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Rosenberg objects to the all bailouts all the time mentality we see with Greece

David Rosenberg is sick and tired of what I call the all bailouts all the time mentality. He writes in today’s Breakfast with Dave piece:

Ban the Bailout

First we have governments bailing out banks (and auto companies and mortgage providers), homeowner debtors, and now we have governments bailing out governments.  When does someone finally say — enough is enough!

Oh no — bank ABC is too big to fail.  Company XYZ is too complex to fail.  And now country GRK is too interconnected to fail.  Give me a giant break.   Look, Greece is not going to “fail”.  They are going to default.  There will be a debt restructuring.  And there will be some recovery.  Bondholders will take a haircut — why shouldn’t they?  Why should Angela Merkel care if German banks own Greek bonds?  Greece has been in default in its recent 200-year history almost half the time.  So has most of Latin America come to think of it.  What about Russia?

So Greece defaults, bondholders who knowingly bought these instruments knowing the historical record went for the yield and simply do not deserve a taxpayer supported bailout of any kind.  To actually come to the aid of Greece (especially after all the accounting gimmickry) would send a signal to investors that the best way to make money is buy the debt of the most risky and highest yielding enterprise because there will always be a bailout.  Rewarding bad investment decisions is a huge mistake, in my opinion.

Let Greece default, the world will not come to an end, and whether or not the country gets a “bailout”, the fiscal drain is going be a pervasive drag on economic activity for at least the next five years.  While there may be contagion risks — same deal.  Investors who bought Club Med bonds with their stretched government balance sheets in order to stretch for yield don’t deserve to be bailed out either.

Taxpayers unite, wherever you live (because you too support the IMF).  These are solvency issues we are talking about, not liquidity issues.  This is about bad decisions, not market failure.

Welcome to the wonderful world of moral hazard, Dave.  You know I am fundamentally against bailouts.  I wouldn’t say I am categorically against bailouts because bailouts are a political decision, not an economic one. Politicians don’t like being held responsible for the economic disaster that results from a large bank, company or country going bust. And they will do whatever they can to prevent this. It’s as simple as that.

In the case of Greece, Angela Merkel doesn’t want the German banks to take a hit. They have a weak capital base and the weakest of them all, Hypo Real Estate, has a lot of exposure to Greece in addition to other already known toxic assets. I talked about this on BNN yesterday afternoon (watch the clip here). More than that, the Europeans are deathly afraid of the whole euro-zone unravelling as the contagion spreads into a Spanish Flu epidemic. It is an attack on Spain that would cause this sovereign debt virus to metastasize into a lethal predator.

The euro-zone shouldn’t really exist. It is poorly designed operationally and its members’ economies are completely unharmonised. The Brits had better thank their lucky stars Gordon Brown kept Tony Blair from railroading them into this thing. The euro-zone is a political construct forced through against the will of the people (in Germany) by the likes of Helmut Kohl and Francois Mitterand. The thinking was that it would promote European integration – and, depending on who you ask, it would also promote the individual interests of specific countries. Kohl, by the way, is the same politician who brought economic disaster to Eastern Germany by binding it into a currency union with the West at a one-to-one Mark for Mark exchange rate. The result was an immediate rise in labour costs and unemployment – a situation that still plagues Eastern Germany today.

But, the fatal flaw in the Eurozone was twofold. On the one hand, it created a gold standard like fixed-exchange rate bind which means that the currency depreciation option is moot. Doing so without some sort of fiscal transfer mechanism is reckless because it severely limits the options of countries during economic downturns when the typical policy options are also likely to be most politicized and polarizing. It is like setting up the United States where each state has national sovereignty and there is no central treasury but there is a central bank.

Meanwhile, the Eurozone has restricted the ECB from printing money as a remedy.  That leaves default and bankruptcy as the only option in a severe economic slump. Some of today’s present political actors are complicit in its construction. Simon Johnson and Peter Boone explain.

