More Process Doesn't Mean Better Governance

I've been a presenter at governance classes at the University of St. Thomas Law School and at various professional association fora.  Every once in a while, there is a somewhat smug comment from a presenter about the 'superior' European corporate governance model, which consists of a management board and a supervisory board.

Well, here come the recent revelations about Volkswagen.  I know a lot about Volkswagens, having been an owner of a Beetle and several Rabbits, including a German built Diesel that got 50+ mpg during the era of high U.S. gas prices.  When they weren't in the shop with inexplicable model year problems, e.g. electrical system problems, fuel line problems, and ignition system problems, they were a joy to drive, real German fun for less than a BMW or Porsche.

Well, here is a link to the governance process at Volkswagen Group. Layering on more internal auditors, creating more process, and complicating financial reporting and notes to the financial statements cannot lower the risk of this kind of corporate value-destroying behavior which may have been implemented deep in the bowels of an engineering organization, but which must have had management consent at various levels.

Now, the Wall Street Journal speculates that the potential losses due to regulatory and judicial exposures in America and the EU could wipe out the firm's equity.  But, the truth of the matter is that strategic and executive mismanagement are also culprits, as they have been for years at America's own hapless General Motors.

The Jetta, is a car I often coveted.  I didn't see the value in its higher prices over the basic equivalent Rabbit/Golf platforms. However, the Jetta was just beginning to get traction over the far more bland Accords and Camrys.  Management made a decision to make the cars feel more like these cars by---wait for it--taking away the driveability of the car.  These seial changes, described in WSJ articles, are just as much to blame as this recent fiasco about engine management software designed to cheat EPA tests in the destruction of value.

Political forces, particularly in the sunsetting Obama administration will fillet out the coffers of Volkswagen for the benefit of client constituencies and for the benefit of the U.S. Treasury.

A CEO resignation isn't enough to fix this problem, and meanwhile VW can kiss its ambitions in the U.S. market auf wiedersehen for years.

Who Blinks First: Greece or Germany?

Some of my most widely read posts, both by numbers and by geographical dispersion, relate to the Euro and the Grexit, dating back to 2012.  This particular one, "Revisiting the Euro and the Grexit," hit it all right on the head.

Today, even the Guardian seems to waking up out of a fog when it writes,

"A month ago, such an outcome(economic collapse or exit) to the Greek crisis looked highly improbable. It now appears far less unlikely, which is one reason why the euro has been under such pressure on the foreign exchanges. At some point, the 35% depreciation of the single currency against the dollar is going to lead to strong exports and a much-needed growth boost."

Bailing out Greece, or Germany blinking, puts another nail in the European experiment.  The EU violated its own rules when it admitted Greece (and others) into the currency union, and a bailout (or other euphemism) is the ultimate practical repudiation of both economic principles and rules.

The multi-year charade that has brought us to this point can't continue by just accepting more austerity: for the economic well being of the people and for the political self interest of its politicians, Greece needs to undertake fundamental structural reforms in taxation, labor market and public pension reforms.  Without some outside representation by the EU machinery in providing technical assistance or monitoring, it's hard to see how blank checks can be written.

If the bitter pill were accepted, how could the current Greek government, elected on a sham platform, continue to hold the confidence of the electorate?

Taking the euro down to stimulate exports helps Germany much more than it will help Greece in the short-term, without labor market and regulatory reform in, for example, Greek ports and shipping.

All eyes may turn to Mario Draghi, but his tune is already tired and won't be enough.

Compassion or Pragmatism: Khodorkovsky is Freed

The power of personal diplomacy should never be underestimated, as Hans-Dietrich Genscher's heroic work to free Mikhail Khodorkovsky shows. Ascribing motives to a person is most often a fool's game, and the theory that President Putin freed Khodorkovsky to curry favor for the Sochi Games seems ridiculous. Compassion? Putting an end to a story that has run its course? 

President Putin wasn't under any compulsion to enter into the discussions that eventually led to the release of interesting, complex, business savvy, and ruthless oligarch who is Mikhail Khodorkovsky.  He is certainly not a saint by any means.  It does seem that Herr Genscher's personal communications style engaged Russian President Putin in a long running conversation that resulted in Khodorkovsky's being freed.  

Elements of pragmatism and compassion were probably both part of the mix.  Germany and Russia have substantial long-term economic interests in what might be called the broader Europeanization of their relationship.  This is most probably why Chancellor Merkel lent her blessing to the Khodorkovsky conversation.  She is most certainly a pragmatist. 

One of the best and most incisive summaries of the whole Russian oligarchic system and economic reform is contained in a London Review of Books article by Keith Gessen. Let's hope that a real economic discussion of cooperation between Russia and Europe is a staple in the business news for 2014.

