Remember how last week, when everyone was talking about and reacting to the stuff going on in Greece, and Kthug had already written Greece off and moved on to Italy? This is why:
1) At this point, it seems Italy is now mathematically beyond point of no return
2) While reforms are necessary, in and of itself not be enough to prevent crisis
3) Reason? Simple math–growth and austerity not enough to offset cost of debt
4) On our ests, yields above 5.5% is inflection point where game is over
5) The danger:high rates reinforce stability concerns, leading to higher rates
6) and deeper conviction of a self sustaining credit event and eventual default
7) We think decisions at eurozone summit is step forward but EFSF not adequate
8) Time has run out–policy reforms not sufficient to break neg mkt dynamics
9) Investors do not have the patience to wait for austerity, growth to work
10) And rate of change in negatives not enuff to offset slow drip of positives
11) Conclusion: We think ECB needs to step up to the plate, print and buy bonds
12) At the moment ECB remains unwilling to be lender last resort on scale needed
13) But frankly will have hand forced by market given massive systemic riskHint:Not Good.Sell EUR, Buy Gold
The Times reports:
Italy’s financial crisis deepened on Wednesday despite a pledge by Prime Minister Silvio Berlusconi to resign once Parliament passes austerity measures demanded by the European Union.
Neither that move nor a reassurance from Italy’s president vouching for Mr. Berlusconi’s sincerity, calmed investors, who propelled Italy’s borrowing costs through a critical financial and psychological barrier of 7 percent, close to levels that have required other euro zone countries to seek bailouts.
Mr. Berlusconi, cornered by world markets and humiliated by a parliamentary setback, appeared to have become the most prominent victim of the broader European debt crisis. But his decision did not remove wide uncertainty about Italy’s ability to tackle the crisis, and some analysts said the prospect of a protracted period of political wrangling could exert further pressure for a quicker exit from the impasse.
Immediately after Mr. Berlusconi’s announcement on Tuesday, stocks rallied in New York on hopes that political change would help pave the way for an easing of the continent’s debt crisis. But, within hours, Europe’s stock markets fell on Wednesday for the third straight day in morning trading.
At the same time, yields on 10-year Italian government bonds — the price demanded by investors to lend money to Italy — surged on Wednesday to 7.4 percent, the highest level since the adoption of the euro more than 10 years ago.
Krugman puts it bluntly:
This is the way the euro ends.
This is the way the euro ends.
Not with a bang but with bunga-bunga.
Seriously, with Italian 10-years now well above 7 percent, we’re now in territory where all the vicious circles get into gear — and European leaders seem like deer caught in the headlights. And as Martin Wolf says today, the unthinkable — a euro breakup — has become all too thinkable:
A eurozone built on one-sided deflationary adjustment will fail. That seems certain. If the leaders of the eurozone insist on that policy, they will have to accept the result.
Every even halfway plausible route to euro salvation now depends on a radical change in policy by the European Central Bank. Yet as John Quiggin says in today’s Times, the ECB has instead been part of the problem.
I wonder how much the turmoil will spread back here to the US and to Asian markets, since everything is so interwined these days.
Joel
Next year might be the year for an inexpensive Italian vacation…
4tehlulz
Fixed for accuracy.
J. Michael Neal
@Joel:
No need to limit yourself there. The whole continent is in the process of blowing up. I suspect that even the countries that aren’t on the Euro are going to experience currency devaluation.
Punchy
Maybe if Germany just invades Italy, Greece, Ireland, Spain, and Portugal, then they’ll all become Puppet Krauts and bask in the wonderfulness of the German economic machine.
In return, Germans get free gyros, Guiness beer, and Leoni Messi.
chopper
welp, time for me to hit the ol’ dusty trail (stretch).
eemom
Yikes. I saw that post title and thought you were LEAVING us, John Cole. :(
Davis X. Machina
The American business/finance community must be heavily conflicted — the consequences for them of a Eurotastrope are real, and dire, but the ECB, far from being the problem, is doing everything they wish the Fed had the balls to do.
cathyx
I’ll guess a lot of turmoil will spread here because we will bail out the European banks too. Baristo, put it on my tab.
MikeJ
@Joel: Might be able to stock up on Amarone too, provided they make wine for export rather than eating the grapes.
PeakVT
I wonder how much the turmoil will spread back here to the US and to Asian markets
In the short term in the US, I think less than you’d expect, because where else can all of the money that will be leaving the Euro go? And the Fed has proven that it will do what is necessary, so in general the US is a safe/er bet. The real problems start when market turmoil falls through to front-line jobs here in the US. Businesses dealing with imports and exports from/to Europe will have bigger problems sooner, of course.
Jim, Foolish Literalist
Dear Perotistas, Bloombergians, and Mitt Romney,
That whole “He’ll run that country like a business” thing? May not be the home run you think.
chopper
i wonder how much derf made off the rising market today. 3 grand? 4?
scav
@eemom: I worried about Tom L. Was expecting a large jpg.
Libby
Got nothing to say about the euro but LMAO at the goggle ad I’m seeing at the bottom of the post. Cain’s Iowa fund. Help him raise $999,999 by Nov. 9…
DZ
4tehlulz –
WTF? Germanyis not the problem. Germany is the most responsible and stable economy in Europe. Italy created this problem themselves by spening far more than they had for more than a decade. Germany and France cannot bail out Italy – it is way too big. Italy is on its own.
