EU predicts European Union and euro-zone to shrink by 4 percent this year
BRUSSELS (AP) -- The European Union said Monday that Europe is suffering "a deep and widespread recession" and that unemployment will rise sharply over the coming two years.
The European Commission said both the 27-nation EU and the 16 countries that use the euro currency will shrink by 4 percent this year, more than double its January estimates, when it forecast a 1.8 percent contraction for the EU and a 1.9 percent decline for the euro area.
Because of the big drop in output, the Commission said some 8.5 million jobs will disappear in EU in 2009 and 2010, more than wiping out the number of new jobs created in the last two years. Euro-zone unemployment will hit a postwar record of 11.5 percent next year, it said.
The EU's executive predicted a "subdued recovery" next year with both the EU and euro-zone economies shrinking by 0.1 percent -- but warned that this would only happen if the banking sector and world trade start to recover. The new forecasts echo those made by other bodies such as the International Monetary Fund.
The EU said manufacturing and exports are suffering, with euro-zone exports "forecast to suffer one of the worst setbacks on record" with a 13-percent slump this year. Europe's manufacturers have been hit badly by the slide in global trade and the strength of the euro against the dollar and other currencies.
Germany, the EU's largest economy, is faring particularly badly in the current economic climate as demand for high-value exports such as cars and machinery dries up. The EU is forecasting that Germany will contract by 5.5 percent this year and only recover moderately when trade picks up next year.
Britain and Italy will shrink by between 4 percent to 4.5 percent, it said, while France, cushioned by heavy government spending that supports growth, will post a smaller 3-percent drop. Spain will also likely shrink by 3 percent.
Both Britain and France will see unemployment climb over 3 million next year -- with France reporting an 11 percent jobless rate. Spain is forecast to fare worse with one in five workers unable to find a job -- an unemployment rate of 20 percent.
The EU warned that even worse may be ahead and banks' efforts to deleverage -- shore up their financial position by putting more money aside to cover bad debt -- "may unravel with greater intensity than currently expected."
It said a bad debt spiral from falling house prices could trigger a wave of business bankruptcies that lift unemployment and lead to more debt defaults.
To avoid this, it called on European governments to shore up confidence in banks by moving swiftly to clean up banks' balance sheets by taking on hard-to-value assets that have racked up huge losses and launching new bank recapitalizations as needed.
EU banks have already written down euro290 billion in losses, it says, calling for close-monitoring of debt defaults, particularly in eastern Europe where many western banks may face bad loan books as housing prices collapse and unemployment rises.
It also warned of "disruptive exchange rate developments" and protectionist measures that could further cut global trade and remove one major crutch to an economic recovery next year.
The EU said Europe faces a limited risk of deflation -- a corrosive spiral of falling prices -- but that several countries will see "disinflation" for several months this year as energy prices plunge from record highs last summer.
The EU now expects euro-zone inflation of 0.4 percent this year -- far below the European Central Bank's guideline of just under 2 percent and said that lower inflation may help support the economy by giving people more money to spend via such things as lower mortgage payments.
The EU made no criticism of European government efforts to stimulate the economy by spending an extra euro135 billion this year-- 1.1 percent of EU GDP -- and more than euro90 billion next year -- 0.7 percent of EU GDP.
But it said government investment and consumption is likely to be the main driver of growth and tax breaks and reductions -- particularly lower company tax rates -- will have little impact on the economy.
Stimulus spending and billions of euros to shore up banks with guarantees and capital injections will massively increase EU governments' debt and deficit, it said.
EU governments will jointly next year run a budget deficit of around euro900 billion -- or 7.25 percent of gross domestic product.
Monday, 4 May 2009
Changing course
Bank of America’s shareholders get tough—sort of 
KEN LEWIS, the boss of Bank of America (BofA), famously said he had had as much fun as he could stand in investment banking in the autumn of 2007. How on earth must he feel now? Mr Lewis’s decision to buy Merrill Lynch in September has cost him his reputation, his independence and, on April 29th, one of his many titles. At the bank’s annual general meeting shareholders re-elected Mr Lewis to the board, but voted to split the role of chairman and chief executive. Walter Massey, a board veteran, replaced him as chairman. Mr Lewis can count himself lucky. True, there was strong logic in buying Merrill Lynch, with its coveted retail brokerage, and Countrywide, a sickly mortgage lender, before that. True too, that the government resisted his belated attempts to get out of the Merrill deal in December, as losses at the bank rapidly worsened.
