Bad Romance

Greece should never have been a member of the eurozone -- and at this point the best way to save both of them from economic catastrophe is to end the relationship.

The economic medicine being applied in Europe is not working. In fact, the patient is getting worse: Greece's economy is collapsing and its debt is rising exponentially, prompting harsher austerity proposals and increasingly violent protests, such as the one on Oct. 19 in front of Athens's parliament. The doctors have responded by prescribing ever-larger doses of the same: ever-larger funds to lend Greece ever-larger amounts and force ever-larger austerity measures upon the country -- a course that can only lead to an ever-larger failure.

And yet the underlying problem is both familiar and resolvable: several governments in Europe have borrowed more than they can possibly repay. Such over-borrowing by governments is not unusual. It has happened repeatedly over the years and has one effective solution: the debt needs to be reduced. This is hardly impossible -- Mexico, Brazil, and seven other Latin American governments did it two decades ago following the prolonged debt crisis of the 1980s, reducing their respective debts by 50 to 70 percent by issuing tradable dollar-denominated "Brady bonds" in exchange for their outstanding debt. Banks took large losses, long foreseen by the markets, and proceeded to rebuild their capital. Prosperity was quickly restored to the over-indebted countries.

Tragically, the eurozone leadership has for three years refused even to consider this most obvious of solutions. Instead, the leadership has been determined to raise ever-larger "bailout" funds to lend ever more to the stressed governments. These new European Financial Stability Facility (EFSF) loans do forestall default in the short term, but they add to the debt total of Greece and other stressed countries and so make the long-term problem far worse. If a borrower has too much debt, one does not help him out by lending more -- that only digs him in further. This is not a "bailout" at all. The defaults, when they come, will only be larger. The markets clearly see this: Sovereign bond rates and credit-default swap spreads, which are closely related to the probability of default, keep climbing ever higher.

Why has the euro leadership been acting in this perverse and dysfunctional way? It is because they desperately fear contagion. If the gift of Latin America-style debt relief is offered to Greece, surely Portugal will be next in line, asking for the same favor. Then comes Ireland -- where government officials have already said their country should be included in any resolution of Greece's problems -- likely followed by others. How could one say no to them after saying yes to Greece? Where would the cascade of losses end? Contagion is the central problem that needs to be addressed.

The way out of this bind is to create a downside to debt relief: It should be available, but must come with sobering consequences. I propose a simple tradeoff: Any country that accepts a wholesale debt reduction must agree to leave the euro.

At first, this prescription sounds harsh and extreme, which may explain why it has received the endorsement of some economists but few politicians or policymakers. In reality, however, the tradeoff offered is benevolent and appropriate. Greece is too unlike the other eurozone countries, and in fact, it owes many of its current problems to the decision to join in the first place. Leaving the euro will unshackle it from the terrible position in which it finds itself. The short-term costs would be considerable, but they are greatly exceeded by the short-term costs of endless, wasted bailouts.

Why? Look at the fundamentals. Greece is less productive economically, and has less productivity growth, than the nations of northern Europe. Productivity growth has enabled Germany to keep inflation low for decades; Greece has had no such luck. Before Greece joined the euro in 2001, its drachma steadily devalued relative to the currencies of northern Europe, an expression of this difference. The ratio of Greek currency value to German currency value dropped by 93 percent between 1976 and 2001. This steady change in relative currency value enabled trade between Greece and northern Europe to expand without significant payment imbalances, to both sides' benefit.

The problems began when Greece, anticipating eurozone entry, tried to stabilize the drachma. Payment imbalances appeared and grew rapidly (see the chart on pages 9 and 10 here). A decade later, Greece's current account deficit has exploded to between $30 billion and $50 billion annually, deficits that represent growing debt from Greece to other countries. These deficits signal that Greece is exporting too little and, more importantly, importing too much. Cheap imports are rising and crushing local businesses. The country's notoriously bloated government budget, a reliable scapegoat for its economic woes, in fact is not the root cause of the country's economic ills -- even if the budget were perfectly balanced, the external debt of Greek banks and firms would have been out of control, an unintended consequence of joining the euro.

With currencies fixed, the only way to cure this payment imbalance is to lower Greek wages and prices, in an attempt to make the country more competitive. Devaluation lowers them in an instant; without that tool, they must be lowered slowly and painfully in local terms. This is what "austerity" tries to do -- and what Greeks are so angry about. If Greece had never joined the euro it would not have ended up in this dreadful position.

