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Thursday, November 10, 2011

Industry Self-Regulation: Too Idealistic for Futures

At the time of MF Global’s collapse amid hundreds of millions of dollars in lost customer funds, commodities and futures trading had for decades been “largely policed by the exchanges where they trade, setting up a potential conflict of interest,” according to the New York Times. The paper continues by pointing out that those exchanges, including profit-making companies such as CME Group, the parent company of the Chicago and New York Mercantile Exchanges and the clearing house used by MF Global, “oversee the very futures firms they rely on for business.” The Times refers to this conflict of interest as one centered on industry self-regulation.

For its part, CME vaunts the self-regulatory structure as a hallmark of the exchange’s “safe and stable markets,” according to CME spokesperson Anita Liskey. “No one has a higher interest in making sure the members don’t fail or cause a loss to the clearing house and other members of the clearing house than CME Group,” she added. CME is a market-maker with a natural interest in maintaining the viability of its markets. The self-regulatory system directs this interest against that of any members who are intent on risking their own credibility by bending the rules for gain.
However, ensuring customer segregated accounts is CME’s responsibility yet the exchange cannot account for the $630 million of missing customer funds at MF Global. For its part, CME blames the latter. According to the Wall Street Journal, CME claimed that MF Global dipped into customer accounts after CME finished an onsite review of the securities firm during the last week of October, 2011. According to the Times, a person close to CME said that CME “verified that customer money was in the right accounts at outside banks on October 26, 2011.” As published in the Wall Street Journal, the CME statement read in part, “It now appears that the firm made subsequent transfers of customer segregated funds in a manner that may have been designed to avoid detection insofar as MF Global did not disclose or report such transfers to the [Commodity Futures Trading Commission] or CME until early morning on Monday, October 31, 2011 [the day MF Global filed for bankruptcy].” Yet if ensuring the viability of customer segregated accounts is the exchange’s responsibility, it would seem that members such as MF Global would not have been allowed to make the transfers as it did.

It is important to distinguish industry self-regulation from that of a firm. Whereas the former involves an industry body (e.g., an exchange) keeping an eye on firms, a firm regulating itself contains no distance at all as that which is being regulated is regulating itself. Industry self-regulation pits one body against others under the theory that differential interests between the industry itself and the individual firms would provide the regulatory incentive. While a better basis than simply having a firm regulate itself, an industry’s interests can dovetail with those of its firms; taking care of its own can be viewed at the industry and firm level as in the best interest of both, with the general public taking on the risk that that interest is not in the interest of others.
Conflating the difference between industry self-regulation and a company regulating itself, Jerod Leman, a trader and broker in Indiana asked, “How many other public companies are self-regulators? Individuals aren’t the regulators on their taxes. You have the I.R.S. for that.” Although Leman erroneously implies that CME and MF Global were one entity (i.e., an individual regulating his own taxes), it is possible that CME saw itself more as a company whose brand included self-regulation rather than as an industry body distinguished from the industry’s firms. In a letter to its regulatory body, the C.F.T.C. in 2004, CME wrote, “As one of the major exchanges in the world, we believe that our market surveillance and financial supervision regulatory capabilities are part of the brand identity that we have created.” Brand identity? Is regulating itself to be effectively privatized as a brand? If so, could it be just another product in the industry—implying that CME was just one firm among others rather than an umbrella organization looking out for the viability of the industry (i.e., the markets in the exchange)? While not morphing into the company that regulates itself, having one firm among others in a given industry responsible for regulating the industry is an altogether different model than industry self-regulation (e.g. NASD being distinct from brokerage houses—rather than a house that just happens to have “regulating security dealers” its brand). It is possible that MF Global treated CME as another company in the industry rather than the regulator—and thus to have competitive tactics in play even without direct head-on-head competition with CME’s “brand.”

