The European masses now understand the dangers of bailouts but will politicians listen?

Posted on May 12, 2010 by


Written By Orphe Pierre Divounguy

The European masses are now showing their discontent with financial bailouts but will politicians finally listen?  The German people are turning away from Chancellor Merkel ruling party, the Irish people attempt to storm their parliament, and the British ousted the labor party Prime Minister.  Europeans are finally saying enough with bad governance, enough with failed policies, and enough with the fiscal mess.  Europeans are starting to demand more accountability from their elected governments.

As the world slowly recovers from the deepest economic downturn since the Great Depression, the European economy is struggling to catch up and to grow again. It seems to have a lot to do with their lack of competitiveness due to high absolute levels of taxation, high levels of regulation and very little reform. We can argue that Europe has become less competitive in the past 10 years. There has been a decline in the ease of doing business, which translated to lower investments and therefore less tax revenues. Less tax revenues in a region where most countries have huge obligations to their populace in terms of unfunded liabilities and all sorts of entitlements, simply means huge deficits and mounting sovereign debt.

Banks in Europe are still struggling with 434 billion euros of losses and write downs from the deepest financial crisis in decades. European banks are still working their way out of the financial crisis, clearing their books so to speak, and the uncertainty caused by the high levels of sovereign debt in the region is not helping that cause. Many of these banks hold substantial amounts of these almost worthless bonds. Europe bank stocks are taking a hit over worries of their exposure to sovereign debt in the region slowing the economic recovery process even more.

In 2009 the Irish government created a fund, the National Asset Management Agency (NAMA) to take on toxic loans from five of the country’s main banks. By the time the last transfer is made in February 2011, NAMA will hold €81 billion ($100 billion) of toxic assets, roughly equal to 50% of Ireland’s total economy. The Irish Government with the backing of some people at the IMF was convinced that NAMA’s purchase of bad loans from the banks with State bonds would increase the flow of credit in the economy since the plan was unveiled April 2009. In a country that had a 2009 budget deficit equal to 10% of their GDP, despite the EU rules that oblige members to keep budget deficits below 3% of GDP, it would seem completely irrational to issue more debt or to use taxpayers’ funds to rescue troubled assets. Among many prominent economists, Nobel Prize-winning economist Joseph Stiglitz criticized the plan by saying that the Irish government is “squandering” public money with its plan to bail out the banks.

Bailouts are bad for many reasons. Bailouts create the wrong incentives. A history of bailouts means that financial institutions can begin to expect the government to cushion any losses. Investors have no incentive to use restraint in risk taking behavior. Bailouts do not discourage reckless and irresponsible risk taking which was one of the main causes for the last major recession. Bailouts also make private banking assets a public problem in a crisis. (See Chart below published by Forbes Magazine dated Feb 8 2010)

Greece was recently promised an IMF –EU bailout. The conditions for the bailout are that they impose drastic austerity measures. The Greek people have responded by taking to the streets. There has been so much protest and a few people have even lost their lives. Last week, German Chancellor Angela Merkel’s ruling party lost a key regional election in North Rhine-Westphalia, the most populous state and the election results could be bad news for Merkel’s unpopular decision to contribute to $28.6 billion to a European Union bailout package for Greece. The Irish people just like the German masses seem to have learned from the Greek crisis, and they are trying to force their elected officials to listen. This week dozens of Irish protesters took to the streets in an attempt to storm the Irish parliament. The Irish people understand that if their government continues with failed policies, among which the NAMA project, and unrestrained spending as compared to total output, Ireland will soon face the same dire economic outcome that Greece is now facing.