But these are figleaves. The Merrill deal was stitched together too quickly. Mr Lewis agreed on a price (in shares, to give him some credit) that looked inflated even before Merrill posted losses of more than $15 billion in the fourth quarter. “As a group, they are not disciplined buyers,” says Jonathan Finger, a disgruntled shareholder. Claims that Merrill paid out lavish bonuses to employees without BofA’s say-so, and that Mr Lewis was forbidden by officials to disclose details of Merrill’s losses to shareholders (both disputed), make BofA’s managers look impotent at best and contemptuous of shareholders at worst. Hostile investors argue that Merrill was already burning money when they voted on the deal on December 5th, before Mr Lewis crossed swords with the government.
The bank’s share price has lost more than three-quarters of its value since September. Things could yet get worse. Leaks about the results of the stress tests that have been conducted on America’s largest banks suggest that BofA, which has already received $45 billion from the government, needs yet more capital (it would probably not be the only supplicant). This could well mean that the government’s preferred shares are converted into common equity. If other investors do not want to get rid of Mr Lewis, the government may do it for them.
For bank shareholders in America, the ground is slowly shifting. Managers and boards will find it much harder in future to argue that they know best after the pasting they have given investors. Chuck Schumer, a Democratic senator, is reportedly planning a bill requiring non-binding “say on pay” votes, independent chairmen and annual elections for boards of directors. The Securities and Exchange Commission is also expected to enact two reforms. One would make it easier for shareholders to nominate their own candidates to the board. The other would stop retail brokers from casting votes, almost always in favour of management, on behalf of investors who have not given instructions on how to vote. These broker votes accounted for roughly a quarter of the BofA ballots.
Working out what effect enhanced shareholder rights would have on banks is harder. Governance activists in America typically laud the shareholder regime in Britain, yet the British banks fouled up just as badly as everyone else. Take RBS, where the shareholders merrily voted to buy ABN AMRO—the deal that sank the bank—after the credit crunch had struck.
The sympathetic explanation is that shareholders face a difficult job of holding banks to account. Banks are opaque and complex firms. Working out the risks they were taking on was apparently beyond most managers, let alone shareholders. Banks are heavily regulated, which created an unhealthy reliance on supervisors, who were also incapable of understanding the risks. And banks are fragile, which makes shareholders think twice about flexing their muscles when confidence is shaky. “There isn’t a halfway house to register effective dissent without risk of nuclear war,” says Peter Montagnon of the Association of British Insurers.
That worry still preoccupies some BofA shareholders. The bank argues that Mr Lewis and his team are skilled at integrating acquisitions; now that Merrill and Countrywide have been bought, in other words, shareholders would cut off their own noses by getting rid of them. That is a bit like saying BofA managers are experts in getting out of holes they have dug for themselves. But the judgments are finer for other banks. Take Barclays, which riled shareholders with a dilative capital-raising in October but has avoided taking government cash. On April 23rd an unusual number of shareholders opposed the re-election of Marcus Agius, Barclays’ chairman, but nowhere near enough to threaten his appointment. That seems supine to some, pragmatic to others.
Even when shareholders raise objections, it is apparently too easy for executives to ignore them. The boss of Legal & General, a large institutional shareholder, has described the way British banks ignored its advice during the crisis as “sobering”. Some think the role of lead independent directors needs to be beefed up. Another idea is for a committee of the most powerful shareholders to dig deeper into the composition of the board. Increased public scrutiny will also make it harder for executives to brush off criticism. Daniel Bouton announced his intention to resign as chairman of Société Générale on April 29th, citing personal attacks since a rogue-trading scandal forced him out of the chief executive’s job a year ago.
There is another, more sinister explanation for the failure of shareholders to discipline their managers—they do not want to. Shareholders accrue all the gains from risk-taking, but their losses are capped by the amount of equity they hold. Once capital is wiped out, any further losses are borne by creditors. A forthcoming paper by Shams Pathan of Australia’s Bond University finds that bank boards that are more aligned with shareholders’ interests are more likely to take risk than those that are under the thumb of the chief executive.
