By Franco Debenedetti and C.A.Carnevale Maffè

Sir, The deal for helping Italian banks sell off the huge stock of troubled loans satisfies Brussels, because it is not state aid, and therefore is, as you say, at best a half-baked solution. Instead of the “Italian job”, as Martin Sandbu has described it (Free Lunch, FT.com, January 27), we have proposed the “Great Swap”.

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To proponents of a cash-free society, the survival of the $100 bill is at best an anachronism, at worst a gift to organised crime. Peter Sands, the former chief executive of UK-based Standard Chartered bank, last week called for the note to be consigned to history, alongside other high-value banknotes beloved of drug barons and kleptocrats. They play little part in the legitimate economy, he argues, but a crucial role in the underground economy.

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articolo collegato di Martin Sandbu

Arigged market price
Almost everything about Italy’s agreement with Brussels over the country’s so-called “bad bank” policy to rid Italian banks of its problem loans should set off alarm bells. It illustrates how halfhearted is Europe’s commitment to reform the way it does banking.

The agreement, as the Financial Times reports today, involves a scheme by which the Italian state will issue financial guarantees for packages of non-performing loans that are burdening the banks’ finances. The guarantees are supposed to help the banks sell off the loans to other types of investors such as hedge funds.

To be clear, getting bad loans off Italian banks’ backs is a good idea. At about €350bn or 17 per cent of the banking system’s total loan book (three times the European average, according to the European Banking Authority’s last transparency exercise), they constitute a large patch of rot on the banking system’s balance sheet. The uncertainty over the eventual size of the losses is bound to restrain both the banks’ willingness to issue loans and their ability to raise capital as and when that becomes necessary. That fact that Italian bank lending is growing again, which is very welcome news, is nevertheless no reason not to shift this uncertainty to investors willing to bear it and whose risk exposure does not damage the wider Italian economy.

It’s such a good idea, in fact, that it’s useful to ask why banks haven’t sold off these loans to foreign hedge funds already. The Italian government’s plan has been to issue guarantees on the bad loans to facilitate their sale. The sticking point with the European Commission has been how to price the guarantees so they don’t constitute a subsidy. The agreement supposedly ensures that the insurance against losses will be sold at the market price for similar loss insurance on equally risky products.

But if it’s the market price, why does the government need to be involved at all? There are plenty of investment banks in the world that will issue loss insurance at a price. And there is little reason to think that the Italian government’s risk assessment is more reliable than a third-party investor’s: on the contrary. The very notion that the government must provide the insurance because the market doesn’t should make us suspicious of the risk it attributes (or rather not) to the loans in question.

If banks are not already selling off loans to private investors, it’s because the price at which they are willing to sell is higher than the price buyers are willing to pay. The reason for that is most probably not that the banks know the loans are better than they look. Instead, it is that a price at which buyers would be interested would expose losses that the banks would rather be without — or pretend to be without.

The only way a state guarantee can get around this problem is by making the bad loans look more attractive to investors, and thereby raise the price they would consider paying to a level that flatters the selling banks. But don’t let Rome and Brussels fool the rest of us into thinking that this is a market price: if the government needs to make it happen, it’s a price at which there is no market.

The alternative policy is, of course, to write down the value of the trouble loans to their real market value, which could be done, for example, by forcing banks to auction them off to the highest bidder with no state-sponsored insurance (banks could buy the insurance privately if they thought it would sufficiently raise the market price). That this has not happened simply illustrates that Rome remains unwilling to apply the spirit of the EU’s new bail-in rules, which requires bank shareholders and creditors to share in any losses. Yet again, a proper restructuring is too much to stomach for a national government.

As Free Lunch has complained during a previous public bout of Italian bank rescues, this unreconstructed attitude illustrates that European governments are still not comfortable with the banking reforms they signed up to in 2012. That is dispiriting but not surprising. That Brussels is willing to play along, however, is both.

