The Irish Times - Monday, November 22, 2010

The ECB may not be the friend it seems


BUSINESS OPINION: Suggestions that bailout may in fact be to protect European interests may not be too wide of mark

WHEN THE history of Ireland’s banking and fiscal collapse comes to be written, the role of the European Central Bank may well turn out to be the most controversial.

The question will be whether they really were some sort of honest broker who in the end forced us to confront our predicament or were they in fact the villain of the piece?

Both narratives have some resonance but the former is very much in the ascendant. The weary relief that characterises most people’s response to the arrival of the ECB, the European Commission and the International Monetary to negotiate a loan for Ireland is consistent with the view that time has finally been called by impartial outsiders on our botched effort to sort out the mess we have made of the Irish banks and our finances.

The main elements of the story are that the banks’ problems are so deep that they exceed the fiscal capacity of the State. We cannot borrow enough money from the bond markets to sort them out and also fund the exchequer deficit, so we have no choice but to turn to the European Financial Stability Facility and the IMF.

While the later point is unfortunately true, the role of the ECB in how we came to this sorry pass is worthy of some scrutiny. A more critical analysis might conclude that its policies over the last two years added greatly to our problems and ultimately its own. And it is the ECB’s problems as much as ours that brought things to a head last week.

One of the main differences between how the two-year-old crisis has played out in Europe and America has been the refusal of the ECB to allow any significant bank fail.

It is worth noting in this regard that Jean Claude Trichet rang Brian Lenihan over that fateful weekend in September 2008 to impress on him the importance of not letting any Irish bank fail. The obvious inference was that the ECB would play its part.

Trichet was, of course, pushing at an open door given the other factors at play in Ireland: profound regulatory failure combined with the inability of the administration or the banks to comprehend the scope of the problem.

But the fact remains that the Government could not have gone down the road it did without the support of the ECB. Frankfurt has provided the liquidity needed to make the National Asset Management Agency function and was committed to a similar facility for the winding up of Anglo.

Above all it has provided liquidity to the Irish system to such an extent that Irish banks account for something like one in every four euro it makes available through its emergency measures. We kept our end of the bargain. No Irish bank has failed although two are to be closed, but crucially their secured creditors are to be paid.

The reason the ECB did this was because it also misjudged the Irish banking crisis. Its calculation that stability in the euro system was best served by letting the Irish banks limp on with massive liquidity support was incorrect.

Instead a situation arose whereby the problems in the Irish banks were not dealt with as they should have been – through letting them fail or some sort of debt for equity swap – and the ECB found its own balance sheet contaminated by the amount of support it had to extend to Ireland as a consequence. Meanwhile, the Irish exchequer is left with a bill it cannot afford.

Now, in order to extract itself from this mess, the ECB has in effect withdrawn its support and said that the Irish taxpayer must now borrow even more money and try – for a third time – to fix the knackered banks so the ECB can get its money back.

The alternative to the Irish taxpayer stumping up – letting the badly broken AIB and Anglo Irish banks fail or default on their bonds – remains resolutely off the agenda at the insistence of the ECB. The reason being the same as it was in September 2008: the Irish banks are systemic in the European context . The big losers if either bank failed are the German, French and other European banks and institution that funded their insane lending sprees. And while these institutions and the euro system are probably strong enough now – as against two years ago – to absorb the loss, the fear remains that an Irish bank failure would trigger some sort of secondary European banking crisis.

Many are of the view that this crisis is in fact inevitable due to the level of debt in the system across Europe and the ECB – and the other European institutions should really focus their energies on getting ready to deal with it in the immediate future.

But, for the time being, the consensus seems to be that it makes more sense to try and put the fire out in Ireland by pushing the burden on to the Irish tax payer and its exhausted administration.

The Government may appear more mendacious and delusional by the day, but when they say this is a European problem they actually do have a point and history could well prove them right.

The EU and the Hedge Funds: regulation or the relinquishment of European sovereignty?
by Jean-Claude Paye*

In a blaze of publicity, the European Union has just adopted a regulatory code for hedge funds to manage the systemic risk that they impart to the general economy. In reality, observes Jean-Claude Paye, the new directive is a sieve which will have an effect contrary to that announced. Its real objective is to summarily control the European funds, while opening the door to U.S. funds which will be able to speculate without restriction at the expense of Europeans.

The City of London, Trojan Horse of U.S. capitalist predation inside the European Union.

