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Satyajit Das: A CDO Cure for Europe?

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By Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2010, FT-Prentice Hall).

Detox Cures

In the first half of 2010, angst about European sovereign debt receded and market volatility eased. In the second half of 2010, concerns about Greece, Ireland, Spain and Portugal returned to dominate headlines.

Greece passed its initial inspections on its restructuring plan from the supervising “Troika” (made up of the European Central Bank (“ECB”), European Union (“EU”) and International Monetary Fund (“IMF”)). In truth, there was no choice, as money had to be made available to enable Greece to continue to function.

Despite progress, the Greek economy slipped into a deep recession, impeding the recovery plan. As the government implemented austerity measures, the Greek economy shrank around 3% to 4%. The government is behind on its program to shrink its budget deficit from over 13% to 8%.

Tax revenues are weak, growing 3.3% well below the targeted 13.7%. This is despite tax increases including a rise in the VAT rate to 23 per cent. Faced by a collapsing economy, rising unemployment, increased numbers of Greeks leaving the country and social unrest, the Greek government even announced a cut in corporate tax rates from 24% to 20%. How this was going to help correct the budget deficit remains a mystery.

The “cure” may be worse than the disease. After implementing similar austerity measures, Ireland’s nominal gross domestic product (“GDP”) has fallen by nearly 20%. The budget deficit as a percentage of GDP has doubled to 14% from 7% Government debt as a percentage of GDP has increased to 64% from 44% at the start of the crisis. It is forecast to go to over 100% having been around 25% during the boom years. The cost of bailing out Ireland’s banking system has risen and may reach 20-30% of its GDP. Ireland’s credit rating has fallen.

In late September 2010, Ireland announced that in the second quarter the economy contracted by 1.2%, against expectations for 0.4% growth raising renewed concerns about European sovereign risk. Similar scenarios are playing out in Spain and Portugal.

Slowing growth in North America and China complicates the problems. Even Germany’s recent strong growth appears to be petering out. The effects of a weak Euro, government stimulus packages and exports of machinery as many industries retooled to lower production costs may have run their course. Real underlying demand remains weak.

Negative or low growth, savage budget cuts and economic restructuring will need to continue for years. Despite the Greek Prime Minister’s impossible MBA spin that the crisis represents a “historic opportunity”, it remains to be seen whether this is feasible. The willingness of government to impose and citizens to bear the decline in living standards necessary to avoid a debt restructuring remains uncertain.

The CDO Solution

In an effort to resolve the problems, Europe announced its version of economic “shock and awe”. Steps include an Euro 110 billion package for Greece, a Euro 750 billion “safety net” for all Euro zone members, ECB funding to vulnerable European banks, particularly in peripheral countries, and ECB purchases of around Euro 60 billion of bonds issued by some of the troubled countries. By late September 2010, risk margins on Greek, Irish, Portuguese and Spanish debt (relative to German government bonds) were above to the levels prior to the announcement of the European rescue plan. In short, the problems remain largely unresolved.

European sovereign debt problems are likely to remain prominent. Economic data, like growth, unemployment, budget position, and debt issuance will be key indicators on the trajectory of the crisis.

Increasingly attention may focus on the European Financial Stability Facility (“EFSF”), a key component of Europe’s financial contingency plan. Klaus Regling, the head of the EFSF and known informally as the CEBO (“Chief European Bailout Officer”), had a brief stint at Moore Capital, a macro-hedge fund, consistent with the fact that the EFSF is placing a historical macro-economic bet.

In order to finance member countries as needed, the EFSF will need to issue debt. The major rating agencies have awarded the fund the highest possible credit rating AAA.

The EFSF structure echoes the ill-fated Collateralised Debt Obligations (“CDOs”) and Structured Investment Vehicles (“SIV”). The Moody’s rating approach explicitly draws the analogy and uses CDO rating methodology in arriving at the rating.

The Euro 440 billion ($520 billion) rescue package establishes a special purpose vehicle (“SPV”), backed by individual guarantees provided by all 19-member countries. Significantly, the guarantees are not joint and several, reflecting the political necessity, especially for Germany, of avoiding joint liability. The risk that an individual guarantor fails to supply its share of funds is covered by a surplus “cushion”, requiring countries to guarantee an extra 20% beyond their shares. A cash reserve will provide additional support.

