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PostGermany's Wirecard Collapses, Declares Bankruptcy (Tor Guimaraes, USA, 06/27/20 7:23 am)
The whole world knows that Communism sucks, but isn't Capitalism grand? Here is a very recent example.
Someone is making a lot of money from the Wirecard collapse on Thursday. Yes, creditors got screwed big time but that is show business nowadays. The payments company filed for bankruptcy in Munich because with 1.3 billion euros ($1.5 billion) of loans due within a week, it is the end of the line. This implosion was forced by its auditor EY, which refused to certify its 2019 accounts, forcing out Chief Executive Markus Braun who admitted that $2.1 billion of its cash probably didn't exist.
EY's statement: "There are clear indications that this was an elaborate and sophisticated fraud involving multiple parties around the world," and that during the 2019 audit it was provided with false confirmations regarding escrow accounts which it reported to relevant authorities.
Wirecard is the first member of Germany's prestigious DAX stock index (the country's top 30 listed companies with a market valuation of $28 billion) to go bankrupt. Creditors have no chance of getting back the 3.5 billion euros they are owed, including 1.75 billion to 15 banks and 500 million to bondholders. "The money's gone," said one banker. "We may recoup a few euros in a couple of years but will write off the loan now."
Across the Pond, this Wall Street Friday sees the big banks, i.e., Goldman Sachs, JPMorgan Chase and Wells Fargo trading lower because the Federal Reserve (FED) ran reassuring stress test results reported Thursday after market close, and temporarily restricted dividends and share buybacks by financial companies (just for the third quarter). This is a nice head fake, since last Thursday, the financial sector led the S&P 500's advances, after regulators eased constraints over certain bank investments, which had first been implemented after the 2008 global financial crisis. This is the FED putting more booze in the punch bowl by easing restrictions curtailing the ability of banks to make investments in such areas as hedge funds. This easing of regulations named the "Volcker Rule" gave an immediate boost to bank stocks because the change could free up billions of dollars in capital for banks to indulge in further financial engineering. The Volcker Rule was part of the limited overhaul of banking regulations approved in the Dodd-Frank Act passed by Congress in 2010 to curtail the activity leading to the 2008 banking crisis, the worst since the 1930s.
But don't worry, Trump campaigned in 2016 on rolling back such over-regulation of the banks, which he described as terrible on the economy because they prevented the banks from making loans to qualified borrowers. This rule rollback, opposed by Democratic appointees at both the Fed and the Federal Deposit Insurance Corporation, represents one of the biggest victories for the Trump administration in its government deregulation drive, besides gutting the education system, the EPA, etc. The Volcker Rule in general prohibited banks from engaging in proprietary trading and from acquiring ownership interests in hedge funds and private equity funds. The looser restrictions approved on Thursday supposedly will allow banks to more easily make investments in various areas of venture capital, allow banks to avoid having to set aside cash when making derivatives trades between different affiliates of the same firm, and eliminate the firewall between ordinary banking activities like demand deposits and making loans to high-risk hedge fund-style activities.
According to financial sector experts, a lack of transparency in this market was a key contributor to the 2008 financial crisis. Last December Volcker criticized the rule change, stating it "amplifies risk in the financial system, increases moral hazard and erodes protections against conflicts of interest that were son glaringly on display during the last crisis." Sen. Jeff Merkley, a key proponent of the Volcker Rule in 2010, stated, "It was only a decade ago when millions of Americans paid the price for Wall Street gambling, in lost jobs, homes and life savings... Re-opening the Wall Street casino is the wrong path forward, one that puts all Americans' financial stability at risk."
Thus, now we have one more sneaky step toward the next 2008 financial crisis on steroids: too big to fail got much bigger, too big to jail more out of the question, while debt by households, corporations, students, and governments rise to enormous amounts. What can we the people do about it besides cry?
JE comments: Wirecard was caught with the little matter of a "missing" €1.9 billion. It's unclear if the money was stolen or never existed in the first place. But for the creditors who've been ruined, the distinction is not significant.
The bigger worry is the loosening of the Volcker Rule, which sounds akin to opening the henhouse to the foxes (I also enjoyed Tor Guimaraes's analogy: more booze in the punchbowl). The "official" justification is that it will free up credit for corporate investment. Doesn't the Fed already do this with its near-zero interest rates? The even larger question: Did we learn nothing from 2008? I suppose the question is rhetorical.
On Wirecards, Punchbowls, and "Teutonic" Central Banking
(David A. Westbrook, USA
06/28/20 2:43 PM)
The punchbowl metaphor (see Tor Guimaraes, June 27th) is ancient in central banking. It has been attributed to a speech given in 1955 by then Fed Chair William McChesney Martin, who himself credits an unnamed "writer" for the metaphor.
Conversable Economist on Punchbowl
The basic idea is this: the job of the inflation fighting central bank is "to take away the punchbowl just as the party is getting good," i.e., to tighten credit as the economy booms, so that it does not "overheat." (Exactly why this is bad rests on a worldview that may be questioned, but let's call it the Teutonic orthodoxy, which tends to be more concerned about inflation than about other things, i.e., the core job of the central bank is to ensure price stability.)
Taking away the punchbowl (usually raising interest rates) when the party is getting good is politically difficult. Not only are powerful parties making money by borrowing cheaply and reinvesting successfully, risk is demonstrably, statistically, lower, until it isn't. Hence the bubble-enhancing problem of credit (leverage, e.g., buying stocks on margin), and hence also the core argument for central bank independence.