Other readables
- An idea developed to address the job displacement due to trade and globalisation may well have a new lease of life in an era of job loss through automation: Lori Kletzler argues for wage insurance, which would compensate displaced workers for the lower salary in whatever job they managed to find.
- New research documents the long-term effect of migrating from a poor to a rich country by comparing winners and losers of New Zealand’s immigration lottery for citizens of Tonga.
- Harvard economist Gita Gopinath chills the optimism about India that many — including Free Lunch — had allowed themselves to feel. about India’s economy. Investment is falling, not just because reform promises have not been kept, but because of growing rot in the banking system. Seventeen per cent of Indian bank loans are in bad shape, and the cost of borrowing has soared.

articolo collegato di John Gapper

After software engineering and financial engineering comes linguistic engineering. Google this week raised its market capitalisation by $25bn by shuffling around some executive jobs and changing its name to Alphabet. Who knew that swapping your tiles in a game of corporate Scrabble was worth so much?
Everyone reads what they want into the new letters. For Larry Page, Google’s restless co-founder, Alphabet means jettisoning the cares of running a corporation and becoming a full-time inventor and venture capitalist, while Sundar Pichai takes the leadership of Google. For employees, it brings the hope of more valuable share options. For Wall Street, it spells clarity.
Only governance renegades would invent a structure with one board for Google and Alphabet, the founding triumvirate — Eric Schmidt, Sergey Brin and Mr Page — stacked above Mr Pichai, and Ruth Porat as chief financial officer of both. “Google is not a conventional company,” wrote Mr Brin and Mr Page in their 2004 founders’ letter, and by heavens they meant it.
Still, being conventional is not the best way to build an innovative business or to make profits. Warren Buffett runs a unique combination of industrial conglomerate and investment fund at Berkshire Hathaway, and it has worked well for him. He made his largest ever acquisition this week, buying Precision Castparts for $32bn.
Berkshire and Alphabet are different kinds of businesses. Mr Buffett values cash flow and mature brands; Mr Page prefers to create things. One of the purposes of this week’s reshuffle is to prove to investors that not as much as they fear is being spent on experimental start-up projects, such as Project Loon’s high-altitude balloons providing internet access to remote areas.
Mr Page’s naming of Mr Buffett as a role model in providing “long-term, patient capital” to an array of businesses is not idle. He thinks that a multi-business group with a guiding intelligence at the centre can beat the single-sector company favoured by investors. The “conglomerate discount” applied by Wall Street can be defeated.
In principle, that is an odd thing for Mr Page to believe. Google’s technology, after all, uses online auctions and markets — the wisdom of the crowd, not human curation. Why should conglomerates such as Alphabet, with their entrenched interests and fiefdoms, be better than capital markets at allocating capital efficiently? Does he trust in inside knowledge only when the insider is himself?
But he is right. Conglomerates can outperform when they exploit their advantages and remain disciplined rather than falling prey to empire-building. Their ability to build a cadre of skilled managers and to pick the right investment projects is strongest in research-intensive industries that invest in intellectual property, which is Alphabet’s territory.
Neil Bhattacharya, a professor at Southern Methodist University in Texas, found in a study that multi-business companies ran operations more efficiently than single-sector ones. They had particular advantages in areas such as software and life sciences because managers could judge more accurately than stock markets which projects were likely to succeed.
This is counterintuitive, given US investors’ liking for simplicity, and view of conglomerates as inefficient. Public conglomerates in the US are valued at discounts of 10 to 15 per cent to single-sector companies, according to Boston Consulting Group — though the discount is lower in Europe, and Asian conglomerates often trade at a premium.
The suspicion originates in the 1970s and 1980s, the era of companies such as ITT and RJR Nabisco. Michael Jensen, a Harvard professor, later criticised the “billions in unproductive capital expenditures and organisational inefficiencies” at conglomerates, praising the trend toward “smaller, more focused, more efficient” enterprises.
Big corporations remain prey to temptation. Boston Consulting Group found that the conglomerate discount is partly due to conservatism. They tend to invest heavily in their original businesses, which may be stagnant or in decline, while undervaluing newer divisions with more potential. Microsoft, for example, suffered from trying to reinforce its Windows franchise.
Yet even investors who are suspicious of quoted conglomerates delegate capital allocation and management oversight in private markets to informed insiders. Venture capital and private equity funds are both forms of conglomerate — they invest capital in a broad portfolio of businesses on behalf of outsiders who believe that such funds possess superior expertise.
Why, though, should investors seeking exposure to new companies buy shares in Alphabet, which then channels Google’s surplus cash into its own venture and growth funds, Project Loon, self-driving cars and life sciences? They could instead invest money directly in a venture capital fund. Why take the longer and less-direct road?
It depends on trust. Investors could also have bought shares in Precision Castparts last week for less than Berkshire Hathaway paid this week, but they do not complain because they trust Mr Buffett. Alphabet’s shareholders must believe in Mr Page and Mr Brin’s ability to use their intelligence and avoid the traditional pitfalls.
To judge by the shares this week, they prefer a conglomerate called Alphabet to a company that had not made plain what it was. Strange as it seems, it is a rational choice.