Given the well-publicised and deep financial problems of some Euro-zone members, the effectiveness of the cushion is crucial. The arrangement is similar to the over-collateralisation used in CDO’s to protect investors in higher quality AAA rated senior securities. Investors in subordinated securities, ranking below the senior investors, absorb the first losses up to a specified point (the attachment point). Losses are considered statistically unlikely to reach this attachment point, allowing the senior securities to be rated AAA. The same logic is utilised in rating EFSF bonds.

If 16.7% of guarantors (20% divided by 120%) are unable to fund the EFSF, lenders to the structure will be exposed to losses. Coincidentally, Greece, Portugal, Spain and Ireland happen to represent around this proportion of the guaranteed amount. Greece whilst an Eurozone member will not participate in EFSF’s lending programs as a provider of guarantees for the obvious reason that nobody would seriously place much value on any such guarantee.

Unfortunately, the Global Financial Crisis illustrated that modelling techniques for rating such structures are imperfect. The adequacy of the cushion is unknown. If one peripheral Euro-zone members has a problem then others will have similar problems. If one country requires financing, guarantors of the EFSF will face demands at the exact time that they themselves will be financially vulnerable.

Rubbery Numbers

The rating analysis published by the Agencies highlights subtle but extremely significant features in the structure designed to ensure the desired AAA rating.

Where an Eurozone member draws on the facility, the amount of funds on lent by EFSF will be adjusted by the following deductions:

A 50 basis point service fee
A percentage equal to the net present value of EFSF’s on-lending margin. For example, the Greek financing package had a margin of 300 basis points. This would translate into a deduction of around 13-14% (depending on the discount rate applied).
[1 and 2 constitute a fungible general cash reserve ("the Reserve") which will support all EFSF debt.]

An additional reserve specific to each loan made by EFSF (“the Buffer”) will be created. The exact methodology of determining this buffer has not been disclosed but will determined by several factors. The first factor will be the borrower and it credit condition. The second will be the position EFSF itself and the level of credit support available for its existing obligations.
The Reserve and Buffer are to be invested in liquid AAA rated government, supranational, or agency securities to be available as credit support for the EFSF’s obligations.

The requirement for the Reserve and Buffer significantly reduces the amount of funds available from the EFSF. Standard & Poor’s (“S&P”) estimated that after adjusting for the guarantee overcollateralization and the exclusion of Greece from EFSF’s program, the EFSF can raise up to Euro 350 billion (20% lower than the announced amount). After adjustment for the fact that borrowing governments cannot guarantee EFSF bonds and deduction of the Reserve and Buffer the potential available EFSF lending is further reduced.

Assuming a Reserve of say 13.5% and a Buffer of 10%, this would reduce the amount available to around Euro 270 billion (39% lower than the announced amount). Assuming an equivalent reduction in the IMF component of the package, the total amount available is around Euro 460 billion. The EFSF’s ability to lend compares to the forecast budget financing need of Greece, Ireland, Portugal and Spain of over Euro 500 billion in the period 2009 to 2013.

The structure outlined also increases the cost of the funding for borrowers drawing on the EFSF facility. This additional cost is generated by the fact that the Reserve and Buffer has to be invested in securities that may earn less than the interest paid by EFSF on any issue.

In order to attain the coveted AAA rating, the EFSF structure has been “tweaked” subtly. For example, Moody’s states that “the Buffer is to be sized so that the remaining portion of the debt issue that is not fully backed by cash will be fully covered by contributions from Aaa-rated member states.” In essence this appears to confirm that the EFSF’s rating relies heavily on the support of the guarantees of AAA countries – currently Germany, France, The Netherlands, Austria, Finland, and Luxembourg. In reality this means that significant reliance is being placed on the larger parties such as Germany, France and the Netherlands.

If the EFSF is drawn upon and increasing reliance is placed on cornerstone guarantors such as Germany and France, it is not clear whether politically it will be possible for these countries to continue the facility beyond its original 3-year maturity. Interestingly, S&P state that: “… we consider it likely that its mandate would be extended if market conditions remained unsettled.”

For investors, there is a risk of rating migration, that is, a downgrade of the AAA rating. If the cushion is reduced by problems of an Euro-zone member, then there is a risk that the EFSF securities may be downgraded. Any such ratings downgrade would result in losses to investors. Recent downgrades to the credit rating of Portugal and Ireland highlight this risk.