As I see it, the risk of default is still there even after the Germans supply the Greeks with aid.  The hope is that this will be enough to quell the markets and stop people from dumping Portuguese and Spanish sovereign bonds – or at a minimum enough to help them roll over their debt on favourable terms. If Spain can buy time and the global economy doesn’t double dip, we could get out of this one.  But if the global economy double dips or contagion pushes yields up too far, Spain will default over at least next 2 years.  There is not much room for error.  We better hope this works.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

14 Comments

  1. Anonymous says:

    I guess i disagree in some extent , usa is able to finance its outrageous deficits because the rest of the world believes it has a much sounder currency despite a fiscal and monetary stimulus of 30% over GDP, yeah print bills as long as the rest think your are dealing well with your economic situation. The truth is that this a recovery on fragile grounds, once stimulus is retired who will replace that extra 10% of GDP carried out by goverment, what if next year usa has another 10% of deficit ? No matter that growth returns this a system too overleveraged due to the abandonment of gold standard replacing work with debt and spending. Viva la vida! Dubai invested in assets not generating a reliable stream cash flow, greece has been living beyond its means for decades o centuries thanks to leftish policies, ireland or spain constructed an economy or infamous miracle too biased on construction and weak employment creation(low income jobs), thus no wonder that revenues plummeted having to increase spending for social help and so on. USA? well will see that ZIRP is the greatest fiasco and that that den of thieves called FED be prosecuted with its WStreets friends. Savers are robbed with this fed polciy , workers income is devalued and taxpayers paying ironically bonuses those who created this mess, mainly bankers and politicians.

    • Carmelo, the long and short here is that the euro-zone governments effectively borrow in foreign currency which they cannot print. That matters A LOT.

      I will be writing a post about the US versus the Euro-zone.

      • Ed is right. To reiterate: there is no financial constraint on the ability
        of a sovereign nation to deficit spend. Note that this doesn’t mean that
        there are no real resource constraints on government spending; this should
        be the real concern, not financial constraints. If government spending
        pushes the economy beyond full capacity, inflation will result. Inflation can
        result even before full employment if there are bottlenecks or if firms have
        monopoly pricing power. Government spending can also increase current
        account deficits, especially if the marginal propensity to import is high. This
        could affect exchange rates. The alternative would be to use fiscal
        austerity to try to keep the economy sufficiently depressed that pressures on
        prices or exchange rates are eliminated.
        But using PIIGS countries as analogues to the US is a result of the
        failure of deficit critics to understand the differences between the monetary
        arrangements of sovereign and nonsovereign nations. Greece is a user of the
        euro—not an issuer. In that respect, it is more like California or even
        Orange County, which are users of the US federal government’s dollar.

        In a message dated 4/29/2010 14:30:53 Mountain Daylight Time,
        writes:

        Edward Harrison wrote, in response to carmelo:

        Carmelo, the long and short here is that the euro-zone governments
        effectively borrow in foreign currency which they cannot print. That matters A
        LOT.

        I will be writing a post about the US versus the Euro-zone.

        Link to comment:
        http://www.creditwritedowns.com/2010/04/rosenberg-objects-to-the-all-bailouts-all-the-time-mentality-we-see-with-greece.html#comment-4
        7494473

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      • Anonymous says:

        Edward let me remember you that the reports of the us federal goverment issued by GAO are observed, also jim grant released a newsletter regarding the status given to us dollar as an undisputed reserve currency.

        johnhaskell you can default by creating inflation in order to devalue your debt

        • Default by inflation is not the same thing as default by inability or refusal to pay. So we can’t conflate the two operationally. For instance, CDOs are based on inability or unwillingness to pay.

          I would also add default by devaluation to the list where the creditors are foreigners. That is the preferred vehicle of countries like the US that have a large percentage of their debt obligations in their home currency.

          I know a lot of people who poo-poo the pernicious effects of higher inflation which unfairly re-distributes income within a society and makes a country poorer vis-a-vis the rest of the world. I think this is wrong. But the reality is true default is true default. Soft default via inflation or currency depreciation are not.

          • Carmelo,
            If “default” was defined by inflation, then why is it I can’t collect on a credit default swap on any country that runs a positive rate of inflation? Even a country running 10, 15n or even 20% inflation is not within the list of what is defined as “default” for the purposes of CDSs. Nor, for that matter, do the ratings agencies define it that way.