Unlike the financial institutions, banks, insurance companies, investment banks which draw on savings, the hedge funds have no designated regulators. They are able to fully utilise the exemptions allowed by the relevant statutes. However, if the speculative funds are not the cause of the actual crisis, but rather the easing of bank credit conditions and the money creation that it triggered, the systemic risk that hedge funds spread to the entire financial system has been brought to light. To enhance their performance, hedge funds have recourse to leveraging. They borrow heavily from the banks, to compensate for the smallness of their outlay and thus induce, in case of problems, a multiplier effect on the imbalances.

By failing to address the system’s potential for going into debt and generating speculative bubbles, the European Union avoids tackling the essential question. The EU directive on hedge funds formally designates a scapegoat: the speculative funds; yet it does not increase their surveillance. On the contrary, it eliminates, in practice, the means of their control by the national authorities.

Fake regulation

This project simply pretends to exercise oversight over the hedge funds [1] and does not incorporate surveillance at the Community level. It does not constitute a step forward in the creation of a European financial space. On the contrary, the directive extends the national level of accreditation of these funds, in permitting organisations domiciled in a member State to have - without authorisation from each national authority - access to the totality of national territories comprising the EU. Contary to the effect foreshadowed, the text reinforces the financially dominant country and thus the City of London which manages the bulk of speculative funds situated on European soil.

The directive is also presented as being part of the fight against tax havens, whereas, in reality, through the City, it will open the door of the European Union, with no oversight by its member States, apart from that, ‘benevolent’, of the British authorities.

After having been accepted by the EU Finance Ministers on 19 October [2], the Proposal for a Directive on Alternative Investment Fund Managers (AIFM) [3] has been finally ratified by the European Parliament on 11 November. It requires the Assembly to legitimise a legal framework that gives discretionary powers to the Commission. The directive leaves a wide margin of manoeuvre to the Commission to determine or to be imprecise on the key points of the legislation, such as the establishment of the maximum levels of gearing, evaluation procedures, restrictions on short selling operations, both at the time of the directive’s deployment and after its establishment. [4] It is for the European Parliament to give the Commission a blank cheque, and to the financial system a green light for ‘self-regulation’.

The text formally fixes a European framework for the hedge funds, in setting up a ‘passport’ allowing the funds to market themselves across Europe, without having to obtain authorisation in each country. The European managers will be able to freely market their funds from 2013. The ‘passport’ will be granted to offshore organisations in 2015. The passport will be reserved to those registered in signatory countries with agreements with respect to taxation and money laundering.

The question of the ‘passport’ was at the heart of the negotiations on the AIFM directive. They were started a year and a half ago between the European Commission, the Council and the European Parliament. The conflict has formally opposed the UK, hesitant at any regulation of hedge funds, to France and to the European Parliament.

Passport to the global European market

If the passport gives access to the entire European market, the national supervisory authorities will be solely responsible. It will be supplied by the supervision authority of the country of origin, once it receives accreditation from the future European Securities and Markets Authority (ESMA), to be operational from 2011. In addition, the ESMA will manage the register of fund managers authorised to operate in the EU. It will have at its disposal an arbitrage power in case of conflict between national authorities on the nature of and guarantees given by a fund.

Like any financial market situated in a member State, the City of London, where 70-80% of hedge funds are domiciled, will be solely dependent on the British regulatory apparatus. Thus, instead of forming a European regulatory framework, the directive encourages competition between the member States. Nothing will prevent the managers from choosing their country of registration as a function of the degree of accommodation by the national authorities towards them.

Fund managers currently are required to specify their maximum debt leverage. This information is transmitted to the national authorities of the European country where the manager is registered. But nothing in the directive obliges the authority to act if the leverage is judged excessive. And the ESMA will have no power to compel the national authority to do it.

The directive gives no means to genuinely control the level of debt. Yet it is precisely this that underlies the systemic risk induced by the hedge funds. They have very little of their own capital and borrow heavily from the banks. It results in an enhanced capacity for action in the markets, out of all proportion with their own capital.

In practice, the directive ignores the degree of leverage; it simply requires the funds to communicate the details to their authorities, without obligation on the part of the authorities to intervene in case of problems. Above all it is a matter of maintaining the independence of the entire financial system. As noted by Guido Bolliger, Chief Investment Officer of Olympia Capital Management [5]: “… rather than going through a directive, it would have been simpler to constrain the leverage that the investment banks in the prime brokerage operations are able to allocate to the hedge funds in increasing the amount of capital required.”

