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BARACK OBAMA: Our challenge is to create a climate where more businesses can post job listings, where folks can find good work that relieves the financial burden they're feeling, where families can regain a sense of economic security in their lives.
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ALEX BLUMBERG, HOST:
Hello and welcome to PLANET MONEY. I'm Alex Blumberg.
JACOB GOLDSTEIN, HOST:
And I'm Jacob Goldstein. Today is Tuesday, August 30 and that was President Obama you heard at the top of the show.
BLUMBERG: Today on the podcast - how you - yes, you, dear PLANET MONEY listener - how you could be funding the bailout of Europe. We're going to talk about this fund that is at the center of the bailout, what you have to do with that fund and it's often called a half-trillion dollar fund. And you would think a half-trillion dollar fund would have well, half a trillion dollars in it.
GOLDSTEIN: But, Alex, if I thought that I would actually be wrong. I'd be way off.
BLUMBERG: Way off. We'll explain all that in a minute. But first, of course, the PLANET MONEY Indicator from you, Jacob Goldstein.
GOLDSTEIN: Today's PLANET MONEY Indicator - 100 billion. European banks may need to raise more than 100 billion euros in new capital in order to prevent another banking crisis.
BLUMBERG: Bank capital of course, that's essentially money that banks hold as a safety cushion against losses. And people are worried about European banks because governments around Europe owe European banks lots of money. People are worried that some of these governments like Greece and Portugal, and other names we've heard, won't be able to pay the banks back.
GOLDSTEIN: So at this big conference this weekend, Christine Lagarde, she was until recently the finance minister of France, now she's the new head of the International Monetary Fund, she drops this bomb. She gets up and she says Europe's banks need to go out and raise new capital and that if they can't do it on the private market, then European governments should step in and essentially put money into the banks and basically take partial ownership of the big banks.
BLUMBERG: And this of course is a huge deal when somebody like Christine Lagarde says that. She's head of the IMF. She was the equivalent of Timothy Geithner in France, so it's like Timothy Geithner coming in and saying all these banks are in trouble and the government should come in and take them over.
GOLDSTEIN: Basically, TARP part two.
BLUMBERG: And of course, all the banks in Europe were like, we're fine. What are you talking about, Christine Lagarde? We're totally fine. Don't worry about us.
GOLDSTEIN: And even European officials were saying no, no, no, don't worry our banks are fine. It's just these temporary funding issues we're having. So there's this high-profile fight raging, and I was very interested in it. So yesterday, I called up this guy Jacob Funk Kirkegaard who not only has an awesome name but is a really smart guy to talk to about Europe. He's a researcher at the Peterson Institute, and he told me that yes, it could be really helpful if the banks go out and raise new capital or even if the governments wind up taking these ownership stakes. It could give people confidence in European banks, which is really important right now. But he said for this to be effective there would have to be a lot of money involved. Just sort of ballpark level, he said 50 billion euros per country - 50 billion euros for Spanish banks, 50 billion euros for Italian banks - that, by the way, was how I got the hundred billion indicator - even more if we're talking about troubled banks in other countries. And, you know, he said the bottom line is at least right now there doesn't really seem to be the political will to do this kind of thing because really this would be seen as another round of bank bailouts and that would essentially be about as popular in Europe right now as it would be in the U.S.
BLUMBERG: Thanks, Jacob. Now onto the program, which is more about the European financial crisis. And we're re-airing a portion of a podcast we did last December, right after the government of Ireland asked for a bailout. This was after the country of Greece had also asked for a bailout. So bailout was on the minds of people all over Europe, and we did a podcast about the fund that was sort of at the center of this European rescue, the fund that would help pay for that bailout - the European Financial Stability Facility.
GOLDSTEIN: And since we aired this podcast in December, the European economic landscape has gotten much worse. Now bigger economies like Spain and even Italy look like they might be in trouble. And so, Europe and the rest of the world is really depending on this fund to support even more struggling countries.
BLUMBERG: So we're rerunning this podcast that explains what exactly this fund is and how it's supposed to work, which I know a podcast about how a fund works sounds really boring, but...
GOLDSTEIN: Sounds awesome to me, by the way.
BLUMBERG: (Laughter) It's actually totally fascinating because when you actually get into the mechanics of it, you start to scratch your head and say, wait a minute, what are we talking about here? So I originally hosted this podcast with Adam Davidson who you'll hear in the tape. Now, the European Financial Stability Facility is a complicated name, but Adam and I back when we first did this podcast in December, we imagined it as fairly straightforward. Here's Adam.
