Hugo Dixon

When confidence in a regime’s permanence is shaken, it can collapse rapidly. The fear or hope of change alters people’s behavior in ways which make that change more likely. This applies to both political regimes such as Hosni Mubarak’s Egypt and economic regimes such as the euro.

Fear that the single currency may break up now risks becoming a self-fulfilling prophecy. Banks and investors are beginning to act as if the single currency might fall apart. Politicians and the European Central Bank need to restore belief that the single currency is here to stay. Otherwise, it could unravel pretty fast.

Until a few weeks ago, the idea that the euro wouldn’t survive the current debt crisis was a fringe view. Since the euro summit on Oct. 26-27, it has become a mainstream scenario. So much so that last week risk premiums on the bonds of even triple-A rated countries such as France and Austria rose to record levels, while Spain became the latest country to be sucked into the danger zone.

The summit itself made two technical decisions which have had damaging, unintended consequences. First, banks underwent a stress test that marked their sovereign bond exposures to market whereas previously regulators maintained the fiction that these positions were risk-free. This meant that lenders suddenly had to start holding capital to back their sovereign debt investments. Not surprisingly, they have become more reluctant to buy bonds. This, in turn, has made it harder for governments to fund themselves.

Second, the summit decided to strong-arm the banks into agreeing to a “voluntary” debt restructuring for Greece. Because the deal is supposedly voluntary, credit default swaps (CDS) – a type of insurance policy that pays out if an entity goes bust – won’t be triggered. This arm-twisting has convinced lenders that CDSs are a useless way of hedging the risk of investing in euro zone government bonds. Without a hedge, many prefer not to hold the bonds at all – again making it harder for states to fund themselves.

After the summit, things went from bad to worse with Greece’s disastrous plan to call a referendum on its latest bailout plan. That idea was withdrawn – but not before Germany and France suggested that Athens might need to be kicked out of the euro unless it came to heel. The snag is that it would be very hard to isolate the Greeks. If one country could leave the single currency, why not two, three or all 17?

As investors thought about the possibility of a euro break-up, they started factoring in currency risk. Under such a scenario, the new Greek drachma would plummet in value; the new Italian lira and Spanish peseta would also take a tumble; even the new French franc would depreciate versus a vibrant new Deutsche Mark. That gave the market another reason to sell pretty much every non-German government bond – again making it harder for those states to fund themselves.

As if this wasn’t bad enough, banks are also suffering from a liquidity squeeze. It’s not just investors who are getting jittery about putting their money in banks; lenders are reluctant to lend to each other because they are not totally sure that their peers will survive.

Banks outside the euro zone are also cutting their lines of credit to those inside the zone. The big four UK banks cut interbank loans by around a quarter in the three months to end September, according to data compiled by the Financial Times. Meanwhile, the United States is about to embark on a new stress tests of its lenders. This will include contingency planning against further disruptions in Europe. It wouldn’t be surprising if this provoked American banks to cut their exposure to their euro counterparts, further exacerbating their funding problems.

These vicious spirals have drowned out the good news on the political front. Italy, Greece and now Spain have new prime ministers, all of whom seem intent on cutting debts and making their economies fitter. But they will struggle to reduce their borrowing costs unless investors can be convinced that the euro is here to stay.

The one thing that probably would restore confidence is if the ECB found some way of supporting governments that were pursuing sensible policies. But the central bank itself and Germany, the euro zone’s main paymaster, have so far resisted this. In part, this is because they think governments won’t have a strong incentive to reform if they are bailed out too easily.

The logic of making countries sweat so that they address problems they have shirked for years, and sometimes decades, is a good one. But the ECB and Germany should remember that carrots are useful incentives, as well as sticks – and, if they don’t provide the carrot soon, the euro may not survive.

The Super Mario Brothers need to work together to save Italy and the euro.

Even if Mario Monti can form a strong government in Italy, the euro zone is vulnerable to bank runs and a deflationary spiral. Stopping that is the role of Mario Draghi, the European Central Bank’s boss. The zone needs vigorous supply-side reform but looser monetary policy. With Silvo Berlusconi gone, the duo and Germany’s Angela Merkel should try to forge a new grand bargain based on this.

Last week witnessed both the Italians and the Greeks dragged to the brink, look into the abyss and dislike what they saw. The two countries have or are in the process of forming national unity governments led by technocrats. This is a step in the right direction. But dangers abound.

The biggest risk is of a visible bank run. There has already been massive deposit flight in Greece as savers fear that the country could get kicked out of the euro – a scenario which is still real despite Lucas Papademos’ appointment as prime minister. But so far there have been no queues outside branches as there were with the UK’s Northern Rock in 2007. If that were to happen, television pictures would be relayed across Europe in seconds potentially provoking copycat runs.

Even without visible deposit runs, euro zone banks are debilitated. Many have already suffered runs in the wholesale markets: U.S. money market funds have sharply cut supplies of short-term cash; and hardly any bank has been able to issue unsecured bonds since the summer. The banks are able to get money from the ECB but only for up to a year. Their funding problems now look set to suffocate industry via a renewed credit crunch.

Meanwhile, the banks’ difficulties are exacerbating governments’ funding problems. France’s BNP revealed this month that it had cut its holdings of Italian debt by over 40 percent in the previous four months. Other banks could follow suit, thinking it is better to take smallish losses now rather than get caught in a Greek-style debt restructuring later. This means that, even if Monti gets a mandate to push through structural reforms–which need to be more radical than those planned by Berlusconi–Rome could struggle to finance itself on decent terms. Ten-year bond yields, which ended last week at 6.5 percent after shooting up to 7.6 percent, need to come down to 5 percent for the country’s debt to be sustainable.

The euro zone may already be in a double-dip recession. A renewed credit crunch plus extra austerity demanded of governments – France was the latest to tighten its belt last week – could push it into a fairly deep one. The snag is that the more governments raise taxes, the faster economies shrink, which in turn makes it harder for them to balance their books and so piles further pain on the economies.

Many European nations lived beyond their means for years. They enjoyed excessively generous welfare states and didn’t allow the free market to operate properly. So big changes are needed. But the current policy mix isn’t working. A new treatment is required that puts more emphasis on the long-term reforms — such as pushing up pension ages, making it easier to hire and fire, reforming bloated civil services and privatization – and less on short-term pain.

