Eurozone fiscal compact

Recent news indicates that the Eurozone will keep a functioning banking system, hardly surprising in light of the alternative. What a new fiscal treaty will do for economic recovery is far less certain. Leaders have demonstrated a commitment, but the size of this commitment remains unknown. This is business as usual in the politics of money. Still, this measure only addresses one aspect of crisis, fiscally irresponsible governments.

No one should have been surprised that final resolution of Greece's problems will be delayed, or that the Spanish government will fall short on deficit reduction. Perhaps, a raised eyebrow is warranted that the Netherlands, long a model of financial prudence, will also fall short.

Spain's government is different from Greece and Portugal in having run a balanced budget during most of the run up to the crash. Spain's private citizens were far less cautious. Real estate speculation inflated wages as well as prices, and Spanish labor priced itself out of competition. Those left holding the bag for mortgages were often those with safe jobs who thought the boom could go on forever.

Now, we see a reckoning; unemployment is reported by several measures to be around 23%. This is well into the danger zone, and perhaps still rising. More troubling is the effect on young workers, 49% of whom are unemployed. People who have jobs are hanging onto them at all costs. Even willingness to work for less is not enough to allow new workers into steady employment. Lack of experienced young labor will bite Spain at a later date. In the meantime this is a social powder keg. On the other hand, the overhang from overpriced mortgages means that simply cutting back on wages will result in a new wave of mortgage defaults, likely followed by bank failures.

We have to ask how Spanish workers and homeowners became responsible for major economic misjudgments by financial institutions. By and large, surviving institutions appear to have guarantees of protection from consequences of misjudgment. This is even true of those which issued the collateralized debt obligations (CDO) and created credit default swaps (CDS) which eliminated natural concern for making bad loans. The percentage of homeowners and workers who understand these instruments is negligible. Who then is responsible?

Until this aspect of the ongoing debacle is addressed many investors will remain on the sidelines. Governments under tight fiscal constraints will not make up the difference.


Today's news is that the latest restructuring of Greek debt has gone through, with good participation by lenders. Those lenders, who had earlier admitted losing about 50% of those loans, are now in a position to lose 74%. This is good in comparison to losing 100%. It also means Greece can plan on borrowing more from the EU in the future. It is certain to need such money. Disaster has again been postponed.

Meanwhile, in news that might pass unnoticed, ABN Amro has admitted to losing 880 million Euros on Greek debt alone. It seems everyone except the general public already knew they had taken a bigger hit than previously admitted. Although I cannot connect the dots in detail this fits an hypothesis of mine. Banks in the Benelux countries have an unusually close relationship with their governments. When the financial crisis hit they were first in line to receive help to maintain liquidity because the alternative was a series of bank failures which would bring the national economy to a standstill. Little of this was in the form of direct handouts, but there was a great deal of help in the form of loans or guarantees which were hard to price under the circumstances. Now we learn that the government of the Netherlands will not soon meet austerity targets set by the fiscal compact because to do so they would have to cut social benefits guaranteed by law, and provoke a massive backlash.

Rescue efforts by many governments have focused on maintaining liquidity in the banking system, which is necessary to prevent immediate bank failures and runs on other banks. We are still in the phase of buying time to solve structural problems nearly four years after the near meltdown. As the belated admission by ABN illustrates transparency does not yet extend as far as investors without inside information. In fact it appears that a lack of transparency is vital to financial survival and success.

We have once again learned, in the case of Texas financier Allen Stanford, that it is possible to run a Ponzi scheme worth billions over a period of years before anyone with enforcement powers catches on. Bernie Madoff was not an isolated exception. If you can make that kind of money with nothing but a smooth spiel why go to all the trouble of real investment? The distinction between that use of financial obscurity and banks like ABN Amro delaying bad news until they have good news to offset the impact wears a little thin. Honesty in finance appears to be outdated and impractical under current conditions.
Regulators in the U.S. remain uncertain about different banks exposure to risks in European finance. In a BBC article on four banks which failed the latest stress test by the Federal Reserve, (including my local SunTrust,) there were some quotes from a financial expert which deserve mention:

"I think the tests are quite significant," said Matthew Bishop, US business editor of the Economist.

"Even the banks that failed like Citigroup failed largely because they were planning to hand too much money back to investors... had they not handed any money back to investors, they probably would have passed."

"My bigger worry is that the Federal Reserve and other central banks completely failed to see the last banking crisis... and I don't necessarily feel comforted that they've guessed the worst case scenario accurately,"

"I'm not convinced that they are any better at predicting the future than they were before."

O.K., so we have high-powered financial experts who can't guess what will happen next any better than astrologers, but the system will remain solvent if banks just drop the old-fashioned idea of returning any money to investors during a crisis. I suppose those investors keep their pin money in the form of Krugerrands in a bunker out back, just in case banks take this advice.

This does wonders for my economic confidence.:eek:

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