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ADAM DAVIDSON, HOST:
I just picture like there's a giant bank account effectively somewhere and all the governments of Europe threw in some billions of dollars and euros into it. And when a country is in a lot of trouble, they can just go to that giant bank account and withdraw some money.
BLUMBERG: Yeah. That's basically what I thought too, but then I was talking to, you know, a semi-regular here on PLANET MONEY, Satyajit Das, who has made us swear that we only pronounce his name once a podcast and from then on we just call him simply Das. He's a former banker and a risk consultant. And he's the author of the book "Traders, Guns And Money." And he was telling me about how this fund actually works and what he was telling me actually blew my mind. So that's what we're going to be talking about today on the program.
DAVIDSON: But Alex, I think before we get to the mechanics of the fund, I think it will be just helpful to set up the problem the fund is supposed to solve. So the Irish government made this huge unprecedented promise to take care of any of the trouble its banks get into. And what we've now learned is the Irish government doesn't have enough money to make good on that promise. They way, way over promised. Now lots of governments, including of course the U.S., have made lots of big promises and gotten in a lot of debt. But Ireland is finding that nobody is willing to lend it money to pay off the promises it has made. It just can't convince investors around the world to lend them money at anything like a reasonable interest rate.
BLUMBERG: Right, countries you can think of them sort of like people. If they seem like good bets they can borrow money at relatively low interest rates. But if they seem risky, just like if people seem risky, the rates they have to pay to borrow money go up.
DAVIDSON: Right. So like in Europe, Germany is considered the safest economy. They have the most money, the healthiest economy so they can issue bonds, they can borrow money at less than 2 percent interest, a very low rate. Ireland has to pay more than 7 percent interest. Now for human beings, you know, if you've got a credit card at 7 percent, that's a pretty good rate. But for a government, especially a government like Ireland that's in massive, massive debt, 7 percent is basically unsustainable. They can't afford it. So it's basically Ireland cannot borrow money.
BLUMBERG: Right, and Ireland is in this acute situation. But there's a lot of other governments in Europe that are also finding it harder and harder to find anyone to lend them money at a reasonable rate. Portugal, Belgium, Spain, even Italy - they're all facing higher and higher interest rates when they try to borrow money. And that could eventually land them in the same situation Ireland is in. And that is where this 750 billion euro European Financial Stabilization Facility comes in. And this is where Das and I started our conversation.
SATYAJIT DAS: This facility is going to basically borrow from the markets, which is 750 billion euros, and lend to whoever needs it.
BLUMBERG: And before we - sorry, just before we...
BLUMBERG: Before we go further, I just want to set up - I just want to make clear something that I think is clear to you but might not be clear to other people. When the European Union says we're going to set up a 750 billion euro facility or a trillion dollars facility, they're not saying we're going to - hey, we're going to chip in a bunch of money that we have lying around into this big pool that's going to be a trillion dollars. What they're saying is we are going to set up this thing, we're going to call it the stabilization fund and that fund will borrow money from whoever's out there that has money to lend to them. And then that fund will lend to the troubled countries throughout Europe that need the money.
DAS: That's correct.
DAVIDSON: Alex, I'm a little confused about something. So investors, you know, around the world are saying we don't want to lend money to Ireland and Portugal and Spain because we're afraid they're not going to be able to pay it back. So why would they say, oh, but we're perfectly happy to lend to this facility which will then lend to Ireland and Portugal and Spain? I mean, isn't it just adding one middle man in between the investors and the bad credit? I don't understand how it solves the problem.
BLUMBERG: Right. And it is a problem and so the stabilization facility came up with what they think is a solution to this problem. They had these core countries of Europe guarantee the fund. So for example if you, Adam Davidson, loaned a billion euros to this stabilization fund and then it lent that money to Ireland and Ireland defaulted on the loan, then there would be 14 other European countries who promised to make you whole; in other words, who've guaranteed your billion dollars will come back to you.
DAVIDSON: All right. So it's kind of embarrassing, but I'm remembering a while ago I wanted to rent an apartment and the landlord did a credit check and said we're not crazy about your credit, Adam. And I got my dad to co-sign the lease and so we were saying to the landlord you don't trust me, Adam, but you should trust my dad. So basically, Ireland is saying to the world's investors, OK, you might not trust us, but, hey, look my dad Germany is signing the loan, so if I'm not good for it Germany is good for it.