            Nice try, but you’ll have to do better.

  2. John Haskell says:

    Carmelo- the Federal Government has never defaulted on its obligations, therefore it is considered relatively creditworthy. Greece takes a rather more casual approach and the markets know this. The creditworthiness of Greece and the US are of different orders entirely.

  3. Kirk Kinder says:

    Ed,

    I think it will be a certainty that Greece will default in the future even with this bailout. They have made too many promises to its citizens and government workers. These costs are only going to increase as time progresses. The unfunded liabilities of Greece, US, UK, France, Germany, and the rest of Europe are staggering.

    I understand Marshall’s argument about no financial constraints on a country that can print its own money, but Greece and other nations will have to rectify their irresponsible actions at some point.

  4. Element says:

    On April 20 2010 – Germany’s Finance Minister refused to hand over 8.6 billion euros in low-interest loans until Athens presents a credible plan to cut spending and put its economy in a persuasive position.

    Thus on April 28 the IMF was getting blunt in saying; “Everyday which is lost is a day where the situation is growing worse and worse, not only in Greece, but in the whole European Union, and it can also have consequences more far away.” – Dominique Strauss-Kahn, IMF Managing Director.

    Now this is getting interesting;
    Germany knows Greece will default. Germany wants the euro lower. Germany knows contagion will spread. Germany knows many of its banks are toast. Germany knows its impossible to rescue EU states without destroying the EMU and its own economy. Germany has decided it is in its best interests to force default sooner rather than later, and not send good money after bad.

    Germany has decided this is an involuntary opportunity to clean up its banks and get ready for new growth. Germany feels the market must punish those who did not live within their means or keep strictly to EMU conditionality agreements. Germany likewise believes German bankers who made such loans must pay a price also, and clean up their mess, or go away. Germany does not care if Greece leaves the EMU or if it stays.

    That’s the ‘discipline’ or ‘punishment’ Merkel is referring to. She is being very logical about this, and her insistence on IMF involvement was apparently to derail the EMF loan offer agreement. Merkel said Greece would not get German money, and I do believe she meant it. It was in fact a real master-stroke to pull the IMF into the line of fire at the last moment on the 25th of March. Merkel got on TV immediately after the EU parliament was announcing it had cobbled together a deal to bailout Greece, if it was needed. And the Swedish PM offered support for Merkel insisting on IMF involvement.

    Merkel is not going to operate to suit US interests, she is pursuing German interests and she knows there’s no way out, so is determined to make the best of a bad situation even if it impairs the EMU and EU in the short-term. This is entirely logical and necessary from her perspective. And if the USA was in Germany’s position, it would do much the same thing (though it will be spun as beggar-thy-neighbour tactics). As far as Germany is concerned they did it to themselves.

    So the IMF are on the hook and serve as a whipping-boy to deflect debtor criticisms off the EU. It’s coming clear the IMF will have to move quickly to negotiate big haircuts on Greek debt. This is after all what Dominique Strauss-Kahn is referring to above, a major EU banking crisis, that will radiate the longer it is left to fester. Well Dominique, you are the bunny now, it’s up to you to get it done.

    Then we have the French;
    France knows what Germany knows. The French know because the French Finance Minister actually sat in on a closed German Cabinet meeting on the 31st of March 2010 (the first time this has ever happened) in which the German Cabinet agreed to force all German depository banks to contribute to an e1.18 billion fund to finance future bank rescues.

    So the French are fully aware of what the German position is (or recently was) with regard to the coming bank crisis.

    Then the next morning Merkel made a short trip to the UK to speak privately with PM Brown ostensibly to talk the Brits into contributing to a mutual European bank rescue fund. The UK Govt publicly mouthed concerns about what that might mean for the UK financial sector’s recovery. So I expect the Big European players all understood by about the 1st of April 2010 that Germany intended to bring on a default. Brown called an election before the crisis hit.

    All that was needed was time, to get the IMF in place and hope GGB rates remained low for a few months. But four weeks later the jigg is up.

