Tuesday, November 20, 2012

Germany's trouble with the truth

In a der Spiegel column, Stefan Kaiser explains why the German government will continue to resist recognizing the losses on the Greek debt, but how eventually, only after the size of the losses has gotten bigger, the losses will have to be recognized.

His argument suggests that the transition from the failed Japanese Model for handling a bank solvency led financial crisis to the Swedish Model is inevitable.

Under the Japanese Model, bank book capital and banker bonuses are protected at all costs.  By definition the policies pursued under this model do not allow for losses on bad debt to be recognized.

Under the Swedish Model, banks are required to recognize upfront the losses on the bad debt in the financial system.

I agree that adoption of the Swedish Model is inevitable.  However, Japan shows that while it is inevitable, at the urging of the bankers, policy makers will push the moment of when the Swedish Model is adopted as far as possible into the future.

This delay guarantees maximum damage to the real economy and the social contract it supports.  It also guarantees maximum bonuses paid to bankers.
At some point, even the best tricks -- the aimless chatter of "other solutions," the putting-off of painful decisions -- don't help any longer. 
At some point, Greece's rescuers in Berlin, Brussels or Paris will have to admit that saving the country is going to cost a lot of money..... the money will simply be a loss for Germany and the other creditor nations. 
They'll have to make it up some other way, such as raising taxes or cutting expenditures.
Under the Japanese Model, the only options for making up a loss from writing down bad debt hurt the taxpayers:  either through higher taxes or less government expenditures.

Under the Swedish Model, a third option for paying for the losses is introduced.  An option that doesn't hurt taxpayers at all.  That option is that banks "pay" for the losses.

The way that banks pay for the losses is through retention of 100% of future earnings to rebuild their book capital levels.

It is common sense that the banks should pay as nobody forced them to extend credit beyond the capacity of the borrower to repay.
There's just one problem, though. This moment of insight and clarity is still a long way off.  
For the time being, it seems as though the euro-zone countries are just going to keep carrying along as they have been. That is, muddling onward and delaying reality for as long as possible. 
This pushing off adopting the Swedish Model is extremely expensive.

It shifts the burden of the excess debt onto the real economy.  As your humble blogger predicted at the outset of the financial crisis, until the losses are realized, the global economy will be in a Japan-style economic slump with a bias towards spiraling downwards that is periodically interrupted by fiscal and monetary stimulus programs.
Angela Merkel is the master of this strategy. The German chancellor wants to push back Greece's necessary payday by at least 10 months. That's because she hopes to be re-elected in the fall of 2013.... 
That means when the euro finance ministers meet on Tuesday to free up the next tranche of Greece's second rescue package, they will only resolve as much as is absolutely necessary to get through the next months. 
They would also rather not have to ask the question as to where the additional nearly €33 billion that it's going to cost by allowing Greece to push back its savings targets again is supposed to come from. And they're less willing than ever to think about long-term solutions, like a debt haircut. 
But this is cowardly and dishonest. Citizens are only going to grow angrier with their politicians....
In Japan, this anger is shown by the high turnover in prime ministers.

In the EU, this anger is being shown by protests.
Like no other government, Germany has stirred up sentiment against Greece and produced arguments about how important it is to be tough on countries in debt. Now it will be that much more difficult for Germany to explain why it all of a sudden makes sense to give money to the very same places.
This is one of the many problems associated with pursuing the Japanese Model.  It is very difficult for a politician to acknowledge that they were wrong in pursuing the Japanese Model even when the facts are clear to the electorate.

Unfortunately, there is no reason to believe that the Germany government is capable of handling the truth about the debt situation in Greece, Portugal, Spain, France, the UK and the US.

More unfortunately, in their unwillingness to acknowledge the truth, the German government is managing to jeopardize the German real economy and Germany's social contract.
The only hope for an end to this mess is the International Monetary Fund (IMF), which obviously takes its principles seriously. For example, the IMF may only give money to indebted countries if they can foreseeably repay the credit and, at the end of the lending program, be able to look out for themselves once more.
How ironic that the IMF is the only hope.  As Asian and Latin American countries will tell you, heading into the financial crisis the IMF's role was to collect sovereign debts for the large western economies regardless of the pain inflicted on their real economy and society.
But this is exactly what Greece cannot do. By all economic logic, the country won't be able to reduce its debt load to 120 percent of its gross domestic product (GDP)by 2020 as planned. At the moment, the country's debt burden lies around 177 percent, and by 2014 it will even be up to 190 percent. 
To recover from such monumental numbers, neither lowering interest rates for old credit nor other tricks that the government is suggesting will work. 
It will actually take either a gigantic economic boom or a so-called debt haircut. This means that the creditors, chief among them the euro countries, would have to release Greece from a big segment of its debts. 
As there isn't an economic boom anywhere in sight, another haircut is going to be the only way out. At least, that's how the IMF and virtually every serious economist sees it. Only the politicians responsible for the situation want to see it otherwise. 
There is no way around it, though. Germany and the other creditor countries will have to pay for Greece. Whether it's called a haircut, bankruptcy, debt forgiveness or a transfer is irrelevant. The only important thing now is that the policymakers find the courage to reveal the truth to their people.
Which means explaining that the Japanese Model and its related policies have failed.  In place of the Japanese Model, the government is going to pursue the Swedish Model and its related policies going forward.

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