Debt Delenda Est
By Bill Bonner • November 22nd, 2010 • Related Articles • Filed Under

Debt Delenda Est

Filed Under: Currencies • Market • Real Estate • The Americas

The subject is debt; it needs to go away.

Debt was the market's bete noire, this week and last. In Europe, it snatched up the Irish and carried them off. Then it attacked the Portuguese. Everyone knew the periphery states were going broke. Their cost of borrowing soared. Then, when the search parties reached them, the Irish turned them away. Debt has it usefulness, the Irish figured. They held out until Wednesday, apparently negotiating terms of their own rescue.

In America, municipal debt collapsed by nearly 10% over the last two weeks. It became more and more obvious that state and local governments were headed for default too. California might get a bailout...but California, like Ireland, is a sovereign state. It could refuse. Borrowers worried that Californians and the Irish might prefer to default like honest incompetents rather than submit to the rescuers' demands.

Debt is underrated. For one thing, it is more reliable than asset values. The crisis of '07-'09 wiped out about a third of the world's equity and property wealth. And it disappeared 7 million jobs in America alone. But debt survived intact. In terms of the cash flow needed to support it, debt actually grew larger.

Central planners can make a recession appear to go away. With enough hot money, they might warm up asset prices or soothe the swelling unemployment rate. But debt doesn't cooperate. Neither monetary policy nor fiscal policy will make it go away. Debt demands honesty. The debtor has to fess up, admitting that he is a fool or a knave. Either he owns up to his mistake and defaults...or he cheats.

"With all due respect, US policy is clueless,"said German Finance Minister Wolfgang Schauble. "It's not that the Americans haven't pumped enough liquidity into the market. Now to say let's pump more into the market is not going to solve their problem."

The English speakers conveniently misunderstand the debt problem. The authorities worked hard not to see the debt crisis coming. They made their careers and reputations by not understanding it. Thousands of them work for governments and central banks...if they caught on to the problem now, they'd probably have to resign.

They pretend that the problem is a lack of "liquidity."Or a failure of capitalism. Or that the regulators dropped the ball. It is none of those things. Each of those problems can be "solved."Short liquidity? The feds can add some; as much as you want. Did capitalism lose its way? No problem again, the authorities will apply more central planning. Not enough regulation? Are you kidding; adding regulation is what they do best.

The real problem is debt. In Ireland, for example, investors, householders and bankers all lost their heads in the bubble era. Your editor bought a house in Ireland in 2006. He knew perfectly well it was overpriced. He had walked the streets of Dublin. He had seen storefronts offering property, not just in Dublin...but in Dubrovnik. He had heard people say that "property never goes down."

Now his house is worth about half what he paid for it - if he could find a buyer. There is no reason to expect that house to ever recover - at least in real terms - to the level it was 3 years ago. That wealth has disappeared. Along with it went the banks' collateral and the value of the debt it backed. It is all dead. It is no more. It has ceased to be. It is past tense. But, rather than let the banks' bondholders take the losses they deserved - in rushed the financial authorities with guarantees and more credit. Ireland's deficit rose to a staggering 30% of GDP. Its national debt will rise from 100% of GDP to 120%.

Meanwhile, California is moving closer to bankruptcy - and borrowing more too. The state is $25 billion in the hole, with no plausible plan to get out. The Milken Institute says unfunded pension liabilities will rise to $10,000 per capita by 2013 - the equivalent of an extra $40,000 mortgage for every household. Like Ireland, California cannot pay the debts it has incurred. The federal government will offer a bailout...but with strings attached.

And soon, the bailers will be in trouble too. According to The Wall Street Journal, a combination of 15 major national governments will have to borrow a total of more than $10 trillion next year, to finance deficits and repay maturing bonds. That's 27% of their total economic output. It also is equal to about twice the entire world's annual savings.

The authorities warn about the risk of "contagion."They sweat to "calm" the markets. But why bother? Debt of this magnitude cannot be repaid. It has gone bad. At least give it a decent burial.


Regards,
Bill Bonner,
for The Daily Reckoning Australia

__________________
"Patriotism means being loyal to your country all the time and to its government when it deserves it."-- Mark Twain

"Inter arma silent Musae"--when the weapons speak, the muses fall silent.

An't nanum hearm deth, doth hwaet ye willath.

It is forbidden to kill; therefore all murderers are punished
unless they kill in large numbers and to the sound of trumpets. -Voltaire

Economic Left/Right: -3.88
Authoritarian/Libertarian: -4.36

Amid Irish Aid, a New Option

Some Critics of Latest Bailout Propose Sovereign Default to Keep Debt in Check

By BOB DAVIS

As another European country edges toward a multibillion-dollar bailout, a number of economists say there is only one way to make creditors share the pain: default.