BLUMBERG: Right, exactly. So the fund has this plan. They feel it's a very safe investment, but they need to prove to the world that it's safe for the world to lend money to this fund. If you want to prove to the world that you have a very safe investment, it's pretty clear what you do. Again, here's Das.
DAS: You go to the rating agencies, the famous Moody's Investor Services and Standard & Poor's and say well, Mr. rating agency, we want this vehicle to be rated AAA. And they look at this and go so let's look at this vehicle carefully. What is your assets? In other words, what do you have? You have loans to people who can't borrow - terrific (laughter) so that doesn't work.
BLUMBERG: (Laughter) You have loans to people who can't pay it back because of - yeah, exactly.
DAS: Well, they can't borrow because they can't pay it back so we're one step even removed from not being able to pay it back. So that's not good, so what have you got? And you got these guarantees. They say OK, this is interesting. So who is guaranteeing this? And the guarantees are, they say, well hang on. Portugal who can't borrow is guaranteeing this. Ireland who can't borrow is guaranteeing this. So you've got basically people who are being lent to who can't pay you back and the guarantors aren't solvent either. So exactly what are you doing?
BLUMBERG: (Laughter) The guarantors are the same people who can't borrow, right?
DAS: That's right. And he said look at each other and go yeah you've got a point there.
BLUMBERG: (Laughter) It's like saying like no, no I can lend to this subprime borrower. Why? Because this subprime borrower is guaranteeing the loan.
DAS: Absolutely. That's exactly right. That's a very good analogy. And when I saw this I just laughed because I said isn't this identical to the logic of the CDOs.
DAVIDSON: Oh man, Alex CDOs?
BLUMBERG: I know, remember them?
DAVIDSON: Right. So many listeners will remember CDOs were that weird financial product. That toxic asset that was at the heart of the subprime mortgage crisis. It was this - well it sounds awfully familiar now. It was this incredibly complicated financial instrument that took a bunch of loans, mortgage loans, to people who really couldn't pay them back, bundled them up, did some financial magic and then sold off AAA perfect-quality bonds to other investors. So when I heard all this, I realized like my analogy of my dad Germany co-signing my lease is not exactly right. Right? Because it's not just my dad Germany. It's my dad Germany plus my deadbeat cousin Spain and my deadbeat cousin Portugal and Italy and Belgium, all getting in on signing this lease.
BLUMBERG: Right, exactly. So it's like you've got like the sort of the more responsible members of your family, like your rich dad Germany and maybe some rich uncles, France and Austria. But then you've got a bunch of these shifty characters in your family, too, that are maybe a little bit less creditworthy. So now I will say, Adam, I did talk to the rating agencies about all this and they do make a convincing argument that this is not a repeat of the subprime crisis, that this AAA rating is legitimate mainly because your dad Germany in this analogy, it's like if Bill Gates was your dad - they have a lot of money.
DAVIDSON: Right, and my dad is a New York actor so not Bill Gates but what if all those co-signing cousins, what if my cousins Spain and my cousin Italy and Belgium and Portugal instead of guaranteeing it have to start borrowing themselves?
BLUMBERG: Yes, the credit rating agency said yes that would be a problem if lots of these countries that are now guaranteeing the fund turned around and became borrowers from the fund and they were borrowing lots and lots of money, then this fund could definitely lose its AAA rating.
DAVIDSON: You know, Alex, this really reminds me of the U.S. in 2008 before Lehman collapsed, before the real heat of the financial crisis. We had the Federal Reserve Bank and the Treasury sort of making these promises. Oh, people shouldn't worry. Don't worry, we have this whole system in place to keep the financial system secure hoping that no one would actually test it. But investors kept testing it and testing it and eventually they did basically bring the whole financial world to collapse. And the U.S. Treasury and the Fed had to basically shore up the entire financial system, bail out lots of banks. It feels like maybe Europe hasn't quite caught on yet, that they're trying to avoid pain by promising us they've solved everything without having actually solved everything. Is that what's going on here?
BLUMBERG: I mean, it definitely - the analogy seems really, really accurate because - and so this facility, it was created in May. It's never actually been used yet. It's never borrowed a cent from anyone. It's never lent a cent to anyone and the authorities in Europe were hoping it never would have to. They were hoping that just the fact that this fund's existence would mean it never had to get used. So like in other words, if investors knew that this fund was there to bail out Ireland, then those same investors would be willing to lend Ireland money in the first place which would mean that Ireland wouldn't need a bailout. Here is Das.