ThatLeftTurnInABQ
Personally I’ll wait until CalcRisk and the other less doomer-oriented blogs put up the Bat Signal before I start to Europanic or have a Goldgasm. If I took everything on ZeroHedge too seriously I would have slit my own wrists four times already, just in this last year alone. Krugman is a different story but he hedges in his last paragraph to the point where his oped article taken as a whole doesn’t say much other than that we live in interesting times. Wait and see what happens.
Chris T.
@Jim, Foolish Literalist: Government Run Like A Business: 911: “Your call is very important to us. Please remain on the line and an operator will be with you shortly!”
Courthouse: “Which justice package would you like? A regular lawsuit is $30,000, or you can buy the Gold Justice package for $50,000. Have you considered our Subcribe-n-Save? For just $100,000 per year, you can file five regular lawsuits! That’s an annual savings of $50,000!”
(and so on)
Martin
I wonder, did we just spend $700B to destroy any competition to petrodollars? Because it’s kinda looking that way.
Villago Delenda Est
Austerity is great if you need to divert resources to say, oh, I don’t know, fight a war or something.
The US experienced austerity in the 40’s. But pretty much everyone, to include the top 1%, was in on the austerity. Because there were dragons that needed slaying.
Now, it’s austerity for the serfs, and the lords need not worry. The austerity is not for a common cause, it’s for the cause of preserving the wealth of some people who bet black and red came up. Or, even more accurately, their agents bet on black, and red came up, and now someone has to pay the croupier. It’s not going to be the agents, it’s not going to be the already rich who were trying to get richer, it’s going to be the janitor, who was never involved in the game in the first place. Yeah, that’s the ticket!
JGabriel
Tyler Durden:
Because it won’t, Tyler. You can’t starve the economy into spending more.
.
Villago Delenda Est
@DZ:
Who loaned the money to the Italians and the Greeks?
Wasn’t it…
THE GERMANS?
Bubblegum Tate
So, uh, does this mean it’s a bad time to travel to Italy? Or will they be overjoyed that somebody is coming there to give them some money?
Sentient Puddle
@4tehlulz: Nah, this one is really on the ECB. Merkel did appear to take a hard line for a while, but she was ultimately willing to bend. It was Trichet who was all damn the torpedoes, all hard money all the time.
Martin
@Bubblegum Tate: It’ll be friendlier if you get in before the riots, though it’ll probably be cheaper after the riots.
Chris T.
@Villago Delenda Est: The thing the rentiers are not getting, for some reason, is that “austerity for thee, not for me” hurts them too. Not as much as it hurts everyone else; perhaps that’s the draw.
Montysano
I’ve been trying to get my head around the workings of the bond market. On a financial blog that I read, a commenter explained that:
I get the first part. I don’t get the second.
Any help?
DZ
@Villago Delenda Est :
Yes, the Germand and the French primarily. They could have let Italy fail 5 years ago. Would that somehow have been better?
wheaton pat
Wait for it…the failure of Italy Greece and the EU is tied into the Community Redevelopment Act.
It has nothing to do with the waive of conservative leaders over the last decade that have reduced tax rates in Italy Ireland,Greece etc etc etc.
Nemo_N
But I thought austerity was going to fix everything because suffering makes things stronger.
Hill Dweller
There is plenty of blame to go around, but the ECB has been a disaster. Their raising of rates earlier this year will go down as one of the most stupid monetary policy decisions in history.
Villago Delenda Est
@Chris T.:
As long as others are suffering worse than they are, they’re fine with that.
They need someone to lord over.
@DZ:
As long as the German bankers don’t actually have to pay for their fuckups, and those Italians do, it’s all cool.
4tehlulz
@DZ: Yeah, it’s never the dealer’s fault, it’s always the user amirite?
@Sentient Puddle: Trichet’s rate hikes were stupid in the extreme, but he’s not responsible for shit like this.
catclub
@Villago Delenda Est: Extremely impolite to point that out.
Also impolite to call the bailout of the Bankers anything other than the bailout of the Greeks.
Also impolite to point out that bankers are supposed to be the experts in the banker-borrower relationship. The experts at evaluating risk.
So sue me.
JGabriel
John Cole @ Top:
Loads.
Example: Last month there were floods in Thailand, the worst in 50 years. Western Digital and Toshiba both had hard drive manufacturing plants in the flood plains. Consequence? A 1 TB hard drive that was $55 six weeks ago now goes for $150-$160. Prices aren’t expected to even start returning to normal until 2012 Q2.
Now that’s just the collapse of a couple of manufacturing plants in Asia. What do you think the collapse of the world’s secondary reserve currency is going to trigger?
Seriously, anyone? Bueller? ‘Cause I’m damned if I know.
.
Napoleon
@Montysano:
The second part makes no sense at all.
Chyron HR
Wrong Way Cole is Wrong again. Italy is shaped like a boot. Are your boots suffering a financial collapse? No, they are just scuffed at the heels. All Italy needs is for a bootblack to polish it up. In summary, groupies.
amk
Reports of death of Euro are premature. China’s no. one trading partner now is Eurozone. Just as they are propping the $, so will they the euro.