articolo collegato di Martin Sandbu

The referendum on UK membership of the EU is still some time off but the rhetorical attacks have begun, calling out those who wanted Britain to join the euro, most of whom have retracted their support or tried to forget it. Eurosceptics do not intend to let them get away with it. If you were so misguided as to have supported the euro then, they argue, surely we cannot take seriously your argument for continued EU membership today.
So, even if euro membership for the UK is not on the agenda, it is important to revisit the case. And the sceptics’ argument is unfounded: there is a good case to make that Britain would have fared better in the crisis inside the single currency than it did outside.
The eurozone’s terrible economic performance weighed heavily on Britain, dashing hopes of a recovery led by investment and exports. It happened because European leaders failed to pursue the best policies — in particular, their failure to end the credit crunch and loosen monetary conditions sooner, and their choice to push austerity even in economies with ample fiscal space.
The important question, therefore, is how the UK would have changed the eurozone’s policies from the inside. The answer is: in ways that would have brought growth back faster.
Take monetary policy first. The Bank of England would be a heavyweight inside the euro, and not just on account of its economy’s size. The BoE’s intellectual pole position on monetary matters and its feel for financial markets, honed by centuries in the middle of the City of London, would have made it a leader within the European Central Bank.
How would that influence have been used? The BoE understood the need for extraordinarily aggressive policy much better than its counterpart in Frankfurt. In October 2008, the ECB raised rates while the BoE embarked on a loosening that cut rates by four percentage points in less than six months. It has kept them at 0.5 per cent since March 2009, the month in which it launched an asset purchase programme that has accumulated government bonds worth a fifth of annual national income.
In contrast, the ECB raised rates twice in 2011, which helped throw the eurozone back into recession with knock-on effects on UK growth. And it took Frankfurt six years to follow Threadneedle Street’s lead on asset purchases.
Britain’s central bankers would have fought for similarly aggressive policies on the ECB’s executive board. Indeed the country’s huge, wobbly banking sector would have left them — and the rest of the ECB ­— with no other choice. (Even outside the euro, UK banks have trillions of liabilities denominated in euros, which the BoE could not have printed in the case of a run. Within the euro, that would have been the ECB’s problem.) One of the euro’s largest economies could not have been bullied the way smaller countries at risk were treated.
We cannot know how successful they would have been, but it is clear eurozone monetary policy would have tilted in a more pro-growth direction, and one that more confidently stabilised financial markets. Had the ECB started a broad bond-buying programme in early 2009, before the sovereign debt crisis was on the horizon, yields might never have spun out of control as they did.
What about fiscal policy? George Osborne, chancellor of the exchequer, can seem more fiscally conservative than Germany. But his original economic plan relied on eurozone demand for UK exports picking up the slack left by brutal deficit consolidation. From his perspective, the optimal policy would have been rapid cuts for high-deficit countries but compensatory stimulus in those with room to do so. That implies resisting Germany’s push for deficit cuts by all. This could have spared the eurozone a second downturn and shortened the UK’s patch of stagnation.
So in the fiscal sphere, too, British euro membership would have tilted policy in the direction of growth. And the influence could have been substantial. Recall Prime Minister David Cameron’s “veto” of the contractionary fiscal compact. In the event it was no veto: Germany pressed ahead, via an intergovernmental treaty committing 26 states to balanced budgets. But its intent was always to change fiscal policy for the currency union as a whole. One eurozone member could have stopped it.
To deny that British euro membership would have made the crisis better for all is to ignore the difference the UK would have made. Perhaps this is credible if one thinks Britain is as mismanaged at home and ineffectual abroad as Italy. But that is a strange view to take for those who believe Britain is so much more capable than its neighbours that it is better off outside their team.

