Wednesday, October 31, 2012

German taxpayers to get stuck with the Greek losses that banks should have taken

In a classic case of socializing the losses, Ambrose Evans-Pritchard discusses in his Telegraph column how it is now unavoidable that Germany's taxpayers will get stuck with losses related to Greece.

Left unsaid was that without a series of bailouts, these losses would have been taken by the banks instead.  Bailouts that were the direct result of the German government's decision to protect bank book capital levels and banker bonuses at all costs.
Every detail of the Greek economy is worse than officially forecast just weeks ago....

In fact Greek GDP contracted by 4.5pc in 2010, 6.9pc in 2011, and will shrink 6.5pc this year, and now 4.5pc next year. 
The cumulative error is colossal. 
The IMF's former deputy chief John Lipsky told an HSBC forum in London earlier this month that it was impossible for the Fund to make any accurate forecast, given the crazy circumstances in Greece. 
I don't wish to be unduly harsh on the IMF – a superb organisation – but actually the Greek Labour Institute and the think-tank IOVE did predict this level of contraction. 
The IMF simply lost its political way in Greece. It knew – or should have known from dozens on rescue operations around the world – that Greece would crash into a self-feeding spiral without a rapid debt restructuring and a devaluation....
The policy never had any chance of working for Greece. The IMF under Strauss-Kahn went along with the EMU agenda, pretending all was well, sacrificing the Greeks to gain time for the European financial system to build up safety buffers.
The Japanese Model for handling a bank solvency led financial crisis never has a chance of working anywhere.

There are a number of reasons that it fails including that placing the burden of servicing the excess debt on the real economy crushes the real economy.

One of the ironies of the Japanese Model is that a substantial portion of the benefit from sacrificing the Greeks to gain time for the European financial system to build up safety buffers flowed out in the form of bonuses to bankers.

Your humble blogger has argued for adoption of the Swedish Model and requiring banks to recognize up front the losses on the excess debt since the beginning of the financial crisis.  One of the advantages of making the banks absorb the losses upfront is that while the banks are rebuilding their book capital levels earnings are not siphoned off to pay banker bonuses.
Thomas Wieser, the head of the European Working Group handling Greece, said today that press reports of further debt restructuring and official "haircuts" in the current Troika talks are pure fantasy. 
If that is so – and what he means is that Germany, Holland, Finland, and Austria will not tolerate a haircut on their holdings of Greek debt – then the creditor countries are trying to maintain a ridiculous illusion for their own internal political reasons. 
Greece cannot claw its way out of a 190pc of GDP debt load. The official haircut is coming sooner or later, and it will be an explosive political moment.
Chancellor Angela Merkel will have to account for direct losses to the Bundestag. A line will have to be written into the German budget covering the X billions of euros. Other line items may have to be cut. Welfare support for Germans, perhaps.
Please note how by socializing the losses, the burden falls on the taxpayer rather than the banks.

If the banks take the losses, then there is no reason to cut welfare support or other similar programs for Germans. [Your humble blogger has proposed a method transferring the losses back to the banks, so it is not too late to adopt the Swedish Model and protect the real economy and German society.]
Having insisted for over two years that German taxpayers face no risk of loss on the Club Med rescue packages – and having indeed told them it generated a profit – she will have to explain why this has gone horribly wrong. 
No doubt she will try to delay this awful moment until after the German elections late next year. 
But the calendar of simmering revolt in Greece is not in her hands. One of the three parties in the pro-Memorandum coalition has already refused to go along with the budget plans. The Government majority is thinning fast. 
My guess is that Mrs Merkel will be forced to admit to the German nation that contingent liabilities are turning into real liabilities long before her elections.
Following up on his column, the Telegraph carried an article on Greek death spiral raises heat on creditors, specifically states and official institutions, to accept debt-forgiveness.

More importantly though, the article confirms what your humble blogger has been saying about the destroying the real economy by putting on it the burden of servicing the excess debt.
A study by Britain’s National Institute Economic Review said the eurozone’s austerity strategy is "fundamentally flawed" and has become self-defeating. "Even on its own terms, it is making matters worse." 
The institute said synchronized fiscal tightening by a group of countries in the middle of a slump does deep damage to the productive economy and may actually worsen the debt ratio, pushing some countries into a "death spiral". 
It said the "fiscal multiplier" rises sharply when interest rates are already near zero and monetary policy cannot easily offset the budget squeeze. "We do not appear to be in normal times but in a prolonged period of depression, which we define as when output is depressed below its previous peak. The impact of fiscal tightening during a depression may be very different," said the paper by Dawn Holland and Jonathan Portes. 
While debt may fall, it cannot keep pace with falling output, as has occurred in Greece. 
"Our simulations suggest that coordinated fiscal consolidation has not only had substantially larger negative impacts on growth than expected, but has actually had the effect of raising rather than lowering debt-GDP ratios. Not only would growth have been higher if such policies had not been pursued, but debt-GDP ratios would have been lower." 
"The direct implication is that the policies pursued by EU countries over the recent past have had perverse and damaging effects." 

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