When banks have only thin slices of equity, or when share prices have dropped precipitously, shareholders’ propensity to gamble goes up even more. A new paper from Lucian Bebchuk and Holger Spamann of Harvard Law School suggests that bankers’ pay be tied not just to equity but to other bits of the bank’s capital structure, such as preferred shares and bonds. Giving shareholders more control makes sense, but like every other solution to this wretched crisis, it creates problems of its own.
KEN LEWIS, the boss of Bank of America (BofA), famously said he had had as much fun as he could stand in investment banking in the autumn of 2007. How on earth must he feel now? Mr Lewis’s decision to buy Merrill Lynch in September has cost him his reputation, his independence and, on April 29th, one of his many titles. At the bank’s annual general meeting shareholders re-elected Mr Lewis to the board, but voted to split the role of chairman and chief executive. Walter Massey, a board veteran, replaced him as chairman. Mr Lewis can count himself lucky. True, there was strong logic in buying Merrill Lynch, with its coveted retail brokerage, and Countrywide, a sickly mortgage lender, before that. True too, that the government resisted his belated attempts to get out of the Merrill deal in December, as losses at the bank rapidly worsened.
But these are figleaves. The Merrill deal was stitched together too quickly. Mr Lewis agreed on a price (in shares, to give him some credit) that looked inflated even before Merrill posted losses of more than $15 billion in the fourth quarter. “As a group, they are not disciplined buyers,” says Jonathan Finger, a disgruntled shareholder. Claims that Merrill paid out lavish bonuses to employees without BofA’s say-so, and that Mr Lewis was forbidden by officials to disclose details of Merrill’s losses to shareholders (both disputed), make BofA’s managers look impotent at best and contemptuous of shareholders at worst. Hostile investors argue that Merrill was already burning money when they voted on the deal on December 5th, before Mr Lewis crossed swords with the government.
The bank’s share price has lost more than three-quarters of its value since September. Things could yet get worse. Leaks about the results of the stress tests that have been conducted on America’s largest banks suggest that BofA, which has already received $45 billion from the government, needs yet more capital (it would probably not be the only supplicant). This could well mean that the government’s preferred shares are converted into common equity. If other investors do not want to get rid of Mr Lewis, the government may do it for them.
For bank shareholders in America, the ground is slowly shifting. Managers and boards will find it much harder in future to argue that they know best after the pasting they have given investors. Chuck Schumer, a Democratic senator, is reportedly planning a bill requiring non-binding “say on pay” votes, independent chairmen and annual elections for boards of directors. The Securities and Exchange Commission is also expected to enact two reforms. One would make it easier for shareholders to nominate their own candidates to the board. The other would stop retail brokers from casting votes, almost always in favour of management, on behalf of investors who have not given instructions on how to vote. These broker votes accounted for roughly a quarter of the BofA ballots.
Working out what effect enhanced shareholder rights would have on banks is harder. Governance activists in America typically laud the shareholder regime in Britain, yet the British banks fouled up just as badly as everyone else. Take RBS, where the shareholders merrily voted to buy ABN AMRO—the deal that sank the bank—after the credit crunch had struck.
The sympathetic explanation is that shareholders face a difficult job of holding banks to account. Banks are opaque and complex firms. Working out the risks they were taking on was apparently beyond most managers, let alone shareholders. Banks are heavily regulated, which created an unhealthy reliance on supervisors, who were also incapable of understanding the risks. And banks are fragile, which makes shareholders think twice about flexing their muscles when confidence is shaky. “There isn’t a halfway house to register effective dissent without risk of nuclear war,” says Peter Montagnon of the Association of British Insurers.
That worry still preoccupies some BofA shareholders. The bank argues that Mr Lewis and his team are skilled at integrating acquisitions; now that Merrill and Countrywide have been bought, in other words, shareholders would cut off their own noses by getting rid of them. That is a bit like saying BofA managers are experts in getting out of holes they have dug for themselves. But the judgments are finer for other banks. Take Barclays, which riled shareholders with a dilative capital-raising in October but has avoided taking government cash. On April 23rd an unusual number of shareholders opposed the re-election of Marcus Agius, Barclays’ chairman, but nowhere near enough to threaten his appointment. That seems supine to some, pragmatic to others.