So far, Germany's guarantees of Irish and Greek debt have been cost free. German yields remain very low. But come the inevitable Greek and Irish defaults, Germany's bond market will also start to suffer.

In Dublin, officials from the International Monetary Fund, European Union and United Kingdom are negotiating a rescue package that is likely to require the Irish government to further squeeze pensions and paychecks but pay off bondholders of Irish banks, whose debts the government guaranteed.
Such a lopsided outcome—which has been repeated since the Latin America debt crises of the 1980s—enrages many voters and signals to investors that there is no price to pay for risky lending because international institutions will always bail them out.

Instead, say economists, lenders should be required to take hits on their investments as a way to reduce a government's bills and to force lenders to be more careful about where to invest their money next time because they will realize the IMF and others won't guarantee they will be paid in full.
"The most important effect is that (a country's) debts won't build up so much," said Harvard economist Kenneth Rogoff, who has chronicled centuries of sovereign defaults.

German Chancellor Angela Merkel tried to move in that direction last month. She convinced fellow EU members to consider forcing investors in sovereign bonds to take losses as a condition of future rescue plans. But the effort backfired when it prompted a sharp rise in borrowing costs for weaker euro-zone governments. Critics say that made an Irish bailout even more likely.

At the Group of 20 summit this month, Germany, the U.K., France, Italy and Spain tried to calm markets by issuing a statement that any new mechanism wouldn't come into effect before mid-2013, after the expiration of a €750 billion bailout fund that Ireland will likely access. Germany is seeking to make sure the "permanent crisis mechanism" that replaces it punishes bondholders as well as taxpayers.



Still, the negative market reaction illustrates the difficulty of making such a change. During times of crisis, any talk of punishing creditors drives up interest rates and makes the situation worse. During times of tranquility, the campaign for change peters out. Creditors move on to other concerns; borrowers don't want changes that can drive up their costs.

"There are countries that believe making the default process easier would reduce their ability to issue debt," says University of Chicago economist Raghuram Rajan, because creditors would demand higher interest rates. If not structured properly, a default mechanism also could prompt a run on government bonds once it became clear a country might apply for a rescue loan, wrote Lorenzo Bini Smaghi, a member of the European Central Bank's executive board, in the German newspaper Die Zeit.

After the Asian financial crisis of 1997 and 1998, the IMF proposed an institutionalized default program, which it called the sovereign debt restructuring mechanism. Under the program, the IMF would have judged a country's ability to pay its debts and the policies it needed to pursue. Another institution would have acted like an international bankruptcy court. The proposal withered in 2003 under opposition from the U.S. Treasury and emerging markets, which didn't want to cede power to an international body.

This time could be different, at least in Europe. Even when the economy recovers, Germany will continue to have a strong political interest in pushing through its "crisis mechanism," to make sure that in the future, bondholders split the cost of bailouts with German taxpayers.
In an interview with the newspaper Der Spiegel, German Finance Minister Wolfgang Schäuble proposed two possible restructuring stages: the first involving a lengthening of bond maturities and the second imposed losses—with a guarantee on the debt that's left—if that wasn't sufficient to ensure debt levels could be sustained. But the EU is far from a decision.

Even if Europe did create a default mechanism, said Mr. Rogoff, the Harvard economist and former IMF chief economist, it's far from clear that developing nations elsewhere would follow. Those nations opposed the IMF's SDRM proposal, he said, and are wary of "giving a blank regulatory check to a big international institution where they don't have enough voice." If the European procedure worked well, resistance elsewhere could eventually ebb, he said, but that is likely to take decades.

—Matthew Karnitschnig and Stephen Fidler contributed to this article. Write to Bob Davis at bob.davis@wsj.com

__________________
"Patriotism means being loyal to your country all the time and to its government when it deserves it."-- Mark Twain

"Inter arma silent Musae"--when the weapons speak, the muses fall silent.

An't nanum hearm deth, doth hwaet ye willath.

It is forbidden to kill; therefore all murderers are punished
unless they kill in large numbers and to the sound of trumpets. -Voltaire

Economic Left/Right: -3.88
Authoritarian/Libertarian: -4.36

So that's what I mean by "domino effect".

It wouldn't be outrageous to take a slice out of "bondholders" rather than let "equityholders" take all the pain. Note: The comparison isn't perfect at the country level since, well, how can you seize a sovereign country?

BUT... it would have to be awesomely planned and slowly discussed/agreed amongst the main creditors because... who hold Greek, Irish or Spanish debt? Most likely - Other European financial houses.