DAS: Unfortunately, now it is going to be tested because what the European Union's worst nightmare is now coming home to roost, which is you have to trigger this. You actually have to trigger this. And it's a beautiful...
BLUMBERG: And that's what's happening - that's what's happening with Ireland. Ireland has now agreed to a European bailout. And that bailout is going to come from the stabilization...
DAS: From the European Financial Stability Fund.
BLUMBERG: So this fund is scheduled to make its first loan to Ireland in January, which means it will need to borrow money from investors around the world, and the governments of Europe have been going around to the leading investors of the world saying, hey, you should lend money to this fund so that we can bail out Ireland and potentially other countries down the road as well.
SCOTT MATHER: Certainly, they've had several initial conversations with us already.
BLUMBERG: This is Scott Mather, and to the finance ministers and central bankers all around the world, he is one of the most important human beings on the planet. He helps run PIMCO, which is the world's largest bond fund and remember when you're buying a bond you're basically lending money. PIMCO has over a trillion dollars under management, which is basically saying they've lent out a trillion dollars - a lot of that to governments all over the world. And they are a pretty key test case because right now PIMCO is not lending money to Ireland. Ireland they think is too risky. But the European Financial Stability Facility is hoping that they will lend money to this facility which will then lend money to Ireland.
DAVIDSON: So in a way the whole point of the European stabilization facility is it's almost like a massive valium for people like Scott Mather's. So Scott Mather's is really nervous. He's looking at Ireland and thinking, oh God, they scare me I don't want to lend them any money. And so Europe is hoping that this facility will make him feel really calm, make him feel like OK I can lend you guys money and then you guys can go ahead and lend Ireland money. So if the whole thing is about shifting Scott Mather's anxiety levels, where is he? Is he willing to do it? Is he willing to give money to this facility?
BLUMBERG: Well, he's still not sure. He's waiting to see the details because they still haven't announced the details, how big the loan to Ireland will be and that sort of thing. But he says if it's just Ireland he's pretty sure it's probably a good bet. After all, you've got all these other countries guaranteeing this thing. But he says that if some of those countries that are currently guaranteeing the fund all of a sudden turn around and become borrowers from the fund in the future...
DAVIDSON: So that's like all my deadbeat cousins who are co-signing my lease suddenly turn to all the other cousins and say hey, can you lend me money too? I know you co-signed Adam's lease. I need you to co-sign my lease and pay part of my rent.
BLUMBERG: Exactly, exactly. That's exactly the problem that he's worried about. And also there's this.
MATHER: To the extent that countries like Ireland and Portugal draw on the program and countries like Spain and Italy are required to guarantee some amount of debt, there's no question that's deteriorating their own credit worthiness.
BLUMBERG: So the more Ireland taps this fund, the more that adds to Spain's already sizeable debt burden.
DAVIDSON: All right. So I'm having trouble getting someone to give me a lease. So I've got my deadbeat cousins co-signing my lease, but by co-signing my lease their landlord is looking at them and saying wait, you already were in debt. We already were nervous about you and now you're saying that you're obligated to Adam's lease? We - we're even more worried about you now. So that makes them more likely to need to bailout themselves which means that this fund of 14 countries is likely to be a fund of 13 or 12 or 11 or 10 countries, all needing to bail out more and more and more countries. It's just like this circular thing that if it spirals out of control will just make all of Europe way worse off. I mean, is this the European destabilization facility?
BLUMBERG: Well - and a lot of people are saying like let's talk frankly, the core, the linchpin of this whole thing is Germany and also to a lesser extent France. And so, if the whole thing blows up, basically the only people who will still be standing are Germany and France and a couple of other smaller economies that are pretty well managed. And a lot of people are saying like let's just talk frankly. Are you guys willing to bail out the rest of Europe or not? Because it might come to that. And if it does come to that, then it becomes even more uncertain because politics start entering this whole thing very quickly. I mean, can you imagine a German politician running on this platform - if elected I will use your tax dollars to bail out the mismanaged economies of your European cousins?
DAVIDSON: All right. Now obviously the people who run this facility, they have answers to all of this and they think that they will convince Scott Mather and the other major investors of the world that this is a good bet, it's well-structured and they can lend their money to it. And that makes me think of one last irony. You know, Scott Mather is not a trillionaire. He doesn't have - he's not investing a trillion dollars of his own money. What he's doing is investing other people's money. It's a bond fund. He's investing other people's hard-earned savings.
BLUMBERG: And as Das says, that hard-earned savings, that is the money that the stability fund is explicitly targeting.