At present, there are no signs of inflation, just the opposite. This is no party. So central banks and governments the world over are doing all they can to make capital available. They are indeed pouring booze into the punchbowl. The problem is everybody worries the punchbowl is poisoned, or at least the party is. So people are not failing to start businesses because they can't get financing. They aren't starting businesses because they have few ideas, opportunities looks scarce, etc. In many places, inflation is too low (the conventional target is 2%), and the specter of deflation looms. But one of the few things the world's elites collectively believe in is monetary policy, and central banks don't have very many tools that are different in kind, so more booze, just different flavors.
As an aside and to respond to Tor, the Wirecard story has a kind of cultural pathos. Germans especially want to see their mighty economy generate start-ups, tech companies. They have a very different, fundamentally conservative and long term, business culture. Think Henkel knives, or even Daimler. But if "innovate or die" is the law of modernity, that's a problem. There is nothing remotely like a German Alphabet, Facebook, Amazon, Apple, etc. So Wirecard was celebrated as a German, but American-style, tech/finance company. Not just celebrated, unfortunately. Rumors began to circulate that something was rotten at Wirecard, leading to journalistic investigations, largely by Dan McCrum at the Financial Times, and short selling. Wirecard accused the FT of colluding with short sellers, an argument that the German regulators bought, and must have wanted to buy. In response, German regulators protected their champion, dismissing any doubts as some sort of Anglo-Saxon capitalist perfidy, prosecuted journalists and suspending short selling, etc. It's fascinating and a bit sad:
Coming back to central banking, one might argue (I have argued) that we are indeed seeing inflation in financial asset prices. Stock market, paradigmatically, but other stuff, too. If anything, central banks have contributed to this inflation, first by cheapening money and lowering debt yield, and second, lately and directly, by buying all sorts of assets themselves, injecting cash into the economy but conversely driving up asset prices.
If central banks are about controlling inflation, one might ask whether central banks should attempt to dampen asset price inflation, if they could. Controlling asset prices is not part of the Fed's "dual mandate," nor the mandate of any other central bank of which I'm aware. At the same time, many central banks do have some regulatory authority over the financial system, and central banking has its roots in financial crises and the lender of last resort function. And, as the GFC [Global Financial Crisis] conclusively demonstrated (and as we now understand the Great Depression), a financial market crisis can precipitate a real economy crisis. So if we look at the European sovereign debt chapter of the GFC, we see action taken to support the financial system, even if the ECB is supposedly guarding monetary stability. Just before the pandemic, the Fed was doing very interesting things in the repo market. By the same token, the Volcker Rule governing trading by banks is, after all, named for a famous central banker. That is, central banks are supposedly in charge of monetary/macro policy, but that must be understood through the banking system, and more broadly, through the portfolio economies on which so much depends, what I call social capitalism. So what should banking policy be, now?
Banks, unsurprisingly, want to be as free/profitable as possible. And if they blow up, we socialize the disaster, as we did during the GFC. So they want to roll back the regulations passed after the GFC, hence John E's cry, have we learned nothing from the GFC? Maybe, maybe not. Banks are safer, we think, but Wirecard casts a bit of doubt. One might also be worried about so-called leveraged loans bundled into CLOs (which are an awful lot like mortgages bundled into CDOs), as my buddy Frank Partnoy recently argued in The Atlantic. So, from a purely bank regulatory perspective, we should be skeptical of the desire to roll back the Volcker Rule and otherwise deregulate.
At least as I see it, the difficulty is this: our current economic problem does not have its roots in the financial markets. COVID-19 is a huge disease that is keeping people from working, or even spending much money. The pandemic is as real economy as it gets. So money is being used to--we hope--stimulate activity. More interestingly, worldwide, money is being used to bridge the mismatch in payment temporalities that the pandemic has caused. Think of a restaurant that must make a monthly rent payment but has no daily, not to say monthly, revenue. (If the GFC taught us about uncertainty and money, COVID-19 is teaching us about time. This is really interesting and deserves further thought, but I digress.)
Where does this money come from? A great deal of it comes from the government, either directly (fiscal spending) or through monetary policy. But--and I do not know why this isn't more widely understood--almost all the "money" in an economy is generated by banks, through lending. (The usual ballpark figure for an advanced economy is 90%. See generally Mervyn King's brilliant The End of Alchemy, which I reviewed in International Finance if you can get past the paywall.) That is, precisely because we need so much money to go into the real economy right now, banks can make a strong case that they should be allowed to operate as profitably as possible.
But there are limits to how much booze any punchbowl, not to say financial market actor, can hold. I'm hardly an inflation hawk, but "more money" hardly solves all problems, a thought I'm going to leave undeveloped here. Most of the foregoing has been pretty conventional/received wisdom (in admittedly wonky circles), but over the last year or more I've been musing upon and occasionally speaking about the political economy of central banking, the "Teutonic" view with which I began, and which animates the vast majority of central bank policy. I have, however, been rather distracted by recent events...
JE comments: This is a great essay, Bert; thanks! It's technical but also accessible. I had to review the Fed's "dual mandate," which since 1977 has been codified as promoting "maximum employment, stable prices, and moderate long-term interest rates." Shouldn't that be a triple mandate?
You also make a very WAISly observation about Germany. Why is the German track record with tech start-ups so poor? It even trails tiny whippersnappers like Estonia. As for the "Teutonic" dogmas of central banking, might this be more than a metaphor? The ethos of Germany's finance policy traces back to memories of hyperinflation of the 1920s, which arguably contributed to Hitler and WWII. Bert, what would the concerns of a "post-Teutonic" central bank look like?