If Ireland default, these banks will likely default too. Thus spreading default across the entire EU or world economy till nothing is standing. That's what I meant by total civilisation collapse. And it was staring us in the face when the commercial paper market freezed in the wake of Lehman bankruptcy.

Remember Lehman? The USA tried what you/these journalists are suggesting with Ireland. "Let the bastards fail and the chips fall where they may". We saw the results - The Treasury and Fed had to intervene even more than before just to stop the domino effect killing the entire US & world economy.

__________________
Unless otherwise specified, I am posting as a regular poster. When I will act as a mod, I'll make sure you're in no doubt.

Quote:

Remember Lehman? The USA tried what you/these journalists are suggesting with Ireland. "Let the bastards fail and the chips fall where they may". We saw the results - The Treasury and Fed had to intervene even more than before just to stop the domino effect killing the entire US & world economy.

A very silly idea. There is a large, and apparently growing demographic which believes that the world's problems can be solved by revenge or, as apologists call it, "karma". It is an awesome sight to see the morality of a formerly civilised country regress to Cosa Nostra principles, or even further back under the influence of smooth-talking witch doctors, to those of the mountain tribes of New Guinea.

But wotthehell, if Zhou Enlai had been asked instead what he though of Western democracy and had said that it is too early to tell, I think recent events have shown that he would have been right.

Just in case some people think I am exaggerating the problems we faced back then with Lehman...

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Commercial Paper | Dollars & Sense

Commercial Paper
Financialization’s (Latest) Weak Link
By Max Fraad Wolff | October 29th, 2008

This is a web-only article from the website of Dollars & Sense: The Magazine of Economic Justice available at Commercial Paper | Dollars & Sense

There may be no better illustration of the staggering pain emanating from financial market turbulence than the carnage experienced recently in commercial paper markets worldwide. Commercial paper (often abbreviated as “CP” in the financial press) is not a synonym for trade journals or advertising-heavy publications of little intellectual value. “Commercial paper” is the term used for short-term loans—for less than 35 weeks— that are made without needing (in the United States) to be registered at the Securities and Exchange Commission (SEC). Companies raise money by selling repayment promises—IOUs—below the full value at the time of repayment. The difference between the price received by firms in the commercial paper market and the amount they pledge to pay is referred to as the “discount.” You may find large household name firms selling $1000 repayments in 90 days for between $960 and $980 today. A few months ago, firms were selling $1000 in 90 days for $990 or more. The discount has risen, as money has become hard to get. Most loans are for far less than 270 days, and loans average around one month’s duration. Trusted firms with good credit ratings can borrow—nearly at will—for low cost when markets function well. So commercial paper markets allow corporations fast and easy access to cash for operations, near-term expenses, and even payrolls. Consequently, commercial paper markets grew to a size of about $2 trillion, and this market became essential to the basic functioning of many firms—and hence to the whole economy.


Commercial paper has become an attractive financing option for companies for other reasons, too. It allows access to large sums with less regulatory hassle, cost, or delay than tends to be the case with bond issuance or traditional commercial bank borrowing. In addition, as short-term interest rates have been very low in recent years, some companies couldn’t resist the temptation to borrow short and cheap with commercial paper and buy longer dated debt that paid higher interest rates. The difference was then a source of “earnings,” or revenue, for firms. This would turn out to be a dangerous game when short-term rates increased and credit became scarce. The short-term nature of the loans requires firms to roll them over, borrowing regularly. In other words, when you borrow for a short time, you need to borrow again soon.

What led to the current meltdown in this market? Of course, many factors come into play. The credit swoon began with a few firms extending (postponing) repayment on commercial paper. A similar situation actually occurred in August 2007. Back then, short-term loans in commercial paper markets had been used to finance mortgage-related investments, and the exploding of the subprime bubble triggered selling that drove short-term rates much higher, making continued borrowing or rollovers prohibitively expensive. But this fear subsided as weaker firms were forced out of the commercial paper market and confidence returned.

The present collapse of the commercial paper market originated with money market mutual funds. Money market mutual funds have been around for forty years. These funds manage cash from firms, charities, universities and individuals. Money market mutual funds make conservative short-term investment to guarantee that money is not lost. The focus on safety centers on the goal of never returning less than $1 for each $1 invested. In industry parlance, returning less than $1 is called “breaking the buck.” In the last four decades this has occurred only twice, and one of these times was September 16th, 2008.