In the 1980s as a MBA student, I studied and wrote on industry self-regulation. I liked the equilibrium “self-maintenance” aspect of the system’s design. It seemed like the perfect private-sector translation of James Madison’s “ambition checking ambition” for the good of the whole without the need of external corrective action. In general, I liked the whole “systems theory” aspect of checks and balances in balance. However, after the financial crisis of 2008, I saw my earlier work as woefully idealistic. Jerod Leman’s observation rings some bells. “The last thing most people want is more regulation, but when something like this happens it definitely raises some flags.” He might be too anti-regulation here. In the wake of the financial crisis, regulating done by government agencies rather than treated as a brand by a profit-seeking company was not necessarily the last thing most people wanted (unless they happened to still work on Wall Street). Yet in spite of any paradigm change concerning the 1980s’ “government is the problem” mantra (in terms of regulation at least), the ensuing Dodd-Frank Act left commodities and futures largely untouched—meaning that CME could continue to carry its regulatory brand rather than hand it over to the C.F.T.C. In other words, our view of industry self-regulation should have changed after the financial crisis, but perhaps this change did not occur. The C.F.T.C. should have stepped in to take over more of CME’s regulatory responsibilities.
In conclusion, the case of CME and MF Global is not akin to one entity regulating itself, so that alternative can be safely excluded. To the extent that CME as regulator acted as simply another firm in its industry by treating its regulatory function as one of its brands, a model other than industry self-regulation was in play—perhaps regulating being one product alongside others in the industry. Such a model for regulation is inherently flawed, for it contains the category mistake of treating regulating as a brand, or product. More generally, industry self-regulation is not one firm in an industry taking on the regulatory function. That would be like making one of several brothers the parent of the others.

To the extent that the “brand” jargon is simply a false-analogy and CME is indeed a case of traditional industry self-regulation, the extent of “common interest” or “collusion of interests” encompassing the industry’s own regulatory association and the firms (and exclusive to anything outside the industry) is sufficiently great that industry self-regulation as a model in practice should only be superfluous to regulation by government agency. A government stands for the whole, societally, while not even an industry’s umbrella organization comes anywhere close to that in coverage.
In other words, industry self-regulation allows for private (industry or firm) gain along with costs as externalities (i.e., someone else pays). Given the tremendous profitability of CDO’s (mortgage-backed derivatives) before the housing collapse beginning in late 2006, it is highly unlikely that a regulatory association of Wall Street investment banks would have put the brakes on the risky practice even at Lehman Brothers because doing so would not have been in the industry’s financial interest.  The prospect of all boats in an industry rising on even choppy waters is too great to ignore for us to rely on industry self-regulation. In the case of exchanges such as CME, they ought to be treated simply as neutral market-makers rather than as regulators. Efforts by such an exchange to protect its markets’ viability should be applauded and encouraged, but certainly not relied on to protect the public’s interest.

Jean Eaglesham, Aaron Luchetti, and Jacob Bunge, “Regulators Enter the MF Fray,” The Wall Street Journal, November 3, 2011. http://online.wsj.com/article/SB10001424052970203716204577013753464771104.html

Azam Ahmed and Ben Protess, “Clients Question Oversight By MF Global’s Regulator,” The New York Times, November 10, 2011. http://dealbook.nytimes.com/2011/11/09/clients-question-oversight-by-mf-globals-regulator/

The Essence of Leadership

According to DePree (1989, p.19), the first responsibility of a leader is to define reality. This might seem metaphysically esoteric, but I believe DePree hit the nail on the head. Even though far less has been written in leadership research about the importance of viewing reality and interpreting it than about traits, styles and situational factors, defining reality is the fundamental task distinguishing leadership as a phenomenon (Caldwell, Bischoff & Karri, 2002, p. 153). As Nanus (1992, p.61) put it artfully, “leaders create realities through the force of vision.” To lead is to interpret experience and communicate a resulting social reality through the force of vision (Nanus, 1992; Enderle, 1987, p. 661). Perhaps surprisingly, defining reality can be relevant to more "bread and butter" business ware such as strategic management.

Translating their vision into reality is the ultimate aim of leaders (Badaracco & Ellsworth, 1989, p. 14). Social reality as paradigmatic can be applied in organizational terms. Organizations are themselves “in essence socially constructed realities” (Morgan, 1986). In “defining the reality of others,” leaders influence “the systems of meaning” which circumscribe organizational activity (Morgan, 1986; see also Rowsell & Berry, 1993). The leader who can define the reality facing his or her organization can create an effective plan for achieving the organizational objectives (Caldwell, Bischoff & Karri, 2002; DePree, 1989). Indeed, those objectives can be derived in part from that reality. Even the basic paradigm or structure of a social reality evinced in a leader’s vision for his or her organization can function as a subtle prioritizing device, with strategic management coming into play in further refining and operationalizing the broad priorities that are in the vision. Leadership is effective if its vision is realized in the actual. In organizational terms, this means that the CEO's vision has been "bought into" to the extent that it has come to reflect the organizational actuality. In terms of strategy, the objectives derived from the paradigmatic social reality of the vision have been realized (which implies that the paradigm has changed!).

