Share This

Friday 24 June 2011

To Repay or Not to Repay Debts?





Jean Pisani-Ferry

BRUSSELS – For months now, a fight over sovereign-debt restructuring has been raging between those who insist that Greece must continue to honor its signature and those for whom the country’s debt should be partly canceled.

As is often the case in Europe, the crossfire of contradictory official and non-official statements has been throwing markets into turmoil. Confusion abounds; clarity is needed.

The first question is whether Greece is still solvent. This is harder to judge than is the solvency of a firm, because a sovereign state possesses the power to tax. In theory, all that is needed in order to get out of debt is to increase taxes and cut spending.

But the power to tax is not limitless. A government determined to honor its debts at any cost often ends up imposing a tax burden that is disproportionate to the level of services that it supplies; at a certain point, this discrepancy becomes socially and politically unsustainable.

Even if the Greek government were to succeed shortly in stabilizing its debt ratio (soon to reach 150% of GDP), it would be at too high a level to convince creditors to continue lending. Greece will need to reduce its debt ratio considerably before it can return to the capital markets, which implies – even under an optimistic scenario – creating a primary surplus in excess of eight percentage points of GDP. Among advanced-country governments, none (except oil-rich Norway) has managed to achieve a durable primary budget surplus (revenue less non-interest expenditure) exceeding 6% of GDP.



This is too much for a democratic country, especially one where the tax burden is very unequally shared. Greece is, in fact, insolvent.

The second question is how serious a problem it is not to repay one’s debts.

One camp notes that, for decades, no advanced country has dared to do this, and that is why these countries still enjoy a positive reputation. If just one member of the eurozone embarked on the debt-default path, all the rest would immediately come under suspicion. In any case, according to this view, contracts simply must be respected, whatever the cost.

On the other side are those who call for the creditors who triggered the excessive debt to be punished for their imprudence. Lenders must suffer losses, so that they price sovereign risk more accurately in the future and make reckless governments pay higher interest rates.

Both lines of argument are valid, but the fact is that countries that have restructured their debt have not found themselves worse off as a result.

On the contrary, far from being banished from bond markets, they have generally bounced back quickly: investors like a sinner who returns to solvency better than a paragon of virtue on the verge of suffocation.

Twenty years ago, Poland negotiated a reduction in its debt and came off better than Hungary, which was keen to protect its reputation. Debt reduction is not fatal.

The third question is whether a Greek default would be a financial catastrophe – and when it should take place. Two channels are at work, one internal and one external.

First, government bonds are the reference asset for banks and insurers, because they are easily tradable and ensure liquidity. Obviously, any doubt about the value of such bonds could cause turmoil. The Greek banking system’s solvency and access to refinancing would be hit severely.

Externally, in turn, other European banks would be affected. But more importantly, other debt-distressed countries – at least Ireland, Portugal, and Spain – would be vulnerable to financial contagion.

So this is a dire situation. But it does not explain the European Central Bank’s attitude. The central bank has motives to be concerned. But instead of trying to find a way to cushion the possible impact of such a shock, the ECB is rejecting out of hand any sort of restructuring.

Indeed, it is raising the specter of a chain reaction by invoking the collapse of Lehman Brothers in September 2008, and threatening to punish any restructuring by cutting banks’ access to liquidity.

But if Greece is not solvent, either the EU must assume its debts or the risk will hang over it like a sword of Damocles. By refusing a planned and orderly restructuring, the eurozone is exposing itself to the risk of a messy default.

Europe, however, is not obliged to choose between catastrophe and mutualization of debt. The best route – admittedly a narrow road – is initially to beef up the financing program for Greece, which cannot finance itself on the market, while at the same time ensuring through moral suasion that private creditors do not withdraw too easily.

This is what is being attempted at the moment. But this breathing space must be used for more than simply buying time.

It should be used, first, to allow other distressed countries to regain or consolidate their financial credibility, and, second, to pave the way for an orderly restructuring of Greek debt, which requires preparation. Gaining time makes sense only if it helps to solve the problem, rather than prolonging the suffering.