The pattern closely resembles that of Argentina in the 1990s. Like Greece, Argentina is a peripheral, relatively inefficient economy without large exports. In 1991, the country adopted a "currency board" that locked its currency to the dollar. Its current account soon deteriorated and payment imbalances grew; Argentina became a major borrower in global capital markets to cover its growing deficits. By 1996, growth had turned negative; by 2000, the country was in a deep, intractable recession with rising unemployment, fleeing capital, and popular discontent. In late 2001, there was a run on the banks, the government seized deposits, riots broke out, and the government collapsed. In 2002, the new government defaulted on its debt, abandoned the currency board, and reestablished the peso. After falling 11.7 percent in 2002, Argentine gross domestic product then grew an average of 7.8 percent per year for the next five years.

A euro exit for Greece would have to be consensual and orderly, under terms agreed upon by both sides, and would require an amendment to the Maastricht Treaty (which paved the way for the creation of the euro), the subsequent Lisbon Treaty, or both. Debt relief would impose losses on euro banks -- including the European Central Bank (ECB) system itself -- which would need more capital to absorb the losses. Greek banks in particular would need to be recapitalized as part of the process. But this is a far better use of scarce bailout funds than simply lending ever-larger amounts to a government that cannot possibly repay them.

It is worth heeding the lessons of the Troubled Asset Relief Fund (TARP), the $700 billion fund created by the U.S. government to manage the subprime crisis in 2008. Its original mission, as its name implied, was to buy up toxic subprime assets in the marketplace, much as the EFSF and ECB have been acquiring bonds of troubled European governments. But the United States soon realized that buying bad assets was a poor use of scarce resources, and TARP quickly shifted to investing capital in troubled banks so that they could work out their own balance sheet problems. European central bankers need to take a similar tack: Stop lending to chronically troubled governments and invest capital in banks instead.

Leaving the euro does not mean that Greece would have to leave the European Union -- it could simply rejoin highly respectable countries such as Britain, Denmark, and Poland that enjoy EU membership while retaining their own currencies. Nor are the nightmare predictions of bank runs and panic in the streets following a euro exit at all inevitable; rather, such worst-case scenarios underscore the absolute necessity of arranging an orderly exit before a disorderly one ensues. If the Greek parliament votes no confidence in the present government, for instance, and opposition parties increasingly adopt pro-default, anti-International Monetary Fund, anti-euro platforms, Greece could see a chaotic descent similar to Argentina's in 2001. In fact, we may be closer to a disorderly breakdown of this kind that we realize -- all the more so given the anti-bank, anti-establishment demonstrations that have recently broken out throughout Europe and the rest of the world.

Breaking with the euro is an undeniably huge step, even for a country in crisis -- and therein lies part of the strength of this solution. Short-term transition problems would be complex and costly -- which should impress countries such as Portugal and Ireland that accepting this tradeoff is painful and to be avoided if possible, limiting contagion. But in the cases where such drastic action makes economic sense, as it does in the case of Greece, all of Europe will have been put onto a far stronger footing.



Luxury Condo, for Saleh or Rent

Why is Yemen’s presidential family loaded up with millions of dollars in D.C. real estate?

Shortly after being named one of the three winners of the Nobel Peace Prize this month, Yemeni activist Tawakkul Karman said that if embattled President Ali Abdullah Saleh is driven from power, investigators should immediately begin searching for assets held abroad by members of his government. The money "plundered" by the regime, she said, should be "brought back to the Yemeni people," according to an account on an opposition website.

If Saleh is forced out -- he has held power for more than three decades -- the asset hunters might want to begin their search in Washington, D.C. Real estate records show that in 2007 a man named Ahmed Ali Saleh bought four condominiums in a luxury building in Friendship Heights, right near one of the capital's swankiest shopping areas. He paid $5.5 million -- in cash -- for the condos. He also owns a property assessed at about $220,000 in Fairfax, Virginia, bought in the 1990s.

Saleh is a common name in Yemen, and the Yemeni embassy in Washington won't comment on the matter, but substantial evidence indicates that the Ahmed Ali Saleh who owns the condos is the eldest son and longtime heir apparent of President Saleh. He also heads the elite Republican Guard, which has allegedly led many of the attacks on the country's largely peaceful protesters at Change Square in Sanaa.

