January 08, 2012
Why we got GFC-2
And so it came to pass that, after my aggressive little note on GFC-1's causes found in securitization (I, II, III, IV), I am asked to describe the current, all new with extra whitening Global Financial Crisis - the Remix, or GFC-2 to those who love acronyms and the pleasing rhyme of sequels.
Or, the 2nd Great Depression, depending on how it pans out. Others have done it better than I, but here is my summary.
Part 1. In 2000, European countries joined together in the EMU or European Monetary Union. A side-benefit of this was the Bundesbank's legendary and robust control of inflation and stiff conservative attitude to matters monetary. Which meant other countries more or less got to borrow at Bundesbank's rates, plus a few BPs (that's basis points, or hundredths of percentage points for you and I).
Imagine that?! Italy, who had been perpetually broke under the old Lira, could now borrow at not 6 or 7% but something like 3%. Of course, she packed her credit card and went to town, as 3% on the CC meant she could buy twice as much stuff, for the same regular monthly payments. So did Ireland, Portugal, Greece and Spain. Everyone in the EMU, really.
The problem was, they still had to pay it back. Half the interest with the same serviceable monthly credit card bill means you can borrow twice as much. Leverage! It also means that if the rates move against you, you're in it twice as deep.
And the rates, they did surely move. For this we can blame GFC-1 which put the heebie-jeebies into the market and caused them to re-evaluate the situation. And, lo and behold, the European Monetary Union was revealed as no more than a party trick because Greece was still Greece, banks were still banks, debt was still debt, and the implicit backing from the Bundesbank was ... not actually there! Or the ECB, which by charter isn't allowed to lend to governments nor back up their foolish use of the credit card.
Bang! Rates moves up to the old 6 or 7%, and Greece was bankrupt.
Now we get to Part 2. It would have been fine if it had stopped there, because Greece could just default. But the debt was held by (owed to) ... the banks. Greece bankrupt ==> banks bankrupt. Not just or not even the Greek ones but all of them: as financing governments is world-wide business, and the balance sheets of the banks post-GFC-1 and in a non-rising market are anything but 'balanced.' Consider this as Part 0.
Now stir in a few more languages, a little contagion, and we're talking *everyone*. To a good degree of approximation, if Greece defaults, USA's banking system goes nose deep in it too.
So we move from the countries, now the least of our problems because they can simply default ... to the banks. Or, more holistically, the entire banking system. Is bankrupt.
In its current today form, there is the knowledge that the banks cannot deal with the least hiccup. Every bank knows this, knows that if another bank defaults on a big loan, they're in trouble. So every bank pulls its punches, liquidity dries up, and credit stops flowing ... to businesses, and the economy hits a brick wall. Internationally.
In other words, the problem isn't that countries are bankrupt, it is that they are not allowed to go bankrupt (clues 1, 2).
We saw something similar in the Asian Financial Crisis, where countries were forced to accept IMF loans ... which paid out the banks. Once the banks had got their loans paid off, they walked, and the countries failed (because of course they couldn't pay back the loans). Problem solved.
This time however there is no IMF, no external saviour for the banking system, because we are it, and we are already bankrupt.
Well, there. This is as short as I can get the essentials. We need scholars like Kevin Dowd or John Maynard Keynes, those whos writing is so clear and precise as to be intellectual wonders in their own lifetimes. And, they will emerge in time to better lay down the story - the next 20 years are going to be a new halcyon age of economics. So much to study, so much new raw data. Pity they'll all be starving.
Posted by iang at January 8, 2012 07:12 AM | TrackBackIt is very tempting to blame the banks, but ultimately I think it boils down to two catastrophic governmental failures...
1. The first was a regulatory system which made reckless gambling the duty of any bank seeking to maximise its return for shareholders - which, after all, is a public company's core duty.
A public company normally has a responsibility to balance risk against reward under the watchful eye of the shareholders and investors. When the government steps in and provides a guarantee (acknowledging that retail banking depends on trust and confidence), it has a duty to replace the fear of loss with sufficient regulation to prevent reckless pursuit of profit. This it failed to do, with the inevitable consequences.
I am not a gambler, but if somebody told me I could go to a casino and they would cover my losses, but let me keep any winnings, I think I would be tempted to behave a little recklessly too..
2. The second was an international culture of living on credit using loans with no expectation of being able to repay the debt in the period of the loan. That in turn meant relying on being able to take out new loans at regular intervals with no guarantee as to rate or even availability of a replacement. That provides any imprudent government with the tools necessary to bankrupt the country it governs, even those with normally sober administrations. It is also one of the practices followed by the banking sector as a way to gain greater leverage than could be achieved by relying on saver deposits for capital. In effect, retail banking was a source of free insurance, not the core business.