Such a new policy mix would require action not just by governments but by the ECB. The central bank is now the only realistic source of mega funding after many non-euro countries made clear at the G20 summit in Cannes this month that they thought the zone should solve its own problems. China, meanwhile, indicated that it would only help in return for unpalatable quid pro quos such as extra power at the International Monetary Fund.

Draghi and his colleagues at the orthodox central bank need to make three radical changes. Germany, the euro zone’s conservative main paymaster, would need to back the changes to give them political cover.

First, the ECB should offer banks longer-term cash to prevent an imminent credit crunch. Governments should simultaneously require their banks to hold more capital so that they have adequate cushions to withstand the hard times ahead. The 106 billion euros of capital injections agreed at last month’s euro summit should be doubled in line with what the IMF recommended. That might then reassure the ECB that it wasn’t lending to potentially insolvent banks.

Second, the central bank should be prepared to act as a lender of last resort to governments which are following responsible policies. The Lisbon Treaty prevents it from lending directly to states, but that shouldn’t stop it leveraging up the European Financial Stability Facility, the euro zone’s bailout fund. The EFSF would then have the firepower to help Italy and Spain if needed. So long as Berlusconi was presiding over a dysfunctional government, it was sensible to avoid bailing it out. But provided Monti can deliver, that would no longer be relevant.

Finally, the ECB should prepare to launch “quantitative easing.” At the moment, inflation in euro land in 3 percent. But it is soon likely to head below the 2 percent level that the ECB defines as price stability. Given that official interest rates are now 1.25 percent, there’s not much scope for further rate cuts. But the ECB could print money to buy government bonds and other assets, in the same way that the U.S. Federal Reserve and the Bank of England are doing.

The ECB does have a government bond buying operation already. But this is a long way from quantitative easing. First, it is small: 0.8 percent of GDP; the U.S. and UK programs are 16 percent and 18 percent of GDP respectively. Second, the ECB mops up all the money it creates when it buys bonds whereas the Fed and the Bank of England inject extra cash into the economy. The main benefit of a similar operation would be to help restore the competitiveness of struggling economies by weakening the euro which, despite the crisis, is astonishingly strong at $1.38.

Such a grand bargain might sound rational. But is it possible to orchestrate a deal between 17 different countries and a fiercely independent central bank? Not yet. But just as pressure from the markets and Italy’s euro partners has pushed Rome into doing things it wouldn’t have contemplated even weeks ago, pressure from the markets and the rest of the world may soon push the euro zone to be more creative too. The Super Mario Brothers need to get cracking.

PHOTO: Newly appointed Prime Minister Mario Monti looks on following a talk with Italian President Giorgio Napolitano at the Quirinale palace in Rome November 13, 2011. REUTERS/Stefano Rellandini

Chaos, drama and crisis are all Greek words. So is catharsis. Europe is perched between chaos and catharsis, as the political dramas in Athens and Rome reach crisis point. One path leads to destruction; the other rebirth. Though there are signs of hope, a few more missteps will lead down into the chasm.

The dramas in the two cradles of European civilization are similar and, in bizarre ways, linked. Last week’s decision by George Papandreou to call a referendum on whether the Greeks were in favor of the country’s latest bailout program set off a chain reaction that is bringing down not only his government but probably that of Silvio Berlusconi too.

The mad referendum plan, which has now been rescinded, shocked Germany’s Angela Merkel and France’s Nicolas Sarkozy so much that they threatened to cut off funding to Greece unless it got its act together — a move that would drive it out of the euro. But this is probably an empty threat, at least in the short term, because of the way that Athens is roped to Rome. If Greece is pushed over the edge, Italy could be dragged over too and then the whole single currency would collapse. So, ironically, Athens is being saved from the immediate consequences of its delinquency by the fear of a much bigger disaster across the Ionian Sea.

Italian bond yields, which were already uncomfortably high, shot up after the Greek referendum fiasco. Berlusconi was forced to pacify Merkel and Sarkozy at the G20 meeting in Cannes by agreeing to a parliamentary confidence vote on his government’s lackluster reform program as well as to monitoring by the International Monetary Fund. The humiliation in Cannes, where Berlusconi’s finance minister pointedly failed to back him, could be the final nail in the PM’s coffin.

The end of the Berlusconi and Papandreou eras should, in theory, be a cause for celebration. Although the Italian PM’s behavior has been scandalous, whereas the Greek PM’s has not been, they have both led their countries deeper into debt. They are also both members of political castes that have enfeebled their nations for many years. Getting rid of them could be the start of a renewal process.

The snag is that it’s not certain that what comes next will be better. In both countries, where I have spent much of the last fortnight, the best outcome would be national unity governments committed to rooting out corruption and cutting back overgenerous welfare states. This could happen either before or after snap elections. Unfortunately, the old political castes die hard. They could continue bickering over who suffers the most pain and who gets the top jobs until they are staring into the abyss — or even fall in.

Many in the rest of Europe, meanwhile, would probably love to push them over the edge if they were themselves strong enough to take the strain. But Merkel, Sarkozy et al have been criminal in their lack of preparation. The so-called comprehensive plan agreed to at the euro summit of Oct. 26 was another case of too little, too late. Not only was the plan for recapitalizing Europe’s banks only about half as big as it should have been as well as foolishly delayed until next June; the scheme for leveraging up the region’s safety net, the European Financial Stability Facility, is full of holes. This became clear at Cannes, where Merkel had to admit that few other G20 countries wanted to invest in it.

The whole of Europe is now in a race against time. The Greeks have to get their act together before the rest of Europe is ready to cut them loose. The Italians have to restore credibility before they get sucked into a vortex from which they can’t escape. And the rest need to put in place really strong contingency plans in case Athens and Rome continue to let them down. If everybody runs very fast, the last week could be the beginning of the catharsis. If not, chaos beckons.

The euro zone’s future hangs on Italy – and Italy’s future hangs on its politics. The best way forward would be a grand coalition replacing Silvio Berlusconi’s discredited government. But after the prime minister’s Houdini act last week, that doesn’t seem likely and other scenarios aren’t as attractive.