The failure of Lehman Brothers on September 15th, 2008 capped a ten-day period that saw the Bank of America purchase of Merrill Lynch, the government takeover of Fannie Mae and Freddie Mac, and the bailout of AIG. The ensuing panic drove the value of a $1 investment in a money-market mutual fund called the Reserve Primary Fund to $ .97. Seized with fear that day, investors began withdrawing their money indiscriminately from money market mutual funds. Federal Reserve action led people to seek the safety of FDIC deposit insurance and US Treasuries. This diverted money from money market funds. Money market mutual funds were big, big buyers of commercial paper. Their exit from the CP market meant, in turn, a potential freeze-up in short-term funding for a large number of companies. Indeed, the situation got so bad that even the most highly regarded companies were largely unable to roll over their debts, and when they could do so, it was only for extremely short periods (sometimes one day). Such a situation, if prolonged, would bring effective corporate planning to an end.

The discounts required to borrow in the commercial paper market eventually doubled for stronger firms, and moved outside the realm of possibility for weaker or more suspect businesses. This led to an enormous decrease in the size of the CP market. From peak through trough, more than 90% of available funds dried up.

The Federal Reserve is leading the way in an attempt to jump-start the CP market. On October 7th, the New York Federal Reserve Bank announced the unveiling of its new Commercial Paper Funding Facility (CPFF). This new program will operate through private primary dealers, and began funding 90-day loans on October 27th. The program is set to run through April 30th, 2009. A “special purpose vehicle” (SPV) will buy the 90-day commercial paper and hold it to maturity. The funding will come from the New York Federal Reserve Bank, and the Pacific Investment Management Company (PIMCO) will manage the accounts. After a few wild days in the week of October 13th, rates began to slowly return to earth. This will be pivotal for positive movement in stock markets. The worst may be behind us; then again, we’ve hoped for that before.

The key lesson from the rapid demise of the all-important commercial paper market is that in an interdependent and financialized economy, markets interact. They can pass along opportunities, but they can also pass along fear, loss, and loathing. We have learned time and again that no man, market, or industry is an island. Commercial paper markets offer one more dramatic and violent example of mutual interdependence and risk.

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To conclude: Yes, the markets can absorb one bankruptcy or two. And, if they occur in "good times", all the better - The assets will be quickly valued and bought by the other, healthy, players.

But when all the players are effectively zombies, at most a question of degree, starting killing off zombies will do nothing but accelerate the rot and destruction until no one is left even half-alive. Half-alive, like Japan now, is better than dead, like Russia in 1989-90. Or worse, Russia in 1920-21... Or Europe circa the collapse of the Roman Empire.

__________________
Unless otherwise specified, I am posting as a regular poster. When I will act as a mod, I'll make sure you're in no doubt.

Quote:

The subject is debt; it needs to go away.

Easy-peasy.

Russia has done it. Argentinia has done it. Brazil has done it. Dozens of nations have done it. Corporately, Citibank and General Motors have done it. The Resolution Trust Corporation has helped hundreds of small banks to do it.

Birds do it,
Bees do it,
Even educated fleas do it;
Just do it,
Just default.

Argentines
Without means do it;
People say in Boston beans do it;
Just do it,
Just default.

Then we'll see where karma takes us to.

Hungary Stocks Enter Bear Market, Bonds Sink on Concern Crisis Will Expand
By Michael Patterson and Krystof Chamonikolas - Nov 29, 2010

Hungary Stocks Drop 20% From 2010 Peak on Concern Euro Crisis Spreads East - Bloomberg

".......Hungary’s central bank unexpectedly raised its benchmark interest rate today to combat the fastest inflation since June and support the forint after the currency sank to its weakest level in two months against the euro.

Prime Minister Viktor Orban’s administration is levying special taxes and funneling assets from private pensions to plug the government’s budget gap while funding crises in Greece and Ireland push up borrowing costs for Europe’s most-indebted nations.

“With global markets under some pressure at the moment, investors don’t need to find an excuse to sell risky assets, and the news flow out of Hungary at present just continues to be downbeat,” Timothy Ash, London-based head of emerging-market research at Royal Bank of Scotland Group Plc, wrote in a report today. “We would continue to recommend reducing exposure.”

Hungary was the first European Union nation to receive an International Monetary Fund bailout during the global credit crisis two years ago after its widening budget deficit and consumers’ spiraling foreign-currency debt spurred investors to dump Hungarian assets......"

__________________
"Patriotism means being loyal to your country all the time and to its government when it deserves it."-- Mark Twain

"Inter arma silent Musae"--when the weapons speak, the muses fall silent.

An't nanum hearm deth, doth hwaet ye willath.

It is forbidden to kill; therefore all murderers are punished
unless they kill in large numbers and to the sound of trumpets. -Voltaire

Economic Left/Right: -3.88
Authoritarian/Libertarian: -4.36