Sunday, 22 January 2012

Hell, Handbaskets and Hellenic Default

Regardless of what the IIF and the Greek government may announce, Greece is heading inevitably for a destabilising default to some or all of its bond creditors. The most articulate and comprehensive account of the reasons why this must be so are documented in the ZeroHedge masterclass on Subordination 101: A walk thru sovereign bond markets in a post-Greek default world. Roubini concurs.

I've written before about what this implies for the financial system:

If any OECD state were to default there would be very serious implications:
- The Basel Accord zero risk weight of government debt would be proved fanciful;
- The assumption of government debt as a liquid asset suitable for bank Tier 1 reserves to meet unanticipated and sudden cash demands will become unsustainable;
- Banks would be forced to recapitalise at much higher levels, forcing even sharper deleveraging and contraction of lending;
- Governments would lose the captive, uncritical investor base they have relied on to finance excess public expenditure for the past 30 years;
- Central banks could be forced to suddenly monetise even more government debt if required to meet the cash demands of a run on their undercapitalised banks.

Worrying, but not unexpected. A few of us predicted back in 2008 that the implosion of RMBS and bank capital, leading to central bank and sovereign bailouts, would fuel a central bank balance sheet and sovereign debt bubble. The central bank balance sheets have since balooned to 20 percent of GDP for the Fed and Bank of England, and 30 percent of eurozone GDP for the ECB. Deficits have spiraled everywhere, despite promises of austerity. Now the sovereign bubble too may burst.

From Deflation Has Become Inevitable in December 2008:

In Lombard Street, Bagehot’s seminal tome on fractional reserve central banking, Bagehot advises any central bank facing a simultaneous credit crisis and currency crisis to raise interest rates. By raising rates they will ensure that foreign creditors remain incentivised to maintain the general level of credit available while the central bank resolves the local liquidity crisis through liquidation of failed banks and temporary liquidity support of stressed banks.

The very opposite policies have been pursued by central banks in the US, Europe and UK since the beginning of the sub-prime crisis in August 2007. They have cut policy rates drastically, and as the crisis escalated and spread, the yield on government debt has dropped to negative territory. Meanwhile they have shielded those responsible for the creation of record levels of bad debt from any regulatory accountability, relaxed transparency of accounts, and provided massive taxpayer-funded financial infusions to prevent failure and liquidation.

While in the short term these policies have expediency and the maintenance of market “confidence” on their side, in the longer term these policies must undermine any confidence a rational and objective saver or investor might have that savings or investment in the US, EU or UK will be fairly remunerated at an above-inflation rate, or that savings and investments will be protected by effective oversight and regulation from the sorts of executive debasement and outright misappropriation and fraud that are beginning to colour our perceptions of the past decade.

Anyone sitting on a pile of cash now is unlikely to want to either (a) place it in a bank, or (b) invest it in the stock market. As a result, the implosion of the financial and real economy must continue no matter how big the central bank’s aspirations for its balance sheet or the treasury’s aspirations for its deficit.

I'm sorry I was right. (sigh)


Anonymous said...

You write with clarity but unfortunately you write too infrequently. Your insight is appreciated, we need more. Thanks for the blog.

Richard said...

I can emphasize with you.

In my case, I was one of the handful of individuals to predict the credit crisis. At the time, I suggested that the impact of the crisis could be moderated if transparency was brought into all the opaque corners of the financial system.

I even managed to get the Paulson Treasury to agree with that.

But then I got run over by Wall Street's Opacity Protection Team and the idea that expediency in the form of bailouts, etc. would somehow shore up confidence in the financial system.

My response then was to predict that until transparency was adopted, the global economy would continue its downward spiral.

Talk about a prediction being true and the author of the prediction wishing he was wrong!

Ultimately though, to paraphrase Winston Churchill, we will find the right answer (transparency), but only after trying everything else first.

Richard said...

empathize not emphasize...

scandia said...

I was listening to some Davos news on CBC radio yesterday. In the report PM Harper was telling Europe to solve " its " problem as that problem was now affecting the economies of other countries. And yes, I smell fear in Ottawa. It appears all the EU leaders have to decide to be nice and stop the silly game. It's not fun anymore.
Yet not one of the leaders at Davos is demanding transparency.
Not one world leader has announced that on his or her return the accounts( all sets ) will be opened for all to see.
The astute person notices this lack of desire for visibility at the top.
So how else can we get a look see?

Anonymous said...

There is near universal belief that defaults lead to collapse. But the fact is that many European countries have defaulted numerous times in the past century and those exist still exist.

Preventing creditors from taking their losses and debtors from restructuring their balance sheets only increases the costs of the inevitable.

As Jim Grant recently noted under President Warren Harding the depression was cured by clearing the inflated credit structure through defaults, high interest rates and getting the private sector going again. Just the opposite of today with financial repression, ZIRP, money printing and transferring private sector creditor losses to the taxpayer. Todays mandarins keep with Einstein's definition of insanity - doing the same thing over and over again and expecting different results.

PeterJB said...

I have the sense that there is strong liaison between the UK and the USA where the senior partner is the USA - which the British need to only know privately

The Prime Directive (of the US)is for the USA to survive its coming socio-economic collapse (it has already collapsed) but the urgent emphasis is to retain the USD as the Global Reserve Currency - for to lose that the USA disintegrates far beyond collapse. Nothing else matters to the US and hence any actions legal or not will be taken.

Greece is merely the bauble to fully engage the trusting eyes and is not where the real game is being played.

The markets as one can now see clearly have been manipulated and distorted by the US for many decades, and IMO here be the real danger, that is to say, if the hard and rusted impositional controls on the manipulations are suddenly released, there will be a full nuclear explosion of the genie out of the bottle. Not good at all for the West - we don't want to meet this genie - but we will because it is growing and now cannot be contained.

Fear and incompetence is the mark of those of the Unholy Alliance ie politicians, bankers, bureaucrats, Corporate ghouls and the MSM (= "leadership").

Bad news: Too many now understand this (the above) and know that they can get away with anything without risk of any Law that remains. Tyranny rules supreme.

Yes LB, good writings. Thank you.

Anonymous said...

Not to worry, that which can not be paid back won't. I suspect that the Greek losses are big enough that everyone has a haircut. It seems to me, to be deckchairs on a well known large sinking vessel at the moment.

Knute Rife said...

I'm not convinced maintaining high rates is a cure-all. We did it here 30 years ago and whipped inflation and kept capital flowing alright, but also crated up much of the economy and shipped it overseas, sowing the seeds for much of the current mess. Iceland kept rates high to counter the inflation from the aluminum speculation and set in motion the kreppa. Of course, in both those cases the regulators took a neoliberal-inspired nap, and the money monkeys ran wild. But I'm coming to believe that's a condition inherent in the system and must be accounted for in any proposal.

On a collateral note, what are your thoughts on an ECB-EFSF bond swap?

Fungus FitzJuggler III said...

Borrowing is stealing from the future. Those who facilitate it, knowing there will be no repayment, whether borrower or lender should suffer penalties.

The credit poison afflicts many others and so should be like a standing army, a publicly owned, and not merely supposedly regulated, good?

The affects of withdrawal are severe!

Anonymous said...

I've speculated that in the US interest rates are being suppressed until the wave of ARM resets pass. Figure that it's kind of the deal-with-the-devil play in that the govt is paying the banks, up-front, to hold off on raising interest rates. Not that, however, it's going to end up stalling the head-long race to (and over) the cliff.

As to one of the responses that states that defaults don't necessarily lead to collapse, well... that was when there was a global economy that has spare capacity, this is an entirely different world.