US Exposure and Greek Restructuring

September 20th, 2011 at 3:26 pm

It is said—by folks much snarkier than I—that European economic policy makers exist to make their American counterparts look good.

I’m not sure I’d go there but one gets the point.

The unwillingness to recognize countries that are facing fundamental insolvency versus temporary illiquidity weighs most heavily on Eurozone economies, but hits ours as well.  The rush to impose austerity, the failure to differentiate the underlying debt issues between countries (e.g., Greece–a fiscal profligate–vs Spain–not!), not to mention the inability for currency to adjust —all of these and more make this crisis seem insoluble.

Over on this side of the pond, however, our banks benefit from a lot less direct exposure to the bad debt in question.  Our holdings of the debt from the problem countries come to less than 1% of GDP, while France, Germany, and the UK are up around 16%.

There are of course, still many steep headwinds holding back the US economy.  And US investors with European holdings (or derivatives thereof) will take haircuts if there’s a default.  But our banks are in much better shape than theirs.

Back in June, I wrote the following (and I wasn’t the only one making such points):

“The more I read about the Greek debt crisis, the more convinced I become that policy makers are looking at an insolvency problem but seeing a liquidity problem. Getting this wrong is a great way to make a bad situation both worse and more protracted.

In a liquidity crunch, your banks are sitting on bad loans and are too undercapitalized to do much about it. Your credit markets freeze and your economy tanks. But your government and central bank are able to leap into the lurch and become the banking system for a while, reflating the private system until it can run on its own again. That’s pretty much what the TARP did.

For something like that to work—and I’m not saying it was the best or only way for us to have gone—a few things need to be in place. Your government must be able to reliably borrow at favorable rates (and lenders must believe you can later pay them back), your banking system must be able to get back into borrowing and lending markets once their balance sheets recover, and if your currency can adjust to help boost external growth, that’s nice too. [I should have added that you need a functioning tax system.]

If none of those things are in place, misdiagnosing insolvency as illiquidity can prolong a disaster and waste a lot of money along the way. I would argue that these conditions were, in fact, present in the US case. They are not in the Greek case.”

The key now is an orderly restructuring of Greek debt—think GM/Chrysler, not Lehman.  That means telegraphing what’s going to happen, who’s going to lose how much in terms of “cents of the dollar,” how long the restructuring will take.  It will be ugly but it’s already ugly.  An orderly default, along with a once-and-for-all commitment to reflate and recapitalize other Eurozone economies that meet the criteria I laid out above, may be the only way to get the ugliness out of the system.


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9 comments in reply to "US Exposure and Greek Restructuring"

  1. EuropeanObserver says:

    first you arge (sic): [I should have added that you need a functioning tax system.]
    Then you say : “They are not in the Greek case”
    As far as I can see one of the most heavy shortcommings of the Greek is that their “tax system” is practically non existent : their revenue out of taxes (income, VAT and property taxes, +++) is simply non existent.

    We other Europeans “hope” that the government of Greece can convince the greek to “begin” paying taxes…

  2. Josh says:

    While the US banks don’t necessarily have large direct exposure to troubled Eurozone countries, US banks’ indirect exposure via CDS is another matter all together…

    • perplexed says:

      That’s a private matter for the banks isn’t it? Our only job is to not ask any questions and provide free insurance in the event it doesn’t work out.

  3. Dan Furlano says:

    I realize every mainstream economist hates MMT but unlike mainstream economists actually have offered a plan.

    Is it perfect, no. Will it help the Euro, yes.

  4. perplexed says:

    Great post! Thanks.

    It would be interesting to know what % of this total debt is governments bailing out insolvent banks if you’ve seen any info on that. I know its huge in Ireland but am not sure of the overall impact. Allowing these banks to operate without insurance for the damage they cause is huge subsidy we can’t really afford. We don’t allow contractors that build our infrastructure to do that, neither does Europe; are these bankers so destitute that they need this kind of support from society to keep them off the streets? If bondholders faced the loses more often perhaps they’d force the banks to insurers who’d watch them more closely. You know, invisible hand & all. But when governments provide free insurance, why bother, the extra profits can just go to the pool for bonuses!

    Yves Smith has some interesting ideas about those that really take the risk getting control of the banks:

    We may not be very exposed to European public & private debt but, due to our failed tax policies of the last decade (at least), we’re very vulnerable to the shortfall in demand that this crisis is about to bring. My guess is we’re going to need campaign finance reform, wealth & inheritance taxes, and radical reform of the banking and financial systems to really get the “ugliness out of the system.” The sooner we get started the better, at least in terms of total ugliness.

    • Chigliakus says:

      You’re absolutely correct as usual. Just wanted to point out that in our current system we’ve allowed depository institutions to gamble with people’s savings. Glass-Stegall, even if it was politically viable to reinstate it, would be insufficient to curb the excesses of the shadow banking system. The thing that really irked me at the time that the bailouts were happening, and still rankles to this day, is that we didn’t nationalize the banks we rescued. (I can’t watch that Yves Smith video right now, perhaps that’s what she’s talking about.) That would impose real costs for the gamblers misdeeds. Hopefully we will at least see the most egregios of the crooks, the guys that knowlingly bundled toxic assets and sold them to their customers even as they were betting against them, brought to justice.

      • perplexed says:

        For most Americans, the most important vehicle for their life savings was the equity in their homes. The fraud conducted by the mortgage industry was to put the equity of all current homeowners at risk by eliminating underwriting standards to increase their own profits, over and over until the scheme blew up. The investment banks & TBTF’s we’re just marketing in stolen goods with their eyes closed and paying the ratings agencies to keep quiet while they defrauded the investors. Like the old story about a company treasurer who takes a million out of the safe, takes it Vegas and puts it on red. If he wins, he’s up a million by risking the company’s money and he just puts their money back in the safe. If he loses, the company is out a million and he flees the country. That’s why they’re bonded. But if you can put the money (or equity) at risk without ever entering the house, and share the profits with your distribution network, its even easier; homeowners and investors take the risk, you and your accomplices get all the profits. See my comment on the Ponzi scheme controversy here

        I agree that we should have nationalized the banks from day one and don’t at all buy the excuse that the world as we know it would have ended. I think the overall costs could easily have been lower (just a guess, I haven’t seen any evidence, but we won’t even know the full cost of what we did do for quite some time – probably by design). The biggest difference would probably be that by now we’d know where all the skeletons are. The way it went down, they’re hidden all over and it will likely take historians years to sort it all out; if the evidence isn’t destroyed. It would be nice to see the price of government capture as line item; maybe that would get the public focused on campaign finance reform.

        Unlikely we’ll see any of the crooks brought to justice; it appears the posse been disbanded for the most part and we’re waiting for crooks to turn themselves in. Who knows, maybe there are investigations going on that no one knows about, but I think it would be pretty hard to keep quiet; there’s always hope though I guess. Pretty strange we haven’t heard more from legal scholars.

  5. perplexed says:

    By the way, many of us are honored to provide some snarkiness if you’ll continue to get the word out as well as you have been! You know, comparative advantage & all that stuff.