Skip to comments.Want To Ruin Your Own Country? Assume Your Banks’ Liabilities
Posted on 12/14/2010 2:25:20 PM PST by FromLori
Recently, I read up on how Iceland is doingsurprisingly well, actually. Unemployment is down, the Krona is going back up. Good balance of trade, good fiscal balance sheet. Quite the turnaround, after its troubles over the last couple of years
so then if Iceland is doing OK, why then are we in the hole that were in?
Why is the American economy slogging along? Why is Europe circling the drain? Why are the bond markets queasy as a patient with a low-grade malarial fever? Why is Ben Bernankes chin quivering and his voice quaking on 60 Minutes? (And by the way: Was that a terrifying spectacle or what?) Why has the conversation turned from bond market risk to sovereign debt risk? Why are commodities rising, equities moving jagged and irrational, and all of a sudden silver is now the new darling of the retail investor?
What the hell is going on? Why are things getting worse, instead of better?
The answer is so simple, it hurts:
When the Global Financial Crisis hit in late 2008, the governments took over the liabilities of the financial sectorand in the two years since that terrible, terrible decision, that single move has turned what was once a problem of financial sector insolvency into a problem of sovereign nation insolvency:
Europe and America are insolventtheyre broke. They cannot pay the liabilities they have assumed.
Thats why were in the trouble were in. Thats why Ben Bernanke is crying himself to sleep every night. Thats why the worlds economies are slowly circling the drain
remember what happened, in the fall of 2008?
The Federal government bailed out the banks with the famednot to say infamousTARP: The Troubled Asset Relief Program, a $700 billion bailout of the banks by any other name.
For its part, in order to save the financial sector, the Federal Reserve expanded its balance sheetthat is, it printed moneyto the tune of $3 trillion dollars, between Quantitative Easing in 08-09, QE-lite in early 10, and now QE2.
The Europeans made the same mistake as the Americans: They tried to save their banking system. They tried to get through the Global Financial Crisis without any pain.
The Germans bailed out their Landesbank, the UK took over Northern Rock. The Irish bankrolled Allied and Bank of Ireland, the Spanish propped up BBVAin short, the European governments all assumed responsibility for all their failed banks. They all pretended that it was a liquidity crunch, when it was clearly a banking insolvency crisis.
Theyre all paying for this sin today. Were all paying for this sin today: The inherent instability in all of the markets today is a product of this decision back in 2008the decision to socialize the financial sectors losses, instead of letting the insolvent institutions fail.
That the Europeans would socialize the losses is understandabletheyre all a bunch of Socialist pinko-proto-Commie Euro-weenie fellow-travelling Reds: The children of Lenin and Mao, first cousins of Che and Fidel.
But Americawhat happened in Americaland of the free, home of the bravehome of the creative destruction that is the lynchpin of capitalism?
In a word: Capitalism was short-circuited.
See, a bond is a loanand whats the underlying risk of lending money? That it wont be paid back. The interest on a loan is supposed to represent the time-value of the money, plus the risk that the money will not be repaid.
Bond holders of all stripes were supposed to know thisthat there was a chance that they would lose the money that they had lent out.
In the run-up to the Crisis in 2008, banks had lent money to dodgy investmentsthose investments in real estate and whatnot went sour in 2007 and 08boom!: The banks had a loss on their bond portfolio.
The banks loss meant that they would default on other loans, to other creditorsusually other banks. So this round-robin of collapsing debt would affect all the banks
the banks that had been prudent would suffer losses on these bad loansbut they would likely survive. (Notice how none of the private banks of Europe got into any trouble? Like I said, prudent.)
but the banks which had been imprudent? The ones which had over-extended themselves? Like all the big banks in America?
They would fail.
So they werent allowed to fail.
In 2008, the rationale was, If the banks are allowed to failthen the entire U.S. economy will die! That was Hank Paulsons dire warning, when he got on one knee in front of Speaker of the House Nancy Pelosi, and begged her for $700 billion for TARPwith no strings attachedin order to bail out the banks.
Thats what Ben Bernanke rationale, when he ordered the drones at the Fed to start buying up all those Mortgage Backed Security turds, printing up money in order to make the bailout happen.
Capitalisms creative destruction was not allowed to have its way with these banks. They were called systemically important. They were called too big to fail
but right away, you know this is bullshit: In capitalism, nothing is too big to fail. Thats the whole point of capitalism: There are no sacred cows.
But enough people in positions of leadership said that the economy would die, if the banks werent savedso they were saved.
And what was the result of this lifeline to the banks?
You can look at it from all sorts of angles, but bottom line, the State assumed the losses of the banks. The banks liabilities became the governments liabilitiesand ultimately, the peoples liabilities. Because the people will wind up paying.
Some fools still believe that if the banks hadnt been saved, then our economy would have died! Died dead! Died like the dodo!
Oh really . . .
Well, I disagree: I think it would have been better to let the chips fall where they maygive capitalisms creative destruction free reignlet the virtuous be saved and the evil perish
in short, I think we would be better off today, if wed let the banking system fail back in 2008.