Given the precarious position of some guarantors and their negative rating outlook, at a minimum, the risk of ratings volatility is significant. The rating agencies indicated that if a larger Euro-zone member encountered financial problems, then the rating and viability of the EFSF might be in jeopardy.

Investors may be cautious about investing in EFSF bonds and, at a minimum, may seek a significant yield premium. The ability of the EFSF to raise funds at the assumed low cost is not assured.

Ironically, the actual structure of credit enhancement encourages troubled countries to access the facility early to ensure its availability. The structure embodies an accelerating “negative feedback loop”.

As market conditions deteriorate, market access becomes limited and countries draw on the EFSF facility (eliminating them from the guaranty pool), increased financial pressure will be exerted on the AAA rated Eurozone countries. The need to maintain adequate coverage to preserve the EFSF’s AAA rating on existing debt will mean that the Buffer will increase and the capacity of the EFSF to lend may become impaired. Moody’s rating analysis indicates that in the event that a large number of countries simultaneously lose market access and draw on the facility, the current lending capacity of the EFSF would likely be overwhelmed. Moody’s believes that it would be unlikely that the EFSF would start issuing under those circumstances.

At this stage, the EFSF have indicated that they don’t plan to issue any debt, as they do not anticipate the facility being used. The facility also has a very short maturity, three years till 2013. The importance of these factors in the grant of the preliminary rating is unknown.

S&P correctly inferred that the “EFSF has been designed to bolster investor confidence and thus contain financing costs for Eurozone member states.” The agency indicated that if its establishment achieved this aim then the EFSF would not to need to issue bonds. However, if as pressures mount and market access becomes problematic for some Eurozone members, then the EFSF and it structure will be tested.

The EFSF’s structure raises significant doubts about its credit worthiness and funding arrangements. In turn, this creates uncertainty about the support for financially challenged Euro-zone members with significant implications for markets.

Inconvenient and Ignored Truths

The real rationale of the European Bailout package and the EFSF is different to that generally assumed. The measures are not designed to assist Greece or the other troubled countries. In reality, they are designed to support banks that have lent heavily to them.

The exposure of Germany and France to troubled European countries remains around $1 trillion. According to the Bank for International Settlements, as at the end of 2009, French banks and German banks had lent $493 billion and $465 billion respectively to Spain, Greece, Portugal and Ireland. Default or restructuring would result in large losses to the banks, potentially triggering a return to the apocalyptic conditions of late 2008.

European banks remain vulnerable. The recent bank stress tests did not seriously test likely losses in case of sovereign debt restructuring and realistic falls in commercial real estate prices. The tests did not apply to the bulk of bank’s holdings, only testing around 20% of the sovereign bonds held, making the test of limited value. The definition of capital was generous. It was effectively a car “crash test” where the testing authority deems the car cannot crash.

In the best case, the measures taken by the EU and ECB will force deeply indebted European countries to take steps to bring their economic houses in order, allowing an orderly debt restructuring. The EFSF and other facilities will also underwrite vulnerable country’s ability to re-finance maturing debt and finance budget requirement.

Banks and other lenders can also build up reserves and capital to absorb any write-offs that are required in such a restructuring. If successful this would minimise losses and limit disruption in the global economy.

The position of Greece highlights the underlying logic. According to the EU’s projection, Greek debt will increase from Euro 270 billion in 2009 to Euro 337 billion in 2014, from 113% of its Gross Domestic Product to 149%, even with the successful execution of the economic actions required. Given that Greece cannot sustain its current level of debt, it is unclear how it will be able to carry 25% additional debt (Euro 67 billion) with an economy that is expected to shrink by 5% during that period.

Discussion about losses lenders to these countries will have to bear are already evident. In extending guarantees of borrowings by its troubled banks, Ireland indicated that junior or subordinated lenders might not receive the face value of their investments. As in any debt restructuring, it is unlikely that lenders will be able to avoid losses entirely.

Major economies have over the last decades transferred debt from companies to consumers and finally onto public balance sheets. The reality is that a problem of too much debt cannot be solved with even more debt. Deeply troubled members of the Euro-zone cannot bail out each other as the significant levels of existing debt limit the ability to borrow additional amounts and finance any bailout. As Albert Einstein noted: “You cannot fix a problem with the kind of thinking that created it.”

