IMF and Greece, the breakup

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The IMF has been on its way out of the Greek Rescue programme for a while now.

The band-of-bandits of Mr Tsipras is getting ready to celebrate ousting the IMF. Before you join in the dance in Syntagma Square, listen to my podcast on what the IMF is, what it does and what it did (and did not do) in Greece.

This is a February 2017 lecture on what the IMF is and what it does. The discussion on the role of the IMF in Greece is from 44’30” onwards.

Enjoy and feel free to comment using the discussion options in this post.

@iGlinavos

Who stands to win from #Trump and #Brexit?

One would say that both Trump and Brexit are the result of populism, complacency and … to be frank stupidity. But they have more things in common. They both benefit the financial industry. See my two recent articles on Newsweek exploring what this new order means for our banker friends.

What does a hard Brexit mean for the City of London? (read here)

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What does Trump deregulation herald for Wall Street? (read here)

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@iGlinavos

The consequences of Brexit

Since 2016 I have been writing on the potential consequences of Brexit. Before the referendum, the aim was to inform the public of the dangers ahead, were Leave to prevail. After the referendum, the aim is to steer policy away from a hard-Brexit.

After Theresa May confirmed she is after a Hard Brexit, I wrote an explanation of what this means for the City, and by consequence the country.

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The prospect of Brexit is already making every wage earner in Sterling poorer, as explained in my Marmitegate piece for The Conversation.

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While we knew of the potential effects of a Brexit vote on currencies, few people appreciate what a hard-Brexit (with no successor agreement) will mean for investment and trade. My article on opportunities for Eastern European investors in a hard-Brexit scenario should surprise many on the Leave side.

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My other published work on Brexit can be accessed via this link.

@iGlinavos

The City and Brexit: A Primer

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Chapter 1: Passporting

The prospect of Brexit has created a tsunami of information as people try to get to terms with the various consequences of a British exit from the European Union. As a teacher of Banking Law, I realised that while a lot of terms are commonly referenced in the financial press, our students – and the wider public- have little appreciation of what is happening and what the implications are.

I am starting therefore a series of short posts on issues Brexit-related from a non-technical perspective for a non-legal audience. You can view this as a primer on the relationship of the world of business with Brexit.

We start with the City and the perceived threat Brexit poses to Passporting. This post presents what Passporting is, why it is important and how Brexit is likely to affect the operation of financial firms & banks out of the UK and with what consequence. This piece is meant to be informative, not partisan, so I will make an effort to avoid repeating why I think Brexit is a very, very bad idea.

What are we talking about?

The City is worried that if the UK departs from the Single Market it will lose Passporting rights. A core consequence of Freedom of Movement for (financial) services is that authorisation granted to a banking business in one Member State will suffice for operations across the EU and it is not therefore required that the process be repeated in another. This principle – nowadays almost sacrosanct as a European principle of banking and financial law – is commonly referred to as ‘Passporting’. The notion of a ‘European passport’ is inexorably linked to the parallel concept of ‘passported activities’. Such activities are termed ‘activities subject to the mutual recognition’. The main reserved activities are, on the one hand, the acceptance of deposits or other repayable funds and, on the other, lending including, inter alia: consumer credit, mortgage credit, factoring, with or without recourse, financing of commercial transactions (including forfeiting). Also, it is important to note that this universal green light applies to the activities a financial institution wishes to perform in another Member State either by means of cross-border, distant services, or by means of a branch office in that other Member State.

Is this important?

The City is a key driver in the British economy. Britain has the highest ratio of services exports to GDP in the G7, at 13%. It also has the biggest share of financial services exports by some way, at 29% in 2012 (the US comes second at 15%). In 2014, financial and insurance services contributed £126.9 billion in gross value added (GVA) to the UK economy, 8.0% of the UK’s total GVA. London accounted for 50.5% of the total financial and insurance sector GVA in the UK in 2012. The sector’s contribution to UK jobs is around 3.4%. Trade in financial services also makes up a substantial proportion of the UK’s trade surplus in services. In 2013/14, the banking sector alone contributed £21.4 billion to UK tax receipts in corporation tax, income tax, national insurance and through the bank levy.

It is not perceived to be in anyone’s interests to sharply and artificially reduce the size of the financial sector in the short to medium term.

What can Brexit do?

Let us assume that Brexit does happen in one of its extreme versions, taking the country out of the Single Market. This will mean loss of Passporting rights, but it will not mean that the heady proportion of GDP contributed by financial services will disappear in its entirety. PwC estimates that the GVA of financial services to the economy will decline by 6-10% (roughly) by 2020, representing a reduction around £7-12 billion in value. Loss of employment is estimated between 70-100.000 in the financial services sector. Why is the projected impact so severe? One after all could point to banks operating successfully in countries outside the EU. An argument of the Leave camp is that reduced connection with Europe frees up options for increased trade in services (including financial services) beyond Europe.

