Wednesday, October 26, 2011

Dexia and Little Old Rhode Island

The Dexia Conundrum and Little Old Rhode Island

Dexia is large Belgian-French bank with offices in many countries, including the United States. Rhode Island is a small state in New England, with population a bit over 1,000,000. 

Despite their apparent dissimilarities Dexia and Rhode Island have something in common.  Neither has the ability to fully meet its future obligations; Dexia to its creditors and counterparties, and Rhode Island to its citizen-pensioners.  Their experience highlights a central practical and philosophical conflict that policy makers have to resolve.  Governments are the mechanism of income and asset redistribution.  They choose how to allocate risk and reward, and who to pick as winners and losers.  How they do that going forward is tremendously important in the evolving conception of the social contract.  What obligations does government have to its citizens, and what obligations does it have to private capital?

Dexia has now had two near death experiences. In 2008, it was near bankruptcy, and bailed out.  This past week, it returned to the public trough, with the governments of France and Belgium rescuing it from collapse. Public money was funneled into a private corporation, sparing creditors and trading partners capital losses. The New York Times had an excellent piece on this

Rhode Island’s situation is less acute, but the Times reports it has a “looming pension crisis.”  In Rhode Island, politicians, led by the Democratic State Treasurer Gina Raimundo, have begun to think about the unthinkable-what happens when there just isn’t enough money to pay state workers their full pensions, and keep up the rest of the services that the State already provides.

There’s a tendency among politicians (and Tea Party and Occupy Wall Street types) to conflate TARP with bailouts.  But they are not exactly the same. While it’s an oversimplification, TARP advanced cash on a temporary basis to large financial institutions to stabilize them and provide liquidity during a credit crunch.  The cash was paid back.  What the French and Belgian governments are doing with Dexia is not TARP-it is really what our government did with AIG.  Dexia, like AIG, is essentially a conduit for public money to permanently pass to private companies. AIG and Dexia were gamblers who made bets, and when they couldn’t pay those bets, the taxpayer stepped in to pay off the winners.

Mitt Romney has made a case that TARP, for all its flaws, was essential, and as much as I rue the lost opportunities to reign in the irresponsible behavior that led to the 2008 panic, I agree with him.  He deserves some credit for bucking the trend.

But AIG and Dexia are fundamentally different.  They don’t merely seek to stabilize; they seek to make private capital whole at the expense of the taxpayer.  Why should a capitalist society do this?  When we enter into a contract-any contract-with a third party-we take some degree of risk.  My parents owned a mom and pop pharmacy for thirty years.  They risked their own capital to buy goods.  When they handed someone his prescription, and that customer had a charge account, they trusted that person to pay them later.  When a charge account went delinquent, they ended up taking the loss.  No government agency came by with a check.  If that is true for a small hometown business, why shouldn’t it also be true for the mightiest of the mighty?  Why shouldn’t the shareholders of Goldman Sachs also be risking their capital when management enters into a contract that goes bad?

The same can be said of the pensioners in Rhode Island.  The balance here is a trickier one.  These are state promises to the individual-essentially deferred compensation.  Why aren’t pensioners entitled to 100 cents on the dollar? Well, in an ideal world, they should be.  The government has an obligation to keep its promises to its citizens.  It also has an equal obligation to maintain basic services and to treat all its citizens equally.  Just as it cannot morally ask pensioners to take nothing, it cannot ask taxpayers for a infinite amount. These are wrenching decisions-they aren't about how many billions in bonuses can be paid to senior management, but whether to close a firehouse or a library.   One hopes that reasonable people can sit down in a spirit of compromise to try to minimize the damage. 

One also hopes that our politicians are up to the task of making fair and prudent choices, although it is hard to have optimism at this point.  Both major parties are binary in their thinking.  The GOP position appears to be cut programs, pensions and entitlements because they are deemed unaffordable, and then plow the savings into tax cuts for the affluent on the dubious assumption that they  “create jobs.”  Then eliminate regulations on the financial services industry (so they can be free to fail again, with no risk to capital?).  The GOP views the European example as a vindication of their own view that the wealthy need even more (see Greg Mankiw, an economist currently advising Romney, in his opinion piece.) Democrats, in their own way, are just as bad-they seem unable to think about serious reforms, and if they are unable to think about it, then they cannot articulate it to those of their constituents who would have to make sacrifices.  You can’t have a “Grand Bargain” when neither party wants to negotiate.

That’s a real problem, because if we were to take a moment to look around us, the signs of instability are everywhere.  The Tea Party and OWS are sideshows compared to the riots going on in Europe right now.  If there’s strong medicine to be administered, there needs to be the perception that it is being doled out fairly. 

And yet, one wonders if there is the will to do this.  Who wins, and who loses?

At Dexia, we have the answer.  It's private capital at the expense of the public.  Alexandre Joly, the head of strategy, portfolios and market activities at Dexia, is quoted as saying that the idea of forcing Dexia’s trading partners to accept a discount on what they are owed “is a monstrous idea.”

A “monstrous idea?”  As monstrous as asking the public to pay for it?