Saturday, February 18, 2012

More Evidence the Greeks Will Default

As Dean is fond of saying constitutional republics, are like, hard. In the case of Greece, no matter what the government does, the people aren't going to accept the necessary measures to pay back their debt, and for good reason, they probably can't. However, in a parliamentary system, such a question should have been put to the people in the form of new elections before the negotiations continue. But the current "unity" government has plunged ahead with voting on austerity measures that seem uncertain to actually solve the debt problem, and definitely won't if too many more buildings are burnt and all the tourists leave. A vote would have the salutary effect of denying legitimacy to the protesters, because they would either have to live with the measures or take responsibility for the consequences of default. Either way, they might receive a dose of reality.

But this all might be mooted because even the Germans don't think the Greeks are going to pay much back, which has been my opinion all along.
The German finance ministry is actively pushing for Greece to declare itself bankrupt and to agree a "haircut" on the bulk of its debts held by banks, a move that would be classed as a default by financial markets.
. . .
Wolfgang Schäuble, the German finance minister, does not believe that any government would be able to implement them.

His pessimism has been tipped into despair with a secret European Commission, Central and IMF report that even if Greece made good on its promises, it would not be enough to reach the target of bringing total debt to 120 per cent of GDP by 2020.

"He just thinks the Greeks cannot do what needs to be done. And even if by some miracle they did what has been promised, he - and a growing group - are convinced it will not pull Greece out the hole,"
The only remaining question is what happens after a de facto default? I think that the Greek economy is going to go through a long depression. The only way they will be able to receive new lending to finance a recovery, will be to pledge physical assets, like their islands and the Parthenon perhaps. Even then, lenders would be reluctant to accept the collateral without constitutional protections to prevent nationalization.

Pretty nice collateral?

But let's also be clear about the game being played by the rest of the EU. An anonymous commenter previously posted that it is not really that big a deal if the Greeks default, the worry is the example set and the impact to banks. Much of the worry has been about the spread of bank failure if Greek default causes Italian and Spanish bond yields to rise. Once again, too big to fail leads to irrational economic policy. No one wants to learn this lesson, not the U.S. and not the Europeans. Heck even the Chinese prop up their banks with enforced savings and below market interest rates for the working stiff. So instead of too big to fail, why don't we require ever increasing capital reserve requirements as banks become larger? That would make it harder for big banks to leverage access to cheap capital from the Fed to make easy money, but that should be their problem.


  1. Preventing bank over leveraging was the point of the Basel III accords, which the banks, both here and in Europe, are busily lobbying to ignore. Their reason is that risk based lending prevents them from making loans due to the fragile state of their balance sheet. Circular logic anyone?

    I suspect that if we can't get some bank lending going prior to the election, Mr. Obama will announce that we are temporarily suspending participation in the Accords. After all, what's more important, a healthy financial system or getting reelected?

  2. Anonymous,
    Hadn't considered that angle. What is to be done to improve the risk profile of their balance sheets? How do you think too big to fail plays into this. Appreciate your comments.

  3. "Too big to Fail" was a political choice. At the root, I think, is our elected officials strong desire to not admit that, despite numerous warnings, they allowed and encouraged the problems to develop, starting with the repeal of Glass Steagall (the Dodd Frank "fix it" bill after the 1929 crash). The choice to allow "too big to fail" has subverted the capitalist system. Risk isn't risk if the government is willing to change the rules. GM, Citi, and several more should have been allowed to go bankrupt and reorganize under government protection. The common stockholders should have been wiped out (they took the ultimate risk and received the ultimate reward from the housing mess) and the executives who overleveraged should have been replaced instead of rewarded.

    Instead, we've opted for "too big to fail." Too late to back up? Probably. We could use a good example, though. The current solution is like a tight rope walker halfway across the wire. All he needs is to keep walking and a period of calm weather. The problem is several years old and we still don't have any structural answers ready for the next squall.

    Basel III is a start. It incorporates and updates risk based lending practices to prevent overleverage. As I mentioned, it also limits overall lending, and due to the current fragile nature of bank balance sheets, there is a move to postpone implementation. After all, it's only been 3 years. Discussions are underway as I write. Reminds me of the Bush strong dollar policy...we support a strong dollar (just not yet).

    In my opinion, IF more government is the selected answer, the best response would be to establish a government agency as part of Treasury to liquidate and restructure "too big to fail" corporations when they fail. Management would have the ultimate incentive to manage risk.