For the last three years, this blog has made the point that a moral drama playing out on the global financial stage. The U.S. Tea Party was based on a concept of liquidating the assets of large debtors and letting the pain be absorbed by the financial system and those who have saved and played by the rules of capitalism will be rewarded. The moral precepts of the “original” Tea Party supporters may have been correct but the timing of favoring system-wide asset liquidation had long passed and the fallout would have led to economic collapse and possible political upheaval. The U.S. could not handle the massive unemployment from a forced deleveraging. While I am opposed to moral hazard in principle, the enforcement of punishing debtors at the expense of the entire system is absurd.
The time to rein in the excesses of capitalism is during good economic times. To do otherwise is folly. (As a matter of fact,I proposed curtailing the banking system’s socialization of risk, privatization of reward back in 2002 in a letter published in the Financial Times as seen below.)
Sir, John Plender (“How banks got in a mix”, August 21) correctly identifies the systemic dangers that accompanied the passage of the Graham-Leach-Bliley act. The repeal of Glass-Steagall has pushed the US banking system to the brink of “moral hazard”. The conglomeration of all financial services under one roof has entangled banks in numerous ethical conflicts. Additionally, Graham-Leach-Bliley has made several institutions so large that the Fed cannot allow them to fail.
A single institution’s deep involvement in every facet of financial dealings does not create greater synergy but greater risk. These large, private profit centres know they are too big to collapse. This realisation adds great uncertainty to the entire financial landscape. Rewarding private profits while socialising the risk is a pathway to disaster. Glass-Steagall should never have been repealed without a bank forfeiting its right to Federal Deposit Insurance Corp insurance.
The German school of credit liquidation is the right message but poorly timed. In the midst of high unemployment across Europe, it is no time to pursue the continued forced austerity on growth depressed economies. Liquidation for the sake of asset liquidation will not put Europe’s economy on a growth path. IT’S TOO LATE FOR THAT APPROACH. It was easy for the hard money moralists too make an example of Cyprus for it’s an economic pipsqueak with nothing but an oversized financial system to support its population. The logic of its only 0.25% of the European GDP gets supported only in the sense that is easy for the liquidation bullies to pound the micro economies into submission.
The FT ran an article about Ecofin and Dutch FM Dijsselbloem–“Dutch Moralist Sends Stern Message.” The basis of the article is that Dijsselbloem wants the bondholders and bank equity owners to be the primary bearers of losses in any bank collapse, but I am sure the stance will change when it is the Spanish or large German Banks are that forced to absorb losses. The European NEGATIVE FEEDBACK LOOP just keeps coiling and the pain of a balance sheet recession coupled with system-wide HIGH UNEMPLOYMENT makes its outcome very ominous. I am left wondering who will bring the honey pot to the Berlin-hosted tea party.
***The yield curves within Europe have still remained very steep as the Cyprus situation has caused a selloff of the longer-term debt and thus steepening the curve. At present, the financial world seems to be accepting the view that the EU crisis is a bank liquidity problem. And, unlike back in July, the financial world does see the contagion from the Cyprus debacle as an issue of sovereign solvency. While debt has become more expensive, the two-year notes are reflecting that demand for sovereign debt is still robust. While Italian 10-year note rose 20 basis points, the Italian two-year note rose only 17 points. The price action in the other peripheral countries was very similar.
Thus we have the markets seeing banking problems but no issue of sovereign risk. Stay tuned and stay aware of the short-end of the curve. German debt has performed superbly as investors and savers rush to place money in German-denominated debt and banks. It is wise to stay close to the center of the financial core.
***The Cypriot and Troika decision to place capital controls on all financial assets sends a very harsh message to all of Euroland. As the song New York, New York says, “If I can make it here, I can make it anywhere, it’s up to you…” This creates a tremendous problem for the EU financial system as all rational people will begin shifting assets to perceived safer harbors to prevent being trapped in any geographic entity. Capital controls are the bane of global capitalism and provide a threat to globalization.
More importantly, cash-strapped European banks will become even more fragile as large depositors such as corporations and money market funds will flee to safer venues. When some of the larger banks become more liquidity deprived, the fallout will be no tea party. Let’s watch the short-end of the debt market and interest rate swaps to identify potential trouble spots.
March 27, 2013 at 9:33 pm |
Is the idea of reigning in excess during good times even feasible at a time when even the slightest market correction has the herd and talking heads on CNBC clamoring for ever greater Fed action?
March 27, 2013 at 9:51 pm |
Paul–that is the FED but the Europeans are in a realm where the OMT has severe conditionality—this is going to be a problem for Mario Draghi that the FED has not been subject to
March 28, 2013 at 4:38 am |
Reigning in excesses of any kind seem impossible to me in good times. The human mind does not function like that. Why then has nothing been done in 2000 already? History tells us that humans started to rebuild mostly out of a major necessity, disaster, war or revolution, not of free will.
