The Hollow Men of the EU

Here we go round the prickly pear
Prickly pear prickly pear
Here we go round the prickly pear
At five o'clock in the morning.

Between the idea
And the reality
Between the motion
And the act
Falls the Shadow


This section of T.S. Eliot's poem 'The Hollow Men' just popped into my head whilst thinking about the latest chapter in the Euro crisis, but other parts of the poem also seem oddly appropriate.  The prompt for thinking about the poem was the ongoing woes of Spain and the reporting about the Spanish budget, and the wider concerns about the Euro. Reuters gives a good overview of the budget:

Ministry budgets were slashed by 8.9 percent for next year and public sector wages frozen for a third year as Prime Minister Mariano Rajoy battles to trim one of the euro zone's biggest deficits.

"This is a crisis budget aimed at emerging from the crisis ... In this budget there is a larger adjustment of spending than revenue," Deputy Prime Minister Soraya Saenz de Santamaria told a news conference after a marathon six-hour cabinet meeting.

Beset by anti-austerity protests and threats of secession by the wealthy northwestern region of Catalonia, Rajoy is resisting market and diplomatic pressure to apply for a rescue, partly out of concern for national sovereignty but also because European Union paymaster Germany insists Spain doesn't need help.

The central government sees budget savings of 13 billion euros in 2013, with spending down 7.3 percent -- not including social security and interest payments -- and income rising 4 percent thanks to a 15 percent leap in value-added tax take.

The budget goes to parliament on Saturday and debates could last weeks. The country's 17 autonomous regions still must present budgets and find an additional 5 billion euros in adjustments to meet overall public deficit reduction goals.

Apparently, the budget was well received with the Euro gaining against the $US, and stock markets rising in response.  As I have mentioned in an earlier post, there was also an audit of the Spanish banks, with the following finding:

Spain's banks need €53.75 billion ($69.23 billion) in new capital, an independent audit showed, a figure below initial estimates that provides a benchmark for the cleanup cost of the ailing sector, the government and the Bank of Spain said Friday.

The number was lower than an €62 billion estimate Spain gave in June, providing some welcome news to the government of Primer Minister Mariano Rajoy which this week announced a series of spending cuts and tax increases in an effort to stabilize the economy amid protests and political challenges from the country's richest autonomous region.

In my last post on the Spanish crisis, I questioned whether the audit would genuinely reveal the true extent of the losses, and that more toxic debt would be revealed at a later date. I am still of that view and, as I stated before, I suspect that we will see further requests for bailouts in the future. In short, I suspect that the requests for bailout money will be given in 'bite-sized' chunks. The disclaimer of liability at the start of the report and the explanation that the report 'methodology and process' was agreed with the Spanish Government and Banco de Espana might be seen as indicative of the reliability of the report.

The devil is in the detail, of course, and a quick look through the report and raised concerns in my mind, such as the limited sample size used for the assesment due to time constraints (p.13), and crucially, the audit assumes that 2014 is the date of sale of real estate assets, but I found no real clarity on how the values were projected, and it makes heroic assumptions that the assets will sell at all. However, I have only briefly glanced through the report and may have missed details or misunderstood sections, and I am not an expert. In other words, I just looked at the report to get a 'flavour' of the approach.

The point is this; it is not the initial positive market reaction that matters, but the reaction once experts have dissected the detail and methodology. It is then that the quieter shifts in markets will take place, and at which time the real judgement on the report will be felt. In many cases, those assessments will not be make public, but will remain proprietary. An article in the FT, before the audit publication, captures the pressures for positive results from the audit:

This time, it has to work. This is the view of senior bankers in Madrid as Spain prepares to unveil on Friday the results of an audit of its financial sector. Many now consider it the Spanish government’s last chance to convince the world that it has the banking crisis under control.

[and]

The investors and analysts that Madrid is anxious to convince, however, are already questioning the integrity of the latest review, with some arguing it is likely to resemble a stage-managed announcement with few surprises.

Mr Guindos has said that the final amount of total capital required is likely to come in at about €60bn, which is close to a provisional estimate of between €51bn and €62bn made by Oliver Wyman and fellow consultant Roland Berger in June.