Until recently, investors didn’t pay too much attention to the multi-dimensional chess game that is Italian politics. The state may have nearly 2 trillion euros of debt, equal to 120 percent of GDP,  but the country is rich: Net household wealth was 8.6 trillion euros in 2009, according to the Bank of Italy. The deal-making and back-stabbing in Rome – or for that matter, Berlusconi’s bunga-bunga sex parties – didn’t seem to matter. True, the country has virtually stopped growing in recent years. But there was even a view that Italy benefited from having politicians that were so concerned with their elaborate games that they couldn’t interfere with the business of business.

All that changed in early July. As the euro crisis gathered pace, scandals and wrangling in Rome unsettled markets. The 10-year bond yield, which had been a relatively comfortable 4.8 percent, shot up to 6 percent in two weeks. Berlusconi and Giulio Tremonti, his previously respected finance minister, fell out. The center-right government, which survives on a wafer-thin majority, was able to pass austerity measures to cut the deficit. But the actions were seen as too little, too late. Investors became hyper-sensitive to Italian politics and were no longer willing to take things on trust.

The rot was only stopped by the European Central Bank wading into the market in August and buying Italian bonds. But even this bought only temporary respite. Despite two European summits last week designed to provide a comprehensive solution to the euro crisis, Italian yields ended the week back at 6 percent. The country is on the edge of a debt spiral as investors’ concerns about the country become self-fulfilling. If borrowing costs rise further, the country’s debts won’t seem sustainable, meaning yields could shoot still higher.

The best way of breaking the vicious spiral would be to have a positive political shock – to counter the negative one delivered over the summer.  And the best way of achieving that would be to have a temporary grand coalition led by a technocrat such as Mario Monti, the former European Commissioner. Its mission would be to take harsh actions needed to solve Italy’s two big problems: debt and low growth. Labor markets would be liberalized; the bloated public sector would be cut down to size; and the over-generous pension system would be reformed. It might even be possible to reduce debt to below the psychologically important 100 percent mark by privatizing assets and instituting a one-off property tax.

Such an outcome doesn’t look likely. Although Berlusconi’s government has come close to collapsing several times in recent months, he has so far managed to pull it back from the brink. The latest crisis was caused by pressure last week from Germany and France to produce a stronger reform program. The Northern League, Berlusconi’s main coalition partner, balked at this. In the end, a compromise was struck which was just enough to satisfy the European allies but not too strong to bring the government down.

This was a pity. If the government had collapsed President Giorgio Napolitano would have been free to call on Monti or somebody else to form a technocratic government. As it is, Berlusconi will now limp on with a lackluster reform program which will struggle to secure the support of the market.

Even worse, the government may not be able to implement its program. The decisive vote in parliament probably won’t occur until January by which time another three months will have been wasted. What’s more, if the government falls at that point, the consensus in Rome — where I spent a few days last week — is that it will be hard for Napolitano to call on a technocrat to take charge and will instead be under pressure to agree to new elections. This is partly because Italy traditionally votes in the spring time and partly because the next elections have to be held anyway by mid-2013, meaning that a new technocratic government wouldn’t have much time to achieve anything.

New elections in, say, March might not be so bad if they delivered a decisive outcome. But Italy’s Byzantine politics make this far from certain. There are three blocs: the right, the left and the center. Current opinion polls show that the left would be the leading bloc but that it might not be able to form a majority without the support of the center. The center, though, is ideologically closer to the right – although it would be loath to join them in a coalition if Berlusconi was still around. Further complicating the picture is that fact that each of the blocks is made up of several parties each with its own agenda.

What all this means is that new elections could easily produce a messy outcome. Even a clear victory by the left wouldn’t necessarily be good. Pier Luigi Bersani, leader of Italy’s Democratic Party, the main left-wing group, hasn’t yet set out a clear agenda. Given that the party relies on support from unions, it might not be able to embrace the free-market reforms Italy needs.

There are, of course, other scenarios: Berlusconi may get his diluted program through parliament; his government may collapse before the end of the year, allowing a grand coalition to take over; even if it collapses in January, Napolitano may find a way of bringing in a technocratic government. Meanwhile, the euro zone last week agreed ways to leverage the European Financial Stability Facility, its bailout fund. This means it should soon have a much bigger war-chest with which to support Italy if its bond yields climb higher. But the EFSF’s resources are not limitless. If Italian politics remains dysfunctional, Europe could soon be back in crisis mode.

The euro zone is like Hotel California, UBS wrote in a report published in September. “You can check out any time you like but you can never leave,” it said, quoting the Eagles song. A British businessman, Simon Wolfson, has now offered a 250,000 pound prize to the person who can come up with the most convincing explanation of how an orderly exit from the single currency is possible.

The problem is the word “orderly.” There are lots of scenarios where a country such as Greece could quit the euro in a disorderly fashion, destroying its own economy and that of its neighbous as well as possibly plunging the world into a recession. But how is it possible to do this without triggering financial Armageddon?

The first difficulty stems from the fact that an exit couldn’t happen overnight. There is no legal procedure for a country to quit. Joining was supposed to be an irrevocable commitment.

Treaties can, of course, be renegotiated or broken. But this couldn’t happen rapidly -– or, more to the point, secretly. There are 17 members of the euro zone; and another 10 European Union members such as the United Kingdom, which don’t use the single currency. If Greece wanted to reintroduce the drachma, it would have to secure the unanimous agreement of these other nations. It is also inconceivable that it could take such a momentous decision without discussing it in parliament. Predict weeks, if not months, of heated wrangling.

Such debate would frighten the horses. Many depositors have already removed their savings from Greek banks. An open discussion about Athens leaving the euro would trigger a stampede. The whole point of bringing back the drachma would be to devalue it in the hope of making Greek industry competitive. Analysts think the initial fall might be 50 percent. If so, anybody patriotic enough to keep their money in a Greek bank would lose half their savings.

Transitional mayhem
Athens could then do three things: allow its banks to collapse; appeal to its euro partners for help; or impose controls on how much money people could take out of its banks.

Allowing banks to collapse in a disorderly fashion would be mad. It would be a sure-fire way to cause economic chaos and social disorder. The recent street protests would seem like a tea party.