Poopyman
@eemom: Wait, the frowny face is because he’s not?
So I guess the Italian collapse means the next wave of boat people will be arriving in gondolas?
J. Michael Neal
@Montysano:
Sure. The problem comes from the fact that Italian debt needs to be rolled over on a regular basis, as does every other country’s. What the quote is saying is that, when the time comes to roll over more debt, Italy won’t be able to afford the interest rates it can sell the new debt at, which at some point would have the consequence that it will default on the debt that is maturing. Since it will be obvious that that is what is going to happen at some point, the value of all of that debt will be reduced because it might be the round that gets defaulted on.
Basically, under most accounting rules, bonds can be held at either the face rate, if the holder intends to hold until maturity, or discounted (or inflated) to the market rate if they do not intend to hold to maturity. However, once a default becomes expected, holders need to write down the debt. Exactly what they need to write it down to depends upon a number of factors.
catclub
@Montysano: All the old 3% bonds are worth about half what they were when the prevailing rate was 3%. If you hold to maturity it is not so bad ( assuming Italy is still there to pay off the principle), but if you sell, or mark to market, you get clobbered.
RalfW
Bond write-downs:
When yields on bonds go up, prices go down.
If I sold a 4% bond two weeks ago for $100, the current owner has to sell it for less than $100 to the next guy so that he can get a net return of 7%, the price the market now demands for lending money – even on bonds issued before the new ‘crisis.’
The discount to the $100 is the added interest.
Via a bond calculator:
A bond selling on 11/9/2011 with a par value of 100.00, a maturity date of 11/9/2021, a coupon rate of 4.00, and a market yield of 7.00 will be priced at $78.93.
cathyx
In case anyone was thinking I was just kidding about the US bailing out the European banks, here is an article saying the same thing:
http://www.zerohedge.com/article/exclusive-feds-600-billion-stealth-bailout-foreign-banks-continues-expense-domestic-economy-
Ken
So if the euro disappears, what happens to securities denominated in euros?
J. Michael Neal
@amk: I wish the Chinese luck with that. I’m skeptical that they can handle the sort of run on debt that we may be on the cusp of.
Montysano
@catclub:
This is a great point, and one that gets missed, I think. A banker used to be a middle-aged white dude in a suit who scrutinized your loan app, looking for a reason to say “no”. If you fucked up, he had to live with the fallout.
Somewhere in the ’90s, the banker began to morph into something quite different, sort of a nasty combination of a used car dealer and a dope peddler.
Bill E Pilgrim
@Bubblegum Tate: Wait a little while. Euro has been wobbling around and gone down a lot but not really enough to make huge difference in a trip yet, i.e. if your 100€ hotel costs $137 now instead of $144 a couple of months ago, meh.
Hasn’t really changed that much, especially considering where it might be going, given all this. Who knows though. Not me.
Chris T.
@Montysano: “AND people holding existing debt are supposed to write it down to market value”: that’s … not quite right. Or perhaps it’s better to say “right, but not complete”.
When it comes to valuation (in dollar or other monetary terms), everything—and I do mean everything—is “worth what you can get someone to pay for it”, no more, no less. That’s why you’re “supposed to mark to market” for accounting purposes.
There are two big problems here: one, there’s not always a market to “mark to”, and two, the market value is just “what you can get someone to pay for it (at this very moment)”, which is what something is worth in monetary terms, but not a very good measure of what something is “really worth” (in some sort of Aristotelean “Pure Object” sense). In particular just because nobody will pay you $10 grand for X today does not mean that you can’t predict (correctly) that someone will pay you $10 grand for X tomorrow (or on Tuesday, or whatever).
The Game is to beat everyone else at predicting future valuation. Hardly anyone wins the game by anything other than luck though. There’s one Warren Buffett, and hundreds of thousands of Everyone Else.
All that said, here’s why the Market Value of existing 4% bonds drops: “Why should I pay you $10k for that bond that has a 4% yield, when I can buy a new one right now that has a 7% yield? I’ll pay you just enough under $10k to result in an effective 7% yield.”
Hence, provided we ignore the issues with “mark to market” in the first place, the value of existing bonds drops because their open-market value drops because people can buy the new higher-yield bonds instead.
catclub
@JGabriel: Cheaper almond Croissants? Yum.
Napoleon
@J. Michael Neal:
Right but that doesn’t mean the bond holder needs to seek anything but full repayment, which seems to be what the commentator is suggesting. The only way you cram down a loss to a bond holder is bankruptcy (although admittedly if a country just refuses to pay there may not be much you could do about it practically).
4tehlulz
@amk: China is having a bit of a time keeping their economy from imploding; I don’t think their in the mood to bail out the EU.
Linda Featheringill
@Chyron HR: #36
:-)
Montysano
@J. Michael Neal:
Perfect. Got it.
PeakVT
@DZ: No, Germany is the problem now. It’s been recognized for a while that austerity programs alone were not going to enable the GIPS to survive. That’s been proven beyond doubt as countries that have embarked on austerity programs keep missing their budget targets because austerity is causing their economies to collapse. But the ECB has come under heavy pressure from Germany to keep inflation low, when in fact should be allowing for a lot more inflation. Without inflation in the north to fix the north-south mismatch of labor prices, the discrepancy has to be resolved with deflation in the south. And deflation is just deadly, because it causes real debut burdens to rise. Raising the debt burden on a heavily indebted country can not and will not produce a good outcome.