In what he labels “the Don Quixote approach to valuation”, Santiago López, an analyst at Exane BNP Paribas, has said it is not credible that the Ministry of Finance has already indicated no listed bank, aside from Bankia, will need new capital under the tests, even though they use aggressive economic assumptions.

[and]

“Spanish banks are not giants but windmills,” Mr López says. “The assumptions of the tests seem reasonable but the conclusion is not credible.”

We have seen plenty of similar bank reviews in the past, and the pursuit of confidence over clarity seems to be the real purpose in many cases, such at the EU bank 'stress tests' that found Dexia to need no additional capital just a few months before it ran into trouble. In summary, perhaps I am wrong about the audit but I do not believe that this is the end of this story. My own view is that it is now just a question of 'when' the next bad news will arrive as the hollow men continue to seek that the crisis resolves, Not with a bang but a whimper.

Added Just after Publication:

German Wages

I just thought I would add a quick note. I stumbled on an article in Slate which grumbles that the low unemployment of Germany is based upon wage stagnation, and could not resist mentioning it.

The real secret to Germany's job market success, though perhaps in some ways related to the labor market regulations, seems to be simpler—don't give the workers any raises:

Now you look at this and you can see why Germans aren't chomping at the bit to offer bailouts to their southern cousins. But by the same token, you can see why the rest of Europe isn't rushing to embrace this model. The pitch for more flexible labor markets is supposed to be that you'll earn higher wages if employers have more freedom to organize work relationships to maximize productivity. Less job security and lower pay is not a great slogan. It is, however, a huge exporting success story. Germany has completely reoriented its political economy around the needs of its export industries which is nice except that just like in all other rich countries the majority of Germans work in non-tradable services.

My central thesis proposes that the shock of oversupply of labour sits underneath the economic crisis. That Germany has followed the logic of this position to its conclusion might be seen as explaining why German workers are still employed. I suspect that, given a choice, many unemployed workers would be pleased to turn back the clock and follow a similar path if it was to keep them in employment. However, before we get carried away with the German success story, it should be remembered that the fallout from the wider crisis may yet pull Germany down. Nevertheless, it is interesting that the German model was the correct response; with the labour supply shock, German workers allowed their compensation to drift down such that their value remained aligned with changing circumstance. And that value still remains high, perhaps reflecting the quality of the German workforce overall.

Another addition Just After Publication:

 I nearly forgot, but there have been several people who have used the Paypal donate button, including some fairly large sums. I just thought I would express my appreciation. In particular, although traffic has remained relatively high (it dropped off during the period when I stopped posting but is climbing again), there is less commentary than before. As such, it is good to know that the blog is appreciated. Thanks!

Spain , Banks and Real Estate - Again....

After two quick posts in succession, this will be a very quick post. Just before my long pause in posting, in June I posted on the subject that Spain would be in a worse state than was being claimed. This is what I said:

My own belief is that the prospects of such a bailout are remote, and that the scale of the problems in Spain have not yet been fully acknowledged. In particular, there are concerns about the true scale of losses for Spain's banks. As the Economist reports, construction and real estate loans grew from 10% of GDP in 1992 to 43% in 2009. The same report highlights the degree and severity of the real estate bust in Spain, and the various (self-defeating) methods the Spanish banks are using to hide or delay the losses.

It perhaps comes as no surprise that there are rumours of delays of an audit of the Spanish banks, although the government denies any delays and is still promising to publish results at the end of July. Even when published, it is not clear how real estate assets might be valued in the context of the broadening problems and downwards spiral of the Spanish economy; the spiral will continue to impact upon real estate prices, and any assessment will only reflect, at best, a guess at the non-performing and underwater loans going forward. In other words, the losses in the Spanish banks are likely to be far greater than is currently accepted, and the Spanish economy likely has a long way to fall yet. When so much of an economy is dedicated to real estate, and real estate goes bust, the damage is going to be huge. As such, even if a large rescue fund were put together, however improbable that prospect remains, the scale of the rescue needed may be larger than is currently imagined.

Well, this is what has appeared in the news:

A bank-by-bank test of financial stability due on Friday is expected to conclude that Spain's lenders are dangerously over-burdened with toxic debts and need to be recapitalised, restructured or shut down. 