Getting help from the euro zone would be ideal. But why would its euro partners want to bail out Greece’s banks, if the country was on the point of quitting the euro? The European Central Bank has already stopped making new loans directly to some Greek banks because they have run out of high-quality collateral. Instead, it has authorised the Greek central bank to provide liquidity, with Athens theoretically on the hook for any losses. But if Greece was about to quit the euro, the ECB would be worried that it would never get paid back. It would hardly want to authorize yet more lending as this could just increase the size of its future losses.

So Athens’ only choice would be to control how much people could take out of their accounts. It would be like wartime –- with savings rationed instead of butter and bread. This wouldn’t be as bad as allowing banks to collapse. But it would still plunge the country deeper into misery.

Brave new economy
The hope, of course, would be that Greece would eventually rebound on the back of a super-competitive drachma. Northern Europeans would flock to its beaches to enjoy half-price retsina and feta. Maybe. But there would be two other questions: how would the government finance itself; and how would inflation be contained?

Athens has too much debt. The latest forecast from the Troika (made up of the International Monetary Fund, the ECB and the European Commission) is that debt will reach 183 percent of GDP by the end of next year. That debt load will loom even bigger if Greece quit the euro. In drachma terms, assuming again a 50 percent devaluation, debt would rocket to 366 percent of GDP. The government has to default even if it stays in the euro; but the extent of the haircut would be bigger if it quits.

Greece also has a primary budget deficit: it is earning less than it spends even before interest payments. A unilateral default would make it a pariah state. Nobody would lend it money to finance its ongoing deficits. That would provoke an even more severe recession in the short run. The government would also be tempted to print lots of new drachmas to fill the hole in its coffers, fueling inflation and debasing the currency.

To avoid such a nightmare scenario, Greece would need to secure an orderly default if it quit the euro. The best hope of achieving that would be to cut a new agreement with the IMF. Most but not all of its debts would be cancelled. But it would have to agree to tight fiscal and monetary policies to make sure it didn’t run up new debts or descend into hyperinflation. In return, it would get some hard currency to manage the transition. But even with such a balm, the journey would be painful.

Vicious contagion
Unfortunately, the problems with a Greek exit from the euro would not stop with Greece. Contagion would be far more virulent than anything witnessed so far.

Seeing what was happening to Greek depositors, savers in Ireland, Portugal, Spain and Italy — and possibly even France and other countries — would run a mile. They would take their euros and deposit them in German, Dutch or Finnish banks. To stop a large chunk of Europe’s banking system collapsing, the ECB would have to authorise unlimited supplies of liquidity for an indefinite period of time.

The key decision would be whether to let any other countries go the way of Greece. Portugal would be seen as next in line because of its need to improve competitiveness. But Lisbon would probably not want to quit. Given that there’s no time to waste in the midst of a bank run, the least bad option would be to rally around all the remaining euro countries and insist they were permanent members of the club.

It might, though, be sensible to take the opportunity of a Greek exit from the euro to arrange simultaneously an orderly default of Portugal and perhaps Ireland while keeping them in the single currency. If their debt levels were cut to more sustainable levels, they would be in a better shape to withstand the whirlwind unleashed by Athens’ departure.

Wherever the line was drawn, it would have to be defended to the hilt. This wouldn’t just be about protecting depositors. Bond investors would believe more departures from the single currency were on their way. Portugal and Ireland don’t matter for the time being because they are supported by euro zone and IMF bailout programmes which don’t require them to tap the market for new money. But Italy and Spain, which are already suffering jitters, would be shut out of the market.

The convulsions from a bankruptcy of Italy, whose debt is nearly 2 trillion euros, would be so seismic that it shouldn’t be attempted unless there really is no alternative. But rescues by other governments wouldn’t be possible either. The region’s bailout fund, the European Financial Stability Facility, isn’t remotely big enough.

Financial jiggery-pokery — such as turning the EFSF into an insurance company to leverage its firepower — might just work in the current circumstances. But it wouldn’t have credibility if Greece was quitting the euro and there were bank runs across the continent. The best way to hold the line would be for the ECB to provide unlimited supplies of liquidity to struggling nations by massively expanding its purchases of Italian, Spanish and other sovereign bonds in the secondary market.

The good thing about the ECB is that there is theoretically no ceiling on how many euros it can print. The problem is that massive liquidity injections to both banks and governments could remove the incentive for lenders and countries to manage their affairs wisely. Once the storm had passed, it would be best to separate the illiquid institutions or governments from the insolvent ones and find a way of restructuring the debts of the latter in an orderly fashion.

But faced with the choice between an imploding euro zone or underwriting delinquency, the ECB would be best advised at least initially to plump for the latter even if that would involve eating its words. Still, there’s no disguising that it would be an unpleasant outcome.

An orderly exit from the euro is a virtual oxymoron. There are ways to minimize the damage –- principally by rationing access to savings during the transition, orchestrating an orderly default of the country that quits and unleashing the ECB as a lender of last resort to those that remain. Even with such a program, the economic damage would be huge. Without it, staying in Hotel California would seem like a holiday. The euro zone would become a towering inferno with everybody scrambling for the exits.

PHOTO: A banner featuring a Euro coin is seen on the European Commission headquarters building ahead of a European Union heads of state summit in Brussels October 26, 2011. REUTERS/Yves Herman

To: Barack Obama
From: Humboldt Pye, Chairman of First Reform Bank

Dear Mr. President:

I’m writing an open letter to you and other G20 leaders on behalf of the chairmen of the world’s leading banks to say sorry.

We do not think banks are to blame for every ill the world currently faces, as the Occupy Wall Street protests and their kin in other countries suggest. A balanced audit would attribute responsibility to policymakers too: you and your predecessors set the rules of the game that we so craftily exploited. Even the public had a hand in the current mess: excess spending in some countries and inadequate taxpaying in others allowed people to consume too much.

But we are not in a position to lecture the rest of society. During the bubble years, we focused first on our own pay packages and then on profits for our shareholders. Insofar as we thought about the wider interest, we comforted ourselves with the belief that financial markets were efficient and free markets were the best way of generating wealth. So, as we pursued our self-interest, the world must by definition get better.