I’ll also point out that as a country with a trade surplus, German banks and other institutions are the ones who have been lending to the GIPS countries at rates that are too low. Germans seem to think that they are not involved in this mess, but accounting identities say otherwise.
PreservedKillick
I see only two ways out of this:
– The ECB starts to act like a central bank and becomes the lender of last resort.
– The PIIGS exit the Euro, at which point the Euro dissolves.
It simply amazes me that there is, or ever was, a belief that austerity would somehow succeed. In all cases where it’s been applied, it has failed to stem the spike in interest rates. Probably because the bond markets are pretty damn clear that austerity is going to cause the country in question to enter a vicious cycle consisting of: austerity causes cuts which cause the economy to shrink which reduces tax revenue which causes more public debt which causes a need for more austerity. Rinse, lather, repeat.
amk
@4tehlulz: It’s hobson’s choice for the chinese at the moment. They need their cash cow to stay valued.
If any of the western governments had any balls (or are not corrupt), they would ask their bankers and their bond holders to take a hike till things turn normal.
PreservedKillick
On the plus side, unwinding the Euro will create a lot of jobs for signmakers, software engineers, finance people, etc. Always a silver lining!
J. Michael Neal
@DZ:
Germany is the problem, or at least a very large part of it. This is not, as some others have said, because it is the German banks that have lent so much money to the Greeks and the Italians (and the Spanish [though not the government, so much] and the Portuguese and the Irish and the Belgians). It’s because the Germans have insisted on running a policy of perpetual trade surpluses with the periphery, and have had the power within the ECB to get enforce that. Most of the borrowing and lending going on is necessitated by that policy choice. Germany *can’t* run a persistent trade surplus without loaning lots and lots of money to whoever they are exporting their stuff to.
At some point, the Germans must face the fact that they have two choices:
1) Keep loaning large amounts of money to the periphery in perpetuity (which is not as strange as it sounds; the exact same thing happens within the currency union known as the United States), or
2a) Start consuming more of the stuff that they are making themselves rather than selling it to other people, or
2b) Accept a higher level of unemployment since they no longer have anyone to sell that stuff to.
I list them as 2a) and 2b) since they are, from an external perspective, largely the same thing.
It is vitally important when examining international trade and debt flows that being a creditor is *not* necessarily a virtue and can often be the exact opposite. A critical underlying element of all of the financial crises in recent years is exactly that fallacy. There are a number of countries, of whom Germany is but one, who need to come to grips with that.
None of this is to deny that policies on the periphery haven’t exacerbated the problem (notably the incredible level of tax fraud in Greece), but they are not the primary factor.
Montysano
@Chris T.:
So a bond issuer may issue a $10K bond, but only be able to sell it for $9.5K? In that event, he’s still on the hook for $10K of principal plus interest?
Martin
@Montysano: One problem during the mortgage market collapse here was that accounting rules say that the value of an asset (such as a bond or a mortgage) is determined by what it sells for on the open market.
So in the case of a mortgage that is valued at $100,000 (to the borrower, because that’s how much they borrowed and presumably how much there is in assets to reclaim if you foreclose) and delivers $1000 a month in revenue, if the market is so frozen that nobody is buying or selling mortgages, then there’s no way to value that asset on the market. So even though it may be delivering $1000 a month in revenue, if nobody wants to buy the underlying mortgage, it has a value of $0, and you need to write down the value of that asset from $100,000 to $0. Now, you’re still getting your $1000 a month, so that may be no big deal for one asset, but if ALL of your assets are doing that, then you have no assets to borrow against, all of those regulatory rules about how much you hold in assets get fucked up because your assets are now worthless, and so on. If there’s faith in the marketplace, external money will enter. But if everyone is convinced the market is going to blow up, no money goes in, everything plummets in value because nothing is being bought, and because everything plummeted in value, there’s no valuation on which to generate new capital. Basically, the system eats itself.
It works the same way with bonds. Italy needs people to buy those bonds, but presumably the people to buy those bonds overlap significantly with the people that hold existing bonds – they’re the people that had faith in the market before, and presumably they’re the ones that should have faith in the future. Now, why would anyone want to buy the 3% bond that I’m holding when they could get 7% instead? So the value of my 3% fixed bond goes down. That reduces my ability to buy 7% bonds. And if everyone is convinced the market is simply going to blow up, nobody is going to see a bargain and jump in – they’re just going to assume that they’ll get screwed like the 3% bond holders were, they’ll wind up with an asset that they’ll be forced to sell at a loss, or their money will wind up being trapped in that asset until they’re defaulted on. Again, the system eats itself.
different-church-lady
Everything’s so intertwined except the markets and the average citizen.
Markets go up and down. Average citizens just erode away no matter what happens in the markets.
ThatLeftTurnInABQ
@Montysano:
JMN and others covered the mechanics of the second part already, so I’ll just point out the last bit: these two conditions form a positive feedback loop because the folks who are losing money when their existing debt is marked down to market value are the very same people who also form much of the pool of potential customers for the new debt. So the interest rates on the latter climb and climb and climb some more as the bondholders look to cushion their losses on the old debt by charging higher rates on the new debt, and of course these higher rates on the new debt render the old debt less servicable than it was before, which increases the risk of a default, and so it goes. Shit meets fan.