Even when shareholders raise objections, it is apparently too easy for executives to ignore them. The boss of Legal & General, a large institutional shareholder, has described the way British banks ignored its advice during the crisis as “sobering”. Some think the role of lead independent directors needs to be beefed up. Another idea is for a committee of the most powerful shareholders to dig deeper into the composition of the board. Increased public scrutiny will also make it harder for executives to brush off criticism. Daniel Bouton announced his intention to resign as chairman of Société Générale on April 29th, citing personal attacks since a rogue-trading scandal forced him out of the chief executive’s job a year ago.
There is another, more sinister explanation for the failure of shareholders to discipline their managers—they do not want to. Shareholders accrue all the gains from risk-taking, but their losses are capped by the amount of equity they hold. Once capital is wiped out, any further losses are borne by creditors. A forthcoming paper by Shams Pathan of Australia’s Bond University finds that bank boards that are more aligned with shareholders’ interests are more likely to take risk than those that are under the thumb of the chief executive.
When banks have only thin slices of equity, or when share prices have dropped precipitously, shareholders’ propensity to gamble goes up even more. A new paper from Lucian Bebchuk and Holger Spamann of Harvard Law School suggests that bankers’ pay be tied not just to equity but to other bits of the bank’s capital structure, such as preferred shares and bonds. Giving shareholders more control makes sense, but like every other solution to this wretched crisis, it creates problems of its own.
New fund, old fundamentals
Has the IMF changed? Or has the world?
BY ANY standards, $500 billion is an impressive birthday present. The IMF’s managing director, Dominique Strauss-Kahn, turned 60 on April 25th, the same day the fund’s steering committee gave its blessing to a proposed tripling of the institution’s resources from $250 billion to $750 billion. As the birthday boy is fond of saying: “The IMF is back.”
But it is back in a new guise. The IMF is notorious for favouring hard money and tight budgets. The new fund (“IMF 2.0” as Time magazine called it) believes in casual Fridays and Keynesian policies. Since January 2008, Mr Strauss-Kahn has urged the world’s biggest economies to loosen their belts. And fiscal stimulus is not just for rich countries, he said at the spring meetings last week. Poor, well-run countries like Tanzania should also try it.
He also referred to a new position note*by Atish Ghosh and four other IMF economists, laying out the options for emerging markets in the global crisis. Those include monetary easing as well as fiscal stimulus and “heterodox” debt workouts. “We really are in new times, no?” the managing director said. “I like this.” His comments raise a further question: do the different prescriptions reflect a new fund or new times?
In the Asian financial crisis, the IMF supported punishingly high interest rates to defend the region’s currencies and combat inflation. Real rates in Indonesia topped 49% in August 1997 (even before the fund arrived). The aim was to bludgeon speculators and impress creditors. The obvious alternative was to abandon the fight and let the currency fall. That would free the central bank to cut rates. Unfortunately, it would also bankrupt any firms or banks that had borrowed heavily in foreign currency in the belief that the traditional parities were sacrosanct.
More than ten years on, the wisdom of the fund’s strategy is still in dispute. (If an economy carries a lot of short-term debt, high interest rates may wreak such havoc that the exchange rate collapses anyway.) But whatever its merits during the Asian financial crisis, the high-rate defence has little appeal today. The benefits of tight monetary policy are more doubtful, and the damaging side-effects of depreciation less severe.
This is because today’s crisis originates with rich-world lenders, not emerging-market borrowers, as Mr Ghosh and his co-authors point out. Gripped by the urgent need to raise cash, foreigners have sold whatever assets they can. Often, they have sold most enthusiastically in emerging markets that are deep, liquid and easily exited. Raising interest rates a few points is unlikely to tempt them back. Besides, the rate gap between emerging markets and America’s Federal Reserve is already wider now than it was a year or two ago.
Most emerging economies now allow their currencies some freedom of movement. In Latin America and Asia, they have also worked hard to contain currency mismatches, borrowing wherever possible in their own currencies, rather than someone else’s. As a result, exchange rates can fall without upending their balance-sheets.