There were many flaws in this intellectual edifice. But contrary to popular belief, the weakness was not so much the failure of the market as the failure to apply the market. Central banks, especially the U.S. Federal Reserve, were always cutting interest rates at the first sign of trouble. The belief that Nanny was always there to rescue the markets lulled us into taking excessive risks. Second, the notion that governments would always bail out banks meant our bondholders didn’t bother to rein us in. Finally, our compensation practices amounted to “heads I win, tails you lose” bets. If our gambles paid off, we went laughing all the way to the bank. If they didn’t, the tab was ultimately left with taxpayers.

Our apology, though, can’t stop here. How we behaved after the bubble burst was arguably even worse. If it wasn’t for the extraordinary government and central bank assistance we’ve received (and still enjoy), most of us would have gone bankrupt. Despite this, we have kept paying our staff mega packages.

Our greed has enraged the people. Countries have imposed special taxes on the industry and pretty much everywhere the regulatory noose has tightened. We are not so naive to think we can swim against this tide, but we have sought to delay and dilute the most significant changes to capital and liquidity rules, which really hit our bottom line.

We have tried especially hard to wriggle out of anything that smacks of nationalization. Those of us who haven’t avoided this fate have had tough controls imposed on bonuses and dividends. The rest of us have therefore preferred to do anything to escape the state’s embrace, such shrinking our balance sheets rapidly, which allows us to boost capital “ratios” without issuing extra equity. Given the binge of the bubble years, deleveraging is appropriate. But rushing the process is probably tightening credit conditions and worsening the economic difficulties.

During this whole process, we’ve communicated terribly. Not that even a great orator like you, Mr. President, would have found this easy. The public assumes that everything we say is self-serving. But a leadership vacuum compounded this problem. Most of us were too cowardly to speak up. The few who did got pilloried – like Goldman Sachs’ Lloyd Blankfein when he made a bad taste joke about how he was doing “God’s work”.

That pretty much left JPMorgan’s Jamie Dimon to fill the void. For a while, he did a valiant job of speaking up for the industry in a down-to-earth manner. But too many flattering profiles about how he was a latter-day John Pierpoint Morgan saving the financial system may have gone to his head. His verbal assault on the Bank of Canada governor, Mark Carney, at the International Monetary Fund meeting in September shocked even other bankers.

We would now like to press the reset button in our relationship with society. At the heart of this will be the regulatory regime you are developing – in particular, measures to make sure that no bank in the future is too big to fail. Our pledge is that we will cooperate as you institute these changes, rather than fight them every step of the way.

We will also try harder to explain what we do. If we can’t show how what we do helps society, we should stop doing it.

We do not, of course, expect the public to believe our protestations of better behavior. So our senior executives are foregoing bonuses for at least two years. We are also going to squeeze cash compensation for other staff. We hope the public will in time appreciate that this leopard can change its spots.

Yours sincerely,

Humboldt Pye

By Hugo Dixon

If anybody can provide a measure of legitimacy to the trials of detainees in Guantanamo Bay, Brigadier General Mark Martins may be that person. Barack Obama will certainly be hoping so. Martins, who was on the Harvard Law Review with the president when they were students, has this week taken over as chief prosecutor for military commissions at a time when the highest-profile Guantanamo detainees are coming to trial. The first death penalty moved a step closer last week when a trial was ordered for Abd al-Rahim al Nashiri, who allegedly planned the bombing of USS Cole in 2000. The case of Khalid Sheikh Mohammed (KSM), the alleged mastermind of the 9/11 attacks, is likely to follow shortly afterwards, in what some people are dubbing America’s Nuremberg trial.

The new chief prosecutor is a mixture of brain and brawn. A Rhodes scholar at Oxford, Martins is also a six-foot three-inch fitness freak. David Petraeus, the U.S. commander of the surges in both Iraq and Afghanistan and now director of the Central Intelligence Agency, describes him as a “once in a generation officer.” Martins also has a track record of tackling difficult assignments.

Guantanamo has been plagued by controversy ever since it was used as a detention camp for alleged al Qaeda and Taliban prisoners in early 2002. Military commissions were established at about the same time to try some of the detainees. The Guantanamo-cum-military commissions process has, to many critics, seemed toxic not least because some detainees were subjected to waterboarding and other coercive techniques before they arrived there; many have been detained for long periods without trial; and the few who have been tried (so far it is only six) were put through a judicial system that didn’t offer the normal protections available in U.S. courts of law.

Martins only has his new job because Obama failed to close Guantanamo as he promised when he was running for office. The president’s initial plan was to release the detainees, transfer them to other countries or bring them to mainland America for trial in an ordinary federal court. But after Congress passed legislation banning him from using money from the military budget to move detainees to the mainland, the administration decided to try at least some at Guantanamo.

The role of chief prosecutor hasn’t been an easy one. Martins is the sixth person in the job in seven years. The first, Fred Borch, resigned after he was accused by three of his underlings of rigging the process so that the accused were sure to be convicted. The third chief prosecutor, Morris Davis, quit after alleging that his superior officer questioned his authority to exclude evidence obtained by waterboarding.  “It’s like a football team,” says Davis. “If you’re on your sixth coach in seven years, it is an indication of a deeper problem.”

In a series of telephone interviews both from Kandahar, Afghanistan, (where he was finishing his previous post) and Long Island, New York (where he was on holiday with his wife, Kate, a former helicopter pilot) Martins accepted that Guantanamo has a toxic image for some. But he said he hoped to challenge that by showing how prosecutions work in practice, including through greater transparency.

Iron Rakkasan

Martins, aged 51, says he decided to go into the military because he was attracted to the outdoors, athleticism and physical vigor as well as the ethic of service. At one point, after visiting Haiti, he considered joining the Peace Corps. But, after talking to some friends of his father, who ran the army’s neurosurgery service, he went to the U.S. military academy at West Point, where he graduated top of his class.