Yemen, the poorest country in the Arab world, erupted in revolt against the Saleh family's rule in February, soon after the fall of Tunisia's Ben Ali. Tribal fighters, young pro-democracy activists, and government security forces have been vying for control ever since. In recent days, the capital has been gripped by violence. International human rights groups say the government has killed at least several hundred demonstrators since the uprising began; some estimates are many times that.

The unrest in Yemen was triggered in part by anger over the ruling family's self-enrichment, of which the military has been a prime beneficiary. (In addition to the Republican Guard, President Saleh's close relatives control other key branches of the military and security establishment.) Yemen is rapidly running out of oil, which underpins the economy, and other resources, which makes the situation all the more explosive.

In Washington, at least some members of the president's family live in posh style. Among the four condos owned by Ahmed Ali Saleh, the most expensive unit, which he bought for $1.7 million, is currently up for rent (furnished) for $7,500 per month. That's more or less equivalent to what a typical Yemeni makes in seven years. The rental listing describes the 2,019-square-foot unit as "LUXURIOUS and SPECTACULAR," with two bedrooms, walk-in closets, two-and-a-half baths (one with whirlpool), hardwood floors, and marble and granite trimmings. The listing also boasts of the building's 24-hour front desk and fitness center, as well as its location "steps from ... [the] best shopping in DC."

Indeed, Saleh's condos are just around the corner from Bloomingdale's, Neiman Marcus, and a multitude of high-end retailers at Mazza Gallerie shopping mall on Wisconsin Avenue. "So perfect, you'll want to move in immediately!" says the listing.

Frank Goldstein, who headed the building's condo owners' association until earlier this year, said that young Yemenis "in their 20s" lived in the condo units and that he was told by the Yemeni embassy that they were cousins and nephews of the president who were attending universities in Washington. Legal records show that Khaled Saleh, which is the name of another son of President Saleh, was living in one of the condos in 2009. A public record database search found that one of President Saleh's grandsons has lived at Ahmed Ali Saleh's Fairfax property. Khaled Saleh and at least two other relatives of the president are currently on the embassy's payroll, according to a document filed by the Yemeni government with the U.S. State Department. (Ahmed Ali Saleh himself lived in Washington in the mid-1990s and graduated from American University, one U.S. source told me. The university confirmed that an Ahmed A. Saleh graduated in the 1990s, but would provide no other information.)

Several people connected with the building, including Goldstein, told me that they never met the condo's owner -- but that the Yemeni embassy in Washington was the contact point when issues arose. When I called the concierge service at the building and said I wanted to get in touch with Ahmed Ali Saleh, the person I spoke with said, "He doesn't live here. If I need anything I call the embassy [of Yemen], and they get someone for me. If you want anything to do with those units, you have to go through the embassy."

Daphne Coates, who manages the units for Legum & Norman Realty, told me: "I've never met him [the owner] or talked to him. I don't know where he lives, here or in Yemen. When I need something I call the embassy, and they find someone for me to talk to."

Goldstein said he was told by his contact at the embassy that one of the president's brothers owned the units. Yet Mohammed al-Basha, a public affairs officer at Yemen's Washington embassy, said the president has no brother named Ahmed Ali Saleh or any relative of that name other than his eldest son. "I don't have answers to your questions," he said when I later asked him directly if the condo owner was the president's son. He suggested I contact the press secretary for Ahmed Ali Saleh in Yemen, who failed to reply to an email seeking comment.

I called the Yemeni embassy on Monday, Oct. 17, and told the receptionist I wanted to speak to the person at the embassy who handled Ahmed Ali Saleh's condos. She put me through to a woman who became indignant when I told her I was seeking confirmation that the president's son owned the units. "So you're asking questions that don't pertain to you," she said. "What business is it of yours who owns the property?" When pressed, the woman, who wouldn't give her name but said she worked with the ambassador, said she would get back to me on the question of ownership. So far she hasn't. When I asked her how else I might confirm ownership, she replied, "Try contacting the government of Yemen and see how far that gets you."

I spoke on backgroundwith four U.S. experts on Yemen who have many decades of combined government and private experience in the country and intricate knowledge of the ruling family. They all said that given the evidence -- including the obvious wealth of the properties' owner -- the president's son almost had to be the proprietor. One termed it "virtually impossible" that he was not, adding, "It is inconceivable that there is another Ahmed Ali Saleh in Yemen who has $5 million to buy condos in Washington." Another said that during his conversations with Yemeni diplomats, several had mentioned that the president's son owned property in Washington.

