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Robert Feinberg: More Perspectives on the EU Crisis

By    |   Monday, 15 October 2012 01:38 PM

A day after the CATO Institute conference on the economic crisis as seen from the United States and the European Union, the American Enterprise Institute (AEI) presented a panel on the same topic as part of its semi-annual review of the ongoing crisis.

AEI’s Desmond Lachman, a former International Monetary Fund (IMF) economist, gave an updated presentation of the same pessimistic view he has offered since 2007, noting that every six months, the European Union seems to go through a cycle of approaching the abyss, taking pro-cyclical austerity measures that provoke a political backlash and getting rescued by bold measures from the European Central Bank (ECB) intended to preserve the euro. However, the austerity isn’t working, and the economies of Greece, Italy, Spain and Portugal are in recessions.

The “good news” is that ECB President Mario Draghi has ridden to the rescue and promised to do “whatever it takes” to save the euro, including buying Italian and Spanish three-year bonds in order to mask the deterioration in the credit standing in those countries. However, this has not stopped capital from fleeing the peripheral countries and heading for the Bundesbank to the tune of 750 million euros.

Lachman listed the reasons for his ongoing pessimism as follows:

• The ECB has not changed the pro-cyclical policy mix of the peripheral countries.

• Nothing has solved the Greek problem, and Greece will soon leave the euro.

• Political troubles persist in Spain and Italy, with Spain facing a secession movement in Catalonia.

• The Bundesbank, the ECB’s largest shareholder, is pushing back against the rescue.

He predicted that the EU recession will deepen in 2013, there will be more fiscal tightening, stress on the banks will increase and constrain lending, the political environment will worsen and Spain’s housing bust will persist, and all this will fall apart in a manner of months. Lachman concluded that Greece will default on the ECB debt, and the Germans will develop an even worse case of “bailout fatigue.”

Chris Whalen, senior managing director of Tangent Capital Partners, challenged Lachman’s view that Germany is a reluctant rescuer. Rather, Whalen contended that Germany sees this as a chance to tighten its grip on floundering France and the Benelux countries, and he suggested that the reason the United States bailed out AIG was to save the French from having to restructure leading banks such as Societe Generale. He proposed that the United States cease trying to support the euro and just let it disintegrate.

Whalen then described a model of U.S. monetary policy that revolves around the housing industry, which has been used since the 1980s as a vehicle for trying to stimulate the economy. He employed the term Housing-Industrial Policy and cited a book on its role in the crisis authored by Gretchen Morgenson and Josh Rosner. Whalen predicted that the rising U.S. debt would eventually cause rates to rise and impede the ability of the Federal Reserve to continue to aid the Treasury by buying this debt. According to Whalen, the U.S. economy is being held back by the fear of fraud, which is causing investors to resist the Fed’s efforts to force them to invest in riskier assets. It is the hedge funds and mortgage banks that are benefiting from the Fed’s programs, whereas private investors and community banks find rates unattractive and would actually like to see them rise in order to provide a spread.

AEI’s John Makin, former consultant to the Treasury, the Congressional Budget Office and the IMF, traced the evolution of Fed policy from an initial “defensive” phase, marked by the first round of quantitative easing (QE) and the Troubled Asset Relief Program (TARP), to more offensive moves to head off inflation in 2010, measures that added to the duration risk of the Fed’s growing portfolio. But these programs did not result in significant improvement in the labor markets. He quipped that if monetary policy were really capable of stimulating economic activity, it should have been brought to bear several years earlier. Makin then made a critical observation that whereas the Fed had been giving assurances that it would withdraw QE at just the right time, in order to stave off inflation, now the Fed is saying it will leave QE in place long enough to let some inflationary momentum build. He cited repeated speeches by Columbia economist Michael Woodford that have argued for using Fed intervention to bring down real interest rates. Makin predicted that the result would be to confront retired investors with even less attractive investment opportunities, with the ultimate risk of a return to the conditions of 2008.

Meanwhile, the ECB is taking offensive measures to keep the spreads of troubled countries down and protect the euro, and the markets have responded with a rally that Makin views as temporary. He concluded that the Fed and ECB “have both made unfulfillable promises. The Fed can’t substantially improve conditions in American labor markets, and the ECB can’t guarantee that the euro won’t break up.” He finds that the Fed’s actions are actually increasing uncertainty. The moderator, AEI’s Alex Pollock, responded by quoting Frank Knight, who said, “Attempts to reduce uncertainty in fact increase uncertainty.”

Robert Feinberg served on the staff of the House Banking Committee for the 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms and trade associations.

Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.

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A day after the CATO Institute conference on the economic crisis as seen from the United States and the European Union, the American Enterprise Institute (AEI) presented a panel on the same topic as part of its semi-annual review of the ongoing crisis.
Monday, 15 October 2012 01:38 PM
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