So yes, the end result is that some banks need to be rescued, leading to a credit environment that bankrupts some of the more exposed nations, leading to more banks going under in stronger nations...
Posted by: DigbyT at January 7, 2012 02:54 PMThere is another issue to do with the Euro Zone crisis you've not mentioned and it's important because it will decide who is going to come out as the winner of the GFC competitions.
To start if you look at both the US Dollar and the Euro superficialy they appear similar in what backs them in terms of industry and agriculture and even the populations etc.
However two significant differences,
1, The US Dollar was the default world trading currency (the Euro never was or ever likely to be).
2, The US has a single financial body in charge "The Fed" the Euro has currently all the Governments of the EU acting in a Sovereign role.
The first difference allows the US Dollar significant latitude that the Euro does not have, because non US entities have to buy it to trade in. The Euro might have had this credability if the Euro Nations had responded to Sadam's offer to sell Iraq's oil in Euro's in return for getting the US of it's back, but Tony Blair put the boot in that for various reasons.
Which highlights the second problem, to most of the Euro Sovereign Nations it is their own self interest not the interest of the Euro Zone or currency that holds sway. It's a little like a life boat of 20 or so greedy people with a few altruistic people. If the altruistic people are strong they can impose some order. However with the inevitable "theft" they eventually weaken faster than the greedy thieves who eventualy rest control and order goes over the side in a greedy race for the bottom of the food barrel.
Which brings up a third issue in that in reality none of the European control bodies are anything but fraudulent (just look at the history of their "books" etc). This dishonest behaviour is rampent and has resulted in mass resignations to avoid "bad press" misusing arrest, search and siezure laws to stop investigations and whistleblowers not just by members of the press but even of the EU's own appointed fraud investigators...
Worse though "handouts" were enshrined into various bit's of EU legislation one of which was the Common Agricultural Policy or CAP. If you look at the cuntries most up to their necks in Euro debt they were all "hanging of the tity of CAP" Take Eire at one point they were getting six Euro's in subsidy for every Euro they put into the EU budget, the same with Greece. However you then have to look at the level of fraud involved in the case of Greece it had CAP hand outs for town squares amongst other frauds.
So not only were the likes of Greece getting loans on the very cheep, they were also getting free money out of the Industrial Nations proping them up, so not only the keys to the sweet shop but deliveries for free...
Maggie Thatcher pointed out back in the 1980's CAP was unsustainable and re-negotiated the UK's payments much to the detriment of the UK farming industry (which also has the side effect of leaving the UK subject to the vagaries of bankrupt food producing nations on which it is dependent for it's daily bread etc). Where Maggie further went wrong was to lead the charge into "de-regulation" with the likes of the Lloyds Act.
And for those still daft enough to think the "freemarket economy" is anything other than a race for the bottom or monopolistic behaviour a study of the Lloyds Act and the subsiquent inflation of the insurance market quickly followed by the LMX Spiral that lead to Lloyds efffectivly going bankrupt is just one object lesson of why lack of financial regulation is a significant and ultimatly terminal mistake.
Of course Maggie also made some other very serious mistakes one of which was a power struggle for ideological reasons with the Unions that all but destroyed British Manufacturing Industry. The downside was that it put the income for the UK into two areas, exploitation of vital non renewable resources (oil/gas) and "service industry" AKA "the banking and finance sector". Both of which has left the UK a hostage to other nations.
It is also a mistake made by Maggies "actor sidekick" "Ronnie Ray Gun" the part time US President and "bomb the Commies" activist. In some respects they appeared to be in competition to see who could be more idiologicaly radical than the other.
So both the UK and US downsized or outsourced and off shored it's manufacturing industries and sold vital natural resources at bottom dollar to other nations that then used them sensibly to build up their own industrial sector.
So much of the ground work for GFC-1 and GFC-2 (and what will be truely world changing GFC-3 starting later this year) was laid down in the 1980's by the idiocy of "political ideals" of "greed is good" and "de-regulation is good" by those with very very short term interests and outlook (the Politico's) who did very very nicely out of it and still continue to do so.
Oh and in any race even one to the bottom there has to be winners and losers not just of individual races but the overal competition and I confidently predict that China is going to be a major collector of medals in this.
The essence of what has given rice to GFC-1&2 is the "slash-n-burn" short term attitude of politicians and the banking and finance sectors, plain and simple. Worse, actually having this behaviour codified in "company law" is just making the issue worse and further codifing the tax payers as the "insurer of last resort" has always been the hight of stupidity as it alowed the "to big to fail" mentality to be exploited because it's always had the opposite effect of that intended, it protects the wolves not the sheep...
It is some what wry that you mentioned JMK, because in many ways he predicted much of this. However if his "solutions" are viable or not will probably be put to the test as badly as possible by the very short term outlook of Western Politicos.
Posted by: Clive Robinson at January 8, 2012 02:29 PM