A huge amount of securities and risk now is held by central banks and governments, which are not designed for such long-term ownership of these assets. There are now no more balance sheets that can be leveraged to support the current levels of debt. The effect of the European bailout and the EFSF is that stronger countries’ balance sheets are being contaminated. Like sharing dirty needles, the risk of infection for all has drastically increased.

The European bailout is primarily a debt shuffling exercise which may be self defeating and unworkable. George Bernard Shaw observed that “Hegel was right when he said that we learn from history that man can never learn anything from history”. The resort to discredited financial engineering to solve the European sovereign debt problems highlights the inability to learn from history and the paucity of ideas and willingness to deal with the real issues.

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29 comments

  1. Maju

    “The measures are not designed to assist Greece or the other troubled countries. In reality, they are designed to support banks that have lent heavily to them”.

    Exactly.

    And that has nothing to do with restoring the real economy but just with keeping some international oligarchs safe.

    Iceland chose the correct path probably by preventing the debt to be piled upon the citizens (and sending bankers to trial, something we still have to see elsewhere) but Greece is, well, being scammed to the last drop of blood.

    And worst is that the plundering scheme is being extended to more and more countries, in a context in which the authorities (Commission, ECB) are not even elected democratically at all.

    It’s an uncontrolled implosion of EU. And not even Germany will get away because there is a problem of a wrongly designed import, rather than export (or balanced) economy.

    The only thing that can be done is to expropriate all banks and any industry that risks leaving the continent or collapsing and declare the debt void as a single bloc. The rest of the world, IMF included, would have to put up with EU doing that because EU is still the largest economic area worldwide and produces some 28% of the Gross World Product (nominal) or 21% PPP.

    But this would need of a social and political revolution happening from bottom up. Not tomorrow, so the plunder will continue and social and political degradation will as well until the steam doesn’t hold up anymore.

    It was and is in any case a fundamental error to insist in budget cuts, specially when these damage the economy by curtailing the demand (lower pensions, salaries, welfare payments… mean lower purchasing power and a weaker economy). EU could have done better, specially as it has a long history of subsidies to the economy, both at the state and union level, and is powerful enough not to be concerned about what bankers think, specially in times of crisis (a crisis generated by bankers, which they are not yet paying).

  2. Sid

    Profound. I am a cat, not a conspiracy theorist, but the key sentence here reads:

    “The [European Bailout package and the EFSF] are not designed to assist Greece or the other troubled countries. In reality, they are designed to support banks that have lent heavily to them.”

    This is the key to understanding the real rationale behind “European solidarity,” and it is not just to keep fat cats in bonuses/destroy democratic socialism/a nefarious plot by a few hedge funds or Anglo-American finance capital as a whole (choose one.) Simply put: everyone in the EU owes everyone else such immense sums of money that the default of any one party will result in cross-defaults all around.

    The Greek government owes money to French insurance companies, Dutch banks, German pension funds and the like. These institutions in turn owe money to their bondholders, depositors, creditors, consultants, and beneficiaries. As a result, national governments are forced to get into the act and prop the system up.

    These goverments were already shaky enough and will collapse if forced to address -either- the bankruptcy of their financial sectors -or- the losses which their citizens will ultimately have to eat as a result of such collapse. The Norwegian option is not really an option for these governments.

    Citizens of northern European countries do not necessarily see it that way. They made a bargain with their banks, insurers, etc. and they stuck to the terms of the deal they made. They do not see why they should in essence be forced to bail themselves out because some Greek bureaucrats decided to play funny number games for years while Brussels turned a blind eye.

    On one level, they’re right. On the other hand, when the boom was on, Dutch pensioners weren’t exactly clamoring for their funds to reduce their investments in Irish properties or questioning their portfolio managers why they were going for the additional yield afforded by Greek government debt.

    n.b. the difference between the EU and Iceland is that most depositors in German banks are German citizens who pay taxes in Germany and vote in German elections. Icesave depositors were mostly denizens of countries like the UK and the Netherlands who have no option to vote for Icelandic politicians who will promise to use government monies to make them whole.

    1. DownSouth

      Sid said:

      n.b. the difference between the EU and Iceland is that most depositors in German banks are German citizens who pay taxes in Germany and vote in German elections. Icesave depositors were mostly denizens of countries like the UK and the Netherlands who have no option to vote for Icelandic politicians who will promise to use government monies to make them whole.