After West Point, Martins got a Rhodes scholarship to study Philosophy, Politics and Economics at Balliol College, Oxford, where I first met him. We were tutorial partners in econometrics. Friends from those days remember him as driven. Neal Wolin, now deputy secretary at the U.S. Treasury, says he was “an extraordinary example of focus and discipline.” The two of them rowed in the Balliol Eight  – “the tip of his oar handle came close to my back about 1,000 times a week”. At one point, the Eight wasn’t performing well so Martins took them off on a team-building exercise. Initially, some (especially the Brits) were reluctant to take part but “eventually everybody buckled to his will. He was almost irresistible.”

For his part, Martins credits Oxford with teaching him how to “stand in someone else’s shoes and try to construct the most powerful argument from that point of view before coming back to the original point of view and see if it can be sustained – and do it honestly.”

After securing a first-class degree, Martins went back to the army as platoon leader in the light airborne infantry before veering off the military track again and going to Harvard Law School. That’s where he came across Obama, when they were both on the Harvard Law Review.

Martins jokes that Obama had many of the attributes of a military man: he was competitive, smart, well spoken, fit and had a knack for finding common ground. “Little did I know that his entry level in the military would be commander in chief.”

It was after Harvard in 1990 that Martins’ long association with Petraeus began. The older man was a commander of the Rakkasans at Fort Campbell, Kentucky and Martins was his legal adviser. Petraeus, who’d heard the younger man was “extraordinary”, decided to give him a test. Knowing that Martins was going on leave the next day, he told him to produce a legal brief by the next morning. “It was on my desk at 5 a.m. — flawless.”

Petraeus tested Martins and his other men physically too. The maximum score in the standard army physical readiness test was 300. That wasn’t good enough for the commander, who developed his own extended scale with extra push-ups, sit-ups and pull-ups, and faster runs. Those who passed got the title “Iron Rakkasan.” Out of a total eligible population of 1,200 during a two-year period, only eight men got the title. One was Martins. “I met the standard myself, I might add,” says Petraeus.

The current CIA boss and new chief prosecutor have worked together on five assignments. One was in Iraq, where Martins was Petraeus’ legal adviser during the surge, supervising 700 legal personnel involved in everything from courts martial to procurement contracts. Martins says it is important to have so many lawyers because “being governed by law is what distinguishes an army from a mob.”

Petraeus also gave Martins the task of helping instill the rule of law in Iraq. A few years later, he had a similar job in Afghanistan. Martins admits it hasn’t worked perfectly: “Rule of law is mostly just a goal.” There are special problems like assassination of judges and witnesses. But he insists that “justice is a cherished notion in both Afghanistan and Iraq” and says the military has helped by providing a secure environment for trials.

In Afghanistan, Martins had another mission relevant to his new role: “detoxify the detention policies” at the notorious Bagram detention camp (a sort of Guantanamo East) where, among other things, two Afghans died brutal deaths in 2002, according to soldiers’ statements obtained by the New York Times. The detox regime involved moving detainees from old facilities to a new purpose-built one and increasing the transparency of the detainee review board.

Human rights groups such as Amnesty International still complain about the system because detainees are not allowed lawyers; they are only represented by military officers. But Martins argues that such a procedure is “consonant with the law of armed conflict” and that it is vital armies have the ability to detain the enemy in war, otherwise there will be an artificial incentive to kill them.

Prosecutor in chief

Now Martins has the task of detoxifying an even bigger problem: military commissions. Wolin, his Balliol rowing buddy who is also a trained lawyer, says the “whole path from Oxford and before has been the perfect training” for his new post.

Commissions have changed a lot in the past decade. There have been two Acts of Congress. The first in 2006, under President George W. Bush, aimed to put commissions on a proper legal footing after the U.S. Supreme Court said they violated the Geneva Conventions. The second, in 2009 during the Obama era, aimed to bring their practices more into line with those of a normal federal court, including banning evidence obtained by torture or cruel, inhuman or degrading treatment. Martins helped draft this Act.

Despite the changes, critics maintain that commissions are still fundamentally flawed. For example, Davis, the previous chief prosecutor, calls the changes to the 2009 Act “lipstick on a pig,” partly because it will still be easier to rely on hearsay in these trials than in federal courts.

Gabor Rona, International Legal Director for Human Rights First, criticizes some of the charges that the accused can face — such as “conspiracy” and “material support for terrorism” — on the grounds that they were only defined as war crimes under U.S. law after the alleged offenses were committed. He also argues that the commissions do not constitute independent courts because the judges and prosecutors are all military officers who ultimately come under the same command.

Meanwhile, Wells Dixon, a senior staff attorney at the Center for Constitutional Rights who represents detainees in Guantanamo, complains that the accused do not have the right to confront their accusers when they are unnamed intelligence agents; that evidence obtained by torture could still seep into the trials; and that parts of trials can be held in secret if the authorities deem that this could compromise national security. He says that holding a death penalty case like the Nashiri one even partly in secret would undermine its legitimacy.

Dixon also argues that commissions are plagued by “inter-agency conflict and bureaucratic paralysis” and that this is one reason why so few cases have been heard. The failure of either Bush or Obama to prosecute KSM is, he says, “an insult to everybody who died in 9/11” as well as everybody else who suffered the consequences of the subsequent U.S. military action.

Martins can only apply the law, not change it. He is also only one of the key people involved in commissions: the judge, jury, defense and the “convening authority” (which decides whether a case goes to trial) also play critical roles. But the Obama administration clearly sees him playing a special role. Jeh Johnson, the Pentagon general counsel, told the Weekly Standard that he wanted Martins for the post because he “brought the right sense of values to military commissions … I didn’t want somebody who was necessarily after the most convictions but rather was focused on making military commissions a credible and sustainable process.”

Martins has several tools he could use to achieve that. For example, he could decide to exclude evidence extracted by coercive means rather than waiting for it to be challenged in tribunal; he could avoid relying on evidence which has to be heard in secret; and he could bring to the commission only accusers who can be confronted by the accused. This would make the tribunals appear more like ordinary courts. He could also cut through the bureaucratic paralysis and get the big cases to trial.

The new chief prosecutor won’t say whether he will conduct trials in this way.  But he admits the need to increase the legitimacy of the process and stresses that everyone must implement the new Act’s provisions on not allowing testimony obtained by torture.

