has disappeared from view. Promises of a nation-wide debate have so far remained unfulfilled. Instead, the AKP has started doing constitutional change ‘a la carte’, especially by ending the headscarf ban. That was a mistake. But a constitution that was hastily adopted in an attempt to ensure the AKP’s political survival would lack legitimacy. Turkey first needs a wider debate about individual rights and a suitable systems of checks and balances. Constitutional change is simply too important for the future stability of Turkey to be rushed (see also
More than just a debate about the headscarf, article by Katinka Barysch, Financial Times, 7 November 2007).
There are other steps the AKP can take to bolster its reformist credentials; and it is taking some already. Erdogan now talks more about the government’s commitment to EU accession than he has done in a long time. After years of delay, a group of MPs has finally submitted amendments to the controversial article 301, under which the likes of Orhan Pamuk have been prosecuted. There is much more that the AKP could do, from liberalising rules for other religions to promoting women’s rights and making it easier for smaller parties get funding and parliamentary representation.
Barroso and other EU politicians should explain to Turkey that, unfortunately, the EU cannot offer an easy way out of the current dilemma. But that whatever the AKP decides to do would be more acceptable if the AKP restarted the modernisation and EU accession efforts that it has been neglecting over the last two years.
Katinka Barysch is deputy director of the Centre for European Reform.
Thursday, April 03, 2008
Eurozone economic outlook: Too much complacency
by Simon Tilford
A year ago the prospect of the dollar falling to 1.60 against the euro would have brought on cold sweats across Europe. Yet, here we are and there is no sense of crisis. Indeed, business confidence remains strong across much of the eurozone, credit is expanding rapidly, and exports are holding up well. On the face of it, the eurozone really does seem to be shaking off the recession in the US and the steep rise in the value of the euro. A closer look, however, reveals a less rosy picture.
It is true that credit growth remains robust, but this is a backward looking indicator. A lot of these loans will already have been in the pipeline. Higher money market rates and the delayed impact of last year’s interest rate increases by the European Central Bank (ECB) will slow credit growth over the coming months. Moreover, domestic consumption is weakening across the eurozone. Crucially, German consumers remain as cautious as ever, despite employment having boomed in the country over the last two years. German retail sales were lower in February than a year earlier, with people particularly keen to avoid large purchases. The German car industry may be flourishing, but this is despite, rather than because of, what is happening in Germany: car sales were down 14 per cent year on year in March. This was an even bigger decline than in the US.
The ECB will not ride to the rescue. Despite the strength of the euro (which lowers the price of imported goods), eurozone inflation hit a record 3.5 per cent in March, over one and a half percentage points above the ECB’s inflation target of “close to but less than” 2 per cent. The strength of inflation is largely down to rising energy and food prices, but it also reflects a pick-up in “core” inflation pressures. With the ECB worried about rising wage settlements in Germany and elsewhere in the eurozone, it is very likely that there will no easing of monetary policy in the eurozone this year.
Nor can eurozone firms look to exports for support, especially if, as appears likely, the euro is set for a period of prolonged strength. The high-flying currency is already hitting exports from the Mediterranean countries hard, and will soon have a similar impact further north. There is little empirical basis for the widespread belief in Germany that demand for that country’s exports is largely unrelated to price. The strength of the global economy is important of course, but there is a close correlation between demand for German exports and the exchange rate.
Of course, there are some exporters for whom the strength of the euro is not a pressing issue. Demand for certain very specialised equipment, such as printing presses or mining machinery, probably varies little by price, because there are few makers of such equipment. Buyers expect the machine to last a long time and are hence more concerned about servicing and reliability than price. But the majority of exporters do not operate in such markets. For example, makers of white goods such as dishwashers and washing machines as well as office equipment and cars – all big German exports – operate in very price-sensitive markets.
The eurozone as a whole is certainly better placed than the US, but Europeans are too complacent about the ability of their economies to ride out the current storm. First, the sensitivity of exporters to the strength of the euro is greater than many believe. Even the eurozone economies most confident about their export prospects – Germany, the Netherlands and Finland – will experience a sharp slowdown in external demand. Second, rising inflation all but rules out cuts in eurozone interest rates in 2008.
Simon Tilford is chief economist at the Centre for European Reform.
A year ago the prospect of the dollar falling to 1.60 against the euro would have brought on cold sweats across Europe. Yet, here we are and there is no sense of crisis. Indeed, business confidence remains strong across much of the eurozone, credit is expanding rapidly, and exports are holding up well. On the face of it, the eurozone really does seem to be shaking off the recession in the US and the steep rise in the value of the euro. A closer look, however, reveals a less rosy picture.
It is true that credit growth remains robust, but this is a backward looking indicator. A lot of these loans will already have been in the pipeline. Higher money market rates and the delayed impact of last year’s interest rate increases by the European Central Bank (ECB) will slow credit growth over the coming months. Moreover, domestic consumption is weakening across the eurozone. Crucially, German consumers remain as cautious as ever, despite employment having boomed in the country over the last two years. German retail sales were lower in February than a year earlier, with people particularly keen to avoid large purchases. The German car industry may be flourishing, but this is despite, rather than because of, what is happening in Germany: car sales were down 14 per cent year on year in March. This was an even bigger decline than in the US.
The ECB will not ride to the rescue. Despite the strength of the euro (which lowers the price of imported goods), eurozone inflation hit a record 3.5 per cent in March, over one and a half percentage points above the ECB’s inflation target of “close to but less than” 2 per cent. The strength of inflation is largely down to rising energy and food prices, but it also reflects a pick-up in “core” inflation pressures. With the ECB worried about rising wage settlements in Germany and elsewhere in the eurozone, it is very likely that there will no easing of monetary policy in the eurozone this year.
Nor can eurozone firms look to exports for support, especially if, as appears likely, the euro is set for a period of prolonged strength. The high-flying currency is already hitting exports from the Mediterranean countries hard, and will soon have a similar impact further north. There is little empirical basis for the widespread belief in Germany that demand for that country’s exports is largely unrelated to price. The strength of the global economy is important of course, but there is a close correlation between demand for German exports and the exchange rate.
Of course, there are some exporters for whom the strength of the euro is not a pressing issue. Demand for certain very specialised equipment, such as printing presses or mining machinery, probably varies little by price, because there are few makers of such equipment. Buyers expect the machine to last a long time and are hence more concerned about servicing and reliability than price. But the majority of exporters do not operate in such markets. For example, makers of white goods such as dishwashers and washing machines as well as office equipment and cars – all big German exports – operate in very price-sensitive markets.
The eurozone as a whole is certainly better placed than the US, but Europeans are too complacent about the ability of their economies to ride out the current storm. First, the sensitivity of exporters to the strength of the euro is greater than many believe. Even the eurozone economies most confident about their export prospects – Germany, the Netherlands and Finland – will experience a sharp slowdown in external demand. Second, rising inflation all but rules out cuts in eurozone interest rates in 2008.
Simon Tilford is chief economist at the Centre for European Reform.
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