A German Sovereign Wealth Fund

Finally, an original and very interesting idea to save the euro, from Daniel Gros, director of the Centre for European Policy Studies in Brussels, and Thomas Mayer, Senior Fellow at the Financial Studies Centre, Goethe University in Frankfurt.

In addition to the benefits of such a fund, the proposal also recognizes the problem of the phony interbank payment systems represented by Target2 and provides an exit. 

As the authors recognize, the objections to this market and investment oriented proposal will be political, directed at Germany and suggesting that it is, once again, taking a ham-fisted approach to the deserving but profligate EU periphery. 

The authors address this by saying,

"...under the current circumstances one has to choose the lesser evil: a strong euro combined with ever-increasing tensions which threaten global financial stability, or a weaker euro without the internal tensions.  We believe that the global economy will be better off under the second scenario."

I would add one thing.  A 'stronger' euro under the ECB proposals is an artificial and illusory construct that would eventually be hollowed out by economics and by the markets. 

Germany and Shared Liability for Eurozone Debt

The German Finance Minister's remarks before today's summit gave encouragement to Eurocrats who see checks being written and more jobs being created for themselves.  I was very surprised to read the headline, until I read this from the Wall Street Journal report itself:

"Mr. Schäuble said Germany could agree to some form of debt mutualization as soon as Berlin is convinced that the path toward establishing centralized European controls over national fiscal policy is irreversible. That (?) could happen before full implementation of treaty changes."

There is very much less here than hit the headlines, in my opinion.  I don't believe that Spain, France, or Italy among many others are ready for any form of European control over their national fiscal policies.  This statement by Schauble is a clever way of throwing things right back into the court of Hollande and the other Eurocommunards.  If you want Germany to agree to some form of debt mutualization--probably not the one you're thinking about--then give up national sovereignty over fiscal policy. 

If the Spanish government is too proud to accept a European bailout and too arrogant to accept aid to its banking sector through European regulatory intermediation, how could they accept this kind of scenario? 

No, I don't believe that much at all has been conceded by Chancellor Merkel, her own words nothwithstanding.  I don't read "concession" into the German Finance Minister's remarks. There is still a long way to go.

Germany Takes a Pragmatic View of Spanish Banking

My friend Ward McCarthy sent me a Reuters note saying that Germany, through several political channels, has expressed the notion of a way for Europe to address a Spanish banking crisis without requiring an ignominious bailout of the Spanish government.  This is a refreshing sentiment.  We've said before that there seems to be nothing special about the nature of the Spanish banking crisis.  It seems to have some parallels with our own S&L crisis of years back.  The U.S. bank resolution process had to work overtime in high gear, but everything got done.

Providing multilateral aid/financing to support a bank resolution in Spain sounds like a potential way forward.  It does suggest backing off the position that no European funds would be provided for a direct recapitalization of Spanish banks.  And, it would seem reasonable that there should be some European participation in the resolution process, although this might be anathema to Iberian pride. 

Let's see how things develop from here, but this sounds like it could be good news.

More Thoughts on BNY Mellon Presentation

Scanning the headlines today, I reflected again on Simon Derrick's presentation in Minneapolis last week. He did suggest that "weasel words" would increasingly populate official statements from European prime ministers and Euroland officials.  The Bundesbank's Chief Economist started the trend, when the WSJ reported "...days after the Bundesbank's chief economist, in testimony to the German Parliament, said German inflation could be higher than the euro-zone average for a time if the country takes steps to boost its service sector and raise investment while Greece and others slash wages and government spending."

The Bundesbank's President Jens Weidmann quickly blustered about the bank's resolve in fighting inflation, but at the same time he alluded to a word, "rebalancing," which seemed to allow the possibility of higher EU inflation rates if the periphery countries made adjustments.  From this, other stories appeared about Chancellor Merkel's being willing to accept the fact that the ECB would have to lead a European triage effort by printing trillions of Euros. 

None of this seems at all probable.  The German electorate is already beginning to turn against the ruling coalition led by Chancellor Merkel.  German banks and businesses, particularly the exporters, would not be happy thinking about the electoral alternatives to the current coalition. 

For over two years, we've explained why we think that the euro was doomed in its current construction.  A weak zone and strong zone European union would be inefficient, ineffective and politically unpalatable all around.  We mentioned Simon Derrick's comment about adopting the euro devastated the economies of Ireland, Spain and other peripheral members.  He also mentioned a true tail risk, something which on the face of it seems impossible.  What if Germany left the euro?  

German interests are not served by any of the possibilities currently being discussed, so the more likely solution is that Chancellor Merkel picks the least repugnant, sub-optimal choice from a bad menu.  However, leaving the euro itself and letting everyone else sort it out is worth thinking through. 

Incidentally, as bad as the prospective returns are for U.S. Treasuries, they may again serve as short-term haven for European assets as they continue to flow out of European banks and investments looking for a better home.