The stress test is expected to show a dramatic deterioration since the previous tests were carried out at the beginning of the summer which suggested a €60bn cash injection would be the worst-case scenario. 

Nomura Global Economics said in a note: "Our initial reaction to the publication of those estimates has been negative. The announced figures are well below the market expectations, which start at around €100bn, and, in our view, not only fall short of bolstering market confidence but may actually increase the risk of Spain losing market access."

Last week, the Bank of Spain said bad debts at Spanish lenders had risen to record levels, with almost one in 10 loans in arrears. It is the highest bad-loan ratio since central bank records began in 1962.

In June, Mariano Rajoy, the Spanish prime minister, negotiated a deal that secured lending from Brussels of up to €100bn to recapitalise the banks. Experts now think that it will not be enough. Amid soaring borrowing costs and a stricken economy, Spain has come under intense pressure to ask Brussels for a full sovereign bail-out.

My own view is that the latest calculation of the losses is still probably way off the mark of the real scale of the losses. This uptick is just that. I am very confident that, in few months time, the figures for toxic debt are going to be raised even higher, and the size of the potential bailout will grow again. I suspect that those doing the audits will be fully aware of this, and that any figures given are there to try to make the scale of the bailout that would be needed less dramatic, by implementing it in small increments. However, we shall see.

Nationalisation of Markets

Every once in a while, the Economist magazine gets it right. In this case, the point is made in the Buttonwood column, titled 'The Nationalisation of Markets':

EACH step taken by the authorities over the past five years has been designed to prop up the economy and save the financial system. But the cumulative effect has been the creeping nationalisation of markets. Central banks are the biggest players in many rich-world government-bond markets. Equity markets seem to perk up only when central banks are expanding the money supply. And banking systems are incredibly reliant on implicit or explicit government support.

It is a very worrying point, and reflects the discussion of Richard Duncan that I considered in a post a while ago. I summarised his position as follows:

The most interesting point about the talk is the dispassionate approach to the current and future situation. He simply accepts that, in a few years time, the world economy will have a horrendous crash, that states are now fully in the driving seat of the world economy, and most importantly that investment choices should now be based upon state action rather than market drivers. In simplistic terms, whenever a government prints money, his answer is buy, buy, buy!

When listening to Richard Duncan, some might suggest that his view is an outlier, or even outlandish. However, we know that, when the Economist reports the same thing (albeit in a column rather than an editorial), there has been a shift in broader perceptions about what is going on in the global economy. For regular readers of the blog, the idea that states are in the driving seats is nothing new. For example, in January 2010 I had the following to say, in a post titled 'Masters of the Universe':

I am not sure that anyone can actually pull apart the increasingly tangled knots between the financial system and the state. They appear to be mutually dependent, with the state providing guarantees, and the financial system funding the state with financial support through bond purchases to shore up their capital ratios, and so forth. How convenient that bank capital adequacy encourages the holding of government debt. Going back to Renaissance Italy, bankers were granted licenses and monopolies if they were willing to lend to the state on preferential terms. Nothing has changed. 

I described how governments were intervening in ever wider areas of their economies. I went on to say the following:

Ambrose Evans-Pritchard is right when he suggests that we should rip up the economics textbooks. What we are seeing is a grand experiment, in which economists and policymakers are attempting to structure wealth in economies by fiat. As each lever is pulled, as each policy is enacted, there are ripples through the world economy. Flooding $US into the markets whilst holding interest rates low sees the export of $US popping up and creating bubbles elsewhere. Backstopping the mortgage market sees foreclosures reduced, but at the risk of calling into question (contributing to doubts about) the financial viability of the state. Holding the value of the RMB down leads to greater trade imbalances. Each policy has a consequence, and each policy interacts with the policy pursued by every other government.

In other words, as each lever is pulled, the consequences defeat the intention of the lever puller. For example, if the trade imbalances destroy the economic stability of the destination of Chinese exports, where will this leave the Chinese economy? The more each state pulls on the levers, the greater the turbulence between each of the economies. The world economy is a dynamic system, such that policy in one country impacts on the economy of another country, which then reacts with its own policy provisions, which then impact upon other countries. It is an endless cycle of reactivity, with each reaction driving further reaction, and developing an increasingly unstable system as each country enacts ever more dramatic policy to counter or ameliorate the effects of the policies of other countries.

