Tag Archives: Bailout

Ukraine’s Fight Isn’t Over

It has been all over the news and has been going on for months. Finally, last week Ukrainian opposition protesters achieved what they were fighting for: the removal of President Viktor Yanukovych. Protests began late last year, when the Ukrainian government rejected a trade agreement with Europe- favoring closer ties with Russia. Among discontent with corruption and social oppression, protesters manifested against the eery relations with Russia, which they felt was dominating their government. Essentially, they want to establish effective relations with the EU as soon as possible. Though protests were relatively uneventful in previous months, they turned very violent last week. At least 88 people died from the clashes last week; most were protesters, but some police officers are also among the deceased. Ex-President Yanukovych now faces an arrest warrant for the scale of violence used to suppress protesters. His whereabouts are unknown, seeing as he fled Kiev soon after the rally.

But the Ukraine now faces a very difficult financial situation. First of all, this political outcome is clearly unfavorable for Russia- which hoped to maintain its control over the formerly-Soviet state. And in reaction to the outcome, Russia has halted its $15 billion bailout package. However, this is quite the predictable reaction from the Kremlin, and I suspect opposition leaders took this into account or where at least aware of this implication. But will this effect be significant? Well, Ukraine’s $176 billion economy is in turmoil following months of protests and last week’s clashes. $15 billion is a considerable proportion of the country’s economy.

Now opposition leaders must find a supplement for this aid, in order to effectively pay back debt and essentially keep the economy running. That is where Western Europe and the United States come in. Sunday, the Obama administration worked with the European Union in order to draw up a bail-out plan for Ukraine. Ukrainians seek $35 billion in assistance – in order to avoid default. Its Finance Ministry said it will first seek a loan from the United States and Poland within the next two weeks, and later hopes to raise it to around $35 billion by the end of 2015. Though specifics on other European’s assistance are not clear at this point, it’s very likely that countries like Germany and France will also be interested in providing aid.

The interesting part of this assistance-package is that the United States invited Russia to participate. Maybe it’s just how I see it- as a slap in the face for Russia- but it does make sense for Russia to be interested in doing so. Putting aside politics (in which the Russians have mainly lost here) it is still in Russia’s best interest to have a sustained Ukrainian economy. Essentially, nobody will benefit from seeing Ukraine bankrupt, and there is enough incentive to keep this from happening. Though it will not be easy for Ukraine after this victory, also considering that some of the Eastern part of the country still supports Russian ties, there is much reason to predict that complete economic turmoil can be avoided.

 

Don’t Get Too Excited With Spain

This past Thursday, Spain began its halt and its reliance on bailout loans from Europe. After the construction sector had its fall out, Spain was in desperate need to fill up the vaults in its banks. While some critics still believe Spain is in its rock bottom pit, some people the Spanish job market may be turning around. “Spain posted seasonally adjusted job growth for the first time in nearly six years.” Officials and independent analysts say “the job-growth threshold is lower now because of a two year old overhaul of labor laws that made it easier and cheaper to lay off workers.” But now, according to Gayle Allard, a professor at IE Business School in Madrid says “companies are as likely to hire because the lower dismissal costs have diminished the risks associated with taking on new workers.” Companies have been seeing an increase in demand from an increase in requests for new employees and workers seeking jobs. As we see the Spanish banks ending their need of loans from Europe, there is progress in the works for Spain.

Although a lot of people have been inspired by the progress of Spain, many economists are not completely convinced that there will be a complete upswing. Why should we be completely confident that there will be a full turn around just cause the banks aren’t taking loans anymore?  Megan Greene, the chief economist at Maverick Intelligence in London says that “The big game that politicians and bank CEOs are playing is ‘extend and pretend.’ If we pretend that our banks are really healthy, then eventually all the assets underlying things on our balance sheets will regain value, and we won’t actually have to take such big losses.” This is the exact reason why countries like Spain and Greece have been in the dumps for the past several years. They have continued to believe things will work themselves out without any major changes. Spain thinks that not having to take bailout loans from Europe is one of their big moves and that the rest of their issues will work out themselves. “So that’s the game everyone in Europe has been trying to play,” Greene continues to say.

Even the job market doesn’t look like it will have the best outcome as some people have been saying. “More than 90% of the new jobs are temporary, some say, and part-time contracts are also increasing.” So yes, it is easier to hire people just as it was easy to let people go, but that does not mean Spain is making great progress. For there to be a complete turn-around in Europe, all the countries are going to have to figure out a way to come together to fix their economies. I do not believe one country will be able to solve their problems on their own. There is too much chaos still occurring in Europe for a major progression to come about.

Big Banks & Moral Hazard

After the Great Recession, many economists cited moral hazard as the prime reason to not bail out failing banks.  Nevertheless, our country proceeded to bail out many major financial institutions in order to minimize the impact that widespread bank failures would have on the economy and equity markets.  Why?

The answer seems to lie in the level of influence financial institutions have on the US economy; it is extremely difficult to let banks fail because they constitute such a significant portion of the economy.  In the USA, for example, the financial sector produces nearly 10% of GDP (NYT: The Rich Country Trap).  Because financial institutions produce such a large portion of the nation’s GDP, they are extremely influential and important to this nations economic success.  Indeed, policymakers call upon the heads of financial institutions when they need help with the nation’s economic problems.

Nevertheless, if we want to reduce moral hazard, we must confront big banks.  In an IMF conference in 2013, Ben Bernanke stated that banks must be allowed to fail in order to eliminate the threat moral hazard.  That said, as the failure of Lehman Brothers in 2008 showed, bank failure can have devastating consequences on the economy.  As such, Bernanke believes that policy makers need to devise a systematic and controlled way for banks to fail.  This systematic failure should minimize the impact of bank failures on the economy.  While I do not understand the details of this systematic failure, my hunch is that Bernanke has proposed gradual bank failure, where failed banks slowly fall out of existence with the help of the government as opposed to dropping out of the economy at the onset of bankruptcy (Bloomberg: Bernanke Says Failing Bank Process Needed to Reduce Moral Hazard).

It seems clear that to avoid another bank collapse, we must reduce the effects of moral hazard.  Ironically, however, banks are so influential that many policymakers lack the guts to address the issue or moral hazard.  Consequently, banks continue to operate knowing that in the event of disaster, the government will likely come to their aid.  To address the issue of moral hazard, therefore, it seems that we must have a transition period, where systematic failure is implemented, bank regulations are increased, and moral hazard is reduced.  Naturally, during this transition period, bank profits and GDP will fall, and this fall in GDP will be painful.  But just like saving money, it will be beneficial in the long run; this transition period will reduce moral hazard while forcing banks to appreciate risk and operate in a responsible manner.

It will be very challenging to find politicians willing to take us through this transition period.  Certainly, politicians proposing a painful transition period won’t easily win the favor of voters.  Maybe, though, if we can sever the ties between political fundraising and banking, we may be able to elect such a politician.