by Wolfgang Münchau

So here we are. Alexis Tsipras has been told to take it or leave it. What should he do?
The Greek prime minister does not face elections until January 2019. Any course of action he decides on now would have to bear fruit in three years or less.
First, contrast the two extreme scenarios: accept the creditors’ final offer or leave the eurozone. By accepting the offer, he would have to agree to a fiscal adjustment of 1.7 per cent of gross domestic product within six months.
My colleague Martin Sandbu calculated how an adjustment of such scale would affect the Greek growth rate. I have now extended that calculation to incorporate the entire four-year fiscal adjustment programme, as demanded by the creditors. Based on the same assumptions he makes about how fiscal policy and GDP interact, a two-way process, I come to a figure of a cumulative hit on the level of GDP of 12.6 per cent over four years. The Greek debt-to-GDP ratio would start approaching 200 per cent. My conclusion is that the acceptance of the troika’s programme would constitute a dual suicide – for the Greek economy, and for the political career of the Greek prime minister.
Would the opposite extreme, Grexit, achieve a better outcome? You bet it would, for three reasons. The most important effect is for Greece to be able to get rid of lunatic fiscal adjustments. Greece would still need to run a small primary surplus, which may require a one-off adjustment, but this is it.
Greece would default on all official creditors – the International Monetary Fund, the European Central Bank and the European Stability Mechanism, and on the bilateral loans from its European creditors. But it would service all private loans with the strategic objective to regain market access a few years later.
The second reason is a reduction of risk. After Grexit, nobody would need to fear a currency redenomination risk. And the chance of an outright default would be much reduced, as Greece would already have defaulted on its official creditors and would be very keen to regain trust among private investors.
The third reason is the impact on the economy’s external position. Unlike the small economies of northern Europe, Greece is a relatively closed economy. About three quarters of its GDP is domestic. Of the quarter that is not, most comes from tourism, which would benefit from devaluation. The total effect of devaluation would not be nearly as strong as it would be for an open economy such as Ireland, but it would be beneficial nonetheless. Of the three effects, the first is the most important in the short term, while the second and third will dominate in the long run.
Grexit, of course, has pitfalls, mostly in the very short term. A sudden introduction of a new currency would be chaotic. The government might have to impose capital controls and close the borders. Those year-one losses would be substantial, but after the chaos subsides the economy would quickly recover.
Comparing those two scenarios reminds me of Sir Winston Churchill’s remark that drunkenness, unlike ugliness, is a quality that wears off. The first scenario is simply ugly, and will always remain so. The second gives you a hangover followed by certain sobriety.
So if this were the choice, the Greeks would have a rational reason to prefer Grexit. This will, however, not be the choice to be taken this week. The choice is between accepting or rejecting the creditors’ offer. Grexit is a potential, but not certain, consequence of the latter.
If Mr Tsipras were to reject the offer and miss the latest deadline – the June 18 meeting of eurozone finance ministers – he would end up defaulting on debt repayments due in July and August. At that point Greece would still be in the eurozone and would only be forced to leave if the ECB were to reduce the flow of liquidity to Greek banks below a tolerable limit. That may happen, but it is not a foregone conclusion.
The eurozone creditors may well decide that it is in their own interest to talk about debt relief for Greece at that point. Just consider their position. If Greece were to default on all of its official-sector debt, France and Germany alone would stand to lose some €160bn. Angela Merkel and François Hollande would go down as the biggest financial losers in history. The creditors are rejecting any talks about debt relief now, but that may be different once Greece starts to default. If they negotiate, everybody would benefit. Greece would stay in the eurozone, since the fiscal adjustment to service a lower burden of debt would be more tolerable. The creditors would be able to recoup some of their otherwise certain losses.
The bottom line is that Greece cannot really lose by rejecting this week’s offer.