Martins is also a great believer in transparency, highlighting two new measures announced last week to increase that.  The first is that there will be near real-time transmissions of the trials’ proceedings to a venue in mainland America, whereas previously the press had to travel to Guantanamo to watch them. The second is a new website containing details on the cases, although the benefit of this initiative was undermined by the fact that it didn’t contain the defense documents in the Nashiri case containing allegations that he was tortured by the CIA.

Petraeus calls the chief prosecutor a “superstar.” But Martins is also up against his toughest challenge yet. His success or failure will to a great extent determine whether Obama can salvage something from the decade-long public relations wreck that is Guantanamo.

Edited by Martin Langfield, researched by Christine Murray. Hugo Dixon is Editor of Reuters Breakingviews.

Photo: Mark Martins with David Petraeus, Simon Gass and Nader Yama at Establishment of NATO Mission. DoD photo by Senior Chief Mass Communication Specialist (EXW) Tom Jones, USN

By Hugo Dixon
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Hugo Dixon
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It was 2006. A young Syrian called Ausama Monajed was on a train to London. One of his hobbies was reading e-books. On this trip, he picked Gene Sharp’s From Dictatorship to Democracy, which maps out strategies for using non-violent struggle to bring down repressive regimes.

Monajed, now one of the revolution’s leaders outside the country, became engrossed. “It was as if I was reading an exact description of Syria,” Monajed told Reuters Breakingviews. The next thing he noticed was a conductor tapping him on the shoulder. The train had arrived at its terminus in Euston Station. “He asked me if I wanted to return where I’d come from.”

Sharp, who was inspired by India’s Mohandas Gandhi and who himself influenced some of the activists behind the Egyptian revolution, stresses that a dictator’s power isn’t monolithic. It relies on the army, police, civil service, business and, indeed, the wider society just to function. Activists should therefore analyze those pillars of support and systematically undermine them.

The best way to do this is not to fight dictators with their own weapons -– matching violence with violence in a struggle they are likely to lose – but to use non-violent tactics. It is much harder for the security forces to kill unarmed civilians than those who fire back at you. The more brutally the regime represses them, the shakier its pillars of support become. Eventually, the violence boomerangs on the regime and destroys it.

Sharp makes clear that non-violent struggles normally don’t succeed through spontaneous combustion. They need planning and training. Most importantly, it is vital to maintain nonviolent discipline – which isn’t easy when activists are being killed, tortured and detained.

Monajed, now 31, was smitten. An economist by training, he had hoped that Syria’s president Bashar al-Assad would be a reformer when he succeeded his father Hafez Assad, who died in 2000.

Monajed worked for the United National Development Programme and then the European Commission on development programs inside Syria. But then he became disillusioned and joined the opposition. After being arrested several times, Monajed quit the country in 2005 and has never returned.

He says he has become one of the regime’s most wanted people after writing an article in the Washington Post this April. This said the U.S. government had several years ago funded Barada TV, a London-based channel beaming anti-regime programming into Syria which he had helped establish.

After coming across Sharp’s work, Monajed studied previous nonviolent revolutions, especially the Serbs’ overthrow of Slobodan Milosevic in 2000. He went to see Sharp, now an 83-year-old academic, in Boston. He also wrote a master’s degree dissertation on the role of the internet and information technology in non-violent struggle with a focus on Syria.

In 2007 Monajed organized a meeting with some disaffected Syrian friends in London. He says it is too risky to reveal their names. They decided to get trained in the techniques of nonviolent struggle and use that as the basis for training others. “We brought Syrians out of the country and trained them in nonviolent techniques,” Monajed says. “The idea was to train leaders and send them back to train others.”

They found it hard to recruit volunteers. They were told nonviolent struggle wouldn’t work in Syria because of religious and geopolitical factors. In the end, they managed to train around 100 people.

Then came the Tunisian and Egyptian revolutions. The whole Middle East was electrified. Syrians began to think they too might get their freedom. People contacted Monajed’s group, saying that now they understood what it was advocating.

Virtual operation center

The first protest took place on March 15 in the Hamidiyeh bazaar in the heart of old Damascus. They chose Hamidiyeh because it is a covered market. There were only about 40 protesters but their chants, calling for freedom, echoed off the iron roof making it seem like there were more. Because the bazaar was crowded, it was hard to distinguish who was a protestor and who was just an onlooker -– again exaggerating their numbers.

The next protests took place spontaneously in Deraa, near the border with Jordan, after 15 school children had been arrested for scrawling anti-regime graffiti on walls. These protests were much bigger, with thousands eventually taking part. The security services fired on unarmed civilians. The killing began in earnest.

After that, protests started mushrooming around the country. Facebook pages were created; people communicated via Twitter; protesters took video clips with their mobile phones and posted them on YouTube. Everything was happening faster than Monajed and his colleagues had imagined. Most of the protests had nothing to do with them. The challenge was how to put some order into the revolution.

An early priority was to set up a “virtual operation center,” staffed by dozens of volunteers outside the country, feeding what was happening on the ground to the world outside. Most foreign journalists were quickly kicked out of the country, including one Reuters journalist who was beaten up by the secret police, so it was important to get information out to the international media. Many of the most popular internet pages were coordinated through a new body, The Coalition of Syrian Pages.

On the ground, “local coordinating committees” started emerging in different neighborhoods. They organize campaigns, raise money to cover living costs of the families of those who had been killed or detained, and help communicate what is happening in their area.

Pillars of support

The Coalition of Syrian Pages has gradually taken a bigger role in coordinating activity. It consists of about 20-25 people, some inside the country and some abroad. Monajed won’t reveal their names. “The authorities don’t know who all the members of the Coalition are or where they are,” he explains.

One of the current priorities is to have a strategic plan that includes action on the ground and international lobbying for things like an oil embargo. This has involved coordinating the work of the activists, most of whom are young, with the traditional cohort of opposition made up of politicians, lawyers and human rights campaigners, many of whom signed the anti-regime Damascus Declaration in 2005.

“Initially there wasn’t a plan; just an idea of demonstrating until the regime falls,” says Monajed. “Now, with the Coalition, we are trying to guide the effort in a strategic manner to knock down the [regime’s] pillars of support.”

A particularly sensitive issue, which didn’t exist in either Egypt or Tunisia, is the potential for sectarian conflict. Assad is an Alawite, a minority Shi’ite Muslim sect. Many of the top positions in government, the military and business are also held by Alawites. But most of the population is Sunni Muslim.