A simple example is the relatively recent Japanese policy of printing money to stave off deflation. With rock bottom interest rates, the newly printed money was simply exported into other countries in the so called 'carry trade'. Within Japan, deflation persisted, whilst the newly printed Japanese money appeared in other countries, contributing to the process of asset price inflation in the countries that were the destination of the carry trade. The policy levers were pulled, but the consequences were far from those that were intended.

What textbook might be able to predict the outcome of such a dynamic system? Despite this, we see the policymakers pulling on their levers, and offering confidence that they know what they are doing. Apparently, the masters of the universe are in control.

I wrote this a long while ago, and we can now see that states are now firmly in the driving seats of global markets. The problem that I long ago identified is now playing out on the world stage. The 'masters of the universe' kept pulling on their policy levers, the ripples radiated out, interacted with the ripples of other policy levers being pulled, and the result is ever more pulling on policy levers. That we are now in a position in which governments are driving markets is unsurprising, and was the inevitable result of the dynamic that states set into action.

The fundamental problem is that, as the world situation deteriorates, the policy actions are becoming ever more extreme. The LTRO was but one example of the escalation, and there is surely more to come. The worrying part of these actions is that those who are pulling the levers are doing so in the belief that they are taking actions to correct problems in their economies, when the reality is that they are now fundamentally in the driving seats of their economies, and the problems that they seek to resolve are problems that they, and their colleagues in other countries, are creating. The markets are now resting on government policy actions, and they created the situation where this was the case. It did not happen by magic, but specifically because the extremes of policy interventions were overtaking 'normal' market signals.

At this point, the sane response would be to pull back. However, as the 'masters of the universe', policy makers are simply too arrogant. They think that they know what they are doing. They cannot see that the current parlous situation is being derived from their own policy responses. They are dealing with a system of such huge complexity that each action that they take can never have a predictable response.  This has always been true to some degree, but the extremes of current policy have changed the degree of the outcomes, and the intensity and the complexity of the feedback from each policy provision. A very simple illustration can be found in the LTRO, as I discussed a short while ago:

The problem is simple. No external investors believe that there is any real commitment to policy that might allow borrowers to pay back their debts. The only way any sane person will purchase the debt is if it sold at fire-sale prices, which means big losses for current holder of 'periphery' European debt. Instead, the only way forwards is for the European Central Bank (ECB) to continue its backdoor bailouts, by continuing to lend to bankrupt European banks so that they can buy their home country sovereign debt, and thereby expose themselves to ever more bad debt.

Having bought so much euro zone debt, banks in the periphery are now major holders of their governments’ liabilities and will be sitting on losses, given recent selling of peripheral debt, according to Das.

“As with the sovereigns, the LTRO does not solve the longer term problems of the solvency or funding of the banks, which now remain heavily dependent on the largesse of the central banks,” said Das, who fears deep recession. “It is a government-sponsored Ponzi scheme where weak banks are supporting weak sovereigns, who in turn are standing behind the banks — a process which can be described as two drowning people clinging to each other for mutual support.”

The analogy in the quote is quite apt. For those that have not read about it, the LTRO (Long-Term Refinancing Operation) is the ECB's complete abandonment of Germanic prudence, whereby bankrupt European banks are being bailed out by the ECB. As one wag put it, the ECB is accepting bus tickets as security for the lending at below market rates. The really stunning part of this is that it is possible to find commentators and analysts who support this lunacy. I mean really, bankrupt sovereigns supported by bankrupt banks, which in turn are supported by bankrupt sovereigns? And this is a good idea?

A good idea? Pour money into banks in countries like Spain, encourage the banks to buy their own sovereign debt and this will fix both the states and the banks. The result of this madness can be seen emerging into the financial headlines. When we read those headlines, we absolutely must remember that someone in a meeting/presentation actually said this was a good idea. This person was one of the self-selected 'masters of the universe', undoubtedly supported their good idea with reams of economic theory, but nevertheless was unable to foresee that their actions have left, for example in Spain, governments and banks in worse condition than before they started.