In short, leadership as the articulation and “selling” of a social reality can be related to organizational structure (and paradigm), organizational mission, and strategic management. This can be seen even in uncovering the very essence of leadership itself. I contend that the content of leadership is ultimately cognitive meaning and felt values. In other words, these are the protons and electrons that make up the atom of leadership.

A leader works to shape and interpret situations out of what has previously remained implicit or unsaid, guiding by common interpretation of reality via vision through foresight, hindsight, a world view, depth perception, peripheral vision, revision, etc. (Bennis & Nanus, 1985). Detecting or fashioning meaning is crucial to formulating a social reality. Smircich and Morgan (1982, p.258) suggest that leaders "structure experience in meaningful ways.” In other words, an essential factor in leadership is “the capacity to influence and organize meaning" (Bennis & Nanus., p.39). Meaning itself can be linked to purpose (and thus to strategy).

In framing or reframing reality, leaders make meaning—one of the first tasks of a leader in serving a purpose (Kouzes & Posner, 1993, p. 196). Fashioning a unified value system of meaning in a vision of a constructed social reality, a leader can relate individual interests to group purpose and thereby influence decisions which are made which in turn influence the interpretation of reality (Rowsell & Berry, 1993, Enderle, 1987, p. 660). The influence is not, however, from meaning alone; human beings are just as motivated by values. Those are just as important in the human experience.

Accordingly, a leader’s meaning making function includes giving meaning to shared values that are important and make a difference (Kouzes & Posner, 1993, pp. 197, 206). A natural leader intuitively taps into values that are felt intensely, weaving them into the meaning in the vision. Leaders interpret social reality in such a way that particular values and/or beliefs are made salient (Rowsell & Berry, 1993). Followers in turn want to make sense of the world around them and feel values that they can believe in. This is the basis of the leader-follower relationship, which is interpersonal rather than intrapersonal as in the so-called “self-leading” fad wherein the follower element has gone missing.

           Besides interiorizing leadership to an intrapsyche phenomenon, it may be tempting to draw on Maslow, Erikson, or Kohlberg to posit a “follower-development” content. James Burns does so for his notion of transformational leadership, which he distinguishes from the more banal type of leadership, which he calls transactional leadership. Transformative leaders are oriented to developing their followers. Yet a paradigm can be radically different, and thus transformative, relative to the status quo, without having content that involves the development of followers (e.g. Nazi Germany). Similarly, Stephen Covey’s notion of servant leadership (which applies Jesus’ model and teachings to business leadership) makes the development of followers salient in the content of a leader’s vision (and approach). Both Burns and Covey adapt leadership process to particular contents of leadership vision. While these are laudatory approaches/contents, leadership vision, consisting of meaning and values, need not include the development of followers.

              All that a leader must necessarily do as per the essence of leadership is satisfy a follower’s instincts for sense-making (satisfied by meaning) and feeling something as important in some way (satisfied by values). Restricting these instincts to particular meaning- and value-content is dogmatic in the sense of being arbitrary, given the essence of leadership as meaning and value (rather than particular meanings and values!). To DePree (1989, p. 53), accurately defining reality is itself a duty, and ethical implications are contained in the content of a leader’s view of reality. This does not necessarily mean that particular ethical principles or values must be part of the content. Rather, the sense-making itself may be viewed as a duty due to the human need for it (regardless of the particular content of the meaning). The ethical implications may simply be that humans have a hard-wired instinct for sense-making that can be satisfied by a social reality (or paradigm) being proffered by a leader. In other words, satisfying a human need for meaning and value may itself be the ethical obligation of leaders, regardless of the particular content of the vision. Ideological leadership may just be dogmatism regarding the purported necessity of a particular content.