The exception is emerging Europe, which is, in many ways, reliving the Asian financial crisis. Households and companies have borrowed in hard currencies, believing that their exchange rates could only harden against the euro in advance of joining it. For these countries Mr Ghosh and his co-authors advocate debt restructuring in advance of monetary easing. (The IMF has also recommended a swift entry to the euro.) But otherwise, their macroeconomic prescriptions are very IMF 1.0: if a parity is to be defended, high rates will be needed. And even if the parity is abandoned, high rates may still be needed to escape an “inflation-depreciation spiral”.
What about fiscal stimulus? In December 1997 the IMF asked South Korea to tighten its belt a notch (a fiscal improvement of 0.4% of GDP). That is now widely seen as a mistake. However, the fund learnt that lesson within a month, urging the Koreans to ignore the fund’s own fiscal conditions. As Jonathan Ostry, one of the paper’s authors, points out, the fund now appreciates that fiscal retrenchment does little to restore confidence unless there is an underlying fiscal problem.
Where a country has fiscal room for manoeuvre, it should by all means use it, the IMF argues. Mr Strauss-Kahn has welcomed the pronounced fiscal easing undertaken by the world’s biggest emerging markets (see chart).In principle, a dollar of government spending can raise output by more than a dollar if it stimulates resources that might otherwise lie idle. Public investment might also yield rich returns in countries short of infrastructure. But most studies show that fiscal multipliers are small in emerging economies, especially over the medium term. In some cases, they are negative.
As the authors are keen to point out, a fiscal stimulus can do more harm than good if it jeopardises the sustainability of the public finances. Governments need a credible plan to set aside enough resources in the future to repay the additional public debt their stimulus has added. As Willem Buiter of the London School of Economics puts it, only fiscal conservatives can use counter-cyclical fiscal policy well.
A textbook case
So how much has the IMF’s thinking really evolved? Its economics is now overseen by Olivier Blanchard, on leave from the Massachusetts Institute of Technology. In the 1990s the fund’s most prominent economist was Stanley Fischer, now governor of Israel’s central bank. Each has written a seminal graduate textbook. So whose text do fund economists now turn to for guidance? The answer is easy: both. They are one and the same textbook: “Lectures on Macroeconomics” (1989) by O. Blanchard and S. Fischer. Perhaps the IMF will not be so different after all.
Promising to try harder
For once, an international institution half-agrees with its critics
YOU are part of a global conglomerate. Your market share has fallen from 18% to 6% in a decade. Well-financed niche-players are moving in, threatening to appropriate the most exciting areas. And now a report by your auditors has said that, even of your remaining business, a third has failed to come up to scratch. If you were a division of General Electric in Jack Welch’s day (“Be first or second in a field, or get out of it”), you would probably be facing closure. Who, in these circumstances, would want to be in charge of global health at the World Bank?
(Yes, some good things happen )
The report in question*was prepared by the bank’s Independent Evaluation Group, an internal monitoring organisation that reports to the bank’s board. It looked at how effective the loans dished out for health purposes by the bank and its private-sector-promoting associate, the International Finance Corporation, have been at doing what they were meant to do.
The sums involved are not trivial. Between 1997 and 2008 the bank provided $17 billion for government-run projects in the fields of health, nutrition and family planning. Over the same period its associate invested $873m in health-related private-sector activity. And although the bank’s market share has fallen as new sources of money have emerged, such as the Global Fund (which deals with AIDS, malaria and tuberculosis) and PEPFAR (an anti-AIDS plan started by the Bush administration), the actual amount it lends for health each year has remained fairly constant.
The evaluators’ criticism was not just that a third of the 220 projects under scrutiny had failed to achieve their goals, but that those goals were often misconceived. In particular, the bank’s remit is to end poverty, but that was the specific objective of only 6% of the projects and a subsidiary objective of only another 7%. Even where poverty reduction was a stated objective, little had been done to find out whether poverty had, in fact, been reduced. If there had been any investigation, it often failed to find any reduction.
There was criticism, too, of the fact that many projects were of a kind more likely to benefit the middle and upper classes which, in poor countries as in rich ones, are often better able to take advantage of infrastructure, such as new hospitals, which the bank helps to create.
Yet another ground for self-reproach was that the failure was concentrated in Africa, the poorest part of the world. Middle-income countries did not do too badly. But in Africa three-quarters of projects were deemed not to be up to snuff.