And here is the rub. As the situation continues downhill, there will likely be another policy response. It will now, as a matter of necessity, have to be even more extreme response than the last policy response. The problem has grown larger, not smaller, and the only 'solution' to the ever growing crisis will be a larger and more extreme policy responses. The illusion of control of the situation continues, but those who think they are in control just do not have any idea (or acceptance) that they are the problem, not the solution.

Huh?

This is (as I start writing) intended to be a very short post. I was just browsing through the economics news and found this rather fabulous quote in reference to Spain's shrinking economy:

It is unclear how he can slash the budget deficit from 8.5pc of GDP last year to 5.3pc to meet the compromise target agreed with Brussels after a bruising confrontation.

“It is frankly impossible, given that it would aggravate the recession and this would crush state revenues,” said Jesús Fernández-Villaverde from the University of Pennsylvania.

This is 'fabulous' as it is a very clear illustration of a point I have made several times. It illustrates just how intellectually bankrupt a large swathe of academic economics actually is. I will just start by putting the quote in a usable format:

• Cutting borrowing will make the recession worse
• If the recession is worse, then state revenues will be lowered
• Therefore, if borrowing is cut, state revenues go down
• If state revenues go down, then payment of existing debt becomes impossible

 What this really means is something like this (this is simplified/basic principle only):

• I am borrowing 200 units of new debt per year
• I have to pay 100 units per year from tax revenue to service my existing debt
• The 200 units create activity in the economy as the borrowed money is used for consumption of goods and services
• The activity in the economy from the borrowing of 200 units sees 50 units of the borrowed money returned to me in tax revenue from the tax on the consumption of the 200 units
• If I do not borrow at all, the tax revenue from activity in the economy will only be 50 units
• If I cut borrowing to 100 units I will only see 25 units of tax returned to me from the 100 units borrowed
• Cutting my borrowing to 100 units means that I have the 50 units + 25 units of tax revenue from the borrowing
• If I only receive 75 units I can not pay for my existing debt, which requires 100 units
• Therefore I will continue borrowing 200 units so that I can pay for my existing debt which gives me the 50 units of no borrowing tax revenue + 50 units of tax revenue from the borrowing and consumption of 200 borrowed units
• If I do not borrow 200 units I cannot pay my existing debt.
• If I borrow 200 units, I increase my existing debt.
• If I cannot pay for my existing debt without borrowing, how will I pay for next years greater debt and greater annual servicing costs?

In short, the process is one in which I borrow 'x' amount for others to consume, and then tax that consumption of the borrowed money in order to return a fraction of the debt to me and pretend that this is revenue, not a fraction of the money borrowed earlier. If I do not do so, I can not support my debt. In short, I need to borrow money in order to make payments on previously borrowed money. In doing so, my debt pile gets bigger, necessitating more borrowing to pay previous borrowing. It is an upwards spiral of debt in order to keep paying existing debt. It is also a downwards spiral into greater and ever less sustainable debt. It is a good method of destroying an economy - unless a choice is made to just not pay the debt.

And this is a solution? Really? 

Note: This is a bit of rushed post, but I hope it all makes sense. If there are any errors in the logic, please feel free to point them out. Also, if (and I apologise in advance if I think it is no better) you can offer an even simpler and clearer explanation, I may use it as a post, with full credit to the author (as anonymous, or by name according to your preferences, so let me know). I really think this is one of the most fundamental examples of just plain odd thinking in economics. As such, getting it as clear and logical as possible would be great. I still feel that my explanation is not quite there, or might not quite hang together.

Update, 30 March 2012: A very good explanation from Carrew below, which integrates the fundamental problem of dishonest politicians.TheFatBigot (I really like this name) also weighs in with some good points about GDP and the underlying foundations of revenue, as does MR. Anonymous has picked up on the rather distorting economy as a medical patient metaphor, and proposes a more apt variant. In the case of Carrew and TheFatBigot, they offer some very good explanation. However, although very good, and somewhat simpler, but I am still looking for the 'killer explanation' that skewers this dangerous economic thinking (something which those less interested in economics might grasp with ease). Further efforts would be welcome.
Update, 2nd April 2012: There are some more good thoughts and explanations below.  An anonymous poster has had a good go at it as well. Perhaps between the various comments and my own explanation, someone can provide a good synthesis that takes the good points from all? As ever, I am impressed with the readership of the blog.