    Now Germany has to say it will provide loans but string it out for as long as possible before finally refusing, and going to haircut stage while the bond rate contagion spreads. It was always going to anyway, delaying it would just make the losses and waste even worse. So the IMF realises it’s been suckered into having to negotiate haircuts, plus provide interim loans to prevent total Greek economic collapse with virtually no strings attached.

    And the French are not being vocal with respect to Germany because they have to manage the domestic politics of huge bank exposures. So they let Merkel take the lead now, and the international heat. France fully knows its banks are toast and also will not want to waste more money on a doomed rescue of Greece, and they likewise want a lower euro. So, make the best of a bad situation.

    As for the Brits their losses will be almost as large as Germany’s as the crisis unfolds, which is why the IMF’s funds have been recently tripled, to ease and slow down the damage to the biggest players. (I sure hope that works)
    And don’t forget that there’s the exposure of each of the PIIGS banking systems, to the mutual debts of the other PIIGS;

    i.e. Portugal = 23.3% Ireland = 41.8% Italy = 3.4% Greece = 9.1% Spain = 10.5% [Source Data: BIS] Thus; Greece’s failure hurts Ireland and Portugal the most. Portugal’s failure hurts Spain and Ireland the most. Ireland’s failure hurts Portugal most. Spains failure absolutely shatters Ireland and Portugal. So if, or rather when either Ireland or Spain fail to refinance (which they will) we get global credit freeze and money panic.

    In a word, dominos.

    Then we have Greece;
    Athens knows it will (soon) default. Athens realises Germany is going to withhold loans, to force it to default (soon). Athens knows it can not pursue the necessary austerity implied by the required spending cuts. Athens knows the Greek people’s demonstrations will turn into sustained riots, unless they get what they need. The removal of liability via destruction of public debt and a reduction of tax take. The Greek people will settle for no less. If they get that they can recover much faster. Athens knows it would be better-off defaulting and forcing haircut debt reduction early and thus require less tax stress and real economy damage. Indeed, the Greek people’s pronounced tendency to protest and even riot is probably the Greek PM’s greatest diplomatic asset in dealing with the IMF and creditors.

    The Greek PM will pursue Greek national interests to maintain social and political stability, plus sovereign authority and economic pre-requisites for ensuring territorial security. Greek Governments have been playing this game for millennia and the Greek people are some of the most sophisticated. The Greeks very much see themselves as aware, enlightened, educated and very advanced people. They believe they have a much superior culture to that of the United States or Western Europe. Don’t fall for the line that Greeks are either lazy, dumb, or socialist. Greeks do not accept they are any of these things. They have an extremely shrewd and complex mix of cultural values and this results in different and very direct priorities. Their culture is advanced and they were this way long before mere Socialism appeared in Europe. Frankly, if you want morbid socialists and do-nothing eco-freaks just visit the EU Parliament, it’s riven with them.

    When you see Greek demonstrators and so-called “left-wing anarchists” breaking stuff and getting violent, what you never hear in western media is that these people are resisting what can be called ‘PAX-America’. That’s what they are against and why the US has never tamed the Greek people. It’s a long-term cultural difference. The IMF is a perfect symbol of PAX-America. The EU is another derivative of that way of thinking and presuming power. What the demonstrators are in fact insisting on is that the Greek ways of life and Greek cultural values be 100% preserved, no matter what anyone from any foreign centralist power pyramid says.

    The Greeks are entirely serious about this, and the ultimate expression of Democracy is people power. And that’s what’s so lacking in the US today and why they find the tame US-Anglo political culture contemptible. They point-blank refuse to play by PAX-America rules or German rules, and any coercive insistence that they do, simply guarantees active resistance. What the Greek people are in fact doing here is making it very clear that the people are in charge of Greece, and elected politicians had better not get the idea that they run things. These are not ‘socialists’ or ‘anarchists’ (and nor are they ‘terrorists’), they are Democrats – real ones! It’s there country it will be governed how they say, or else. Greek governments know the people will win the deficit debate. Even the Police and Military know they can not force anything on Greeks.