      That’s true, but the following is also true:

      n.b. the difference between the EU and Greece is that most depositors in German banks are German citizens who pay taxes in Germany and vote in German elections. The depositors were mostly denizens of countries like Germany and France who have no option to vote for Greek politicians who will promise to use government monies to make them whole.

      And yet, Greek politicians, unlike Icelandic politicians, continue to carry water for German and French banks and are willing to put a bullet in the head of their own populses in order to bail out the German and French banks.

      Do you not see something wrong with this picture?

      1. DownSouth

        And the German and French savers, instead of blaming the Greeks, should focus their anger on the true architects of this fiasco—-the sociopaths (neoliberals) who constitute their banking, corporate and political class.

      2. Positrol

        You are comparing apples and oranges. In the Greek case, we are talking about debt that the country (i.e. all citizens combined) took on – not private banks like in Iceland …

        1. DownSouth

          The distinction is not nearly so great as you would have us believe it is.

          A brief study of neoliberalsism shows that it matters little whether the debt run up is private or public. One of neoliberalism’s magic tricks is how quickly private debt can be converted to public debt.

    2. Eric

      If one assumes that the Greek nation has the intention of meeting their debt obligations, then the bailout does in fact assist them in doing so. Since the money was spent by the Greek nation as it was intended (maybe unwisely, but that is a different matter), I think it is dishonorable to make any assumption that Greece does not intend to pay. So if you are helping a party pay it debts, to hint that it is really meant to protect its creditors is meaningless: that is exactly the debtor/creditor relationship. If you feel that Greece intended to stiff its lenders and this bailout is some nefarious way to prevent Greece from doing so, please explain that more clearly.

  3. a

    “The European bailout is primarily a debt shuffling exercise which may be self defeating and unworkable.”

    And what, since 2008, hasnt been? The Fed buying MBSs isn’t a debt shuffling exercise? Or what about the US Treasury lending with 3% or even 0% down to housebuyers? Does anyone, outside the government, certain saltwater economics departments, and the more delusional parts of Wall St., actually think these are better than self defeating?

    Pointing out that a proposal may not work, is not interesting. *No* proposal may work.

    Point out a solution that will work, and the world will beat a path to your door.

    1. DownSouth

      a,

      Granted, there is nothing that can put the spilled wine back in the bottle.

      And granted there is no difference between what is going on in the EU and what is going on in the US. They’ve both become neoliberal wet dreams.

      But there are things that can minimize wine being spilled in the future. Essentially, the policies being pursued by both the EU and the US come right out of Hoover’s playbook. He recapitalized the banks, but made no effort to reform the banks, replace their management, or reign in their abuses with regulation.

      Then came “a social and political revolution happening from bottom up,” as well as one from the top down, as is well documented by Frederick Lewis Allen in his book Since Yesterday.

      So when FDR came to office, he continued with Hoover’s policy to recapitilize the banks. He did not, however, continue with Hoover’s laissez faire absolutism. He did not continue with Hoover’s austerity for the rank and file.

      So there are options available here other than what you would have us believe.

  4. Romeo Fayette

    Yves–
    It’s interesting to consider how the dog may be chasing his tail with this EFSF. Nevermind that the PII[G]S (minus Greece) guarantors of the credit they’ll eventually need to draw/default on in emergency, Germany/France are backing this and on the hook (like 19 other members) to guarantee the Facility’s loans.
    The $520bn rescue package SPV has a backing by member countries, with a surplus cusion AND a cash reserve for additional support. What’s funny–get this–is that “An additional reserve specific to each loan made by EFSF (”the Buffer”) will be created… The Reserve and Buffer are to be invested in liquid AAA rated government, supranational, or agency securities to be available as credit support for the EFSF’s obligations.”
    Let me get this straight: Germany contributes to the guarantee, then its contribution is invested back into Germany’s AAA government paper? I can think of so many words/phrases from the financial crisis du jour to describe this…

  5. Jackrabbit

    Sovereign Debt Crisis. The bastard child of “kick the can” politicians and “I’ll be gone, you’ll be gone” bankers.

  6. DownSouth

    Tax revenues are weak, growing 3.3% well below the targeted 13.7%. This is despite tax increases including a rise in the VAT rate to 23 per cent. Faced by a collapsing economy, rising unemployment, increased numbers of Greeks leaving the country and social unrest, the Greek government even announced a cut in corporate tax rates from 24% to 20%. How this was going to help correct the budget deficit remains a mystery.

    [....]