Lemming: Apologies, I found a comment from you which escaped the approval process for some reason. I am not sure how long it sat unpublished, but apologies if it was a long time.

The EU Downgrades

This will be quite a short post. It has been impossible to miss the news from last Friday about the downgrades of several EU countries by Standard and Poor's (S&P):

Ratings agency Standard & Poor's downgraded the government debt of France, Austria, Italy and Spain on Friday. But it kept Germany's at the coveted AAA level.

The downgrades deal a blow to the eurozone's ability to fight off a worsening debt crisis. All told, S&P cut its ratings on nine eurozone countries.

The rating agency ended France and Austria's triple-A status. It also lowered Italy's and Spain's by two notches and did the same for Portugal and Cyprus. S&P also cut ratings on Malta, Slovakia and Slovenia.

"In our view, the policy initiatives taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone," S&P said in a statement.
France's downgrade to AA+ lowers it to the level of U.S. long-term debt, which S&P downgraded last summer.

S&P had warned 15 European nations in December that they were at risk for a downgrade.

The way that the press have reacted is as if this is some kind of shock, even though the potential for a downgrade has been been trailed, as is mentioned in the quote above. S&P's statement about why they made the downgrade can be found here. It has also had an impact on the rather dubious Euro bailout fund, with this from the WSJ:

Standard & Poor's Ratings Services on Friday said it had stripped triple-A ratings from France and Austria and downgraded seven others, including Spain, Italy and Portugal. It retained the triple-A rating on Europe's No. 1 economy, Germany.

The downgrade to France, the bloc's second-largest economy, will make it harder—and potentially more expensive—for the euro zone's bailout fund to help troubled states, because the fund's own triple-A rating depends on those of its constituents. The downgrades also speak to how deeply the concerns over countries on the euro zone's periphery have penetrated its core. Worst-case fears weren't borne out: France avoided the two-notch downgrade S&P had warned of last month.

So, is this really news? In some senses 'yes', and in some senses 'no'. The most interesting thing about the ratings agencies is that they are supposed to look into the future and make assessment of asset risk, but they nearly always seem to play 'catch up' with the reality on the ground. Even the most casual browse of the financial news would have told anyone that the problems of the Euro were spreading from the so-called periphery into the so-called core. The S&P downgrade is, as always seems to be the case, just playing catch-up.

However, it is news in the sense that it has real impacts. The first impact is on the bailout mechanism, as mentioned in the WSJ article. However, another impact is upon European banks. I expected to find a raft of headlines to this effect, but a search of Google News did not turn up what I expected (perhaps my keywords were not right, and I missed the articles). In particular, those banks that hold the sovereign debt of the downgraded countries will see further erosion of their already (in many cases) strained balance sheets. The only example I found discussing this point was curiously in reference to Japanese banks:

France’s loss of its AAA rating probably won’t have any immediate effect in Japan as domestic banks’ holdings of French bonds aren’t large, Azumi said in Tokyo yesterday, according to Kyodo News.

It is now an open secret that the ECB has been bailing out European banks in the hope that they will in turn use the money to purchase European sovereign debt. This from Wolfgang Münchau in the FT:

And no, the European Central Bank’s huge liquidity boost is not going to fix the problem either. I do not want to underestimate the importance of that decision. The ECB prevented a credit crunch and deserves credit for that. The return of unlimited long-term money might even have a marginal impact on banks’ willingness to take part in government debt auctions. If we are lucky it might get us through the intense debt rollover period this spring. But a liquidity shower cannot address the underlying problem of a lack of macroeconomic adjustment.

Regular readers will know that I do not agree that the bailout was a 'good thing', but I quote this as it as it makes the point about the indirect purpose of the bailouts. I have mentioned before that there are large chunks of debt coming due in the next couple of months, and funding these chunks of debt may be a severe problem. I used this chart from the Economist before, as it paints the picture well:



When bank balance sheets are already under strain, the question is what they might do with all of the money that the ECB is pouring into their balance sheets. The new Basel accords are demanding higher levels of capital, and the ratings of assets will impact upon their compliance. The question is this; with their balance sheets already strained, when the periphery debt looks ever more dangerous, and the core debt is now being recognised as high risk, why on earth would any bank actually purchase high risk European sovereign debt?