    Frankly, I’m glad they are like this, totally stubborn and uncompromising. We have them to show us exactly how to put any banker or politician in their place, or force them out, if necessary. PAX-America never tamed Greece during the cold war, and the EU won’t succeed this century either. The Greeks are more likely to stay in the EU simply to mock and frustrate the Angela Merkel’s of the EU world, and to keep EU central authority dictums ultimately toothless. We are about to see that Greece is quite capable of living within its means, and still a happy relaxed place to live. But they don’t pay taxes? Ah, but that’s the Libertarian in them – keep out of my pockets and I won’t riot and burn down your Parliament. Like it or not, that’s the outcome of millennia of Culture, Philosophy and Civilisation and it isn’t going to change for the US or EU no matter what anyone does or says.

    Now let’s see, this year the big European states have so far shut-out Turkey, threatened Iceland, made noises about Romania, strung along the Eastern Baltic states, and are now asking Greece to kindly get-lost. Oh yes, Federation is going well. But then again, Australia’s Federation came about immediately at the end of the ultra-severe 1890s Depression, for it was obvious that lumped together with a common currency and policy we would be much stronger than if we remained separate bickering colonial states. The EU still might get it together if Germany gets told to get off its high-horse.

    As for the notion Spain is an uncompetitive basket case, I don’t buy it. Two recent examples; Germany, USA and France each have a well deserved reputation for building advanced high-performance naval ships for export. Australia had a requirement for 3 to 4 advanced long-range Air Warfare Destroyers in 2007, and bids were received from USA, Germany and Spain. The US was mortified that its latest and most advanced air-warfare and anti-submarine destroyer variant had been beaten by the Spanish design variant. Germany’s newest most advanced missile destroyer variant was eliminated early.

    And at the same time Australia required 2 large LHDs. An LHD is a 20,000 to 40,000 tonne fixed-wing or rotary-wing aircraft-carrier type amphibious assault ship. Detailed bids were received from both France and Spain. The French were aghast that the Spanish ship won, and it was not a matter of price, the Spanish design was bigger and more expensive but simply the most competitive, capable and suitable ship for the required role.

    So Spain can compete in ultra complex design, heavy engineering, and advanced technology implementation and integration against the best of the best who have been doing it for years. It’s not just Germany and France within the EU who can design and assemble cutting-edge stuff.

    The Spanish economy is sick, yes, but they can and will resolve this, and if they have to remove the public debt and implied tax burden to do it, I think that’s what’s going to happen. At that point recovery becomes easier and faster and given the unemployment levels who could blame them.

    At the moment the focus is on the harsh downside of default, but there’s a faster-growth upside of having no, or far less debt with lower taxes and a cleaned up banking system. As that becomes clearer, expect a lot more defaults to occur. This is ‘nuclear-delevering’ – delevering the fastest shortest way. Who cares if banks full of non-performing loans who can’t even lend anymore go broke and go away? They should go broke, and Angela Merkel seems to implicitly agree.

    “We hope negotiations will be concluded in the next few days. Then Germany will make up its mind. This is about the stability of the Euro area as a whole and we will not shrink from our responsibility. Our precondition however is that Greece will accept an ambitious austerity program.” – Angela Merkel, 29th April 2010.

    It could not be any clearer that Greece is being systematically humiliated and can not and will not accept the intensity of austerity Merkel has in mind, so Germany will not provide loans and Greece will have a default trigger to obtain the necessary major haircuts, greatly improving its debt to GDP ratio, and EU banks will flounder as the IMF scrambles to arrange the haircuts, while hoping to avoid or slowdown a global contagion and credit freeze, and all the rest.

    “I think the handling of the Greece case shows that everyone knows we can not allow the same situation with countries as with Lehman Brothers. … We have to insist that the only way to survive this crisis is with a comprehensive, believable and un-sparing program that will be implemented in Greece.” – Angela Merkel, DW-TV, 29th April 2010.

    Merkel reportedly said that what was really needed was a long-term solution to Greece’s problems. i.e. she’s not interested in this ad-hoc patch-up. It was reported that in a meeting with the Heads of the EMU and IMF, that Greece will require as much as e135 billion in low-interest loans. Clearly that’s a bridge too far.