Jean Pisani-Ferry is Director of Bruegel, an international economics think tank, Professor of Economics at
Université Paris-Dauphine, and a member of the French Prime Minister’s Council of Economic Analysis.

Thursday 23 June 2011

How Capitalist is America?





The Rules Of The Game  COMMENT By MARK ROE

IF capitalism's border is with socialism, we know why the world properly sees the United States as strongly capitalist. State ownership is low, and is viewed as aberrational when it occurs (such as the government takeovers of General Motors (GM) and Chrysler in recent years, from which officials are rushing to exit). The government intervenes in the economy less than in most advanced nations, and major social programmes like universal healthcare are not as deeply embedded in the United States as elsewhere.

But these are not the only dimensions to consider in judging how capitalist the United States really is. Consider the extent to which capital that is, shareholders rules in large businesses: if a conflict arises between capital's goals and those of managers, who wins?

Looked at in this way, America's capitalism becomes more ambiguous. American law gives more authority to managers and corporate directors than to shareholders. If shareholders want to tell directors what to do say, borrow more money and expand the business, or close off the money-losing factory well, they just can't. The law is clear: the corporation's board of directors, not its shareholders, runs the business.

Someone naive in the ways of US corporations might say that these rules are paper-thin, because shareholders can just elect new directors if the incumbents are recalcitrant. As long as they can elect the directors, one might think, shareholders rule the firm. That would be plausible if American corporate ownership were concentrated and powerful, with major shareholders owning, say, 25% of a company's stock a structure common in most other advanced countries, where families, foundations, or financial institutions more often have that kind of authority inside large firms.

Diffused ownership

But that is neither how US firms are owned, nor how US corporate elections work. Ownership in large American firms is diffuse, with block-holding shareholders scarce, even today. Hedge funds with big blocks of stock are news, not the norm.

Corporate elections for the directors who run American firms are expensive. Incumbent directors typically nominate themselves, and the company pays their election expenses (for soliciting votes from distant and dispersed shareholders, producing voting materials, submitting legal filings, and, when an election is contested, paying for high-priced US litigation). If a shareholder dislikes, say, how GM's directors are running the company (and, in the 1980's and 1990's, they were running it into the ground), she is free to nominate new directors, but she must pay their hefty elections costs, and should expect that no one, particularly not GM, will ever reimburse her. If she owns 100 shares, or 1,000, or even 100,000, challenging the incumbents is just not worthwhile.

Hence, contested elections are few, incumbents win the few that occur, and they remain in control. Firms and their managers are subject to competitive markets and other constraints, but not to shareholder authority.



In lieu of an election that could remove recalcitrant directors, an outside company might try to buy the firm and all of its stock. But the rules of the US corporate game heavily influenced by directors and their lobbying organisations usually allow directors to spurn outside offers, and even to block shareholders from selling to the outsider. Directors lacked that power in the early 1980's, when a wave of such hostile takeovers took place; but by the end of the decade, directors had the rules changed in their favor, to allow them to reject offers for nearly any reason. It is now enough to reject the outsider's price offer (even if no one else would pay more).

Corporate elections

American corporate-law reformers have long had their eyes on corporate elections. About a decade ago, after the Enron and WorldCom scandals, America's stock-market regulator, the Securities and Exchange Commission (SEC), considered requiring that companies allow qualified shareholders to put their director nominees on the company-paid election ballot. The actual proposal was anodyne, as it would allow only a few directors not enough to change a board's majority to be nominated, and voted on, at the company's expense.

Fierce lobbying

Nevertheless, the directors' lobbying organisations such as the Business Roundtable and the Chamber of Commerce (and their lawyers) attacked the SEC's initiative. Lobbying was fierce, and is said to have reached into the White House. Business interests sought to replace SEC commissioners who wanted the rule, and their lawyers threatened to sue the SEC if it moved forward. It worked: America's corporate insiders repeatedly pushed the proposal off of the SEC agenda in the ensuing decade.

Then, in the summer of 2010, after a relevant election and a financial crisis that weakened incumbents' credibility, the SEC promulgated election rules that would give qualified shareholders free access to company-paid election ballots. As soon as it did, the US managerial establishment sued the SEC, and government officials felt compelled to suspend the new rules before they ever took effect. The litigation is now in America's courts.