Comrade Dread
@amk: What happens when they run out of yuan?
DZ
@PeakVt:
Convenient to address only the last 3 years and not what came before. Moreover, none of you guys seem to have a clue about how this stuff actually works. Banks are not driving this – central governments arer driving it. German and French banks have absolutely no choice about whether or not to loasn money – if the gov’t says you loan, you loan.
Next I don’t disagree with the idea that austerity alone will not fix the problem, but more loans to countries that refuse to act responsibly in any way just makes the whole mess impossible. Modest austerity measures from 2001-2006 when the Italian economy was doing well could have made a huge difference, but the Italian people don’t give a fuck. They figured someone would bail them out. Well, I think that well is now dry.
amk
@Comrade Dread: yuan ? what yuan ? They got dollars and euros, baby. By the sackfuls.
Bubblegum Tate
@Bill E Pilgrim:
Well, we wouldn’t actually be going until April or May 2012, but we were thinking we should start booking soon. In light of all this, it might be smarter to hold off on booking for a bit.
chopper
@4tehlulz:
this. they have their own real estate bubble that’s a-poppin’, and their own bond yield curve just flipped which is a bad fuckin’ sign. part of the rumor mill propping the markets (at least in the US) up for the last month was the deus ex machina of china ‘stepping in and propping shit up’. it hasn’t ever materialized but i guess that’s the way this shit works.
Bill E Pilgrim
@PreservedKillick: I realize you’re kidding but having lived through the change to the Euro, I can just tell you that it’s nah gah happen, if for no other reason that that alone.
It’s not going to happen for lots of more fundamental and serious reasons of course but I can’t tell you what an upheaval it was, the years of planning and transitioning and psychological trauma and when you could or couldn’t cash in your old money and just watching everyone in the stores scratching their heads looking at the prices suddenly not understanding intuitively what the price per kilo meant anymore and on and on. Also restaurants and other businesses took the opportunity of confusion to jack up prices, often “rounding” up to some Euro figure much higher than what it had been before.
Greece– dunno about that, things are pretty dire there, but I can tell you that when people say “if they did, it would be complete chaos”, believe them. And the idea of a bunch of countries following suit — nope. Never.
J. Michael Neal
@Napoleon:
This is not true. From an accounting perspective, which is where this matters, taking a loss on the bond becomes mandatory when there exists a likelihood of default.
What has happened in recent years is that there have been shenanigans played as to what constitutes a likelihood of default. Technically, this decision is made on a per loan basis. In the mortgage market, it has become clear that the expected number of defaults has increased, but that does not mean that any particular mortgage has become a likely candidate. From there, the instruments are complicated enough that default on any *particular* bond is often little more than guesswork even if the overall likelihood has gone up.
Therefore, banks have been declaring that they intend to hold debt to maturity and that it doesn’t have a likelihood of default thanks to the above process. The problem here is that, with regards to sovereign debt, all of that goes out the window. Since there is just one government of Italy rather than millions of individual mortgagers, an increase in the overall likelihood of default is not separate from the likelihood of any particular debt reaching that threshold. The shorter the maturity, the more likely one can claim that the full value will be realized. However, the possibility of an Italian default now exists for all time horizons, and that’s going to require that most of the bonds get written down.
Montysano
@Martin:
But if I understand correctly, the US banks are currently excused from strict mark-to-market and are instead operating on a mark-to-fantasy basis, i.e. still valuing the asset at the inflated pre-2008 price, and that if they were forced to mark-to-market today, many would be instantly insolvent. If true, it sounds like another bomb that’s ready to explode.
daveNYC
@Villago Delenda Est:
Um, that’s not austerity. Austerity is not spending money, and in the 40s we were spending money hand over fist.
uptown
@DZ:
France is reported (by Deutsche Welle) to have a ton of local governments that are going bankrupt. If Italy goes, so will France.
Liberty60
@Jim, Foolish Literalist:
If there is one silver lining in all this, it is that we may finally drive a goddamed stake through the heart of our CEO worship.
Judas Escargot
@DZ:
Nobody forced the German (or French) banks to go balls-deep into Greek or Italian debt, either. They can bail out the debtor countries, or bail out their own banks when those go under (as they inevitably will, if default happens). Either way, there will be some bailing to be done. Which will be less destructive?
There is no such thing as ‘on your own’ in the global economy, kimosabe. One of the dirty little flipside-facts of globalization that (most of) the ruling elites seem to have trouble recognizing. Countries aren’t people/households. It’s a destructive fallacy to treat economic failures as moral ones.
IMO they need to create and issue some kind of “Euro-bond” that spreads the risk across all the countries, and is used to fund these bailouts as they are needed. (You might think that Italy is doomed, but that doesn’t necessarily imply that Europe as a whole is doomed, so bet your money on that instead).
Not being a lawyer, economist or financial advisor, I have no idea what the mechanics of such a thing would look like though.
J. Michael Neal
@DZ:
No. Fiscal austerity on the part of the government would have done zero to prevent this. To see why, you only need to look at the Spanish situation.