               Sadly, I have found some rather sordid, self-serving dogmatism among some leadership development consultants, who relegate or even dismiss the academic literature on leadership when that literature is inconvenient. This does not stop those consultants (who, by the way, seem misplaced or lost in referring to themselves as “coaches") from advertising leadership as a legitimate field because much is presumably known. For those practitioners, knowledge is valid if it is “actionable.” If being actionable were the (or even a) criterion for epistemological value, Einstein’s special theory of relativity would have been worthless as a theory during his lifetime. Are pseudo-academic peddlers in any position to dismiss Einstein simply because he could not empirically test his theory or apply it in the technology extant in his day?

             To digress, at universities in the American states, the assumption that practice counts as academic knowledge enables professorships in professional schools (law and medicine, specifically) to be filled by people who have earned only the first (i.e., undergraduate) degree in the school (i.e., the LLB/JD and MB/MD, respectively). In contrast, European states require professors to have earned the respective doctorates (i.e., the JSD and DSciM, both of which entitle the prefix-title, “Dr.”). Given the rarified context of American professional education, physicians and lawyers presume that they are qualified to engage in academic research “on the side,” as if they had earned a research degree (which is the doctorate in a given school of knowledge). In fact, even some non-professionals in business presume themselves qualified to engage in academic research in business simply because they work in the business sector. In the culture whose roots include the practical philosophies of Ben Franklin and William James, the entitlements of praxis have been allowed (and perhaps even encouraged!) to over-reach on to academia even as academic credentials. It is as if practice itself could substitute for advanced study (i.e., beyond a school’s first degree). Relatedly, training is typically conflated with educating, and education is reduced to vocation—especially at the professional schools. Europeans would be wise not to follow the Americans in vocationalizing universities into places where virtually anyone can be a professor of something. 

              Regarding leadership development consultants, an “actionable” model could seem to be correct (and thus as legitimately trumping the relevant academic literature) when it could actually be a case of the blind "leading" the blind. In actuality, it is extremely difficult to establish causally a relationship between a model on an intangible concept (i.e., leadership) and an organization's financial performance.

              Lest leadership not completely succumb to being reduced to a fad exploited in the midst of commercial anti-intellectualism, I proffer this theory of leadership that, while relatable to strategy, is not sourced in being “actionable.” That is to say, the meaning of the concept of leadership is derived a priori. To be sure, respectable leadership development consultants can be found who do not presume to determine or extirpate the academic knowledge on their field's topic on the assumption that their particular praxis is hegemonic. I welcome interaction with those practitioners. In fact, I hope they apply the knowledge that has been provided by business academics as a source of strategic competitive advantage over competitors who conflate consulting with scholarship.

              The concept of leadership is extremely difficult to define because it is so intangible. That it has been defined all over the map only adds to the difficulty because no one can be wrong about his or her particular use of the term. All too often, the content is simply one's ideological or pecuniary agenda self-sanctified at the altar of leadership. In stitching together an abstract yet applicable theory drawing on the work of several scholars and derived a priori, my intent has been in part to expurgate the superflous surfeit that has managed to make its way into the concept by hook or crook.

Click to add a question or comment on the essence of leadership.

b.n.:  For citation purposes, citing a blog essay is not the most desirable or suitable. The above essay is based on my paper, “Strategic Leadership as a Source of Competitive Advantage: A Qualified Dualistic Model,” which is in the 2003 proceedings of the Midwestern Academy of Management (St. Louis). A copy of the paper (see subheading, “The Essence of Leadership”) can be downloaded by clicking on “proceedings” above and scrolling down to Session 25. Hint: comparing the content under the "Essence" subheading in the 2003 paper with the essay above can show 1) whether there is progression in the scholar's thought and 2) any specific impact on the scholar's thought from what the scholar may be reacting to (or against) at a particular time. Scholars are only human, and outside influences can impact the trajectory of a theory through a scholar's life. Longitudinal “depth perception” (i.e., comparing the two essays) can thus show as much about the particular times in which the essays were written as about the development of the theory from the ideas themselves. For instance, what of the business culture of 2011 is evident in the essay above that is not in the 2003 paper? How has that culture influenced the scholar's approach to his theory in 2011? Does the impact enhance or detract from the theory in its ability to explain leadership as a concept and phenomenon?