The answer of why the impact is so severe is rather mundane. It is a matter of increased costs and upset balance sheets. No one is suggesting that banks headquartered in Britain will no longer be able to do business in Europe. The problem is that if the industry loses Passporting, compliance and administrative costs will increase markedly. Funds will need to move to the continent if accounts in Euros can no longer clear from London. While this does not mean that banks will close (after all, major banks already have a presence in the continent), it does suggest costs in the short and medium term. With the movement of funds, some (but not all) jobs will go. The cumulative impact of Brexit (especially if it also means exit from the Single Market) is that Britain will present a very different business proposition than it does now. This difference amounts to a few billion pounds wiped off the country’s GDP. This is not apocalyptic, but it is unavoidable if a hard-Brexit is the base scenario.

There is another aspect of Brexit impacts arising from a reduction to the size of the City. The Revenue will face a sharp loss of income if significant amounts of economic activity migrate to the continent. This, on top of increased budgetary needs due to a deteriorating economy (especially since the UK runs a budget deficit at around 6% at the moment) will be a bad hit to state finances.

Can other business, attracted from overseas, compensate? The answer to this question is yes, but only partly. The UK cannot, and should not, seek to become a big-island tax haven. It cannot jump from being the centre of European finance to Singapore-by-the-channel. Even if this were the aim, the price to pay for attracting international funds will be tax breaks and sharp tax cuts. This will not compensate for the loss of tax income, even if it helps firms retain a presence and preserves some part of the City.

Conclusion

Passporting is important and stepping out of a harmonised zone for the provision of financial services entails a loss of business which will not annihilate the sector, but will significantly reduce it. Any adjustment will take place over the longer term and in 2030, the City will still be smaller than it was in June 2016. Brexit, if it means exit from the Single Market, will not turn Canary Wharf into a parking lot, but it will not do any favours to the Treasury or growth in the British economy.

@iGlinavos

An evil plan would have been better than this

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When we (by this I mean fellow Remainers) tried to reflect on Brexit post the fateful referendum on 23 June, we assumed that Brexit was part of an evil plan.

Such evil plan consisted of a Thatcherite take-over under the guise of a far-right coup. We did not think for a second that Boris really wanted out of the EU, or that May was really that keen to rain fire on the economy just to appease UKIPers. We thought this is all a rouse, a clever way to gain power and finish the Thatcherite revolution that Blair ameliorated, and Cameron distorted through the self-imposed pain of austerity, while keeping the state living (albeit at a barely capable level).

Boris, May and the rest of the gang (we though) is out for a final push in the deregulatory, privatising revolution that will establish Britain as the new Reaganite America, the Land of Opportunity for the rich, corporates, foreign dudes with deep pockets.

We were wrong.

The reality it seems is far worse than a Thatcherite revolution. It could even be worse than a far-right takeover by the likes of that scumbag Farage.

The reality is this: Incompetence, lack of vision, lack of plan, lack of intelligence, coupled with utter bollocklessness.

This is it ladies and gentlemen. The famous Brexit government of Mrs May lacks all of the above and is unlikely to grow the necessary bits within a relevant timeframe.

What has the victorious Brexit government actually done after it took over from yellow dog Cameron? It has celebrated the Olympic successes (well deserved). It has gotten into arguments about secondary schools (less well deserved) and has given speeches. Lots of speeches. Brexit means, eh Brexit, in case you missed that one. It has not actually done anything pointing towards what Brexit will be like, when it will happen and how the economy, society and foreign policy will reallign as a result.

For a government that demonstrates this distinct lack of bollocks, a lot of it has appeared in public pronouncements. Sadly, Fox and Davis seem to understand little, and know less of what is involved and what they are doing. May in the meantime is being disgraced in international fora as the obvious realities (to everyone but 52% the electorate) hit home.

No discussions with Europe prior to Article 50 activation

No trade deals with Europeans before discussions are completed

No trade deals with anyone else before a trade deal with Europe

No buffers or interim arrangements while this goes down

The only thing in plentiful evidence is damage control. The Bank of England is trying to keep the economy breathing. The government is promising everyone money (without explaining how it will find it) to plug gaps that will emerge after the end of European supports. Projects are announced and promises made. This smells a little like Tsipras of Greece. Listen to May explaining how everything will turn out ok, and then listen to Tsipras’ speech yesterday in Thessaloniki. No cigar for spotting the commonalities.

