The Neoliberal Religion 24

Want To Ruin Your Own Country? Assume Your Banks’ Liabilities
Tuesday, December 14, 2010

http://gonzalolira.blogspot.com/2010/12/want-to-ruin-your-own-country-assume .html

Recently, I read up on how Iceland is doing—surprisingly well, actually.
Unemployment is down, the Krona is going back up. Good balance of trade,
good fiscal balance sheet. Quite the turnaround, after its troubles over
the last couple of years—

—so then if Iceland is doing OK, why then are we in the hole that we’re
in?

Why is the American economy slogging along? Why is Europe circling the
drain? Why are the bond markets queasy as a patient with a low-grade
malarial fever? Why is Ben Bernanke’s chin quivering and his voice
quaking on 60 Minutes? (And by the way: Was that a terrifying spectacle or
what?) Why has the conversation turned from bond market risk to sovereign
debt risk? Why are commodities rising, equities moving jagged and
irrational, and all of a sudden silver is now the new darling of the retail
investor?

What the hell is going on? Why are things getting worse, instead of better?


The answer is so simple, it hurts:

When the Global Financial Crisis hit in late 2008, the governments took
over the liabilities of the financial sector—and in the two years since
that terrible, terrible decision, that single move has turned what was once
a problem of financial sector insolvency into a problem of sovereign nation
insolvency:

Europe and America are insolvent—they’re broke. They cannot pay the
liabilities they have assumed.

That’s why we’re in the trouble we’re in. That’s why Ben Bernanke
is crying himself to sleep every night. That’s why the world’s
economies are slowly circling the drain—

—remember what happened, in the fall of 2008?

The Federal government bailed out the banks with the famed—not to say
infamous—TARP: The Troubled Asset Relief Program, a $700 billion bailout
of the banks by any other name.

For its part, in order to “save the financial sector”, the Federal
Reserve expanded its balance sheet—that is, it printed money—to the
tune of $3 trillion dollars, between Quantitative Easing in ‘08-‘09,
QE-lite in early ‘10, and now QE2.

The Europeans made the same mistake as the Americans: They tried to save
their banking system. They tried to get through the Global Financial Crisis
without any pain.

The Germans bailed out their Landesbank, the UK took over Northern Rock.
The Irish bankrolled Allied and Bank of Ireland, the Spanish propped up
BBVA—in short, the European governments all assumed responsibility for
all their failed banks. They all pretended that it was a liquidity crunch,
when it was clearly a banking insolvency crisis.

They’re all paying for this sin today. We’re all paying for this sin
today: The inherent instability in all of the markets today is a product of
this decision back in 2008—the decision to socialize the financial
sector’s losses, instead of letting the insolvent institutions fail.

That the Europeans would socialize the losses is understandable—they’re
all a bunch of Socialist pinko-proto-Commie Euro-weenie fellow-travelling
Reds: The children of Lenin and Mao, first cousins of Che and Fidel.

But America—what happened in America—land of the free, home of the
brave—home of the creative destruction that is the lynchpin of
capitalism?

In a word: Capitalism was short-circuited.

See, a bond is a loan—and what’s the underlying risk of lending money?
That it won’t be paid back. The interest on a loan is supposed to
represent the time-value of the money, plus the risk that the money will
not be repaid.

Bond holders of all stripes were supposed to know this—that there was a
chance that they would lose the money that they had lent out.

In the run-up to the Crisis in 2008, banks had lent money to dodgy
investments—those investments in real estate and whatnot went sour in
2007 and ‘08—boom!: The banks had a loss on their bond portfolio.

The banks’ loss meant that they would default on other loans, to other
creditors—usually other banks. So this round-robin of collapsing debt
would affect all the banks—

—the banks that had been prudent would suffer losses on these bad
loans—but they would likely survive. (Notice how none of the private
banks of Europe got into any trouble? Like I said, prudent.)

—but the banks which had been imprudent? The ones which had over-extended
themselves? Like all the big banks in America?

They would fail.

So they weren’t allowed to fail.

In 2008, the rationale was, If the banks are allowed to fail—then the
entire U.S. economy will die! That was Hank Paulson’s dire warning, when
he got on one knee in front of Speaker of the House Nancy Pelosi, and
begged her for $700 billion for TARP—with no strings attached—in order
to bail out the banks.

That’s what Ben Bernanke rationale, when he ordered the drones at the Fed
to start buying up all those Mortgage Backed Security turds, printing up
money in order to make the bailout happen.

Capitalism’s creative destruction was not allowed to have its way with
these banks. They were called “systemically important”. They were
called “too big to fail”—

—but right away, you know this is bullshit: In capitalism, nothing is too
big to fail. That’s the whole point of capitalism: There are no sacred
cows.

But enough people in positions of leadership said that the economy would
die, if the banks weren’t saved—so they were saved.

And what was the result of this lifeline to the banks?

You can look at it from all sorts of angles, but bottom line, the State
assumed the losses of the banks. The banks’ liabilities became the
government’s liabilities—and ultimately, the people’s liabilities.
Because the people will wind up paying.

Some fools still believe that if the banks hadn’t been saved, then our
economy would have died! Died dead! Died like the dodo!

Oh really . . .