Badaracco, J. L., and R. R. Ellsworth: 1989, Leadership and the Quest for Integrity (Harvard Business School Press: Boston).
Bennis, W., and B. Nanus: 1985, Leaders: The Strategies for Taking Charge (Harper & Row: New York).
Caldwell, C, S.J. Bischoff, and R. Karri: 2002, “The Four Umpires: A Paradigm for Ethical Leadership,” Journal of Business Ethics 36, 153-163.
De Pree, M.: 1989, Leadership Is an Art (Doubleday: NY).
Enderle, G.: 1987, “Some Perspectives of Managerial Ethical Leadership,” Journal of Business Ethics 6 (8), 657-663.
Kouzes, J. M. and B. Z. Posner: 1993, Credibility: How Leaders Gain and Lose It, Why People Demand It  (Jossey-Bass: San Francisco, CA).
Morgan, G.: 1986, Images of Organisation (Sage: Newbury Park, CA).
Nanus, B.: 1992, Visionary Leadership: Creating a Compelling Sense of Direction For Your Organization  (Jossey-Bass: San Francisco).
Rowsell, K, and T. Berry: 1993, “Leadership, Vision, Values and Systematic Wisdom,” Leadership & Organization Development Journal 14(7): 18-22.
Smircich, L., and G. Morgan: 1982, “Leadership: The Management of Meaning,” Journal of Applied Behavioral Science 18: 257-273.


Tuesday, November 8, 2011

Greco-Roman Achilles’ Heel: Democracy or Leadership?

In assessing the abilities of the E.U. states of Greece and Italy to manage their respective debt-loads as expected by E.U. leaders, the impacts from the governance systems can be distinguished from the impact from compromised or failed leadership. In general terms, a forceful, visionary leader can leverage an existing governance system to “produce.” However, it is also true that a faulty system can make transformational leadership difficult if not nearly impossible.

According to Rachel Donadio of the New York Times, “it is not only the economy that is on trial, but also the ability of democratic government to make highly unpopular choices.” It is worth asking whether the length of a given legislative term of office is sufficiently long for the long term benefits from a highly unpopular vote to reward a legislator with another term in office. In the case of Greece and Italy where major structural fiscal changes are needed in the context of applying triage to gaping deficits, a term of three or four years may not be sufficient.Going further, even having a few years left in office might not be sufficient if the population does not grasp the situation sufficiently to pressure the representatives to make hard choices. Javier Noriega, an economist with an investment bank, admits, "I don't know if the Italian public has gotten its head around the fact that it's going to get much worse in Italy before it gets better, and that there is a lot of difficult work ahead." Without understanding the need for things to get much worse, the people would pressure their representatives not to make the hard choices. Indeed, democracy itself may contain a proclivity in favor of immediate consumption that could inhibit necessary structural fiscal changes from being enacted. So Roberto D’Alimonte at Luiss Guido Carli University in Rome remarks, “I don’t think it’s that the markets are too strong, but that democracy is weak.” It can be objected, however, that this verdict is far too vague. After all, democracy includes more than one type of democratic system.

Rather than democracy itself, the problem facing Greece and Italy could have been how the patronage-heavy political cultures interact with the parliamentary system of multiparty coalitions. Donadio writes in the midst of the debt-crisis-induced political transitions that “Greece and Italy have famously complex political cultures, but today they are both driven by a simple dynamic: no established parties want to assume the full political cost of pushing through unpopular austerity measures and changes to the labor market.” With unity governments notoriously difficult to negotiate, the politics of reconstruction can fracture. Even so, it could be objected that a strong leader could pull the political factions together if the leader were sufficiently charismatic and the message were portrayed as sufficiently urgent. For instance, in the face of a seemingly bloated and paralyzed U.S. Government, Ronald Reagan stridently campaigned in 1980 for the American presidency saying, "Government is the problem" and stressing a vision of "New Federalism" wherein appreciable governmental sovereignty would be shifted back to the American republics. At the state level of the E.U., neither Papandreou nor Berlusconi evinced such leadership (charisma or vision). Leadership, rather than the system of governance, might have been the real culprit.