A New York Times story last year said there was a sense in Yemen that the country was run as "a family corporation." A 2005 State Department cable, written by an officer at the U.S. Embassy in Sanaa and released this year by WikiLeaks, made the case that "Rampant official corruption impedes foreign investment, economic growth, and comprehensive development." The State Department's most recent annual human rights report on Yemen says that "officials frequently engaged in corrupt practices with impunity" and that international observers "presumed that government officials and parliamentarians benefited from insider arrangements and embezzlement."

"It's a poor country, so there isn't a lot of money to steal, but because it's poor it needs every dollar it can get," David Newton, who served as U.S. ambassador to Yemen between 1994 and 1997, told me. "Corruption really hurts." 

President Barack Obama's administration -- which has been targeting suspected al Qaeda militants operating in Yemen with drone strikes, including U.S.-born cleric Anwar al-Awlaki, who was killed in late September -- has worked closely with Saleh's government on counterterrorism matters but has spoken out against the regime. During his address to the U.N. General Assembly on Sept. 21, Obama said Yemenis calling for Saleh's ouster were seeking to "prevail over a corrupt system" and that "America supports those aspirations."

The State Department has asked for $35 million in foreign military financing for the next fiscal year for Yemen. Total military, security, and economic aid to the country has surpassed $100 million during the past two years, according to a report by the Congressional Research Service.

Stephanie Brancaforte, the Berlin-based campaign director for Avaaz, a global human rights group that has worked extensively on Yemen and that alerted me to the D.C. properties, criticized U.S. policy. "Saleh's forces have not only killed protesters -- they have inflicted a humanitarian crackdown by intentionally cutting off water and electricity to millions of people," she said. "The U.S. invested more than $100 million to fight terrorism in Yemen, but that money has primarily gone to prop up a corrupt family.... Meanwhile, the average Yemeni is less likely to be a victim of terrorism than malnutrition."

Ahmed Ali Saleh is one of the most powerful men in Yemen, and his father has long groomed him to be his replacement (though the president recently promised that his son would not succeed him). When President Saleh was evacuated to Saudi Arabia in June after he was seriously burned in an attack on the mosque he was attending, the younger Saleh moved into the presidential palace and took charge. His troops have been directly implicated in some of the worst abuses against protesters.

A September 2005 cable from the U.S. Embassy in Yemen, released by WikiLeaks, said the president was using the years leading up to a scheduled 2013 election to "groom his son (a la Mubarak), make him increasingly visible, and place him in positions of higher responsibility so that he will be seen as an acceptable candidate." But the cable said that "there are considerable doubts as to his [Ahmed Ali Saleh's] fitness for the job" and that he did "not currently command the same respect as his father."

The cable also called Ahmed Ali Saleh a force of "the status quo, [which] is becoming increasingly difficult to maintain, given a declining economy, rising frustration over official corruption, and increasing U.S. and international pressures on the regime to change the way it does business."

Ahmed Ali Saleh is certainly not the only controversial foreign official to have bought real estate in the United States, but the transactions could attract scrutiny if, for example, the funds used for the purchases could be shown to have originated in corruption. Ahmed Ali Saleh clearly fits in the category of "senior foreign political figures" as defined by the USA PATRIOT Act, who are supposed to be subject to especially careful due diligence by American financial institutions before accepting their money.

Jack Blum, an attorney and former Senate counsel who played a key role in investigations into the Bank of Credit and Commerce International and the Lockheed Corp.'s overseas bribery scandal, summarized the key questions surrounding Ahmed Ali Saleh's condo-buying: "Was an American bank involved at any point in the transactions, and if so, did it file a suspicious activities report? If so, was anything done with it, or did it just make for interesting wastepaper? Where did he get the money? Could he have afforded to buy the properties on his official salary?"

Al-Basha, at Yemen's Washington embassy, would not provide information on the salary of President Saleh, his son, or other top government officials.

Meanwhile, back in Yemen the uprising continues. President Saleh has repeatedly said he's going to leave office -- only to back away at the last minute.

The rental listing suggests that neither the president nor his eldest son plan on retiring to Washington anytime soon, however. The property owner "will consider long term lease," the listing says, so it looks as though Ahmed Ali Saleh isn't ready to move in to his luxury condo just yet.