Tuesday, November 20, 2012

Spain's banking problems highlight a global reality

In reporting on Spain's banking problems, the Wall Street Journal highlighted the global reality that until losses are realized on both public and private debt that is never going to be repaid the global economy is going to be in a Japan-style slump.

But the Wall Street Journal does not stop there, it points out that wherever there has been a recovery there has also been a deep debt restructuring (also known as adopting the Swedish Model for handling a bank solvency led financial crisis).

It is one thing when your humble blogger makes this observation, and I have since the financial crisis began, it is entirely another when a mainstream media paper like the WSJ starts making this observation.
Spain’s banks are struggling with €182 billion ($232 billion) of bad debts, some 10.7% of their loan books. 
Until these debts are restructured and the Spanish banking sector’s bondholders are forced to eat their losses — including the sovereign and the various multi-national agencies like the European Central Bank, which holds considerable amounts of Spanish collateral — not much is going to be resolved. 
But Spain is merely a microcosm of the widespread problem of too much debt having been accumulated in the good times, now unable to be paid back.
So far, massive infusions of central bank liquidity have helped to stave off widespread bankruptcies, particularly in countries like the U.S. and U.K., where it’s been supplemented with massive fiscal transfers. 
But members of the Bank of England’s policy-setting committee are starting to realize the U.K. economy’s problems won’t be resolved anytime soon, or even in the next few years, by keeping interest rates at zero.
Regular readers know that the policy makers response of adopting the Japanese Model for handling a bank solvency led financial crisis and preserving bank book capital levels and banker bonuses at all costs never works (except for the bankers).

The only solution that works is adopting the Swedish Model and requiring the banks to recognize upfront the losses on all that debt that won't be paid back.
Deputy Governor Charlie Bean noted recently that a low-rate policy keeping dysfunctional businesses alive “inhibits the process of creative destruction as unprofitable firms are closed and the liberated resources shifted.” 
Governor Mervyn King has noted that monetary policy can only delay, not prevent, the necessary and painful restructuring....
Indeed, Spain and the U.K. highlight how much of the global economy’s current malaise — increasing stagnation of productivity, poor growth or outright recession — is down to the failure of policymakers to allow a resolution of that pile of bad debt.
It’s worth reflecting that wherever there has been recovery, it’s come on the back of deep debt restructuring and the consequent degree of short-term pain, be it in the Baltic states, Ireland or Iceland....
Please re-read the highlighted text as the Wall Street Journal has just confirmed what your humble blogger has been saying about the Swedish Model.
But John Hussman, a fund manager, warns that accounting rule changes and official indulgence in kicking non-performing loans down the road through “amend and pretend” measures mean that there’s a lot further to go before the mountain of unsupportable debt is resolved. And until it is, economies will continue to struggle on.
Economies struggling is the least of the bad outcomes that result from pursuing the Japanese Model.  As economies struggle, policy makers are tempted to rewrite the social contracts.

No comments: