Modeling Europe on Dubai to Resolve a Bastiat Flaw

July 31st, 2011
in Op Ed

by Guest Author Andrew Butter

Larry Summers has written a prescription for the Eurozone in an opinion piece at the Financial Times.  After you get by the problems Summers has with his dark history (Andrei Shleifer, Brooksley Born and the matter of a lost $1.8 billion at Harvard), the article actually makes some good points, and does so with a clever turn of pen.  I particularly liked the part about how “US policymakers were applauded for about 12 hours for their willingness to let Lehman go bankrupt”.

Follow up:

I infer from Summers’ essay that success in dealing with financial meltdowns will not be achieved if the process gets bogged-down in the blame-game or has unrealistic expectations about how debtors are going to pull themselves up by their bootstraps. And, above all, the inference is that resolving such a crisis is all about the parties that might legitimately hold back and ring-fence their losses should avoid doing that.  Instead, resolution requires pragmatism and boldly cutting out the gangrene, even if it hurts, and costs.  

Summers should know; he had first-hand experience in Mexico, Indonesia, and Russia and he was involved in various aspects of the U.S. Credit Crunch, both before and after. Some say he helped play a part in creating it, although there no real evidence that lack of regulation of derivatives caused that Charlie Foxtrot. Credit default swaps did not create securitization fraud, they just gamed it. But either way, who better to catch the bent gamekeeper, than the fox?

If my dad was still alive he would laugh himself to death. He said this was going to happen ten years ago, just like it happened in the UAE in 1977-1980; and then the same thing happened in Dubai just recently.

The situations are all about the combination of the Fairy Godmother syndrome blended with Frédéric Bastiat’s idea that “the alleged sophisticate concentrates on ‘what is seen’ and neglects ‘what is not seen’,” which can create an explosive mix.

The PIIGS borrowed money and the lenders lent money on the implicit guarantee that if anything went wrong, then Big Brother would step in and magically make it right, somehow.  And sure they cheated a bit, what’s the harm? If it’s possible to circumvent the Maastricht Treaty using swaps created by God’s Workers, well why not, after all Fairy Godmother will pay in the end? And then when you get away with it once, well, why not, just a little bit more?

All the while the sophisticates in Brussels were concentrating on what was “seen” and neglecting what was “not seen.”  Putting aside the indignation of hard-working Protestant German and French taxpayers having to bail out lazy Catholics, (and yes I know there are Catholics there too, but I’m talking taxpayers here) there is some blame to be spread around.

I am thinking blame, as in “oversight.”  What were the bureaucrats in Brussels, the regulators in the ECB and the accountants auditing Societie Generale etc…THINKING?!!

I tell you what they were thinking, they were thinking that Big Brother Fairy Godmother would make it all right, and that in the meantime there were bonuses and fat EU salaries to be made, by not rocking the boat.

The European debt crisis is European and will come to resolution in Europe.  There are two choices:  (a) pull back and let the European Union collapse; or (b) swallow deep, and deal with it, and let the European Union go forwards. Without debating the pros and cons of the EU, don’t ever let any man fool you that having a baby is painless an neither is an abortion.

In 2008 the world woke up to the news that the economic powerhouse Dubai had not actually invented a way to turn desalinated water into gold and was somehow, mysteriously in debt to the tune of $100 billion, which for an economy of $60 billion (before they doctored the numbers), is a lot of debt to rack up in five years.

Everyone thought that Uncle Abu Dhabi would come to the rescue, although, prior to the event, no one had actually told them they had that job. Then they did, sort of, but not without a fight; and they played their cards very well.

What no one had “seen” when they joined the dance to lend money, was that there was a link missing out of the chain that connected the $100 billion to (a) the legitimate government of Dubai and (b) to Abu Dhabi as the “senior partner” in the United Arab Emirates.  The missing link:  Much of the debt was securitized by assets in free-zones which are legally outside the jurisdiction of UAE commercial Law.

You won’t hear much about the Dubai Debt Crisis these days.  Dubai still works.  The water comes through the pipes, the electricity didn’t get turned off, and the Dubai Municipality still does an excellent job cleaning the streets and collecting the garbage, as if nothing happened.  Although “unseen” there is still activity, as the creditors come back, and back, and back again, to negotiate with Uncle Abu Dhabi about how much of a haircut (more like a shave) they can take without squealing.

If the European Union is to survive then the Fairy Godmothers are going to have to stand firm and declare that they are going to sort out the mess. And then they are going to have to start playing hardball, not so much with the debtors but with the creditors.

“Austerity” has a nice ring to it, like cutting out a pound of flesh or breaking legs as a mechanism of imposing financial discipline. But that’s not how grown-up financial systems work, they work on the principle that for the foundation of AAA debt, no matter what you got to do to slice it and dice it to create it, the LTV (loan to value) needs to be less than 70% and the DSCR (debt service coverage ratio) needs to be greater than 1.2 - period. So when the loan sharks who don’t care about such details, pile into the police station, demanding their “legal right” to break legs or else they will short, the best thing to do is to break a few of their legs.

Start off by looking hard at how much of the debt that was piled on by the PIIGS was legitimate.

The bankers who lent and who created the swaps and the other instruments of deception had to know that they were circumventing the Law, as laid down in the Maastricht Treaty.  It’s one thing for government to protect legitimate bond-holders; it’s something else completely for them to assist loan-sharks in collecting on their out-standings.

The rest of Europe bears a responsibility for what happened; they need to help the PIIGS to dig themselves out of their hole, and austerity is not the way to do that.

Punishing the population in Greece, Italy and Ireland for the fact that their elected government took kick-backs from the rich to allow them to avoid paying tax:

  1. Not fair (the people who are slated to pay the bill (the younger generation) did not vote for that or get a slice of the cake; and
  2. It’s not smart - the only legitimate condition to demand in a crisis is that there is real change in governance.

And insofar as the creditors are concerned, if the loans were legal, and the borrowers were not circumventing the Maastricht Treaty by taking those loans, then honor them.   Just to mention here, there is nothing wrong with negotiation in some cases - as in if you owe a billion you got a problem, if you owe $300 billion the creditors got a problem.  And if there are questions, just politely educate the lenders that, in civilized society, loan-sharking is not legal.

Like Bob Dylan said, “to live outside the Law, you gotta be honest”.

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Greece: No Deal Without a National Referendum by Michael Hudson

EU: Politics Financialized, Economies Privatized by Michael Hudson

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The Rough Politics of European Adjustment by Michael Pettis

About the Author

Andrew Butter started off in construction in UAE and Saudi Arabia; after the invasion of Kuwait opened Dryland Consultants in partnership with an economist doing primary and secondary research and building econometric models, clients included Bechtel, Unilever, BP, Honda, Emirates Airlines, and Dubai Government.
Split up with partner in 1995 and re-started the firm as ABMC mainly doing strategy, business plans, and valuations of businesses and commercial real estate, initially as a subcontractor for Cushman & Wakefield and later for Moore Stephens. Set up a capability to manage real estate development in Dubai and Abu Dhabi in 2000, typically advised / directed from bare-land to tendering the main construction contract.
Put the unit on ice in 2007 in anticipation of the popping of the Dubai bubble,defensive investment strategies relating to the credit crunch; spent most of 2008 trying to figure out how bubbles work, writing a book called BubbleOmics. Andrew has an MA Cambridge University (Natural Science), and Diploma (Fine Art) Leeds Art College.



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