    By late September 2010, risk margins on Greek, Irish, Portuguese and Spanish debt (relative to German government bonds) were above to the levels prior to the announcement of the European rescue plan. In short, the problems remain largely unresolved.

    [....]

    The real rationale of the European Bailout package and the EFSF is different to that generally assumed. The measures are not designed to assist Greece or the other troubled countries. In reality, they are designed to support banks that have lent heavily to them.

    Welcome, Portugal, Ireland, Spain and Greece to the neoliberal shangri-la.

    Mexico has been living this nightmare for nigh-on 30 years, and we can all see how well that turned out.

    Unfortunately for Portugal, Ireland, Spain and Greece Mexico had a few trump cards that those countries lack:

    1) A de facto dictatorship and police state so that the government could force austerity down the throats of the populus

    2) Huge natural resources (oil and gas) that the government could pledge as collateral

    3) A “safety valve” to the north, with something like 30% of heads-of-households being able to find employment in the US so they could send money back to their families in Mexico

    4) A nifty $35 billion per year in cash income from the north derived from the sale of illicit drugs

    1. Crocodile Chuck

      down south,

      ” Huge natural resources (oil and gas) that the government could pledge as collateral”

      uh, I’ve read that Cantarell (Mexico’s equiv. of Ghawar in Saudi) is declining by 3% (a MONTH). Mexico is no longer the largest oil exporter to the US-today, its Canada.

      1. DownSouth

        Crocodile Chuck,

        According to Carlos Fuentes, writing in A New Time for Mexico, Mexican president Ernesto Zedillo pledged Mexican oil production as part of the bailout deal he arranged during the 1994 Economic Crisis in Mexico.

        The beilout is described here by Wikipedia, which fails to mention the part about Zedillo pledging Mexico’s oil production:

        The Mexican “bailout” attracted criticism in Congress and the press for the central role of the former Co-Chairman of Goldman Sachs, U.S. Treasury Secretary Robert Rubin. Rubin used a Treasury Department account under his personal control to distribute $20 billion to bail out Mexican bonds, of which Goldman was a key holder.[4] In late 1995, “[n]ewly installed President Ernesto Zedillo said he needed the cash to pay off bonds held by Citibank and Goldman Sachs, lest the New World Order come crashing down around the ears of its panicked acolytes.”[5] According to Hannibal Travis[6], Associate Professor of Law at Florida International University College of Law, the “former manager of $5 billion in Mexican investments at Goldman Sachs became U.S. Secretary of the Treasury and lobbied for legislation that forced U.S. taxpayers to contribute in excess of $20 billion to bail out investors in Mexican securities, in a form of ‘corporate socialism’”.

        All this happened well before Cantarell took its nose dive in production.

        Even though the “reforms” undertook by Zedillo moved Mexico from a neoliberal paradigm to a neoliberalism-on-steriods paradigm, and produced some of the richest men in the world such as Carlos Slim, it nevertheless has decimated Mexico’s working and middle classes.

  7. Mickey Marzick in Akron, Ohio

    No matter how one chooses to spin it, the recent Irish and Greek efforts to address their respective debt/credit crises with austerity has its limits. [Martin Wolf has espoused this view for quite some time]. Squeezing the turnip for more blood or the olive for more oil will not produce the desired result: the economic growth that makes debt servicing and its retirement possible. If anything, the squeezing threatens to spread to the more prosperous farms – France and Germany – threatening outright famine for all parties involved instead of occasional hunger for some.

    The solution is to produce more turnips or olives or to find a substitute – a new cash crop. Yet the prospects for doing so in the real economy would appear problematical. Even “farming” emerging markets may signify little more than a transfer of wealth instead of its actual creation. The latter is the key. Agriculture and manufacturing have reached their upper limits for additional expansion at a profit. Perhaps more efficient production will allow for profit taking. But even then such gains from productivity have their limit. Another turnip farm, olive grove, steel mill, auto plant, etc will only add to an already saturated market suffering from excess capacity. [POSTSCARCITY?]

