Sovereign debt bubble thread

[Sheilbh]

This article from the Economist is pretty interesting:

The hangover
America is recovering from the debt bust faster than European countries. Why?
Jan 21st 2012 | from the print edition


ALMOST half a decade after the onset of the rich world's credit bust, depressing evidence of its after-effects is visible in everything from feeble output figures to swollen jobless rolls. But for a truly grim picture, read a new report on deleveraging by the McKinsey Global Institute. It points out that in many rich countries the process of debt reduction hasn't even started. America has begun to pare its debt burden, although the drop is small compared with the build-up in 2000-08 (see chart). But many European countries are more, not less, in hock than they were in 2008. There the hangover could last another decade or more.

These transatlantic differences stem from the trajectory of private debt. Government borrowing soared everywhere after 2008 as government deficits ballooned. But in America the swelling of the public balance-sheet has mirrored a shrinking of private ones. Every category of private debt—financial, corporate and household—has fallen as a share of GDP since 2008. The financial sector's debt is now at its 2000 level. Corporate indebtedness, never very high, has shrunk. So, more importantly, has household debt. America's ratio of household debt to income is down by 15 percentage points from its peak in 2008, after rising by over 30 percentage points in the eight preceding years. McKinsey reckons America's households are between a third and halfway through their debt-reduction process. They think the household-debt hangover could end by mid-2013.

In Europe private debt has fallen much less and in some cases even risen. In Britain the financial sector's debts have grown since 2008. In Spain corporate debt, far higher as a share of GDP than in most rich countries, has barely budged. But the biggest difference is among households. Even countries which saw the biggest surges in household debt during the bubble era, such as Britain and Spain, have scarcely seen a dent since 2008. McKinsey's analysts reckon it will take British households up to a decade to work off their debt burdens.

It's not that American households have been more frugal or disciplined. Household debt has fallen largely thanks to defaults, particularly on mortgages. America had a bigger housing bust; in some states non-recourse lending rules make default easier (people can walk away from home loans without fear of losing other assets). Some two-thirds of America's $600 billion decline in household debt is due to defaults. With another $250 billion of mortgages in the process of foreclosure, further reduction is likely.

Europe's post-bubble economies, in contrast, have seen smaller drops in house prices, lower mortgage costs thanks to variable interest-rate mortgages, and gentler treatment from banks. The Bank of England suggests that around 12% of British mortgages receive some kind of forbearance. Fewer people are turfed out of their homes, but the millstone of debt weighs for longer.

America's private-sector debt reduction has also taken place against the backdrop of loose fiscal policy. Although state and local governments have been cutting back, the federal government has (at least until now) put off most fiscal tightening. In Europe, however, the sovereign-debt crisis means governments have been forced, or chosen, to undertake swingeing budget cuts long before the private sector's deleveraging is done.

Note the Nordics

That stands in stark contrast to most successful bouts of debt reduction. The McKinsey report pores over two episodes that it considers most relevant for today: the experiences of Sweden and Finland following their banking busts in the early 1990s. Debt reduction took place in two stages. In stage one, the private sector reduces its debts; the economy is weak and public debt soars. In stage two, growth recovers and the longer-term process of reducing government debt begins. In both these cases growth was buoyed by booming exports, a boon that seems unlikely this time. But it is telling that Sweden did not begin its budget-cutting until the economy had recovered; and that when Finland tried an early bout of austerity, this worsened its recession.

The McKinsey analysts carefully avoid suggesting this means Europe's austerity is misguided. Circumstances today are different, they argue: European governments began with higher debt and deficits, leaving them with less room for manoeuvre. But the message is clear: America is closer to Sweden's successful template than Europe is. Debt reduction is very difficult without economic growth, and the scale of Europe's austerity makes it hard to see where that growth will come from.

That's all the more true because Europe's governments have been remarkably timid, compared with the Nordics, in exploiting another avenue to growth—structural reform. The report underscores just how dramatically Sweden and Finland overhauled their economies in the wake of their debt crises. Banks were nationalised and restructured; whole sectors, such as retailing, were deregulated. Thanks to a slew of efficiency-enhancing reforms, productivity soared and investment boomed.

Nothing so bold has been attempted this time. America has not managed much in the way of growth-enhancing structural reforms and has a long to-do list, from improving worker training to reining in health-care costs. But it is in Europe where the potential gains from structural reforms are greatest and where the policy focus has nonetheless been overwhelmingly on austerity.

That may change. With much of the euro zone in recession, structural reforms are getting higher billing. Spain's new government began with an extra dollop of austerity; it now wants to accelerate the freeing of its rigid labour rules. Italy's prime minister, Mario Monti, first raised taxes and cut spending; now he is about to take on the unions. Angela Merkel, the German chancellor, is saying that Europe's leaders need to focus on growth. But a shift in the policy mix will not stop many European countries' debt burdens from spiralling yet higher. Depressing, indeed.

Am I right in thinking that most states have since got rid of non-recourse mortgages?  I thought they were a significant factor in the crisis.