Meanwhile, back in the City of London Financials are packing their bags. Why you ask? Because they are not stupid. Banks and financial institutions are not going to stick around to see whether this band of jokers will manage to maintain their EU passports (financial ones) in two years time. They will do two things (trust me on this): 1) They will relocate the bulk of their business to European capitals to be sure that there is no disruption in their business. 2) They will keep a presence in London from which to run international business in a ZERO-TAX environment, which the government will need to institute as a sweetener to keep everyone from fleeing as the excrement hits the fan post Article 50 activation (which cannot be delayed post 2017). It is a win-win for the industry. It is a sorry deal for Britain.

Also, the Europeans are not stupid either. Brexit presents them with a golden opportunity to snatch resources, business and human capital. You will see not only preferential conditions offered to the financial industry to relocate, but also incentives for businesses and staff to set up in Europe. For example look at universities. We have been losing market share (international students) to European institutions teaching in English for a while now. Brexit gives a unique opportunity to institutions to expand their English business-focused programmes and there is a strong incentive for well respected staff from the UK to relocate to Europe. And they will, in droves.

Brexit was a crap idea even before everyone realised the entire thesis for it was lies, mistakes and racism. The total utter lack of ability to make Brexit happen is even worse than the stupid idea to begin with. Even if you were positively inclined towards leaving the EU, for whatever reason, before this summer, you ought to have realised now what it really means. If you are still a staunch Brexiteer, I am sorry to pass judgment on you, but you are an idiot. Further, you are an idiot that deserves what will happen to you.

An evil plan would have been better than  this.

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@iGlinavos

US politicians finally agree on something (that no-one saw coming)

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Many things are happening in the new populist phase of American politics. Some are less expected than others. For instance, the GOP joining forces with the left of the Democrats in asking for the restoration of Glass-Steagall was not something many saw coming. The new Republican Party platform calls for restoring the law that separated commercial-banking and securities activities at Wall Street firms, a regulatory change advocated by both Elizabeth Warren and Bernie Sanders. The following offers some background on this law and how it is linked to the regulation of financial markets in the US.

 

Glass-Steagall is the offspring of crisis and a totemic legislation of the New Deal. Crisis can be (and many argue, indeed, it should be) a catalyst in developments in policy that can at times lead to rapid and wholesale reversals of policy directions. One such reversal was the expansion of regulation in the United States after the 1929 crash and the initiation of the New Deal by the Roosevelt administration. As a product of pressure from various sources, the New Deal was grounded in no single coherent or systemic theory. Perhaps the most prominent unifying theme was the popular conviction that an unregulated free market guided solely by the invisible hand of private interest could lead only to the dispossession associated with the depression. The Roosevelt administration responded to this popular perception (in sync with Keynes’ ideas) by offering the countervailing power of government, administered by disinterested expert regulators, in order to discipline the market and stabilise an economy that laissez-faire had all but destroyed. The result was a stunning expansion of administrative authority both within and independent of the executive branch. What is particularly interesting is that the state sought to set in place a regulatory framework that would prevent the re-emergence of circumstances that could lead to another bubble and subsequent catastrophic crash.

 

One of the most important legislative responses to the failures of the Depression (particularly in the banking sector) was the work of Senator Carter Glass, Representative Henry Steagall and other proponents of the Banking Act of 1933, known as the Glass Steagall Act. The Act’s backers were convinced that the banks had played a significant role in promoting unsustainable booms in the real estate and securities markets during the 1920s. As a solution to this problem it was suggested that commercial banks should restrict their operations to the acceptance of demand deposits and the extension of short-term, self-liquidating loans to finance the production and sale of goods by businesses. Banks therefore should be prevented from making unsound loans and investments that encouraged an overbuilt real estate market and an immense overexpansion of real estate values. The banks should also be discouraged from making investments in securities that undermined their solvency during stock market downturns and they should be restricted in making loans to finance the purchase of securities. Liberalisation that removes the above restrictions has since been shown to produce a banking system that is more vulnerable to systemic risk. Admittedly, deregulated financial markets generally promote faster growth rates by providing more extensive financing to consumers and businesses during economic expansions. However, by encouraging greater reliance on external funding, deregulation creates a higher risk that consumers and firms will become overextended and end up insolvent if external funding sources shut down during economic contractions. An example of this happening was the credit crunch of 2008. As Amato and Fantacci explain in their book The End of Finance, the reliance of the economy on ever-increasing availability of funding (known as liquidity) propels what is a market economy to its turbo-charged, crisis-prone financialised version, something the aforementioned authors equate with modern capitalism.

