Sovereign debt bubble thread

[Iormlund]

Spain decided to wait the crisis out rather than bailout its banks in 2008. Turns out that was a big mistake. Portugal is also bailing them out now. And then there's France, Belgium, Germany, Austria ...

Ireland is certainly not alone when it comes to banking troubles.

[The Minsky Moment]

Joan:  so you're saying if there had been no global downturn in 2008 lenders would have been happy to roll over Greek debt at 3% until the end of time?

I can't answer a pure counterfactual.  What I do know is that Greece's lenders were perfectly happy to roll over Greek debt for 10 years at minimal spreads over Bunds.  Absent the downturn, I can't think of any particular reason why that wouldn't have continued.

Your narrative also doesn't fit my recollection of events as regards bank recapitalization.  Of course Irish banks went belly up and got nationalized (foolishly IMO) before yields started to rise in other countries.  But I'm unaware of any other bank recapitalizations that took place before the exit from Greek bonds.

Germany and Spain were exposed because of the state's effective responsibility for the liabilities of quasi-public institutions like the Landesbanken and IKB in Germany and the cajas in Spain.  In both cases the exposure of the central government was obscured by the fact that regional governments took the immediate hit.  Most Eurozone countries also conducted "stealth" recaps in the sense that expanded deposit guarantee schemes and asset purchase programs were used to bolster bank stability but at the cost of taking on significant liability exposure which did not take long to materialize.  The recaps that Spain is doing now is just the other shoe dropping.

[Admiral Yi]

Do you have some stats to back up your argument, something that shows the share of deficits going to bank recapitalizations perhaps?

And tell me how you reconcile this story with your "Germany could have fixed everything with a Greek bazooka to end contagion" argument.

[Admiral Yi]

And a quick side question Joan: why don't companies auction their bonds like Treasury, instead of paying an underwriting fee?

[MadImmortalMan]

The economic crisis commenced in 2008

That crisis is over.



It's not operative to talk about it as the current one. It caused a lot of problems and got us where we are, but the current crisis is a sovereign debt one. We've nationalized the 2008 bubble and now we're stuck with too much debt. Even more than we were before. That's the current issue. Not 2008.

[Crazy_Ivan80]

The economic crisis commenced in 2008

That crisis is over.



It's not operative to talk about it as the current one. It caused a lot of problems and got us where we are, but the current crisis is a sovereign debt one. We've nationalized the 2008 bubble and now we're stuck with too much debt. Even more than we were before. That's the current issue. Not 2008.

Same crisis, different spot it's raging in other words.

[The Minsky Moment]

That crisis is over.

GDP has not come back to pre-crisis levels, and employment remains way off.
So not only is the crisis not over, but what is being seen as a fiscal problem is actually just a side effect of the 08 crisis.

It is tautological that the sum total of net household savings plus net business savings (retained income - investment) plus government savings (negative of the deficit) plus the current account must sum to zero.  This crisis was and remains one of recovery from an investment and consumption bubble and is worldwide.  Its resolution required (and still requires) the private sector to reduce their debt exposure.  Since every nation cannot run a current account surplus, that means government had to increase indebtedness to give the private sector room to liquidate. 

Government deficits are the inevitable and unavoidable by-product of the recovery process.

[DGuller]

I think we should just let the private sector run up its own debt to make room for their deleveraging.  I don't think that government should be involved in this, individuals know much better how much they need to borrow to deleverage.

[Iormlund]

I think we should just let the private sector run up its own debt to make room for their deleveraging.  I don't think that government should be involved in this, individuals know much better how much they need to borrow to deleverage.

The private sector, at least here, cannot provide that stimulus. There's no financing to be had, and those few with access to it, don't want it. They'd rather pay down debt or save for a rainy day (outside Spain if possible).

[The Minsky Moment]

Do you have some stats to back up your argument, something that shows the share of deficits going to bank recapitalizations perhaps?

The easiest example is Ireland, because they were the most transparent about assuming private bank liabilities without subterfuge.

But Spain - which is the pivotal country in the Eurozone - is a useful example here.
First, on the revenue side, both direct tax receipts and total revenue fell about 5 percent since 2008.  That includes a year-on-year decline from 2010 to 2011, indicating the real economic impacts are still working there way through to the fiscal side.