As a unity government was being negotiated in Greece, Donadio observed, “Forceful leadership also now seems to be in short supply.” According to Landon Thomas, many Papandreou critics claimed that the prime minister “shirked an opportunity to grab history by the lapel and shake out all the elements of an entrenched Greek state that, through decades of wasteful borrowing and spending, had brought [Greece] to the verge of bankruptcy.” Papandreou’s critics said “that while he was on the receiving end of numerous proposals, he was never really able to develop his own true voice. He could never, they say, make the case to his austerity-ravaged people that he truly spoke for them. He could not rise to the level of a Churchill in 1939, said Yanis Varoufakis, an Athens-based political economist who years ago was an adviser to Mr. Papandreou. ‘At a moment like this you need leadership.’” Instead, during the tense negotiations with the E.U. leaders. Papandreou “showed himself to be a relentless bureaucratic tactician.” In other words, Greece needed a transformational leader but had only the transactional sort.

When a macro system is structurally out of balance (e.g., fiscally), mere bureaucratic adjustments are insufficient—they are like trying to get from Chicago to New York City by walking. Instead, a vision based in a different paradigm is needed, accompanied with broad proposals for fundamental change.

Donadio observed at the time of the political crisis, “(w)ith high debts, vast underground economies, low birth rates and more pensioners than workers, there is no doubt that Greece and Italy need structural changes to survive. But with deeply entrenched political patronage societies, governments in both countries have been unwilling or unable to carry out such changes, which would require striking the heart of their own constituencies.” The transformational leadership needed “sends” its vision out to the society as a whole, rather than appealing to “patronage societies.” The leadership works outside “normal channels.” Because such a leader risks alienating his or her base, which typically has an interest in the status quo, transformational leadership requires courage and even the willingness to sacrifice oneself as a leader for the principles undergirding the paradigmatic vision.  Far too often, people in power, such as Papandreou and Berlusconi, would rather hold onto power than risk it to see their vision realized. Such an orientation (i.e., of power for its own sake) undercuts trust—which Greece had exhausted even before Papandreou gained power (even he didn’t know the extent of the deficit when he took office).

Papandreou’s credibility in the E.U. was instantly diminished when he announced days after the summit that the negotiated deal would be subject to a popular referendum in Greece. He lost credibility with his own people when he announced the cancellation of his proposal giving them the decision. Of course, it is possible that the structural changes needed in Greece were too much for one person to push through. “Transforming Greece is a task ‘beyond Hercules,’ said Daniel Gros, the Director of the Center for European Policy Studies. ‘It’s beyond the capacity of a single person, because you need much more to change a country, to change an administrative apparatus, to change political habits.’ But Italy, he added, is different. ‘There’s enough social cohesion left so that one could do something if you had the right leader,’ he said, echoing the view that . . . Berlusconi’s government had lost credibility.” Indeed, the Italian leader’s tenure would soon be cut short too.

Distrust eviscerates transformational leadership. The lack of credibility hits charisma and vision particularly hard, and these two play particularly important roles in transformational leadership. Whereas transactional leadership can avail itself of back-room deal-making, the transformational leader must be credible as a person for his or her vision to also be credible, and thus believed in as though a faith. At the time Papandreou announced that he would resign, Donadio reported, “So strong is the distrust that Europe’s finance ministers refused to release the next $11 billion in aid for Greece until the two leading political parties signed a letter affirming their commitment to meeting the conditions of the loan deal reached [in October 2011] with European lenders.” With the Greek government so distrusted, it would be difficult if not impossible for a transformational leader to gain a sufficient footing to regain the trust and push through structural reforms.

At the time of the debt-crisis, the E.U. itself was in great need of transformational rather than transactional leadership. Whereas Van Rompuy and Barroso are good at chairing meetings and facilitating deal-making between E.U. state leaders, the two E.U. officials lack vision, at least publicly. The E.U. “stage” lacks an integrative voice that evokes a more solid paradigm for the union. “At bottom, the euro zone crisis is a result of imbalances in which weaker countries like Italy and Greece are forced to compete in the same currency with mighty Germany, something that will cause recurring crises even if the current one is fixed, experts say. ‘In the longer run, the Euro zone cannot be viable unless something is done to tackle the imbalances that gave rise to the crisis,’ said Charles Grant, the director of the Center for European Reform, a London research institute. ‘Either there has to be a convergence of unit labor costs, via effective reform in the south, or there must be permanent transfer union, with payments flowing from north to south.’” In other words, a transformative vision is needed for ever closer union or that union could split apart from internal economic fractures capable of triggering political disturbances. Given the sad experience of Europe with “transformational” leaders seeking a European “audience” in the 1930s, the singular model of leadership, which is so dominant in American political culture, is perhaps not likely to emerge at the E.U. level. Yet it is unknown whether the E.U. itself can survive continued transactional leadership that operates only incrementally.