And I have proof that it would have been better: I can prove that if wed let the insolvent banks fail, the worlds economy would be better off today. We wouldnt have the current uncertainty, and instability.
Compare-and-contrast the fates of Ireland and Iceland:
Both had the same problem: Disproportionately large banks for the size of their respective economies. Both banking sectors of both countries had taken on liabilities which rendered them vulnerable as a babys belly to a falling knife.
In 2008, the knife fell: A lot of the assets on the balance sheets of both banks were proven to be worth fractions on the Euroif not worthless altogether.
But in the fall of 2008, the two countries fates diverged:
On the one hand, Icelands people refused to have their government be saddled with the debt of their insolvent banks, Landsbanki and Kaupthing and the others. The Icelanders requested an IMF bailout to the tune of $2.1 billion (compared to their GDP of $12 billion). But they refusedvociferouslyto be saddled with the debts of their banks.
Chilling in Iceland. What were the consequences? The Krona suffered an 80% devaluation, interest rates went to the moon. Unemployment spiked from 6% to 9.3% in a month . . .
. . . but it wasnt that bad. It wasnt fun, but it wasnt the end of the word, either. Even with severe austerity measures that included higher taxes on all sectors of the economy and severe cuts in public services, unemployment reached only 9.6% at its worst point, averaged 8.8% during 2009, and is now only 7.6%. Source is here.
On the other hand, what did Ireland do?
When its banks were shown to be insolvent in the fall of 2008, Prime Minister Brian Cowen went and guaranteed the Irish banks. In other words, he made the Irish government assume the debts of the banking sector.
Ireland hasnt had a moments peace of mind ever sincefor two years, the Irish have been stumbling about, trying to make good on their banks liabilities, while the country slowly sinks.
Finally, a couple of weeks ago after a bond market mini-panic, the Irish were bailed out by the ECB and the IMFthe Irish fought centuries of British rule, only to finally surrender their sovereignty to bureacrats from Brussels.
Drinking and crying in Ireland. Will the Irish situation get any better?
In a word, no. The Irish are still saddled with the eurothey havent been able to devalue their currency, in order to restart their internal economy, and make themselves attractive to foreign capital. Coupled with that, they have had to take severe austerity measures and tax hikes, in order to make good on the bonds that the Irish banks owe.
That is to say: The Irish people are suffering, so that UK and German bankers dont have to take any losses.
Meanwhile, in Iceland today, after seven consecutive quarters of negative growth, the Icelander economy is picking up. In 2011, the Icelander government will have a surplus; the balance of trade is already in surplus. With the devalued Krona, Iceland became a magnet for foreign investment. Unemployment is going down.
Things are good in Iceland.
In Ireland? Not so muchand they wont be getting any better any time soon. The rosiest predictions have the Irish economy turning around in 2013, 2014 . . . maybe.
What lessons do these two countries teach us?
The Icelanders recognized that their right handtheir banking sectorwas gangrenous: So they cut it off. A lot of tears, a lot of short term agonybut the rot was cut off.
The Irish? They tried to save their gangrenous hand back in 2008so then over the next two years, their whole arm has now turned gangrenous.
But instead of cutting it off, theyre trying to save the arm tooand theyre praying that the gangrene doesnt get to the body and kill them.
These are just two small countriesIceland and Irelandand Im sure a lot of critics will say, These two countries have nothing in common with giant economies like the U.S. and the EUnothing in common at all!
Oh, but thats where theyre wrong: Economics is trigonometrythe ratio of a diagonal of a square is the same no matter the size of the square. Likewise with economies: The basic problem of any economy is the same, regardless of its size.
An overlarge economylike the American and European economiesmight be able to palliate the symptoms of the economic disease. They might even be able to hide the symptoms altogether, and make fools think for a little while that the disease is all gonethe patient all better.
But truth outs, one way or another.
The sin of the American and European economies was to guarantee the banks. Whether out of stupidity, blindness or corruption, America and Europe pretended the banking insolvency was merely a liquidity issue
so they socialized the banks losses.
Thats why the American economy is teetering, while Europe goes from crisis to crisisGreeceIrelandSpain nextItaly soon to be up.
Because of stupidity, blindness or corruption, the American and European leadership saddled their people with debts that cannot be paid.
I have argued in my hyperinflation pieces that the only way to get out of an unpayable debt is to either default on the debt, or inflate away the currency.
The Europeans are grimly trying to pay off all the debts while defending a strong euroits an ugly sight.
The Americans are trying to inflate away their debtthe Federal Reserve is now fully monetizing the Federal government debt, conjuring money out of thin air and thereby covering the fiscal deficit.
In other words, in both cases, the gangrene has spread from the hand in 2008, to the limb in 2009 and 2010and now as we welcome 2011, the gangrene has spread to the body.
All in all, I think were all going to wish we had done like Iceland. If we had, wed be chillin like the Icelanders, instead of crying ourselves to sleep every night.
No need to say more.
Excellent and pertinent article.
Here is another you may find interesting
Elite’s Pathological Dysfunction?
I wonder how Iceland would be faring had everyone else followed their lead? Would they still be a magnet for investment if America’s and Europe’s banking systems had gone down in flames?
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