Given this background, the regime’s four main pillars of support in order of importance, according to Monajed, are: the security forces including secret police; the Alawites; army generals, especially those who are Alawite; and the Sunni business elite, many of whom have prospered since Assad partly liberalised the economy.

In order to knock down these pillars, it is essential to keep the campaign peaceful, says Monajed. “People don’t want a Libyanisation of the situation,” he says, referring to the civil war across the Mediterranean Sea.

So demonstrators give roses to the army and don’t insult them in their chants. The underlying message they are trying to send to the top generals is: “We differentiate between you and the security service.” Some soldiers have mutinied after being ordered to kill unarmed protesters.

The message to the Alawites is that they are being held hostage by the Assad regime –- and it can’t be in their interests to engage in a war of elimination. The protesters have used chants stressing the unity between Sunni, Alawites and Christians (another minority) and called on Alawite and Christian generals to lead the transition to democracy.

Despite this, there are signs of sectarian violence. There has already been at least one case of a group of Alawites being killed — in retaliation for a Sunni elder being killed and cut into pieces, according to Monajed. That, in turn, provoked a ferocious backlash against Sunnis in the city of Homs.

Meanwhile, the message to the business community is that they won’t continue to prosper under Assad. The Syrian pound has fallen on the black market, tourism is dead, consumer demand has been thwacked and the economy is shrinking.

What about the secret police? This is the toughest part of the regime to crack, according to Monajed. He doesn’t have a simple message for them. Rather, he predicts that, as the revolution goes on, the regime will get tired and exhausted. The top generals may then liaise with Alawite leaders, arrest Assad and the top security chiefs, and form a transitional council with members from all parts of the community.

Tactics and counter-tactics

While strategizing is important, nothing will happen without action on the ground. Although protests have been the most visible tactic, they are not the only method being deployed.

There are low-risk tactics for those who don’t want to go on protests where they could get killed. One is to release “freedom balloons” at a specific time in a particular city, to give people courage that they are not alone. Another is to open their windows at night time and play revolutionary rap songs.

Activists have drawn up “lists of shame” of businesses, actors, intellectuals, imams and priests who are considered too close to the regime. These are used to determine boycotts and strikes. Campaigners have also produced lists of government informers, according to the Financial Times. Their aim is to put pressure on them and isolate them. However, there are also reports of at least two informers being killed.

The Assad regime has been far from idle. As of last week, 1,634 civilians had been killed, according to Avaaz, the human rights group. Then on Sunday tanks were sent into the central Syrian city of Hama, in what looks like an attempt to break the protesters’ morale before the holy month of Ramadan, which has now started. Demonstrations have been particularly big on Fridays after people have gathered to pray in mosques. Some protesters have been saying that Ramadan could be like a month of Fridays.

As the regime’s violence ramps up, it would be natural for the protesters either to lose courage or to take up arms themselves. The challenge for Monajed’s group will be to ensure that neither happens. If they succeed, they will then have a chance to witness whether a nonviolent struggle can really bring a brutal regime tumbling down.

By Hugo Dixon
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A deal was better than a disaster. But last week’s planned rescue of Greece has the astonishing by-product of increasing its debts. It also lets private creditors off lightly while making taxpayers elsewhere in the euro zone pay through the nose. It doesn’t even mark the end of the crisis.

True, the sustainability of the Hellenic Republic’s debt has been improved. Its government will receive 109 billion euros of new 15-30 year loans from the euro zone at an interest rate of only 3.5 percent. Private-sector creditors will also swap or roll over 135 billion euros of existing bonds into new longer-term instruments.

But this private-sector involvement comes at a huge cost. Because the European Central Bank put the fear of God into politicians about the consequences of a Greek default, private creditors have been handled with kid gloves. Sure, they are going to suffer 21 percent losses compared to the face value of their bonds (assuming a 9 percent discount rate). But that’s much less than the 50 percent haircut that is needed to put Greece’s finances onto a stable footing.

What’s more, the financial fiddling used to corral the creditors actually means Greece’s debt will rise. This is mainly because Athens will need to borrow 35 billion euros to buy collateral to partially guarantee the new bonds it will give its creditors.

The deal also envisages Greece borrowing 20 billion euros to buy back debt with a face value of 32.6 billion euros. The price, equivalent to 61.4 percent of face value, is another sweetheart deal for the creditors. A more muscular approach would have cut them to half face value.

Taxpayers in other euro zone countries, by contrast, are digging deep. Imagine they applied the same 9 percent discount rate that private creditors think is appropriate. Their new 109 billion euros of loans would be worth only 54 billion euros, according to a Breakingviews analysis. In other words, they are the ones taking a 50 percent haircut.

Taxpayers elsewhere might chip in, too, if the International Monetary Fund makes a contribution. But it would be surprising to see the Washington-based institution pay a third of the total bill as it did with Athens’ first bailout. Non-European countries, even the United States, are balking at the amount of money the institution is pouring into Greece.

Two factors could tilt the deal back in favor of the taxpayers and away from the private-sector creditors. First, the euro zone leaders hinted in their communiqué that Greece might be asked to give them collateral too. As well as providing taxpayers with protection, the collateral would give Greece an added incentive not to veer off its economic fitness regime. Given the length of the program and the fact that the Greek opposition has refused to buy into it, there is a sizeable risk Greece could stray.

Second, private-sector creditors will still be on the hook for 150 billion euros – or 115 billion euros once the collateral is subtracted. This means that, if and when it becomes apparent that Athens can’t bear its debts, it will be possible to give them another, more severe, haircut.

But even if these mitigating factors kick in, the deal is very much a second-best option. It would have been better to have done a full restructuring of Greece’s debts now. A forcible swap of all the private sector’s bond holdings, currently around 200 billion euros, at 50 percent of face value would have cut the need for new official funding to Greece to virtually zero.

In the Middle Ages, a common scam was to sell a cat in a bag while pretending it was a far more valuable pig. Buyers who didn’t look inside the bag first were conned. In those days, the word for bag was “poke”. Taxpayers outside Greece are being sold a pig in a poke.