See related essay on the E.U. leaders and direct democracy in Greece.

Rachel Donadio, “In Turmoil, Greece and Italy Deepen Euro Crisis,” The New York Times, November 8, 2011. http://www.nytimes.com/2011/11/08/world/europe/greece-and-italy-sink-under-turmoil-as-euro-crisis-widens.html

Landon Thomas, Jr., “A Greek Political Scion Undone by Ecconomics,” The New York Times, November 8, 2011. http://www.nytimes.com/2011/11/08/world/europe/prime-minister-george-papandreou-of-greece-undone-by-economics.html
Eric J. Lyman, "Europe Debt Crisis Takes Down Berlusconi," USA Today, November 9, 2011. 

Monday, November 7, 2011

Greece & Italy: Undercutting Market Confidence in the E.U.

As a federal system, the E.U. can be expected to contain a certain amount of economic disparity. The state bond yields in October 2011, for example, were—one could say—“diversified.” Investors relishing high risk-return could partake in Greek bonds while retired investors could safely stick to the German variety. A healthy federal system proffers something for nearly every taste, while constraining the outliers for the sake of unity.

Unity does not require uniformity. However, too much diversity can cause a federal system to come apart due to divergent pressures seeking more expression. Also, if the high-risk “end” is sufficiently risky, the ensuing atmosphere of uncertainty can undo the federation’s financial system. Uncertainty, like anxiety, can subtly eat away at a system to the point that it cannot pull itself out of its funk

Perhaps indicative of an on-going drag on the E.U.’s financial system (and economy), European bankers and investors were not as assuaged as expected by the debt-deal announced by E.U. leaders in late October 2011. According to Bowley of the New York Times, investors were “still demanding greater certainty on how Europe would pay for a rescue package aimed at stopping the Greek financial contagion from spreading to Italy or Spain.” The instinct for greater certainty is itself indicative of a lack of faith in the E.U.’s beleaguered state leaders being able to manage the state debt loads on the “higher end.”

“The problem in Italy is not primarily the real data,” Germany’s finance minister, Wolfgang Schaüble, said. “The debt is high, the deficit is not — economic data are not that bad. The problem is a lack of trust from the financial markets.” It is not that the markets are inherently so distrusting. “The real problem is that in reality, the austerity bill is an empty box into which they have to put things that will be very unpopular,” said Mario Deaglio, a professor of economics at the University of Turin. “I think that they will try to fill it with lemons, with minor measures,” he added, noting, according to the New York Times, that over the years Italian governments have promised to sell off state assets in dozens of austerity packages “without ever selling a thing.” The same can be said of the state government of Greece. It can perhaps be said that the markets’ mistrust is ultimately rooted in the Greco-Roman cultural proclivity to live the easy life, even if on borrowed time, rather than face a harsh reality and make substantive decisions that are truly painful.

The numbers in November 2011 only reinforced the fear that Greece and Italy were about to slide off the edge without having legislative majorities willing and able to challenge the states’ patronage systems of excess largess. For example, Italy’s cost of borrowing jumped to the highest rate since the state adopted the euro. The yield on 10-year Italian notes surpassed that on Spanish debt by nearly a full percentage point, reaching 6.51 percent on November 7, 2011. Mark McCormick, currency strategist at Brown Brothers Harriman, opined that “Seven percent would be a point of no return” in terms of Italy’s access to the private market on terms the state could viably afford. Bowley notes that the rising yield was “troubling because once the interest rates on the debt of Greece and Portugal surpassed 7 percent they shot up far higher, requiring those [states] to turn to outside sources of financing.” On November 9th, the yield shot above 7 percent, with Berlusconi set to resign. As if that cocktail was not sufficient to give the markets the jitters, it was generally believed that even leveraged to (possibly!) 1.4 trillion euros, the European Financial Stability Facility would not be able to bail out Italy, whose GNP was at the time more than three times those of Greece, Portugal and Ireland combined

From the charts showing the market gauges above, the patient’s condition can be readily diagnosed. Rather than micro-manage the numbers as financial wonks are wont to do, I want to place Italy’s condition in a larger European perspective. The market gauges flashing on Italy can be tucked into the upper end of the middle section of “rising risk” in the “euro zone” divide. In other words, the diversity of yields in the state bonds is too “top heavy” on the risky end, even given the innate economic heterogeneity that is natural in a federal system on the empire scale. In other words, even as a federal system, the E.U. is out of balance.

