Tuesday, February 14, 2012

Is Greece about to prove that Swedish model works?

In a Bloomberg article, German finance minister Wolfgang Schaeuble says that Europe is better prepared if Greece defaults on its debt than it was two years ago.

The implication of this comment is that a Greece default and its related losses will be easily absorbed by the Eurozone and global banking system.

Hopefully, he is right.

Better yet from your humble blogger's perspective is the fact that if the Eurozone and global banking system can absorb the losses without triggering contagion, the Greece default confirms that the Swedish model works.

The banking system will have absorbed the losses on the excesses in the financial market rather than the real Greek economy.

Yes, it will take Greece some time to transition to the Drachma.  On the other hand, it can do so without the burden of the debt that it could not afford to pay.

More importantly, once the Eurozone and global banking system has confirmed again that it can absorb losses and keep functioning, applying the Swedish model becomes the default policy choice.

Why would Portugal, Spain or Italy want to subject their citizens to endless depression, when the global banking system can absorb the losses and let these countries focus their resources on growing their economies?


Fungus FitzJuggler III said...

You are a hopeless optimist!

I hope you are correct as I am on a euro pension in a non-euro country! Worse, this country is well run, comparatively, fights most corruption and is turning itself into a vast quarry, and has interest rates that allow 6%+ on deposits ....

The losses will be borne by someone in the financial arena. The USA injected the contagion, please express an opinion or be deemed coward on whether they will bear it or Europe?

Richard said...

Yes, I am an optimist.

The losses can and should be borne by someone in the financial arena. The best market participants to take the losses are the banks.

If the sovereigns socialize the losses, it needlessly uses up their debt issuance capacity and limits what policies they can pursue to restore growth.

There are two advantages to keeping the financial system losses in the banking system.

First, all the losses can be recognized today. As a result, the real economy is saved from the asset price and funding distortions that occur when losses are hidden.

Second, for those banks with a viable franchise, their losses can be paid for from future bank earnings. The losses for the banks without a viable franchise can be temporarily covered by the government and these too repaid by the banking industry from future earnings.

I realize that it will take the banking industry years to generate the earnings to cover all the losses. This is a feature and not a flaw to a Swedish model solution to a banking crisis.

Anonymous said...


While I agree that the financial engineers in the U.S. bear much of the responsibility for this crisis, I cannot quite see how they directly caused housing prices in places such as Ireland or Spain to increase dramatically. This statement is simply a corollary to the rebuttal of the argument that Fannie and Freddie caused the global credit crisis. That's a popular notion this election year.

Richard's proposal to use the Swedish model to absorb losses as a safety valve makes sense, although the political clout of the financial oligarchy (in Simon Johnson's words) and the degree of global regulatory capture (both political and intellectual) reduces considerably the likelihood that such a proposal will pass easily.

The degree to which the financial oligarchy and their lobbyists can disseminate "the big lie" is truly amazing. Take for instance one current statement making its way through regulatory apparatus, that the buyers knew what they were buying before the crisis hit and that, therefore, transparency isn't really the answer. That argument stands on its head the work of the Presidential Working Group of March 2009. Yet, when the lie is repeated often enough and it's big enough, strange things happen.

It's a result of the regulators listening primarily to the sell side or its allies, something Charlie McCreevy and Paul Volcker's G30 warned against. To understand the needs of the buy side, one must seek them out and then listen to them through the din of the sell side (which includes the financial industry lobbying groups according to McCreevy).

The sell side has captured the power structure of the regulatory bodies. It has hired the best and the brightest leaving the regulators with less intellectual firepower to counter bad arguments. It's Opacity Protection Team dominates the media, drowning out opposing views and relegating them to "fringe" status.

Proponents of the Swedish model may have the better intellectual argument, but until the media focuses on the need for the banks to absorb the losses to protect the real economy, Japanification for the EU and US appears most likely.