Monday, March 11, 2013

Banks saved, but a generation may have been lost

Since the beginning of the financial crisis, your humble blogger has been talking about the adverse impact on society of the choice of the Japanese Model for handling a bank solvency led financial crisis and protecting banker bonuses at all cost.

In a Reuters' article, the President of the European Parliament suggests that the cost of protecting bank book capital levels and banker bonuses might be a "lost" generation.

The cost is not limited to this lost generation.  The lost generation is being counted on to have the earnings needed to support the social welfare programs of the older generations.

If the lost generation doesn't have these earnings, then the social programs, like Medicare and Social Security, for the older generations will have to be cut back.

Reducing the promise of the social programs creates economic headwinds.  Just like the Retirement Plan Death Spiral, savers will attempt to offset the decline in promised benefits by cutting back on current consumption.  This makes the situation worse for the lost generation and increases the size of the needed social programs cuts in a negative self-reinforcing feedback loop.

Having either a "lost" generation or reducing the social programs is unacceptable given that there is a proven alternative to the Japanese Model, the Swedish Model, that protects the real economy, the social programs and society.

Under the Swedish Model, banks are required to recognize upfront the losses on the excess debt in the financial system.  This protects society and the real economy by not forcing the diversion of capital that is needed for growth, reinvestment and social programs to cover the debt service on the excess debt.

The Swedish Model could still be adopted today and bring an end to the financial crisis that began on August 9, 2007.

Since the Swedish Model could still be adopted, policymakers have to make the decision every day to continue pursuing the Japanese Model and its related policies like austerity and zero interest rates.

Since the Swedish Model could still be adopted, every day since the financial crisis began policymakers have chosen to put protecting banker bonuses ahead of protecting the real economy and society.  Apparently even at the cost of a lost generation.

While the article talks about Europe, the same is true in Japan, the UK and the US.
Europe has spent hundreds of billions of euros rescuing its banks but may have lost an entire generation of young people in the process, the president of the European Parliament said. 
Since the region's debt crisis erupted in Greece in late 2009, the European Union has created complex rescue mechanisms to prop up distressed countries and their shaky banking sectors, setting aside a total of 700 billion euros. 
But little has been done to tackle the devastating social impact of the crisis, with more than 26 million people unemployed across the EU, including one in every two young people in Greece, Spain and parts of Italy and Portugal. 
That crippling level of unemployment has led to protests and outbreaks of violence across southern Europe, raising the threat of full-scale social breakdown, including rising crime and anti-immigrant attacks that can further rattle unstable governments. 
"We saved the banks but are running the risk of losing a generation," said Martin Schulz, a German socialist who has led the European Parliament, the EU's only directly elected institution, since January last year. 
"One of the biggest threats to the European Union is that people entirely lose their confidence in the capacity of the EU to solve their problems. And if the younger generation is losing trust, then in my eyes the European Union is in real danger," he told Reuters in an interview.
Please re-read the highlighted text as the risk of losing an entire generation and the stability of society is simply too high a price to pay to protect banker bonuses.
Schulz, 57, who finished high school but did not go to university and began his career as an apprentice bookseller, said he had recently taken part in a debate where he was challenged by a Spanish woman over the issue of young people being abandoned for the sake of rescuing wealthy banks. 
"She effectively raised the question: 'You have given 700 billion euros for the banking system, how much money do you have for me?'" he said. "And what is my answer?
"If we have 700 billion euros to stabilize the banking system, we must have at least as much money to stabilize the young generation in such countries," he said. 
"We are world champions in cuts, but we have less idea ... when it comes to stimulating growth."...
The way to stimulate growth is to have the banks absorb the losses on the excess public and private debt.

This frees up the capital that is currently being used for debt service on this excess debt to be reinvested.

This ends the need for economic policies that stifle demand like austerity or zero interest rate policies.

This also eliminates economic distortions from zombie companies whose loans were restructured by banks engaging in extend and pretend.

In short, by making it harder for bankers to be paid cash bonuses, the real economy can resume growing and the social safety net can be protected.
"Greece, Spain and Italy have perhaps the best educated generations they have ever had in their countries, their parents invested a lot of money in the education of their children, everything they did was right," said Schulz.
"And now they are ready to work the society says, 'No place for you'. We are creating a lost generation."

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