Less capitalist

The lesson is that the United States is less capitalist than it is “managerialist.” Managers, not owners, get the final say in corporate decisions.

Perhaps this is good. Even some capital-oriented thinking says that shareholders are better off if managers make all major decisions. And often the interests of shareholders and managers are aligned.

But there is considerable evidence that when managers are at odds with shareholders, managerial discretion in American firms is excessive and weakens companies. Managers of established firms continue money-losing ventures for too long, pay themselves too much relative to their and the company's performance, and too often fail to act aggressively enough to enter new but risky markets.

When it comes to capitalism vs. socialism, we know which side the United States is on. But when it's managers vs. capital-owners, the United States is managerialist, not capitalist. - Project Syndicate

Mark Roe is a professor of law at Harvard Law School.

Wednesday 22 June 2011

Debt-consolidation plans vital





MAKING A POINT By JAGDEV SINGH SIDHU

IT'S easy to picture the worst when the news around us is not savoury at all.

The platter for such troubles will include the second-quarter slowdown induced by the earthquake and tsunami in Japan. Output around the world has been shaken by the ramifications of the supply shock from Japan.

Then there is the report card on the US Federal Reserve's second round of quantitative easing (QE2). For many, QE2 really did not help the foundation of the economy. Unemployment is still sticky and there is still weakness in the housing sector but the stock market and commodities boomed with cheap liquidity flooding the market.

Inflation jumped as raw material prices surged and that, in effect, robbed a lot of people of purchasing power.

Looking at Greece, one has to assume a default is a certainty and is just a question of time. In fact, the CEO of Pimco, the world's largest bond fund, expects that to happen and many, too, agree looking at the economic structure of Greece.

Despite the gloom, the prognosis for the global economy really has not changed much.

The International Monetary Fund (IMF) expects the world economy to grow by 4.3% for 2011, which is 0.1% lower than previously estimated.

It has cut its growth forecast for the United States to 2.5% in 2011 from an earlier estimate of 2.8% in April.

IMF's Olivier Blanchard, who is its economic counsellor and the director of the research department, said predicting the economic direction for the US was too early but felt the slowdown of the US economy was more of a bump on the road than something worse.



“But assuming that oil prices are going to stay roughly stable, which is what the markets seem to predict at this point, we think that spending by consumers and firms should remain steady in what is, however, very clearly a very weak recovery. This has been a longstanding forecast of ours. The recovery in the US is a very weak one,” said Blanchard last week.

The outlook for Japan saw the biggest change as the earthquake and tsunami are expected to see that economy contracting by 0.7% this year from an earlier forecast of a 1.4% growth made in April.

The IMF has stuck to its projections for the two most populous countries, estimating growth for China and India to register 9.6% and 8.2% respectively this year. Those estimates were unchanged from April.

With troubles in Greece hogging international financial news and people wondering about the repercussions of a default by Greece on financial institutions in Europe and the US, the IMF said the risk of contagion was real and could derail European recovery and even that of the world but thought advanced economies, in which Europe features prominently, was forecast to grow at 2.2% for 2011, down 0.2 percentage points from earlier thought.

Its forecast for emerging and developing economies is 6.6% for 2011, which is up 0.1 percentage points since April.
While forecasts are relatively flat, the IMF did say risks were visible and highlighted the debt issue not only in Europe to be one of the hazard points for the global economy.

It feels debt-consolidation plans, even in the US, needs to be in place for the medium term to avoid higher borrowing costs and slower economic growth in the future.

In Asia, asset and price inflation are seen as the key risks and it feels countries with large current account surpluses should allow their currencies to appreciate.

“All countries must choose the right combination of instruments at their disposal fiscal, monetary, macro prudential to slow their economies in time and avoid costly boom-bust cycles,” said Blanchard.

Whether the bad news translates to most people's economic nightmare is something most businesses and investors are keeping an eye out for. It would appear that, for now at least, prospects and risks are balanced.

Deputy news editor Jagdev Singh Sidhu has filled nearly every large container at home with water to prepare for a dry couple of days but water is still flowing strongly from the main pipe.