Spain did exactly what you wanted them to. The government was very responsible about its fiscal situation. They’re still fucked. Because of the monetary policy imposed by the ECB, the interest rate differentials just meant that, instead of German banks loaning huge piles of money to the Spanish government, they instead loaned huge piles of money to Spanish banks, which in turn loaned those piles to people buying houses in Spain. When things when bad, all of those Spanish banks were on the verge of going bust.
At that point, the two choices were for the German banks to take their enormous losses right then, or for someone to bail out the Spanish banks in order to keep the German banks solvent. *That’s* the point where the Spanish government’s fiscal situation became grim, because they were the ones who conducted the bailout by moving the bad bank debt onto its balance sheet and turning that into bad government debt.
So long as the Germans are determined to run a trade surplus and control the levers of power necessary to make it happen, their trading partners MUST accumulate vast amounts of debt. There’s no way to run a trade surplus without that happening. None.
DZ
@Upton:
At some point, that could happen. Spain, Portugal, Ireland and Greece will go first, however. Plus, France has a far stronger underlying economy, and they would come through it far better off than the others. If the Eurozone fails, look to Germany, France and Holland (maybe Belgium) to create their own union.
JGabriel
@PreservedKillick:
“NO EUROS! GOLD ONLY! NO, WE WON’T TAKE DOLLARS, YOU FUCKING AMERICAN ASSHOLE! WHAT PART OF ‘GOLD ONLY’ DO YOU NOT UNDERSTAND? WE WROTE IT IN ENGLISH SPECIFICALLY FOR YOU, JACKASS!”
.
RobertB
1) I see that the guys at zerohedge
2) have been to the
c) Peter King School of Bullet Point Usage
4) I think.
DZ
@Uptown:
Please forgive me for butchering your handle.
daveNYC
@J. Michael Neal:
Not entirely accurate, it’s technically possible for a partner to export even more goods than they’re importing from Germany, and thereby run a surplus, but in reality that’s stupidly unlikely so you’re pretty much correct.
JGabriel
@RobertB:
5) …
6) Profit!
Or maybe the Gnome School.
.
J. Michael Neal
@Montysano:
Sort of. As explained above, it’s never necessary to operate under a strict mark-to-market regime. It’s not something that’s currently excused; it’s ALWAYS excused if you are going to hold until maturity. Unless there is a likelihood of default. Which is hard to define in this situation.
Is it another bomb waiting to explode? Maybe. I’ve gotten very frustrated with people saying that it’s immoral that the banks are making enormous profits after the bailouts. Far too many people fail to recognize that those profits *are* the bailouts. Kevin Drum in particular, since he has shown at other times that he really should know better,keeps doing this. He, like a lot of others, have stated correctly that we are in a balance sheet recession without seeming to understand what that means. Among other things, it means that focusing on income statement accounts like net profits is completely irrelevant to the problem. If you look at a balance sheet, you won’t find an account named “Net Income” or something like it anywhere. Net Income feeds into the asset and (hopefully) owner’s equity portions of the balance sheet, but it does not, in and of itself say *anything* about whether the entity is solvent.
Now, this does mean that the huge bonuses they’re paying themselves at a lot of the banks are even more obscenely ridiculous, but that’s a (slightly) different issue.
JGabriel
@Judas Escargot:
As far as that goes, one could argue that people/households aren’t just people/households anymore.
.
Judas Escargot
@RobertB:
Imagine a pack of hyenas or jackals, salivating over some unfortunate toddler that got lost in the savannah. That toddler is about to keel over and die from dehydration.
If those animals could talk, they’d sound a lot like the commenters at zerohedge.
Villago Delenda Est
@daveNYC:
It’s austerity if day to day consumables are being rationed, because you need to carefully husband resources for the war effort.
You were using up resources hand over fist to fight the war, not to benefit the material needs of the population. The surplus products of human labor were being used to blow shit up, not to make life more pleasant.
At least, that’s what austerity USED to mean.
Now it means peasants starve while lords gorge.
This makes for overstressed tumbrels when it’s time to settle accounts.
Judas Escargot
@JGabriel:
Don’t laugh. I half wonder what would happen if we all incorporated ourselves en masse and did all our business as… businesses. What would the implications be? Could we all start making unlimited, anonymous political donations, too?
Chris T.
@Montysano:
You have to be clear on all the various players in the game, or you’ll trip over a niggling detail. :-)
The key “players” here amount to: (1) the bond issuer itself (Feds, business, municipal govertment, whatever); (2) random shlub holding an existing bond; (3) “the market” of bond-buyers. We’re looking at Player 2 here, the guy holding some existing bond.
The existing bond has (in principle, at least) two parts, a “face value” (the original principal) and a set of “coupons” (each one good for some fixed amount of interest on the principal). As each coupon matures—usually every six months—he gets to clip it off and mail it in for the interest money, and when the bond matures, he sends off the now-couponless paper to get the principal back.
The question you asked is more about the position of the Bond Issuer, who is Player 1 here. What he does is print up a fancy piece of paper (with face value and coupons) and put an interest rate number on each coupon. He then sells to Players Three (there’s lots of them) and hopes he gets the face value—which means he put the “correct” interest rate on the coupons. If he put the “wrong” interest rate on the coupons, he can sell the new bond for more or less than face value.
In the end, it works out the same for Player 1, he just ends up with less (or more) cash per piece-of-paper sold than expected (so that he has to sell a few more or less than originally anticipated).