Well, I disagree: I think it would have been better to let the chips fall
where they may—give capitalism’s creative destruction free reign—let
the virtuous be saved and the evil perish—

—in short, I think we would be better off today, if we’d let the
banking system fail back in 2008.

And I have proof that it would have been better: I can prove that if we’d
let the insolvent banks fail, the world’s economy would be better off
today. We wouldn’t have the current uncertainty, and instability.

My proof?

Compare-and-contrast the fates of Ireland and Iceland:

Both had the same problem: Disproportionately large banks for the size of
their respective economies. Both banking sectors of both countries had
taken on liabilities which rendered them vulnerable as a baby’s belly to
a falling knife.

In 2008, the knife fell: A lot of the assets on the balance sheets of both
banks were proven to be worth fractions on the Euro—if not worthless
altogether.

But in the fall of 2008, the two countries’ fates diverged:

On the one hand, Iceland’s people refused to have their government be
saddled with the debt of their insolvent banks, Landsbanki and Kaupthing
and the others. The Icelanders requested an IMF bailout to the tune of $2.1
billion (compared to their GDP of $12 billion). But they
refused—vociferously—to be saddled with the debts of their banks.

Chilling in Iceland.
What were the consequences? The Krona suffered an 80% devaluation, interest
rates went to the moon. Unemployment spiked from 6% to 9.3% in a month . .
.

. . . but it wasn’t that bad. It wasn’t fun, but it wasn’t the end
of the word, either. Even with severe austerity measures that included
higher taxes on all sectors of the economy and severe cuts in public
services, unemployment reached only 9.6% at its worst point, averaged 8.8%
during 2009, and is now only 7.6%. Source is here.

On the other hand, what did Ireland do?

When it’s banks were shown to be insolvent in the fall of 2008, Prime
Minister Brian Cowen went and guaranteed the Irish banks. In other words,
he made the Irish government assume the debts of the banking sector.

Ireland hasn’t had a moment’s peace of mind ever since—for two years,
the Irish have been stumbling about, trying to make good on their banks’
liabilities, while the country slowly sinks.

Finally, a couple of weeks ago after a bond market mini-panic, the Irish
were bailed out by the ECB and the IMF—the Irish fought centuries of
British rule, only to finally surrender their sovereignty to bureacrats
from Brussels.

Drinking and crying in Ireland.
Will the Irish situation get any better?

In a word, no. The Irish are still saddled with the euro—they haven’t
been able to devalue their currency, in order to restart their internal
economy, and make themselves attractive to foreign capital. Coupled with
that, they have had to take severe austerity measures and tax hikes, in
order to make good on the bonds that the Irish banks owe.

That is to say: The Irish people are suffering, so that UK and German
bankers don’t have to take any losses.

Meanwhile, in Iceland today, after seven consecutive quarters of negative
growth, the Icelander economy is picking up. In 2011, the Icelander
government will have a surplus; the balance of trade is already in surplus.
With the devalued Krona, Iceland became a magnet for foreign investment.
Unemployment is going down.

Things are good in Iceland.

In Ireland? Not so much—and they won’t be getting any better any time
soon. The rosiest predictions have the Irish economy turning around in
2013, 2014 . . . maybe.

What lessons do these two countries teach us?

The Icelanders recognized that their right hand—their banking
sector—was gangrenous: So they cut it off. A lot of tears, a lot of short
term agony—but the rot was cut off.

The Irish? They tried to save their gangrenous hand back in 2008—so then
over the next two years, their whole arm has now turned gangrenous.

But instead of cutting it off, they’re trying to save the arm too—and
they’re praying that the gangrene doesn’t get to the body and kill
them.

These are just two small countries—Iceland and Ireland—and I’m sure a
lot of critics will say, “These two countries have nothing in common with
giant economies like the U.S. and the EU—nothing in common at all!”

Oh, but that’s where they’re wrong: Economics is trigonometry—the
ratio of a diagonal of a square is the same no matter the size of the
square. Likewise with economies: The basic problem of any economy is the
same, regardless of its size.

An overlarge economy—like the American and European economies—might be
able to palliate the symptoms of the economic disease. They might even be
able to hide the symptoms altogether, and make fools think for a little
while that the disease is all gone—the patient all better.

But truth outs, one way or another.

The sin of the American and European economies was to guarantee the banks.
Whether out of stupidity, blindness or corruption, America and Europe
pretended the banking insolvency was merely a liquidity issue—

—so they socialized the banks’ losses.

That’s why the American economy is teetering, while Europe goes from
crisis to crisis—Greece—Ireland—Spain next—Italy soon to be up.

Because of stupidity, blindness or corruption, the American and European
leadership saddled their people with debts that cannot be paid.

I have argued in my hyperinflation pieces that the only way to get out of
an unpayable debt is to either default on the debt, or inflate away the
currency.

The Europeans are grimly trying to pay off all the debts while defending a
strong euro—it’s an ugly sight.

The Americans are trying to inflate away their debt—the Federal Reserve
is now fully monetizing the Federal government debt, conjuring money out of
thin air and thereby covering the fiscal deficit.

In other words, in both cases, the gangrene has spread from the hand in
2008, to the limb in 2009 and 2010—and now as we welcome 2011, the
gangrene has spread to the body.

All in all, I think we’re all going to wish we had done like Iceland. If
we had, we’d be chillin’ like the Icelanders, instead of crying
ourselves to sleep every night.