Thursday, October 06, 2011

Every Solvent Country is the Same, But Each Insolvent Country is Insolvent in its Own Way

As readers of KPC, you are of course among the world elite, the cognescenti, the "go-to" people. But I want to make sure you understand why it is that everyone is so worried about Greek default. After all, Greece has 9 million people, about the same size as North Carolina. Why worry?

In 2007-8, the reason that we had to bail out a bunch of big banks is that they had totally loaded up their balance sheets, including their reserve requirement assets, with illiquid and not very valuable CDOs and derivatives on other kinds of mortgage-backed securities. So, the problem was not so much the orginators, because they had dealt the crap and disappeared. The problem was the "smart banks," who had picked up all this bad paper because it had a high rate of return, and lap-dog rating agencies had continued to call it AAA, meaning it satisfied Basel Rule requirements for reserves.

This is a no-lose from the perspective of the banks. They got 7-8% if things go well, and get bailed out if things go sour. The guarantee of a bail-out essentially forced the banks to invest in crap, or else leave money on the table.

Amazingly, it has happened AGAIN. I almost can't believe it, but it has. The problem with Greece is not that anyone gives a flying firetruck about Greece. The problem is that Deutschebank and all the big American banks have once again loaded up on a high-risk bet. Greek bonds, especially if purchased at a discount last summer, pay a large return. We have to bail out Greece, the argument goes, NOT because it will help Greece but because otherwise the big banks will go under. It's pure theft, extortion. German citizens have to give money to the Greek government to save American banks. Because the banks bought up all that Greek debt to make money. And they are going to win. Again.

It's enough, I tell you, to make me sympathetic to the Occ Wall St folks. They have a point. Seriously, they have a point. They are insane, unfocused, and ignorant of basic economics. But there's something happening here, and what it is, is now all too clear.

Anyway, just a M. Lewis's "The Big Short" was useful for understanding the American crisis of 2007-8, his new book, "Boomerang," is great for understanding the current echoes around the world.

His basic thesis echoes Tolstoy (though these are my words, not his): Every solvent country is the same, but every insolvent country is insolvent in its own way. Iceland went nuts on derivatives, Ireland had a housing bubble that left three bedroom houses selling for upwards of 40,000,000 euros, Greece doubled the salaries, and workforce, of its public sector, California....well, I don't want to think about California.


Thomas Oatley said...

A certain class of social scientists (most certainly the lowest class) call that multiple conjunctural causation, I believe.

piefarmer said...

Do you find the moral hazzard theory satisfactory in the 2007-2008 collapse?

Here is an interesting theory from the 2011 Journal of Financial Economics. (Kind of a behavioral finance approach to product innovation)

Joel said...

There are of course two sides to every transaction. Why should only one side suffer?

I like what Iceland did, what is wrong with asking lenders to take part of the responsibility for bad loans?

German banking and manufacturing made lots of money loaning money and selling good to Greece - why shouldn't they take losses

I like this piece