In today’s world, nobody actually prints any paper—it’s all electronic—and one may buy bonds that have the virtual coupons “stripped off” (aka Strips), or bonds with coupons for 0% interest (aka Zeros), but the fundamental idea is the same. Not only that, the tax rules are set “as if” there were actual coupons, so that one can wind up paying tax on phantom interest. (It’s a big mess, part of the Full Employment For Accountants Act that is the current tax code.)
ThatLeftTurnInABQ
@J. Michael Neal:
The problem I think is that the only balance sheets being repaired recently are those belonging to the banks, at the expense of causing everyone else’s balance sheets to deteriorate. This is one of the rare cases of a zero-sum (or worse) game in economics, and a reason why we really should call the latter using a term from Adam Smith’s day, political economy. Because the decision as to whose balance sheet gets repaired is a political decision, not a purely economic decision. I normally don’t like to quote Lenin, but this really is a who, whom? situation.
different-church-lady
@Judas Escargot: Point of order: hyenas or jackals would not wait for the child to die.
Maybe you’re thinking of vultures: they have to wait for decay because their beaks are too weak to pull apart solid flesh.
different-church-lady
@Judas Escargot: Dilbert would stop being satire and instead be comic verite.
Karen in GA
@wheaton pat:
What do you mean, “wait for it”? I had that conversation with my brother-in-law a year ago. I kid you not.
Him: “It’s because the Democrats made banks lend to minorities!”
Me: “The Democrats made banks lend to minorities in Iceland? Really?”
Him: barely perceptible pause, then “Yeah! The rest of the world follows our lead!”
(This was in the same conversation that he said “Obama wants to wipe out private industry,” then not thirty seconds later complained because Obama was making everyone buy health insurance. “How is making everyone buy insurance from private companies ‘wiping out private industry’?” “That’s different!”)
David Koch
Arrivederci roma,
Goodbye, goodbye to rome . . .
City of a million moonlit places,
City of a million warm embraces,
Where I found the one of all the faces,
Far from home!
Arrivederci roma,
It’s time for us to part,
Villago Delenda Est
@ThatLeftTurnInABQ:
Which is what is going on right now in the Eurozone. These decisions have more to do with whose balance sheet gets repaired. Which is why it’s bailing out banks that made loans that have gone south, for whatever reason.
This is not to dismiss the problems in Greece that have a lot to do with a bunch of Greeks wanting a free lunch (as tax evasion is a national pastime there), but the bankers in Frankfurt want some of that free lunch too, it seems.
The housing collapse in the US is a good example of free lunch takers being more than happy to sell bogus “securities” backed by other people’s money (or assets) and they get to collect fat fees in the process.
It’s fraud, basically. But no one dares say that.
J. Michael Neal
@ThatLeftTurnInABQ: I largely agree with your analysis, though there are other details in it. What I doubt is that most people think of it that way. Based not only upon this but also plenty of other evidence, I don’t think most people understand the distinction between an income statement and a balance sheet. They really do think that high profits is the only thing that matters.
David Koch
Hilarious.
60s hippie Paul Krugman acts as if he’s never taken part in Bunga-Bunga parties.
Sure Paul, sure.
PeakVT
@DZ: German and French banks have absolutely no choice about whether or not to loasn money
What’s your point? Whether it was private institutions acting independently or government policy, surplus countries having been loaning to the GIPS at rates that were too low. Since Germany has had by far the largest surplus, it was the largest lender.
Convenient to address only the last 3 years and not what came before.
I did address it. Accounting identities. If one country runs a surplus with another country, the money either needs to be recycled back to the deficit country via capital accounts, or inflation will happen in the surplus country. Interest rates control how much gets recycled back. The surplus countries recycled too much back because they didn’t demand risk premiums from the deficit countries. The same dynamic is happening between the US and China because China has effectively pegged its currency to the dollar. If China and the US, or Germany and Greece, had currencies that floated freely, the trade balance would have worked itself out naturally. Without a natural adjustment mechanism, the imbalance can continue until it reaches a breaking point, where the deficit country defaults.
Bill E Pilgrim
@Villago Delenda Est: You’re sort of debating or describing two different definitions of the word austerity. Which is fine, but so yes people lived in austere conditions back then, however “austerity programs” or policies that people are talking about these days refers to the government cutting way back on spending, which is the opposite of what was going on back then.
Also, unemployment was something like 1.2% by 1944. So there was rationing and so on, yes, but actually in a way that figure is a good demonstration of where we could possibly be now had there actually been a massive employment program like back then.
Austerity (definition #2) is not only making people’s lives miserable, it’s ensuring that it stays that way for a long time. That’s why it’s such a disaster as policy.
Judas Escargot
@different-church-lady:
Fair enough, city boy here (I wouldn’t last much longer than that toddler). It was that ‘amoral/cackling’ image I was going for.
I tend to think of vultures as bankruptcy lawyers. They’ll carve up what’s left of you with professional precision, but it’s not at all personal. Strictly business: You were already finished, they’re just cleaning up the mess you made.
ThatLeftTurnInABQ
@DZ:
If the quotes in the LA Times article Italy at the breaking point are both accurate and representative (e.g. politicians tend to say different things in front of different audiences) then it appears that Sarkozy and Merkel are looking at this problem very differently, with the former envisioning a two-tier Eurozone with a shrunken core and a 2nd class periphery, and the latter having in mind some sort of expansion (which brings to mind the question, what is the German for: Ponzi scheme).