Domination of Anglo-Saxon finance

A provision of the accord presents itself as a means to fight against tax havens. The speculative funds, located in some countries which inhibit effective information exchange, especially on taxation matters, are no longer able to be marketed in the EU. The issue is important when one knows that 80% of hedge funds are located in these offshore centres.

However, following pressure from London, the final text limits the scope of the directive to ‘active’ marketing. This signifies concretely that nothing will prevent a European investor, a bank, an insurance company, a mutual fund, from buying units of funds located outside the EU, which should not have obtained a European passport for non-compliance with the directive’s criteria. This provision thus gives access to European territory to capital located in the tax havens but in contact with the City, such as the Channel Islands and the Cayman Islands or, for example, those managed directly by the US, such as Delaware.

This is a violation of the spirit of the legislation for, in this case, no information will be conveyed to the regulators who will not be able to evaluate the exposure to risk of European ‘investors’. But above all it is a new abandonment of the EU member countries to the omnipotence of Anglo-Saxon finance. Even the formal possibility for an EU member State to appeal before the ESMA, in case of disagreement with the national authority of a third country, will not produce a modification in the balance of forces.

This directive thus falls within the restructuring of financial markets, revealed by the G20 of April 2009 regarding “the fight against tax fraud” [6], that is to say in the legitimation of the Anglo-American stranglehold on European finance. However, if the primacy of the City throughout the European Union, regarding the management of the speculative funds, is overwhelming (80% of the industry is British, as against 5% for France), this power must be put into perspective. The British funds represent $212 billion, compared to a total of $1000 billion for those located in the US. Thus the London market appears above all as the Trojan horse of U.S. hedge funds.

Jean Claude-Paye
Belgian sociologist and essayist. His latest published works are La Fin de l’État de droit, La Dispute 2004; and Global War on Liberty, Telos Press 2007

DeSpiegel 22.11.2010

Now the European governments must face a different reality, coupled with the question of what happens in 2013..... (The European rescue fund expires in 2013.)

Internal Government Document Outlines Planned Crisis Mechanism

Chancellor Merkel is determined to prevent the rescue fund, in its current form, from becoming a permanent solution. She envisions that the construct will be replaced with a "permanent crisis management mechanism" when it expires in 2013. A plan developed by the German Finance Ministry has already been coordinated with the Chancellery, the Foreign Ministry and the Economics Ministry. German Finance Minister Wolfgang Schäuble intends to present the plans in detail at the next meeting of the Euro Group and the council of finance ministers in Brussels in early December.

According to a "non-paper" drawn up by the Finance Ministry, "the crisis mechanism is designed to allow for a fair balancing of interests between the debtor country and bond creditors," so that "systemic effects" on financial markets and the monetary union are avoided. A non-paper is a document that is so confidential that it doesn't really exist.

According to the Germans' plans, the conditions for all new bonds in the euro zone would include a debt restructuring clause as of 2013. The goal of the clause is to "make it possible to achieve a legally binding change in the payment terms through majority decisions of the creditors in the event of the debtor's inability to perform." The document lists maturity data extensions, rate reductions and debt waivers as measures.A neutral chief negotiator would mediate between bankrupt countries and investors. "This task should be assigned to an inter-governmental institution that can also be a provider of financing at the same time," the document reads.

The new facility could also provide ailing countries with liquidity assistance. The money for the program would come from two sources. First, there would be the revenue from the penalties euro-zone countries would pay for repeatedly violating the upper deficit limit. Second, the euro-zone countries would pay into the fund, with their contributions possibly being based on their shares in the ECB.A condition for the procedure is an analysis of a country's "debt capacity" prepared by the European Commission, the ECB and the IMF. German government experts are convinced that their plan will be successful.

But many countries have completely different ideas. Luxembourg Prime Minister Jean-Claude Juncker supports the idea of issuing euro bonds. These are government bonds whose repayment is not guaranteed by the issuing country but by the entire monetary union. The southern euro-zone countries think this is an excellent idea. The Germans and the Austrians are against it. This sort of project would penalize those "who are dutifully sorting out their national finances" and benefits those "who haven't done their homework," says Austrian Finance Minister Josef Pröll."When everyone is liable for everyone else, there is very little incentive for individual countries to keep their own house in order," warns Christoph Rieger, a bond expert at Germany's Commerzbank. This, says Rieger, jeopardizes the currency as a whole.