That is not to say that things were all bad. It is, of course, good that the bank has an independent evaluation mechanism at all. It also remains to be seen whether other global-health bodies are doing better, though that may become evident soon. A report on the Global Fund’s impact is to be published in May, and GAVI (the Global Alliance for Vaccines and Immunisation) is also undergoing independent scrutiny. It is also fair to say that the bank’s managers have taken most of the criticism on the chin, and promised to do better in future.
What the bank needs, in a crowded market, is a niche of its own, and it is trying to carve one out. Sensibly, it is not competing hard in the fashionable area of infectious disease, which is occupied not only by the Global Fund, PEPFAR and GAVI, but also by the (American) President’s Malaria Initiative, the Gates Foundation and numerous bilateral deals between governments. Instead it has, since 2007, been building up its activities in the less glamorous but equally vital area of “health systems”. This means getting local bureaucracies to recruit the right staff and deliver the right drugs to the right people at the right times, and knocking the heads of aid agencies together to eliminate gaps and overlaps in coverage. That, plus an expansion of its nutritional and reproductive health work, should be enough to protect the agency from a Welch-like fate.
YOU are part of a global conglomerate. Your market share has fallen from 18% to 6% in a decade. Well-financed niche-players are moving in, threatening to appropriate the most exciting areas. And now a report by your auditors has said that, even of your remaining business, a third has failed to come up to scratch. If you were a division of General Electric in Jack Welch’s day (“Be first or second in a field, or get out of it”), you would probably be facing closure. Who, in these circumstances, would want to be in charge of global health at the World Bank?
(Yes, some good things happen )
The report in question*was prepared by the bank’s Independent Evaluation Group, an internal monitoring organisation that reports to the bank’s board. It looked at how effective the loans dished out for health purposes by the bank and its private-sector-promoting associate, the International Finance Corporation, have been at doing what they were meant to do.The sums involved are not trivial. Between 1997 and 2008 the bank provided $17 billion for government-run projects in the fields of health, nutrition and family planning. Over the same period its associate invested $873m in health-related private-sector activity. And although the bank’s market share has fallen as new sources of money have emerged, such as the Global Fund (which deals with AIDS, malaria and tuberculosis) and PEPFAR (an anti-AIDS plan started by the Bush administration), the actual amount it lends for health each year has remained fairly constant.
The evaluators’ criticism was not just that a third of the 220 projects under scrutiny had failed to achieve their goals, but that those goals were often misconceived. In particular, the bank’s remit is to end poverty, but that was the specific objective of only 6% of the projects and a subsidiary objective of only another 7%. Even where poverty reduction was a stated objective, little had been done to find out whether poverty had, in fact, been reduced. If there had been any investigation, it often failed to find any reduction.
There was criticism, too, of the fact that many projects were of a kind more likely to benefit the middle and upper classes which, in poor countries as in rich ones, are often better able to take advantage of infrastructure, such as new hospitals, which the bank helps to create.
Yet another ground for self-reproach was that the failure was concentrated in Africa, the poorest part of the world. Middle-income countries did not do too badly. But in Africa three-quarters of projects were deemed not to be up to snuff.
That is not to say that things were all bad. It is, of course, good that the bank has an independent evaluation mechanism at all. It also remains to be seen whether other global-health bodies are doing better, though that may become evident soon. A report on the Global Fund’s impact is to be published in May, and GAVI (the Global Alliance for Vaccines and Immunisation) is also undergoing independent scrutiny. It is also fair to say that the bank’s managers have taken most of the criticism on the chin, and promised to do better in future.
What the bank needs, in a crowded market, is a niche of its own, and it is trying to carve one out. Sensibly, it is not competing hard in the fashionable area of infectious disease, which is occupied not only by the Global Fund, PEPFAR and GAVI, but also by the (American) President’s Malaria Initiative, the Gates Foundation and numerous bilateral deals between governments. Instead it has, since 2007, been building up its activities in the less glamorous but equally vital area of “health systems”. This means getting local bureaucracies to recruit the right staff and deliver the right drugs to the right people at the right times, and knocking the heads of aid agencies together to eliminate gaps and overlaps in coverage. That, plus an expansion of its nutritional and reproductive health work, should be enough to protect the agency from a Welch-like fate.
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