In general terms, if the federal system’s state-bond yields on the “high end” get too high or the bonds come to dominate the spectrum, the E.U. itself could become overwhelmed under the disproportionate weight on that end. In other words, regional economic diversity in a federal system should be balanced—not reduced to zero! Diversity itself is not the problem; indeed, it is one reason for having a federal system, as federalism explicitly accommodates differences (albeit up to a point).

Compounding the E.U.’s economic problems, European banks were wary about lending to one another even after the October debt-deal was announced. “As European banks have lent less to each other, they have instead socked away cash at the European Central Bank. Banks’ deposits at the central bank have shot up at the same time that borrowing from the central bank has risen.” Meanwhile the “voluntary” 50% write-off of Greek bonds by private creditors (without triggering insurance) compromised the credit default swap market as an indicator of how the market is perceiving bond-risk. Adding to the risk generally was uncertainty on how the proposed $1.4 trillion European Financial Stability Facility would keep Italy from getting sucked into the debt contagion, particularly given China’s cautiousness in being willing to invest in the Facility.

In short, the atmosphere of uncertainty amid the general perception of continued risk continued to characterize vital European banking indicators after the “debt-deal to end all debt-deals” was announced in late October, 2011. At the very least, bankers and investors had a “wait and see” attitude. Market confidence could be expected to continue to ebb away from the decay caused just by the atmosphere itself. It is perhaps like the effect of acid rain on stone buildings, slowly eating away at their foundations. This phenomenon of general skepticism could even eat away at the viability of the E.U. institutions themselves. What the market needed was to see more definitive decisions coming out of them, which in turn would require transferring more governmental sovereignty to them from the state governments. Such structural reforms are difficult even without “acid rain.” The market’s verdict of continued uncertainty after the debt-deal announcement in October 2011 did not make it any easier to fortify the E.U.

Click to add a question or comment on European banking indicators in the wake of the E.U. debt deal announced in October 2011.


Graham Bowley, “For Markets in Europe, the Focus of Fear Moves to Italy,” The New York Times, November 6, 2011. http://www.nytimes.com/2011/11/07/business/in-europe-anxious-market-shifts-focus-to-italy.html

Rachel Donadio and Elisabetta Povoledo, “European Debt Crisis as Berlusconi’s Last Stand,” The New York Times, November 9, 2011. http://www.nytimes.com/2011/11/09/world/europe/support-for-berlusconi-ebbs-before-crucial-vote.html

Sunday, November 6, 2011

On the E.U. Debt Crisis: Lessons from the Early U.S.

In the March 2, 2010 issue of the New York Times, Roger Cohen illustrates how useful EU-US comparisons can be. He is careful to compare the E.U. of his time not to the contemporaneous U.S., but, rather, to it a few decades into its founding. In other words, he corrects for the impact of time on political development. This is not to say that the E.U. in 2010 was akin to the U.S. under its Articles of Confederation. The Articles treaty evinced far less integration politically and economically. For example, whereas the Articles sported only a common council of delegates from the states, the E.U. in 2010 had a presidency (the European Council, whose president was Van Rompuy), an executive branch (the E.U. Commission, whose chief executive was Barroso), a bicameral legislature (the E.U. Council (of Ministers) and the E.U. Parliament), and a supreme court (the European Court of Justice, or ECJ). In fact, whereas under the Articles the American republics held governmental sovereignty, the ECJ held in 1963 and again in 1964 that E.U. law is supreme over state law and state constitutions. In short, whereas the Articles did not split the atom of governmental sovereignty, the E.U. in 2010 was a federal system of dual sovereignty. Like that of the U.S., the E.U.'s federal system is itself on the empire level; its republics being commensurate with the early modern kingdoms.

The complete essay is at "Is the E.U. a Federal System?"