March 28, 2013 at 4:45 am |
Yra,
while i understand that it is easy to bash Germany as the bad guy, please consider there is a Troika (EU, ECB and IMF).
It´s the IMF that is playing hardball. AS THEY ALWAYS DID!
the IMF never gave handouts but made sure that it gets a grip at the underlying problems (=debt load).
why? because it´s backed by the US who wants their money back, while Germany understands that any EU backed “loan” to cyprus is a gift that will never be paid back.
and i agree with Paul – things will always be the same. there is never such thing as a right moment for austerity/tightening. there´s always a group of lobbyists that makes sure that even the tiniest cut is being labeled a desaster. either you´re “making a recession worse” or “you endanger the recovery”.
thats the reason why we are where we are. because keynesian principles have always be applied in one direction only.
wish you happy Easter holidays!
March 28, 2013 at 6:03 am |
Green–this is not to bash the Germans for if you go back and read blog postings from the beginning of the Greek crisis you will see that I was very sympathetic to what I called the “good Bavarian Burghers” and that would push back when they realized who was being asked to finance the entire Euro financial system.But the continued push for austerity in a deleveraging economy is causing great pains and that is my point—morally the Germans are correct but the timing is wrong.And yes you are right and that ias the Perpetual Bubble that Bernard Connolly has written about for twenty years–intertemporal misallocation continues to borrow from the future and prevents any dealing with the problem–Brnard has warned of this since the lunacy of the Maestro Greenspan
March 28, 2013 at 6:07 am |
Green–also my disdain for the IMF has also been recorded over time and I the lowest opinion of Christine Lagarde and the recent activity proves it out.Hence the reference last week to her as the Joker
March 28, 2013 at 7:31 am |
Please do note that under the current German dictatorship, the Cypriots made no decisions. These were all handed down.
My sources tell me of an incident in the Presidential Palace where non of the Cypriot alternative plans were acceptable to the troika. The President lost his temper, got up threw a chair towards the empty area of the room and left the room to calm down.
Please also note of the backstage deal between the Eurogroup and the central bank of Greece. While initially there were thoughts of Cyprus selling the Greek branches, there was a change of mind. The Cypriot government understood that the branches were a negotiating card. If Laiki or any other Cypriot bank was closed then this would lead to a systematic effect via the Greek banking system. So the Cypriot government told the Greeks that the branches would not be sold. The Brovopoulos (who had the backing now of the troika) respond that if the Cypriots didn’t sell them the banks, then he would nationalize them. That is how the new EU plan to destroy the Cypriot banking sector was born and able to be executed….
Daylight Robbery.
March 28, 2013 at 8:22 am |
Great summary: “the continued push for austerity in a deleveraging economy is causing great pains and that is my point—morally the Germans are correct but the timing is wrong.”
So tell me HOW this ends! (Gen. Petraeus)
March 28, 2013 at 8:38 am |
Marianne–{I always knew it was Marianne and not ginger for a reason}– you make a very good point but as Bill White of the BIS in 2006 posited–the role of central banks and macroprudential regulators is to lean against the wind and not just to clean up the mess.Good solid central banking is dependent upon being ahead of the curve and identifying the risk ;may not be popular but that is the role of a good central banker–Paul Volcker comes to mind as does Tietmeyer,Axel Weber,Sclesinger,Otto Pohl—etc.
March 28, 2013 at 11:23 am |
Green makes an excellent point about things remaining as they are re the attacks by lobbyists and other assorted groups if money is cut from this budget or that plan etc.
Remember, one man’s fraud/scam/waste/mis-allocation of money is another man’s pay check. And normally the one who’s getting paid has more power/influence to make sure things remain just as they are…..
Perhaps the only way for things to get back to any sort of financial normality is when the money STOPS, ie there is nothing left in the kitty and NOBODY will lend another penny (at any interest rate). Then, we can back to proper financial basics.
March 28, 2013 at 12:29 pm |
Alex–theortetically correct ,but in practice won’t happen —the serial bubble blowers are in control–all over the world except the middle europa and when push comes to shove with Deutsche Bank so highly levered and we have not yet discussed the french banks—we await the newly quiet Mario draghi
March 28, 2013 at 5:16 pm |
Great discussion as usual!
I reached for my old copy of Hoyle’s and checked. It’s still true (unfortuantely), but bad politics always trumps good economics.
A good weekend to all,
Kevin
March 29, 2013 at 2:16 am |
You waste pixels thinking there is a choice. Given that humans choose not to self-reign, it will be force upon us, at the most in-opportune time. Buckle up.
April 9, 2013 at 3:57 am |
Appreciate you sharing, great blog article.Thanks Again. Much obliged