Davis X. Machina
@Karen in GA: The actual size of that small mind for which a foolish consistency has been a hobgoblin has dropped far, far below what Emerson could possibly have imagined….
les
@Judas Escargot:
I think you’re right that this is the trick–one reason US bonds are good is the economy being spread over all the states, instead of evaluating state by state–but there sure doesn’t seem to be much will to do it in Germany and France, where it has to happen.
JGabriel
@ThatLeftTurnInABQ:
Ask, and ye shall receive:
According to the Dict.cc English-German Dictionary.
I confess, I’m partial to Schneeballsystem. It just sounds so double-entendery.
.
4jkb4ia
Two thumbs up, John. You get it. AFAIK.
PeakVT
@PeakVT: Let me add that the US has large regional trade imbalances but the money gets recycled via the federal government through various programs.
Karen in GA
@Davis X. Machina: That’s only because Emerson never met the guys my sister brought home. She’s a schmuck magnet.
4jkb4ia
@Linda Featheringill:
I’m glad that was a spoof. I was desperately hoping. But under the assumption it was a spoof, I laughed very hard.
EriktheRed
Why the hell did Kthug be right so often in the past??
As a result, I find it hard to not believe that it’s as bad as it looks.
cat
@Montysano:
In case nobody answered your question. This isn’t going to a technically exact explination but will give you the gist of it.
If you buy a 10 year bond that costs $10,000 and pays 4% interest it has a value of ($10,000 + 10 years of interest) – (time value of money).
For ease of explination lets say if you held the bond for all 10 years you’d have $14,000 2011 dollars in 2021.
Now in a pretend world ,where nothing has changed and money has no time value, you held it for 1 year and went to go sell it on the open market it would be worth $14,000 less one years interest payments. So say $13,6000 2011 dollars.
Now in the real world where interest rates are going up you have to offer a discount to sell your bond because people can buy a $10,000 bond paying 8% and have $18,000 2011 dollars in 2021 rather then your $13,600. In order to get them to buy your bond 4% one year old bond you have to make it ‘worth’ the same by selling it for much less then its long term worth.
So for institutions that buy bonds and with their cash and then use those bonds for collateral for short term loans when they do need cash its a disaster.
Again in a pretend world example.
You have a 9 year bond for 4% with a total value of $13,600 you can get a short term loan for $13,300 with your bond as collateral.
But when new 10 year bonds for 10% are being sold with a total value of $18,000 you will only be able to get a short term loan of say $8,000 when using your 9 year 4% bond as collateral as thats how much the orginator of your short term loan could get on the open market to replace the cash you failed to pay back.
Hawes
So, to recap: Financial institutions and central banks feed a massive real estate bubble. The bubble bursts because that’s what they do. The US and the EU bail out the same institutions that created the mess, because the world needs liquidity. The US and EU do almost entirely nothing to help the average middle class working families who are suffering.
Small efforts are made to rein in the worst abuses of the financial markets. But because of “globalization” – which mostly benefits the same institutions that caused this crisis – there is no way to really put the screws on them. These financial institutions then start shorting the PIIGS to make a quick buck, helping to drive their bond markets to the edge of collapse. But because they are also involved on the non-derivative side of the bond market, they need the PIIGS shored up so the banking system doesn’t fail again.
Lather, rinse, repeat.
Can I haz my revolution now?
4tehlulz
@Hawes: You forgot to mention how the CRA is to blame for the whole thing.
chopper
and tomorrow we get to find out if italy can make a bond auction work. my guess is going to be ‘no’.
different-church-lady
@Judas Escargot: Well, there’s gotta be a way to make this work. Maybe the kid is actually a gazelle wounded by cheetahs — an animal too big for the hyenas to bring down themselves, but they’ll jump on the moment the thing is down.
No matter what, the takeaway is that canines are saying the equivalent of “fresh meat”.
I’m now officially overthinking this.
Joel
@JGabriel: I’m no economist, but I imagine a collapse in the euro means yet more investment in US treasuries.
William Hurley
Austerity destroyed the EEC. How will the respective nations fare post-unwinding?
Unfortunately, the US may be the example Europeans come to fear for themselves. Once Obama signs the austerity plan the President’s own Deficit Commission produces, the US will leap ahead in the race to the bottom.
Omnes Omnibus
@William Hurley: You are a very silly man.
William Hurley
@Omnes Omnibus:
I may be silly but those facts are stubborn.
Does that make you you foolish?
William Hurley
@Joel:
Where, then, will the trillions held by corporations and sovereign banks go?
The US is and will remain the safest investment on the planet for a while yet.
Hawes
@4tehlulz: I thought it was ACORN.
Alex S.
The problem isn’t Germany per se, it’s the economic gap between the strong and weak economies within the EU with Germany being the strongest. The Euro strangles the weaker countries and benefits the stronger ones. Germany’s economy isn’t nearly as deflationary as Greece’s. There is a real danger of inflation there if the ECB follows a loose monetary policy. A solution would be to transform the EU into a real fiscal union, but noone wants this. In the end, the EU in its current form might be doomed to fail.