WHAT a tragic outcome at British Airways. The airline’s management is hardly perfect but it is almost unbelievable that BA’s staff have chosen to walk out like this. The strike – supported by an astonishing 92 per cent of those voting – will last for 12 hellish days from 22 December to 2 January, ruining the holidays of at least 1m travelers and angering all of its customers. BA is hemorrhaging cash, its pension deficit is gigantic and could destroy its merger with Iberia – its last chance – and it needs to slash costs, as Willie Walsh, its combative boss, knows all too well. It is a tragedy that many of the staff don’t seem to understand this. If anything, the cuts they object to may actually turn out to be too timid to avoid disaster. The stark truth is that time is running out for BA; we must all hope that this strike doesn’t turn out to be the beginning of the end for a once great airline.
BLAME THE EURO
Many different factors helped to fuel the bubble but they all had one thing in common: an excessively low cost of borrowing. But one of the main drivers of the folly has until now been completely ignored: the European Union’s economic and monetary union, which drove down yields on government bonds across the Eurozone, even though the underlying economies – Greece, Italy and Ireland – hadn’t really changed. Lower interest rates, needless to say, helped promote unsustainable house price and commercial property booms.
A fascinating piece of analysis reaches me from Monima O’Connor, a former JP Morgan banker and headhunter. In 1990, Italy’s short-term rates were approximately 18 per cent, France’s 10 per cent, Spain’s 15 per cent, Germany’s 6 per cent and the UK’s 10 per cent. By 1996, as the alignment process with Germany moved ahead, rates in Italy and Spain were down to 9 per cent, France and Germany were at 4 per cent and the UK was at 6 per cent. Final convergence took place when the euro was introduced and the prevailing interest rates on 2 January 1999 was 3.25 per cent for the 3-month Euribor. Obviously, some differences remained and some of the reduction was due to improved inflationary and fiscal performance – but a lot of it was also due to political strong-arming, pressure being brought to bear on analysts and some cooking of the books.
Within nine years, O’Connor calculates, rates had fallen by approximately 50 per cent in nominal terms for Italy, 60 per cent for France, 40 per cent for Spain, and 33 per cent for Germany. One result of this phoney low interest rate environment and declining real rates of return was that investment managers, investment banks and particularly pension funds trustees sought out higher rates of return in alternative asset classes. Structured products became more attractive and there was a boom in real estate. Artificially low costs of borrowing triggered artificially high amounts of credit creation.
This specifically European dimension to the bubble has been largely forgotten. It is also clear that the pressure on the euro is intensifying. Greece’s debt burden is soaring out of control: it is denominated in euros, which Athens cannot print (only the European Central Banks can do that) and it cannot devalue either. Greece must either introduce swingeing cutbacks, be bailed out by Germany, default on its debt or quit the single currency. What a euro-mess.