[Tamas]

And the welfare states continue to fall as a failed historical experiment.

[The Brain]

Early 90s was great in Sweden, we got rid of so much Soc Dem garbage.

[Zanza]

If those numbers are correct, there must have been a massive reduction of private debt in Germany as public debt went up a lot more than just 1.2% over the last three years.

I agree with the general message that we need structural reforms to allow for more growth again.

[Ideologue]

And the welfare states continue to fall as a failed historical experiment.

Incorrect.  Only the flawed European model that involves funneling massive amounts of money to beggar countries with no central control, and when the inevitable happens, enacting draconian austerity measures that cripple GDP for a generation.

[Tamas]

And the welfare states continue to fall as a failed historical experiment.

Incorrect.  Only the flawed European model that involves funneling massive amounts of money to beggar countries with no central control, and when the inevitable happens, enacting draconian austerity measures that cripple GDP for a generation.

You have perhaps one or two  of the biggest European powers who can maintain a welfare state with their huge economies. Ergo, they are the EXCEPTION. If you read the article, even the scandis cut back on stuff to avoid falling in the pit.
When you have to take loans to finance the daily running of your country, well that is when you cleary failed and should backtrack to a sustainable model. That is what many European states have failed to do, for decades, but now that the financial crisis has dried up available loans and due to the euro they can't inflate their debtors money into oblivion, they are being kept honest.
Boo fucking hoo.

[DGuller]

Am I right in thinking that most states have since got rid of non-recourse mortgages?  I thought they were a significant factor in the crisis.

Doesn't sound right at all.  I haven't heard of a single instance of a state changing the recourse status of the mortgages.

[Sheilbh]

Am I right in thinking that most states have since got rid of non-recourse mortgages?  I thought they were a significant factor in the crisis.

Doesn't sound right at all.  I haven't heard of a single instance of a state changing the recourse status of the mortgages.

Maybe that's the wrong phrase.  I remember this being a digression in a lecture on Land Law.  I'll try and remember.

[Zanza]

The welfare state is supremely successful political experiment. And it is possible to keep the spending and revenue balanced. If you don't do that, it won't work obviously, but that's true for every policy.

[Sheilbh]

The welfare state is supremely successful political experiment. And it is possible to keep the spending and revenue balanced. If you don't do that, it won't work obviously, but that's true for every policy.

Agreed.  I think there are two challenges that are largely unaddressed with the welfare state that are long term threats.  The welfare state is designed generally for growing populations and generally for full employment.  Those elements can't be taken for granted any more and I think reform needs to reflect that.  Those are core structural issues that affect spending, but balancing spending and revenue's a failure of politicians that doesn't necessarily indict the policy itself.

[The Minsky Moment]

And the welfare states continue to fall as a failed historical experiment.

I think you missed the point of the Economist article.
From a macro perspective, a key function of the welfare state is to substitute public for private indebtenedness during a severe recession, thus accomodating reduction in private debt and counteracting the dangers of debt deflationary spiral.

[MadImmortalMan]

From a macro perspective, a key function of the welfare state is to substitute public for private indebtenedness during a severe recession

It has certainly accomplished that with aplomb.

[Iormlund]

That may change. With much of the euro zone in recession, structural reforms are getting higher billing. Spain's new government began with an extra dollop of austerity; it now wants to accelerate the freeing of its rigid labour rules. Italy's prime minister, Mario Monti, first raised taxes and cut spending; now he is about to take on the unions. Angela Merkel, the German chancellor, is saying that Europe's leaders need to focus on growth. But a shift in the policy mix will not stop many European countries' debt burdens from spiralling yet higher. Depressing, indeed.

While I have been saying for a while that the focus should have been structural reform and not austerity, I have to warn that my impression is that it is way too late for said reforms to spur growth on their own. Nobody will hire over here even if you can fire older people on the spot (young people have been free or almost free to fire for ages). Simply because there's little work to do as it is. You'll get less failed businesses as they are able to shed some weight. Nothing more.

[PJL]

Apparently Greece is now in a position to say sod off to the bankers & the troika and default without having to go back to the markets as their taxes now cover all their spending less interest payments. Which means it has strengthened their position with respect to everyone else.

Source - http://www.bbc.co.uk/news/business-16746455

Tables are turning on Greek debt deal

The time for reaching a Greek debt deal is fast running out. That's one thing everyone can agree on here in Davos.

But what's less often noticed is that the balance of power around the negotiating table has also shifted lately; against the Eurozone institutions and politicians who most want to see a deal, and in favour of the Greeks themselves.

There are three reasons for this shift.

First, the need for more debt relief for Greece has become even more blindingly apparent.

Second, it has become clear that the official sector has to contribute if it's going to happen politely.

Finally, and more quietly, the Greek government has slashed its way to a primary budget surplus: as of now it is only borrowing money to pay off the debt. That could change things quite a bit.
Skyrocketing cost

Let me say a bit more about all of this.

