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.