Two weeks after the U.S. Congress passed TARP, the European Union announced its own framework for stabilizing the continent’s banks. In an October 13 statement, President Nicolas Sarkozy unveiled the French government’s response.
Forty billion euros to recapitalize French banks; €320 billion to guarantee their
debts; €1.7 trillion at the European level. Do we hear a higher bid? In racing to
see who can announce the most enormous bailout plan, the governments of the
rich countries are taking big risks.
First, there’s no guarantee that this publicity strategy will quell the crisis and
avert a painful recession. Financial markets do like big numbers. But they also
like to know exactly what the money will be used for, who will get how much,
for how many years, and under what conditions. Yet on this score, murkiness
prevails. In truth, governments are behaving like the worst of the corporations
they’re supposed to be regulating. Every accounting gimmick is making an
appearance, with special mention going to the French president. Annual flows
are confused with stocks, hard cash with mere bank guarantees, single operations
are counted multiple times. And everything gets added up: the bigger, the better.
We find ourselves in a grotesque situation where the American and French
authorities are rushing to hand out public money, with no real conditions, to
banks that don’t want it. The €10 billion lent last week to big French financial
institutions was supposed to stimulate lending, but the commitment is merely
verbal. Yet there is a whole legislative and regulatory arsenal that could force
banks to lend some of their funds to small and medium-sized businesses, which
would have been worth revisiting and improving in the current crisis.
Next, and most important, this strategy, based on misleading announcements
of numbers in the hundreds of billions, risks disorienting the public in the long
run. After explaining for months that the public coffers are empty, that even the
smallest cuts involving a few hundred million euros are worth making, suddenly
the government seems willing to take on unlimited debt to save the bankers!
The first source of confusion that needs to be clarified comes from the fact
that annual flows of income and production are constantly being mixed up with
stocks of wealth, though the latter are far larger than the former. For example, in
France, annual national income (that is, GDP minus depreciation) is around €1.7
trillion (€30,000 per capita). By contrast, the stock of national wealth is €12.5
trillion (€200,000 per capita). If we move to the American or European level,
these numbers should be multiplied roughly by six: €10 trillion in income, €70
trillion of wealth.
The second important point is that 80 percent of total income and wealth
belongs to households: by definition, firms own almost nothing, since they pay
out most of what they produce to wage-earning and stock-owning households.
That’s what makes it possible to understand how the initial shock caused by the
subprime crisis, which came to about a trillion dollars (the equivalent of ten
million American households each having borrowed $100,000), though modest
in size compared to total household wealth, could threaten the whole financial
system with collapse. Thus, the biggest French bank, BNP Paribas, reports €1.69
trillion in assets against €1.65 trillion in liabilities, leaving €40 billion in equity.
Lehman Brothers’ balance sheet was not much different before its collapse, nor
are those of other banks around the world. The central fact is that banks are
fragile organizations that can be devastated by a $1 trillion writedown of their
assets.
Given this reality, it’s legitimate to intervene to avert a systemic crisis, but
only on several conditions. First, there must be guarantees that the shareholders
and managers of banks bailed out by taxpayers will pay a price for their
mistakes, which hasn’t always been the case in recent interventions. Second,
aggressive financial regulation must be put in place to ensure that toxic assets
can no longer be sold into the markets—with the same vigor that food regulators
use when supervising the introduction of new products. This will never be
possible as long as we leave more than $10 trillion in assets to be managed in tax
havens in the most opaque fashion. Finally, we have to put an end to the obscene
compensation packages of the financial sector, which helped stimulate excessive
risk-taking. That will require more heavily progressive taxes on high incomes,
the polar opposite of France’s current tax-shield policy, which aims to
preemptively exempt the best off from any effort to foot the bill. With that kind
of a strategy, we will probably have to prepare ourselves for even more severe
crises to come—social and political ones.
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