News is leaking out that the”haircuts” on European Sovereign debt are going to be greater than imaginedjust several weeks ago!”EU looks at 60%haircuts for Greek debt.” (http://www.ft.com/intl/cms/s/0/66bdcbc0-fc11-11e0-b1d8-00144feab49a.html#axzz1bRwsVH3F)
Three months ago Europeanofficials agreed to a 21 percent haircut.Then, in the last several weeks, the figure moved to around 50 percent.
And, still officials aredawdling.
European banks are troubled,and we hear about how the “French Banks Fought Oversight.”Seems as if French banks and Frenchregulators consistently ignored the reality of the situation within the banksclaiming that no problems ever existed.
Of course, bankers arenotorious for claiming that problems do not exist on their balance sheets!But, this is not new. (See my http://seekingalpha.com/article/300076-european-bankers-balk-at-big-write-downs.)The bankers’ denial of any problems on theirbalance sheets is maintained right up to the time hey begin to argue that “Itwas not our fault!”
The problem I have with allthis is that attention is being deflected from the real issues while blame isbeing diverted from the real culprit.
The real culprit, to me, isthe post-World War II attitude in America, the UK, and Western Europe that thecreation of debt, especially by governments, could keep unemployment at lowlevels and this would end the possibility of social unrest caused by masses ofunemployed persons.The result was thatthe latter half of the twentieth century became the “poster child” for thebenefits of what can be called credit inflation.
Creating debt, especiallygovernment debt, was not just a policy of the left, but it was also the policyof the right.The creation of debt wouldresolve almost all social issues since it kept people at work.This would also help politicians getre-elected.
In the 1960s we added to thegoal of keeping people working the goal of seeing to it that every family ownedtheir own home.This was especially thecase in the United States.I was workingfor a cabinet secretary in the early 1970s in a “conservative” administration,and one of the major goals of this administration was the development ofmortgage-backed securities.
The reason for thedevelopment of this instrument was certainly not an economic one.The reason for the development of themortgage-backed security was to get politicians re-elected.The argument was that if more Americans ownedtheir own home, the more willing they would be to re-elect those Senators,Representatives, and Presidents that supported this goal.
The government’s developmentof the mortgage-backed security, of course, brought several new things to thefinancial markets, like ‘slicing and dicing’ cash flows, that paved the way forthe financial innovation that was to take place later in the century.
Of course, the major driverbehind all of this was the continual efforts of the national governments tocreate credit through deficit spending to hire large numbers of peoplethemselves, to almost continuously stimulate the economy to keep unemploymentlow, and to continue to find ways to put more and more people into their ownhomes.
This is the essence of creditinflation!And, the central banks,fundamentally, helped the national governments to write the checks.
The undisciplined creation ofdebt, however, does not end well.Thisis the story that Carmen Reinhart and Kenneth Rogoff tell in their book “ThisTime is Different.”And, for the UnitedStates, the UK, and Western Europe, this time was not different and financialcrisis arose.
The point I am getting at isthat the resolution of a financial crisis is not a unique action.However, many of those in authority arecrying out “This time is different”!
One of the boldest “criers”is Fed Chairman Ben Bernanke.I havewritten my opinion of him in an earlier post. (http://seekingalpha.com/article/300076-european-bankers-balk-at-big-write-downs)But, Mr. Bernanke is not the onlyauthority at the central bank that is searching for a new or better way toconduct monetary policy. (http://professional.wsj.com/article/SB10001424052970203752604576643510352250474.htmlmod=ITP_pageone_0&mg=reno-secaucus-wsj)
Gillian Tett also writes inthe Financial Times that “Central Bankers must update outdated analyticaltoolkit.” (http://www.ft.com/intl/cms/s/0/877b7bfa-fb21-11e0-bebe-00144feab49a.html#axzz1bRwsVH3F)
Let me just say in answer tothis situation we are in: This time is not different!
The problem is too muchdebt!The cause of the problem was 50years of credit inflation in the United States, the UK, and WesternEurope.This debt must be worked off andit takes time to work off excessive amounts of debt.Again, I recommend you check the Reinhart andRogoff book.I have also just written apost on this:
http://seekingalpha.com/article/300450-the-u-s-economy-will-continue-to-grow.
And, the lessons from thisexperience are not new.Don’t issue toomuch debt!Don’t just focus on short-rungoals…like fiscally stimulated low unemployment, like everyone owning their ownhome, like governments hiring all their own supporters…and so on and so forth.
The problem is not financialinnovation or greed or speculators.These things will never go away.
The problem has been that thecredit inflation created in the last 50 years has created huge incentives todevelop financial innovation, to exercise greed, and to benefit fromspeculation.And, in the frenzy, thingsgot out-of-control.
That is where we aretoday.The haircuts that are nownecessary are large and if something is not done about them soon, the haircutswill get even larger!What if thewrite-down on Greek bonds were 90 percentWhat if the write-down on the bonds of Italy were 50 percentPortugal…60 percent Spain…And, France…
Over the last fifty years orso, people in the United States, the UK, and Western Europe have been livingpretty well.They can live wellagain.But, we need to get away fromKeynesian policies that promise something for nothing and return to somefundamentals that have played well over the years.
This time is notdifferent!Discipline and integrity arewinners and have always been winners.But, in a state of chaos, returning to discipline and integrity isdifficult and painful.The historicallesson, however, is that if people do not return to a condition of disciplineand integrity the pain and suffering does not end…and in many cases it willonly get worse!