    A tired looking IMF head said, “It’s difficult because what has to be done by the Greek Govt and the Greek people is difficult, they have to go back on tracks to avoid a huge deficit that has been accumulated and it er can-not be done without being painful.” – Dominique Strauss-Kahn, DW-TV, April 29 2010.

    On top of this German opposition parties say they want private banks and speculators to contribute to the bailout [huh?] and called for drastic regulation against speculators on the currency and finance market, before a rescue loan is applied. And that is the Parliamentary environment that Legislation for a multi-billion euro aid package must be presented to the German Parliament for approval – some time next week.

    Well good luck with that! I suspect it will not even get close to passing – as intended. The German debate and Newspapers are digging-in about why they must work until age 67 to pay for Greek retirement packages and pensions that kick in at age 62, and several other issues. There’s no political will to mount an extend-and-pretend operation for Greece, and Merkel would get politically immolated if she tried to impose that.

    Germany knew this was coming months ago but did not get ready, or rather did, Merkel looked for ways to slow it down, while constantly increasing the hurdles to providing loans, while rightly pointing out that in a few months the same problem will re-emerge anyway, so either fix it or go away. To me its clear Merkel is building a case for refusing to provide loans in order to force an essential default before the first week of June. She’s already talking the language of a deep crisis because she knows there is going to be one and is already committed. She’s going to make sure Germany is not on the hook, and can not be blamed for not providing a temporary easy-out. She’s right about this being like Lehman Brothers, i.e. where no bailout came from on high to save the miscreant.

    “Time has proven to be the most expensive commodity – most expensive commodity now the markets are in crisis. Our political and economic allies can give us the time the markets refuse to give us today. We ask for no bailout, we are only asking for reasonable terms on our loans. … It would be dangerous for Greece, damaging for Greece, and we already feel the damage. But it could be catastrophic for the European Union and the World.” – George Papandreou, DW-TV, 29th April 2010.

    The problem is, the market is offering reasonable terms, and so is Germany, and he knows it, but he also knows it’s politically and economically impossible for both countries. France is not even interested in talking about this. The French President instead took a holiday to China, and the French Finance Minister is conspicuously absent (probably digging a slit trench).

    Oh yes, this is the Angela Merkel dog and pony show, as planned, and she’s definitely up for it. She’s not flinching at all. She’s not even going soft. She’s going harder and harder each day, and is not interested in playing extend-and-pretend for anyone. This is going straight to default, and George knows it, and that’s also what he knows is the only viable result. Even if he wanted to he could not impose such austerity – and Merkel knows it. Get ready for a very bumpy roller-coaster ride down the other side of the credit-bloated Global GDP bubble.

    Ed, I believe that when Merkel talks about “stability of the Eurozone” I think she means many years hence, not 2010, she’s the girl on the spot and she intends to fix as much of this mess as she can, and not leave it for the next guy/girl – and why wouldn’t she?

  5. Scott says:

    Hi Ed:

    If I am a bank with no reserves or depleted reserves, but I’m sitting on bonds that may be written down I’m not buying more of them and no one else was in the end. This is what the rising yields were signaling, correct?

    So, my sovereign puts a bid on rollovers, ensuring that my bank probably gets paid on my bonds, but does that create a situation where new money comes in and buys bonds after the specs make their money on the squeeze the government put creates?

    To Rosenberg’s point, isn’t the only opportunity here to push yields up and then profit on the ride back down? I’m not saying any single party can do that, but we create a mentality of durress and then bottom fishing which creates zero value. I want to speculate on the trade when I think about it. Why not? I either hold the bag when the sovereign defaults, my borrowing costs go up, or my monetary unit loses value, or my taxes are increased, so I should try try and make a buck too. If I do succede (sic), at least I’m not the last loser.

    I’m just wondering how recapitalizing banks and deficit spending create any savings to grow on. What is the time limit before capital depletion trumps the paradox of thrift in the mind of an economist? I’m guessing about my lifetime as far as everyone else but me is concerned.

    It’s a credit driven world though and I’ll never win this macro argument.

    SH