    The debt/credit mountain in the WEST, whether public or private, signifies the decoupling of production from investment as well as a decoupling of production from consumption that occurred over the past four decades in the real economy. All the king’s banks and all the banks’ men aren’t going to put Humpty-Dumpty back together again because the opportunities for investment in the real economy are nil and consumption predicated on the additional expansion of credit is no longer sustainable within the current political economic paradigm predicated on market confidence. [Let’s not forget the TRILEMMA either…]

    More austerity kills the very growth – GDP – with which to pay down the debt, undermining the rationale for its imposition in the first place. [Hopefully, the idiots running this country are paying attention.] Yet the prospects for “growth” in the real economy are limited by excess capacity and market saturation, if not satiation. The expansion of debt/credit only digs the hole deeper with the prospect of ever retiring it becoming a figment of Humpty Dumpty’s imagination. Muddling through with the CDO solution in the “hope” that this situation – conundrum – will get better before it gets worse is something that Mr. Das’ article suggests has its limitations – a mere bandaid to keep the banks/ECB from hemorrhaging and killing the patient or the patience of those suffering. In the short term, the bleating and the bleeding will continue… but for how long is the question.

    Huis clos?

    1. DownSouth

      Mickey said:

      The debt/credit mountain in the WEST, whether public or private, signifies the decoupling of production from investment as well as a decoupling of production from consumption that occurred over the past four decades in the real economy.

      This kind of reminds me of what Glenn was speaking of yesterday when he used the terms “real world” and “fake world.”

      According to David Sloan Wilson, writing in Darwin’s Cathedral, human beings are the only animals capable of abstract thought. And I suppose this can be a great asset. But it can also be a great liability.

      This bit of wisdom seems to be appropriate for the current situation:

      It is a mistake to think that some of our impulses—-say mother love or patriotism—-are good, and others, like sex or the fighting instinct, are bad. All we mean is that the occassion on which the fighting instinct or the sexual desire need to be restrained are rather more frequent than those for restraining mother love or patriotism. But there are situations in which it is the duty of a married man to encourage his sexual impulse and of a soldier to encourage the fighting instinct. There are also occassions on which a mother’s love for her own children or a man’s love for his own country have to be suppressed or they will lead to unfairness towards other people’s children or countries….

      The most dangerous thing you can do is to take any one impulse of your own nature and set it up as the thing you ought to follow at all costs.

      –C.S. Lewis, “Right and Wrong as a Clue to the Meaning of the Universe”

  8. Wabac Machinist

    “We have spent two years cutting deficits and we still do not have things under control,” said Constantin Gurdgiev, a professor of finance at Trinity College in Dublin. “We already have a solvency crisis. Now we are setting ourselves up for a liquidity crisis.” — from today’s NYT piece on the govt. takeover of another Irish bank.

    Hmmm. Any comments?

  9. traderjoe

    Stepping back for a moment – there can be no solution to the multiple debt crisis’s rolling throughout the economies of the world. This situation is the mathematical certainty of fractional reserve fiat banking – which is destined to eventually collapse. In fractional reserve banking, all money is created through lending. A lender gives a borrower a $100 loan. But only the principal of the loan is created. The borrower must pay the interest through the borrowings of others (otherwise the money does not exist).

    The loan growth needed to support principal and interest payments is an exponential curve (hence the rolling multiple bubbles as we reach the end game). And all exponential curves must fail at some point. And when loan growth stops or declines, then not enough money exists to pay back the loans outstanding. This may be the reason for QE, as it creates some money for additional payments. But it will not be enough.

    Since fractional reserve fiat banking is fundamentally flawed, there cannot be a fix within the system. Austerity and stimulus are false promises as neither will work. Bailing out the banks will not work. It is merely a matter of time.

    I’m so tired of hearing the FinMins talking about saving their banking systems. Why? Shouldn’t the bond holders bear the losses? Isn’t that what being an investor means? Why should taxpayers pay for investor losses? Of course, that means the end of the financial system as we know it. Bring it on. It’s not capitalism without failure…

  10. Rodger Malcolm Mitchell

    traderjoe,

    You said, “In fractional reserve banking, all money is created through lending.”

    When a bank’s reserves do not support it’s lending, the Federal Reserve Bank provides the needed funds. Thus, for all practical purposes, fractional reserve lending does not exist.

    What limits bank lending? The bank’s own capital. A bank with zero reserves can lend millions, but those loans must be supported by the bank’s own capital. Perhaps it should be called “fractional capital lending.”

    Federal deficit spending creates money. Though federal borrowing continues, it is a relic of gold standard days, and should be discontinued.

    Finally, taxes and taxpayers do not pay for federal spending, which itself creates money ad hoc. If taxes were $0, this would not affect by even one penny, the federal government’s ability to spend.