To see the need for greater debt relief, you need only look at the skyrocketing cost of servicing Greek debt. For all the "cheap" loans flowing to Greece from the Europeans and the IMF, the Greek government had to pay 23% more in debt interest in 2011 than in 2010.

Forecasts for its total debt relative to GDP get revised up almost every week and look less and less plausible.

The second new reality follows directly from the first. To put it bluntly, the truth is slowly dawning that no "voluntary" arrangement to cut the value of debt held by the private sector is going to provide Greece with enough relief.

Either the haircut for the private sector has to be a lot more than 50%, in which case it is very unlikely to be classed as "voluntary" by any stretch of the meaning of that word, or the stock of debt that's part of the deal needs to grow to include bonds held by public sector institutions like the ECB, which has bought around €40bn (£34bn; $53bn) of them.

As we have seen this week, Germany and the ECB are still dead set against this.

They say it might not be legal under the Treaty. They also think, reasonably enough, that there's an important principle at stake. If the official sector runs into a burning building when the private sector are all running out, the rescuers shouldn't be the ones to get burned.

But, you might say, that is why firemen have trouble getting insurance. It's a dangerous line of work no matter how much protective clothing you have.

Maybe it's not fair, but if the Germans want their first - and supposedly last - foray into "private sector involvement" to happen in an orderly way, it's looking as though they're going to have to swallow some losses for the ECB, or find some other way for the public sector to be involved.
Ambitious debt reduction

You might ask why any of this strengthened the hands of the Greeks, as I suggested at the start.

One reason is that the IMF is now firmly behind a more ambitious debt reduction. As we have seen this week, the IMF's managing director is also on Greece's side pushing for public sector involvement in the deal.

But another key factor, which few seem to have tumbled to, is that the costs to Greece of the government walking away from the table and suffering a disorderly default have fallen noticeably since last summer, at least when compared to any plausible (orderly) alternative.

The key to this is to look at the Greek government's budget outturns for the second half of 2011, published earlier this month.

As Graham Turner of GFC Economics has noted, these show a real step-change in the effort to cut spending and actually collect more Greek taxes.

You'll remember it was the Greeks' inability to get a grip on spending or taxes in the first half of 2011 that caused the big overshoot in their deficit, and such paroxysms in Berlin and Brussels (not to mention the markets).

The primary budget - excluding debt interest payments - for the first 6 months of the year had a deficit of €5.1bn, which was almost exactly the same as the year before.

Tax revenues had fallen by more than 5%, year-on-year, and non-interest spending had risen by more than 8%.

That was when the fiscal equivalent of Eurozone special forces parachuted into Athens as part of the second rescue package, with EU tax officials seconded to the Greek finance ministry. If the numbers are to be believed, they have made a massive difference.

In the second half of 2011 the latest figures show tax revenues up 1.4% year on year and non-interest spending falling by an impressive 7.4%. As a result, the Greeks seem to have managed a 1.8bn euro primary surplus in that period: the overall deficit was still massive, but all that borrowing was going toward debt interest, not domestic spending.
Less terrifying

Here's why this matters: traditionally, countries that need a massive write-down of debt will try very hard to avoid a disorderly default when they are still borrowing from the markets to fund basic government services.

However, the balance of arguments shifts a bit, when they "only" need to raise money in the markets to service their debt. Further budget cuts, simply to pay investors their interest, are harder to defend politically. And the immediate fallout for basic services of losing access to the markets gets slightly less terrifying.

Don't get me wrong. If it happens, as so many people now expect, a full-blown Greek default would still be horrendous for its financial system, and its domestic economy - at least in the short run. (That's quite apart from the impact on its eurozone neighbours. I'm only thinking here about the implications for Greece.)

For all that, the balance of costs and benefits to Greece relative to the current path is not what it was years ago, when it's primary deficit was 5% or 6% of GDP.

And, let's face it, the stick-with-it scenario is not looking so hot either.

Earlier this week, the IMF's chief economist, Olivier Blanchard, spoke eloquently about the dangers of the crisis.

He noted that one of the more pernicious things about the current situation was that countries under pressure were doing the "right thing" in terms of budget cuts, but were not getting rewarded for it, either by the markets or by their supposed eurozone allies. That's more than unfair; it's dangerous.

The irony is that Germany's very emphasis on putting fiscal tightening before everything else has actually now put Greece in a stronger position to default.

If that is not what Angela Merkel intended to happen, she will almost certainly need to give some ground in these debt negotiations to prevent it. Assuming it is not already too late.

[Admiral Yi]

[quote author=The Minsky Moment link=topic=4552.msg368231#msg368231 I think you missed the point of the Economist article.
From a macro perspective, a key function of the welfare state is to substitute public for private indebtenedness during a severe recession, thus accomodating reduction in private debt and counteracting the dangers of debt deflationary spiral.
[/quote]

Please explain to me how a country with unlimited central bank money creation power can ever be caught in a deflationary spiral.