Transcript | 7. lecture: Politicians and bankers – a dangerous combination - University for modern Slovakia

In several lectures we have already stated that in connection with the crisis we face it is becoming clear that politicians have become hostages to banks and bankers, especially those large ones.

Why is it so? As we have already shown in the lectures of second trimester, today's fractional reserve banking has embedded by definition the risk of money depreciation and risk of attacks on banks. Over time, central banks were created as institutions that have to protect against attacks on banks and they took the role of monetary policy, thus determining the amount and prices of money on the market.

Banks differ from other, non-financial institutions mainly in that for the most part they deal not with their own, but with outside sources – outside money. And it is true that the world’s financial market today is very closely interlinked, so to speak each bank deals with everyone, each bank lends, but also borrows: to people and from the people, to companies and from the companies, to banks and from the banks, to central banks and from the central banks, to governments and from the governments. Capital adequacy ratio is around 10%, which means that banks are doing business on 90% with foreign sources and that if a bank goes bankrupt, the owners of the bank lose their capital, but the problem that is created is much bigger. And if the bank is really big, its fall will cause literally global problems. Recall that the global financial crisis was caused by the collapse of U.S. investment bank Lehman Brothers in September 2008.

The problem is therefore that many banks in the world today are too big to be able to fail (too big to fail). Big banks in the U.S. but also elsewhere in the world in recent decades have become really big. Just to illustrate, the proportion of the total assets of the six largest U.S. banks in the U.S. GDP grew from 18% in 1995 to 65% in 2010.

Let us look now at the role the banks had played and being playing in the eurocrisis. As we have said in the fifth lecture of this trimester, the eurocrisis problems started in Greece. The new government, that came into office in autumn 2009 found very bad, unsustainable public finances and the economy as a whole. In December 2009, all the rating agencies started rating Greece worse and interest on the Greek debt began to rise. Greece began to have difficulty borrowing, thus in April 2010 it applied for financial aid from eurozone countries and the International Monetary Fund (IMF). Early in May a loan of EUR 110 billion euro was approved of which 80 billion euro was provided by euro area countries.

Responsible European politicians claimed at that time that it is crucial that we save the euro and that is not only a problem of liquidity (i.e. the lack of money), which can be resolved with a loan and problem is gone: the problem of Greece and the euro hazard problem. Today, it is more than evident that it was not just a liquidity problem and not only the problems of the euro are not solved, but problems of Greece, either.

Decision on loan for Greece was not meet positively in the countries that provided money. The governments did it, despite the fact that politicians generally oppose doing unpopular things. Why politicians did it this way, why suddenly they were are able to agree on unpopular thing so quickly? Was it really so necessary and good deal?

I think it was the wrong decision and a bad solution and I had described the reasons for my opposition to the Greek loan in details in this blog on early May 2010. The arguments, which I provided, still apply, moreover, is now clear that the loan did not help either Greece. The standard procedure, namely a declaration of insolvency of the country and the subsequent debt restructuring would be a better solution also for Greece itself. The restructuring would reduce the overall debt burden of Greece, which today continues to grow despite the draconian austerity measures and in the next year will exceed 150% of GDP. It was the first wrong button turned on, after which the further went, also turned bad.

So why then politicians in May 2010 (among them Fico and Počiatek) decided that way? Or in other words, since everyone knows that the leading duo in the euro area is a couple Germany - France, why Merkel and Sarkozy decided that way? The short answer is - because of banks.

They all remembered very well what had happened after the collapse of Lehman Brothers and also feared that if Greece would fall the infection would pass to other PIGS countries (Portugal, Ireland, Spain). And that would kill the French, German, Dutch, and Belgian banks. The banks from these countries have the greatest exposure in the PIGS countries. In the case of French banks it is up to 37% of GDP, Dutch 33% of GDP, Belgian 28% of GDP, and German 21% of GDP.

And so the politicians being hostages to big banks, decided to save them with money of taxpayers. It is true that they had to choose a good solution and if it was decided otherwise, it would also cause major problems. Several large banks would have to be rescued and it is true that the rescue would have been again only for taxpayers' money. But it would be a much better solution because:

1. It would be a real solution, while overlapping of old loans with new ones, bailouts,  financial stability facilities are not a solution,
2. It would be a fair solution, because the banks would carry the bill for irresponsibility and risk. The rescue would have been associated with the expropriation of existing owners of banks and exchange managements,
3. It would be fair also due to a fact that although the cost of banks rescue would be bored by the taxpayers, but not only by them, moreover, mostly it would be the taxpayers of those countries whose banks would be rescued,
4. This solution would also minimize moral hazard, and thus the risk of repetition of similar reckless behaviour in the future,
5. It would be politically more passable, without discrediting the market economy in the public eyes, because people reasonably reject the chosen approach, which means the privatization of profits and nationalization of losses.