    The government spends by crediting the accounts of its creditors, a process that requires only the touch of a computer button. No tax money is involved, as all taxes are destroyed upon receipt.

    I should mention that this is not the case for the states, counties and cities, which do spend tax money. Unlike the federal government, they are not monetarily sovereign (See: http://rodgermmitchell.wordpress.com/2010/08/13/monetarily-sovereign-the-key-to-understanding-economics/ )

    1. traderjoe

      @Roger – we disagree on several aspects, and rather than writing a long rebuttal, I’ll just slip in a couple of comments:

      1. In a 10:1 fractional reserve system, a bank keeps $1 in reserves and loans $9. This $9 is loaned into existance.

      2. The rest of your comment hints at MMT. Unfortunately, our currency is the Federal Reserve Note, not a hypothetical US Treasury Dollar. The Federal Reserve is a privately-held banking cartel. In order for the government to spend money, it must first borrow the FRN’s from the Fed. It cannot simply spend them into existence. The UST does not create the currency of the land (even though it is the only institution that can per the Constitution).

      That means the priavetly-held Fed creates currency for free (out of thin air) and in return receives a lien on the future productivity and labor of the citizens of the US (an interest bearing note). The fact that the income tax and the Fed were created in the same year is no coincidence.

      1. Ming

        trader Joe,

        Who is more powerful? Is it the people of the united states and their representatives( the US government) or is the Fed and it’s private and hidden owners. Who gave who the legitimacy to exist? That legitmacy exits because the US government has given it to the Fed… conversely if it should serve the purpose of the people of the United States, a lucid and uncorrupt government , could either remove the legitmacy of the fed or alter it’s mandate, or remove it’s owners.

        There is one partially legitmate objection… this would substantially change the rules under which government and business operate, and it is not fair to change laws and agreements ex- posit facto… but throughout history laws are modified or repealed based on their effects on people… or do you disagree with law( that goes against thousands of years of history) that made slavery illegal?

        1. traderjoe

          Ming, I’m not quite sure of your question. But in an attempt to respond:

          1. The voters should be the most powerful, but they have been ‘brainwashed’ and indoctrinated to believe that the current system is the ‘best’ one available (even though it systematically robs them of purchasing power/wealth over time). The Fed (read about its history) is an illegitimate institution that has corrupted wide swaths of government. Just for instance, it has never been audited by the government.

          2. The Fed does not serve the purposes of the people. It serves it’s banker owners. TARP, ZIRP, all benefit the banks, not the taxpayers.

          3. The current ‘democratic’ two-party system is a ruse to suggest the voters have a choice. The corporations/defense firms/banks are in charge of the system, and have captured the regulators/government.

          4. The system will have to implode before the people wake up and demand change. There is no indignation yet. Only fear to maintain the status quo because the new system is unknown – therefore to be feared.

          5. You could have a modification of laws which would account for the end of the Fed. This has happened two other times in our brief history (this is our third central bank).

  11. scraping_by

    The banksters are currently protecting themselves and their revenue by using a vocabulary trick. When governments talk about “austerity” they’re talking about diverting tax revenue from social welfare, human improvement, and public infrastructure to debt service.

    Austerity is visionary. Diversion is chicanery.

    Austerity is sacrifice. Diversion is embezzlement.

    Austerity is noble. Diversion is short-changed.

    Accurate speech is currently in nobody’s interest. The banksters and their government lickspittles would like to keep the money gusher abstract and continuing. The citizen/victims aren’t ready to rise up and kick them out, so they can’t look at being robbed too closely, either. If there’s an uprising and default, it’s down the pike a ways.

  12. hermanas

    Earlier today I was thinking of the Spanish Civil War, tonight news from Ecuador. The end of the road ahead?

  13. Psychoanalystus

    My friends,

    I would like to take a moment out of my relaxed and easy-going day to thank hard-working Germans, frugal Frenchmen/Frenchwomen, and charitable Americans everywhere for imposing these on-going austerity measures on us Greeks. We assure you that we truly enjoy our new Mercedeses, our beachside villas, and our Olympic-size swimming pools which you have so generously financed for us. Please keep the loans coming – we assure you that the austerity measures are working.

    Now, my friends, please allow me to return to my frappe me Pagoto (Nescafe frappe with ice-cream).

    Wishing ya’ll a productive day, truly yours,
    Psychoanalystus

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