The problem is this, that in the topsy-turvy world of banking regulation the ratings agencies really matter. They are, of course, completely hopeless in their assessment of risk, but they nevertheless have major impacts. However, it does occur to me that there is the possibility that the bailout of the banks by the ECB might come with strings attached, in backroom deals, that as a quid pro quo, the banks agree to continue to purchase dubious Euro sovereign debt. I can only speculate on this but, if such an agreement has taken place, it is a great way to increase the contagion. It really is kicking the can down the road.

Furthermore, as many (including myself) argued, the establishment of the Euro bailout fund would spread the problems into the Euro core, as countries such as France were already in a position of having too high levels of debt. A long time ago, I discussed the problem of who would be left to do the bailing out when every country was racking up too much debt. The context of the discussion was the US, if I remember correctly, but the same applies here. It has long been the case that any bailout is being funded by countries borrowing more money to enact the bailout. They are not using a net credit position to bailout, they are just borrowing more on the basis of having a better credit position than the bailee. However, when they are in a position of having too much debt themselves, they start to tip their own creditworthiness into the danger zone. Again, using your own fragile creditworthiness to support the less creditworthy is another case of kicking the can down the road.


The problem with such can-kicking is that it ratchets up the final consequences of the crisis. I have argued against the idea of contagion before, as the problem was not one that might be compared with a contagious disease, but more like a cancer that is destroying from within each country. However, the actions of trying to avert a major crisis are genuinely creating contagion. It was in the early points of the crisis that I suggested that contagion was the wrong metaphor for the problem, but it now seems appropriate. I am genuinely puzzled at what is going on. It just seems that policy-makers must actually see that they are in a hole, but they continue to keep digging it deeper.


It is not as if I am alone in questioning the endless successions of bailouts. Again, it does not take long to find voices expressing concern. What on earth do those who are enacting the policies think the end of the game might look like? Do they really believe that, for example, that one year from now that the Euro crisis will have ended, that sovereign debt problems will have disappeared, and that Europe will be on the road to economic recovery? They must, surely, have some kind of belief that this will be the case, and this must be why they continue to try to 'solve' the crisis? However, if they were to stop digging their hole for just a moment, the absurdity of this idea becomes apparent.

The crisis is getting ever larger, not diminishing. The fact that the ratings agencies are downgrading is just a belated indication of the reality of the situation, and just highlights exactly how bad things have become. When such clueless organisations have finally accepted the depth of the crisis, then it must be very, very bad indeed.


Note: A longer post than intended...

Update: 

Just after I completed the post, I found this in the Telegraph:

Use of the European Central Bank's three-year funding programme is expected to exceed €500bn in February when lenders are offered their second chance to access its new long-term refinancing operation (LTRO), according to Credit Suisse.

Last month, banks borrowed a total of €489bn using the LTRO, which has effectively seen the ECB take on the role of providing a large part of the funding required by several eurozone banks.

Analysts at Credit Suisse point out the ECB's willingness to provide an increasing proportion of the short and longer-term funding required by eurozone banks has led to a widening gap in the size of its balance sheet versus those of the Bank of England and the US Federal Reserve.

The ECB's balance sheet has risen in size to close to 30pc of eurozone GDP from just over 20pc before it launched the LTRO. By comparison, the Bank and Fed's balance sheets are both worth just under 20pc of domestic GDP.

And later:

The ECB's decision to increase its exposure to banks has effectively seen it provide the "bazooka" markets had been urging it to use to help stem the debt crisis.

Spanish banks that borrowed money using the LTRO are thought to have used most of it to buy Spanish government debt, leading to a lowering in yields.

Interesting, is it not? It still does not discuss the problem of the downgrades for the bank balance sheets, but it is there in the subtext. I still suspect my Google News search was looking for the wrong key words, so if anyone has seen an article on the effect of the downgrades on bank balance sheets, a link would be welcome.