Second, in 2008, the central government comitted 200 billion Euro to guarantee the liabilities of the banking sector, and another 50 billion to purchase distressed assets.  The guarantee did not involve the actual expenditure of cash at the time, but it did leave the state on the hook.  What has happened in the last 6 months is that bill came due - because of the losses in the real economy, Spanish banks are not viable without recapitalization - and the estimates I have seen are that the amount required will ultimately be  . . . 200 billion Euro.  The initial bailout plan proposals all provided that recap funds were to be funneled through the treasury, which would have the effect of adding about 20 percent to Spain's debt/GDP levels overnight.  That prospect has been a key driver of Spanish bond yields, and the failure to specify a clear path to direct recapitalization from a European fund explains why the recent deal and austerity commitments have had little effect on yields.

And tell me how you reconcile this story with your "Germany could have fixed everything with a Greek bazooka to end contagion" argument.

Nobody could have fixed anything, there is no fix.  There is only the option to staunch the flow of blood so the patient can heal.
Right now, even though the crisis first manifested in Europe, the US is now about 2 years ahead of Europe in terms of resolving the damage to the financial system.  The Geithner/Paulsen bazooka gave the banks cover to recapitalize, with the assistance and further accomodation of the Fed.  The US coupled that carrot with the stick of hard "stress test" to set targeted capital levels.

The US did all this before mid-year 09.  Most of Europe, OTOH just fiddled during this time period -- credible stress tests were not performed until July 2011, and the EU is not now cobbling together its own bazooka - asssembling it in the field with spare parts.  The consequence is as the new Basel standards worked their way through committee, the Eurozone banks were exposed as badly under-capitalized. 

A big reason why peripheral bonds yields have been rising is because the markets are pricing in the risk that governments will have to absorb the cost of recapitalization in one form or another.  Even now, the Spanish debt/GDP ratio is only 68 percent.  That in itself should not cause panic.  What is causing panic, however, is that if Spanish contigent liaibilities to the ECB and under the bailout process are included, the ratio balloons quickly to over 100 percent.

And a quick side question Joan: why don't companies auction their bonds like Treasury, instead of paying an underwriting fee?

A lot of companies issue in private placements although they still typically pay a fee to a placement agent.  Direct sales are not unknown, but less common.  The reason is that if a company wants to reach a broad investor base, they usually need to access to investment bankers relationships with big securities buyers.  Because of the central position of Treasury securities, the US government doesn't have that problem - they just need to put up a sign and the investors come to it.

[The Minsky Moment]

The private sector, at least here, cannot provide that stimulus. There's no financing to be had, and those few with access to it, don't want it. They'd rather pay down debt or save for a rainy day (outside Spain if possible).

Taking Basel 3 as a proxy for amount of deleveraging that is required to bring the financial sector back into balance, that sector probably needs to increase net savings by at least a half a trillion dollars over the next 5 years or so.
I assume that most would agree that it would not be a good idea for private US and European households to increase their net indebtedness to ease this adjustment by boosting consumption.
Non-financial business enterprises could in theory bridge the gap by radically increasing investment, but that is very unlikely in present circumstances.
China has its own over-leveraging problems it is working out and Japan obviously is in no position to be a source of strength to the world economy.
Thus, the alternative to net government dis-savings is and still remains a deflationary spiral or at a minimum a partial collapse of the international banking system

The anti-keynsian position to square this circle is that austerity will have such a massive positive boost to business confidence, that non-financial enterprises will turn on the dime and ramp up investment in response.
If you believe that, there is this bridge in Brooklyn, really nice bargain, special price this week only . . .

[Admiral Yi]

Joan: you've repeated the savings and investment accounting identity many times.  The part you fail to address is what to do if governments' need to deleverage is as great or greater than the private sector.  Governments don't have infinite capacity to supply investment opportunities to households and businesses.

[MadImmortalMan]

Since every nation cannot run a current account surplus,

Why not?

[Admiral Yi]

Why not?

Because for every surplus there has to be an offsetting deficit.

[Barrister]

Since every nation cannot run a current account surplus,

Why not?

Because current account balances equal out to zero.  It is the net balance between exports and imports.  If one country exports more than it imports, by definition another country must import more than it exports.