 

The financialisation that came to characterise US (and global) capitalism before the crash of 2008 was the product of protracted deregulation. While deregulation has been a dominant trend in the US since the mid- 1980s, it came properly into its stride in the latter part of the 1990s. By 1998 regulators and the courts in the United States had allowed banks to make substantial inroads into the securities and insurance sectors by exploiting loopholes in the Glass Steagall Act and the Bank Holding Company Act of 1956, both enacted with the memories of the Great Depression present in people’s minds and considered strong legal barriers to bank entry into the securities and insurance fields. The model of finance to emerge after the repeal of the Glass Steagall Act was based on securitisation and became known as the ‘originate and distribute’ model. A securitisation is a financial transaction in which assets are pooled together and securities representing interests in the pool are issued (see here for an explanation). Under the originate and distribute model, financial institutions would create assets (such as loans) then repackage these and sell them to investors. The resulting funds would be used to originate more assets which in turn would be re-repackaged and sold, recommencing the cycle. This model of banking recreated in a way the institutional framework that had led to the crash of 1929. By allowing the banks to lend not on the basis of deposits but on the strength of the money markets, the way was opened for the financial sector to depart from the fundamentals of the real economy, creating fictional wealth.

 

In confirming the return of universal banking powers to the financial holding companies, allowing the combination of commercial with investment banking, the Gramm-Leach-Bliley Financial Modernization Act repealed several Depression era safeguards in 1999. Unlike the system of finance established in the United States in the 1930s, the new model of finance allowed competition between commercial banks and investment banks for securities business. As a result, opportunities for profit increased dramatically, encouraging investment banks to engage in ever more risky proprietary trading – speculating with their own capital to increase returns. A key boost to the trade of derivative financial products via the process of securitisation we just described was given by another major step in deregulation in the form of the Commodity Futures Modernization Act of 2000. The new legal framework was not merely reflecting innovations in financial markets, but changes in the law spawned the so-called innovations. In other words, it was not changes to the markets that brought about the conditions that created the credit crisis but, crucially, changes in the law. The Commodity Futures Act suddenly and totally removed century-old legal constraints on speculative trading in over-the-counter (OTC) derivative financial products. It is useful to remember that derivatives were not always seen as a clever way to speculate but rather as a risk limitation technique. Derivatives were considered in US jurisprudence to be valid methods of dealing with risks of future events, and while hedging was legal, speculation in OTC derivatives was not and courts would not allow enforcement of financial bets whose sole purpose was speculation (as opposed to risk diversification). One way that the pre-2000 system dealt with speculative derivative trading was by moving it to clearing houses which assumed the risks associated with such transactions and kept the volume of trading low in order to minimise the exposures of the clearing houses themselves. This system operated fairly consistently on the basis of the common law (eventually codified by the Commodity Exchange Act of 1936), which retained the prohibition of speculative trading outside regulated exchanges. The Commodity Futures Act of 2000 represented the final blow to this system of controlled derivative trading. After the Act, speculative trading in derivatives was in effect legalised in the US with the result that a massive market in OTC products grew with-out anyone being able to assess the systemic risk effects of ever expanding volumes of trading.

 

The response, post credit crunch, at least in the US, has been to try and reverse the tide by restoring legal limits to derivatives trading outside clearing houses in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Will reinstating 1930s era regulation deal with the risks of further crises stemming from financial markets? It is correct that on its own this initiative cannot be a cure-all. On the other hand a more controlled, smaller financial sector has lessened capacity to destroy the real economy during one of its cyclical, self-generated disasters.

 

More on the issue of regulation and debates on reform post-financial crisis can be found in my book which can be obtained here and here.

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@iGlinavos

BVerfG and the ECB’s OMT programme

Today 21 June 2016 the BVerfG has affirmed the legality of Mario Draghi’s OMT programme. In doing so, it followed the lead of the CJEU. Nothing remarkable here, but two important issues arise:

  1. the BVerfG had initially insisted on a ban on debt restructures (no pari passu treatment of ECB held bonds in case of a sovereign default). This is absent from the final decision.
  2. the exclusion of Greece (or any other non-conforming/non-rescue programme participating Euro member state) is a prerequisite for the legality (no direct financing Treaty provisions) of ECB actions.

We learn this therefore: The ECB can do ‘whatever it takes’ so long as the Eurozone remains under strict supervision and conditionality. Otherwise the ECB is exposed to risk of loss that would be considered illegal.

This is not necessarily good news for Greece, or anyone planning ‘alternate’ paths (think Spanish election).

Read my background article on the BVerfG and the ECB’s OMT programme on the EU Law Analysis blog.

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@iGlinavos