DAS: Pension funds and other investors who buy normally highly rated, which is AAA-rated, bonds.
BLUMBERG: So the people who are bailing out Ireland are teachers and postal workers?
DAS: Absolutely, and you and me.
BLUMBERG: You and me, pension funds and other.
BLUMBERG: Yeah. So Adam I will tell you that if you want to get really depressed about the situation in Europe, Das is a good person to talk to. You know, for a lot of the reasons we laid out here, he is dubious about the stabilization fund's ability to trick people into lending money more cheaply to countries like Portugal and Ireland and maybe Spain. And he's even dubious about the whole project of bailing out countries in the first place. Like Ireland and Greece for example, they both got bailouts.
DAS: All of this with Ireland and with Greece isn't going to fix anything because the fact of the matter is Greece obviously had to do certain things to its domestic economy like cut spending, raise increase taxes. But the fact of the matter is the Irish have already done it and that hasn't worked. So what's actually happened in Ireland is that economy has shrunk - wait for it - nearly 20 percent. So it's like the entire economy shrinking by 20 percent.
DAS: Their unemployment is in the mid-teens. It's probably actually higher but it's around the mid-teens as the official figure. Their budget deficit including the cost of bailout of the banks has forced their debt to GDP ratio from about 25 at the low to well over 100. So basically, the - what I would call the austerity cure which is the IMF going to prescribe for Ireland, they've already taken and it hasn't worked. And the other thing is, if you look at Greece which is trying to go through this, it hasn't worked there either. And the reason it hasn't worked is according to the best forecasts from the IMF, Greece's debt will go from 270 billion euro, which they can't afford to service and pay back, to round about 340 in five years. That's if they actually do all the things that the IMF is telling them to do and if they can't service 270, can somebody explain to me how they're going to be able to service 340? It's quite an extraordinary, extraordinary set of assumptions that people have made. So essentially it's not going to work. And all we are doing in the meantime is basically muddling the issue, obfuscating the issue. But the fact of the matter is, the lenders to these countries will ultimately have to take substantial write-offs.
BLUMBERG: And right now...
DAS: That's going to be the shareholders, the bondholders, everybody's going to have to do that. And this is going back - really, what we are doing is reverting back to the period of 2008, end of 2008, early 2009 and the credit markets are again going to seize up.
BLUMBERG: Oh, really? You think it's going to get that bad. You think it's going to get as - you think it's going to get post Lehman, AIG bad again?
DAS: It could. It could. If this thing gets out of control and there are signs that it is starting to get out of control because after Ireland people will go off after Portugal then they'll go after Spain. And the problem is Spain and particularly Italy are huge countries with a huge amount of debt. And at that point in time it becomes very difficult to predict how this will work. I wouldn't wish the end of 2008 or early 2009 on anybody, but that is now a real risk and it's not me saying that. The BIS, the Bank of International Settlement, which is the central banker to all the central banks, in April this year, in their annual report said that the entire global financial system was very, very fragile. And they say this time if there is a shock of any kind the capacity of the global system to cope is questionable. So what I'm just restating is exactly that, that if anything goes wrong here it could get very ugly, very, very quickly.
BLUMBERG: OK. So, Jacob, it's me back in the present and since this podcast aired, some of the predictions that Das described have come to fruition. Portugal asked for a 75 billion euro bailout in the spring. Spain and Italy are still big question marks, but it's looking more and more like they'll need at least some money from the fund.
GOLDSTEIN: And so, this means that Europe and ultimately investors all over the world are really looking to now just two countries with big relatively healthy economies in Europe - Germany and France. And basically the bottom line question is, will Germany and France bail out the rest of Europe?
BLUMBERG: And we are going to be reporting on this in the weeks coming up. Caitlin Kenney and Zoe Chace are both going to Europe. They're leaving this afternoon, and over the next few weeks they're going to be reporting about the economic crisis there, how people in Germany are looking at their role as potential European savior. We're going to hear a lot from them in the weeks coming up.
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MAGNET: (Singing) Like a broken record plays, I'll say it again just in case. Yeah, yeah.
BLUMBERG: As always we'd love to hear your questions, comments at npr.org/money.
GOLDSTEIN: And you could also find us on Facebook or on Twitter. Or you can email us at firstname.lastname@example.org. I'm Jacob Goldstein.
BLUMBERG: And I'm Alex Blumberg. Thanks for listening.
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MAGNET: (Singing) Seems the damage had been done, yeah, yeah, left a note you were gone, yeah, yeah.
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