Friday, October 21, 2011

Europeans Facing More of a "Haircut" Than Preciously Thought

News is leaking out that the “haircuts” on European Sovereign debt are going to be greater than imagined just several weeks ago!  “EU looks at 60% haircuts for Greek debt.” (
Three months ago European officials agreed to a 21 percent haircut.  Then, in the last several weeks, the figure moved to around 50 percent.
And, still officials are dawdling.
European banks are troubled, and we hear about how the “French Banks Fought Oversight.“  Seems as if French banks and French regulators consistently ignored the reality of the situation within the banks claiming that no problems ever existed. 
Of course, bankers are notorious for claiming that problems do not exist on their balance sheets!  But, this is not new. (See my  The bankers’ denial of any problems on their balance sheets is maintained right up to the time hey begin to argue that “It was not our fault!”
The problem I have with all this is that attention is being deflected from the real issues while blame is being diverted from the real culprit.
The real culprit, to me, is the post-World War II attitude in America, the UK, and Western Europe that the creation of debt, especially by governments, could keep unemployment at low levels and this would end the possibility of social unrest caused by masses of unemployed persons.  The result was that the latter half of the twentieth century became the “poster child” for the benefits of what can be called credit inflation. 
Creating debt, especially government debt, was not just a policy of the left, but it was also the policy of the right.  The creation of debt would resolve almost all social issues since it kept people at work.  This would also help politicians get re-elected.
In the 1960s we added to the goal of keeping people working the goal of seeing to it that every family owned their own home.  This was especially the case in the United States.  I was working for a cabinet secretary in the early 1970s in a “conservative” administration, and one of the major goals of this administration was the development of mortgage-backed securities.
The reason for the development of this instrument was certainly not an economic one.  The reason for the development of the mortgage-backed security was to get politicians re-elected.  The argument was that if more Americans owned their own home, the more willing they would be to re-elect those Senators, Representatives, and Presidents that supported this goal. 
The government’s development of the mortgage-backed security, of course, brought several new things to the financial markets, like ‘slicing and dicing’ cash flows, that paved the way for the financial innovation that was to take place later in the century.
Of course, the major driver behind all of this was the continual efforts of the national governments to create credit through deficit spending to hire large numbers of people themselves, to almost continuously stimulate the economy to keep unemployment low, and to continue to find ways to put more and more people into their own homes. 
This is the essence of credit inflation!  And, the central banks, fundamentally, helped the national governments to write the checks.
The undisciplined creation of debt, however, does not end well.  This is the story that Carmen Reinhart and Kenneth Rogoff tell in their book “This Time is Different.”  And, for the United States, the UK, and Western Europe, this time was not different and financial crisis arose.
The point I am getting at is that the resolution of a financial crisis is not a unique action.  However, many of those in authority are crying out “This time is different”!
One of the boldest “criers” is Fed Chairman Ben Bernanke.  I have written my opinion of him in an earlier post. (  But, Mr. Bernanke is not the only authority at the central bank that is searching for a new or better way to conduct monetary policy. (
Gillian Tett also writes in the Financial Times that “Central Bankers must update outdated analytical toolkit.” (  
Let me just say in answer to this situation we are in: This time is not different!
The problem is too much debt!  The cause of the problem was 50 years of credit inflation in the United States, the UK, and Western Europe.  This debt must be worked off and it takes time to work off excessive amounts of debt.  Again, I recommend you check the Reinhart and Rogoff book.  I have also just written a post on this:
And, the lessons from this experience are not new.  Don’t issue too much debt!  Don’t just focus on short-run goals…like fiscally stimulated low unemployment, like everyone owning their own home, like governments hiring all their own supporters…and so on and so forth.
The problem is not financial innovation or greed or speculators.  These things will never go away. 
The problem has been that the credit inflation created in the last 50 years has created huge incentives to develop financial innovation, to exercise greed, and to benefit from speculation.  And, in the frenzy, things got out-of-control.
That is where we are today.  The haircuts that are now necessary are large and if something is not done about them soon, the haircuts will get even larger!  What if the write-down on Greek bonds were 90 percent?  What if the write-down on the bonds of Italy were 50 percent?  Portugal…60 percent? Spain…?  And, France…?
Over the last fifty years or so, people in the United States, the UK, and Western Europe have been living pretty well.  They can live well again.  But, we need to get away from Keynesian policies that promise something for nothing and return to some fundamentals that have played well over the years.
This time is not different!  Discipline and integrity are winners and have always been winners.  But, in a state of chaos, returning to discipline and integrity is difficult and painful.  The historical lesson, however, is that if people do not return to a condition of discipline and integrity the pain and suffering does not end…and in many cases it will only get worse!   

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