While the two are literally a world apart, Greece and a homeowner in Youngstown Ohio have something in common. They are both so indebted and under collateralized that they have no hope of repaying. The difference is that the homeowner in Ohio and their bank have accepted reality - that default was inevitable - and the Europeans are about to.
The ECD and IMF and European banks are still trying to modify Greece. The Ohio homeowner is past that! The creditor in the case of the Ohio homeowner tried modifications too, but in the final analysis there was no way to achieve any viable situation without massive debt forgiveness. Due to the complicated legal structure of the loan and all the interested parties upstream, as well as the ramifications such a policy action would have on other loans, a straight write-down of the balance was not possible. In the end for the homeowner, foreclosure was the only option.
In effect, the foreclosure results in a write-down for the bank anyway. But where does that leave the homeowner? Better off!! The homeowners credit may be ruined, but by the time of the foreclosure their credit was destroyed already anyway. At least after the foreclosure the homeowner is off the hook for the mortgage note. They are effectively released from their indebtedness and free to start life over financially. And, they can go rent or purchase a different house for a lot less than they were on the hook for before. On the other hand, the bank and whatever investor that owned or insured the loan is left with the loss. Repeat this scenario enough times and you've got the mortgage crisis which ultimately grew so vast that it morphed into the financial crisis of 2008 the fall of Lehman, Fannie & Freddie, AIG, and others.
But what about Greece - who's better off when Greece realizes that there is no hope of repaying their debt and just defaults? What happens when mass opinion in Greece is that the stresses of continuing the struggle to pay its debt is simply not worth it to them! Like the homeowner who realized that it was better to accept a new reality, eventually Greece will do so too. Eventually the homeowner decided, and Greece will too, that they need to walk away from their obligations and let the chips fall. And like the homeowner who enjoyed living in their home for as long as they could while continuing to mount up more and more unpaid debt and interest while enjoying free rent, Greece is going to soak up as much time and debt as possible before they pull the plug.
If it were just Greece, and if it were just one homeowner or even one town of homeowners, the creditors would just lick their wounds and life all around would go on normally except for the debtors. If the default of either the homeowner or Greece were an isolated case, the debtor is up the proverbial "shits river without a paddle." But it's not just Greece and it wasn't just one homeowner that is drowning in debt. Therein lies the difference in the financial dynamics which threatens the world's financial system.
Like the USA housing crisis, the scope of European countries that are insolvent is such that if one defaults and the others follow a crisis is set off. I know it seems like there is already a crisis, but I believe what we have now is "strain." A crisis will be the day Greece or Belgium or some other country throws in the towel and defaults. Unlike the current situation with the USA housing crisis which has been adjusted for with USA banks, in the case of the "PIIGs" and others default is not yet "baked into" the Euro or world banking system. While the USA banks have written down their mortgage losses, the European banks have not written large scale defaults into their capital structure. If one of the insolvent European countries such as Greece defaults, the banks will have no choice but to adjust their financial balance sheets to take into account these defaults on a massive scale. Once they do they become greatly under-capitalized. Then, like the USA banks, they will need the bailout! It will be the sequel to the book, and now the movie, "Too Big to Fail."
From a practical standpoint, the credit rating companies are forcing the issue. Which only raises the cost of carrying the debt to these countries and puts more pressure on them to default. The straw will eventually break the camel's back. It could be today or tomorrow or next week, but eventually Greece and a half-dozen other Euro-member countries are going to give their European friends the bird. It's notable that in the case of the Ohio homeowner they also had to give up the keys to their home. Whereas, at least Greece residents get to stay in country. Greece may be better off - even better off than the homeowner in Ohio.
I'd love to play this scenario out further because the outcome sure doesn't end here. But that's all the time I have for this post!
Wednesday, May 25, 2011
Tuesday, May 10, 2011
Can you say QE3?
It's been widely assumed that QE2 is the end of quantitative easing and that there will not be a QE3. Could the Federal Reserve be willing to risk the economy contracting as result of the Fed pulling back the punch bowl cold turkey, at the same time congress is doing major fiscal tightening? With the Federal Reserve buying nearly 70% of Treasury issuance do they expect to simply stop buying and still have successful auctions? I don't buy it. QE3 may not look like QE2, and it may not even be branded "QE" any #, but I think whatever the Federal Reserve calls what they're doing it will "walk and talk like a 'QE' duck." So what might it be?
I have a few thoughts about this. (Not surprising.) My first hunch is that they do some restructuring of their balance sheet in cooperation with the Treasury such that they extend the terms on shorter term T'Bills to longer terms. By converting their 1, 2, and maybe 3 year notes to 10+ years they reduce the strain on holding successful actions by reducing the need to refinance these notes as they come due over the next few years. Second, the Federal Reserve could to look for a way to write down their MBS holdings, thereby giving relief to the obliges. This would be a great back door way to give relief to the housing market and at the same time help to further repair banks and mortgage holders balance sheets. No doubt that would produce liquidity that would make its way into the economy. Last but not least, they have to find a way to motivate banks to push their reserves into the economy. Maybe they will stop paying interest on reserves.
Do you remember when Paulson, Geitner, and Bernanke dreamed up TARF and produced a three page document that sailed through congress in a few days to save the world financial system from ruin? My sense is that something is brewing that will be announced before QE2 wraps up and the debt ceiling needs to be raised. What they come up with will have to be sold to the financial markets and congress. It will have to include something from Congress on adjustments to entitlements and other spending in order for the whole package to be credible. It will be pitched, with the help of the President, as the best (only) way to save the Federal government from default. But it will also be sold as positive solution that will put America back on solid ground and lead to years of economic expansion.
If this happens, and the Federal Reserve and the Treasury can pull this off with the help of the President, I think Dow 16K is a real possibility!
I have a few thoughts about this. (Not surprising.) My first hunch is that they do some restructuring of their balance sheet in cooperation with the Treasury such that they extend the terms on shorter term T'Bills to longer terms. By converting their 1, 2, and maybe 3 year notes to 10+ years they reduce the strain on holding successful actions by reducing the need to refinance these notes as they come due over the next few years. Second, the Federal Reserve could to look for a way to write down their MBS holdings, thereby giving relief to the obliges. This would be a great back door way to give relief to the housing market and at the same time help to further repair banks and mortgage holders balance sheets. No doubt that would produce liquidity that would make its way into the economy. Last but not least, they have to find a way to motivate banks to push their reserves into the economy. Maybe they will stop paying interest on reserves.
Do you remember when Paulson, Geitner, and Bernanke dreamed up TARF and produced a three page document that sailed through congress in a few days to save the world financial system from ruin? My sense is that something is brewing that will be announced before QE2 wraps up and the debt ceiling needs to be raised. What they come up with will have to be sold to the financial markets and congress. It will have to include something from Congress on adjustments to entitlements and other spending in order for the whole package to be credible. It will be pitched, with the help of the President, as the best (only) way to save the Federal government from default. But it will also be sold as positive solution that will put America back on solid ground and lead to years of economic expansion.
If this happens, and the Federal Reserve and the Treasury can pull this off with the help of the President, I think Dow 16K is a real possibility!
Saturday, May 7, 2011
On the Edge of Mutual Destruction
We are finally on the edge of financial mutual destruction. If congress fails to address our deficit and debt crisis in a credible way and investors around the world lose faith in Treasuries and the dollar collapses the USA standard of living will be destroyed. American's buying power will be annihilated. Then what?
There's no question that IF this happens the world will be thrust into a great depression! The USA is the biggest customer on the planet and if we stop buying international goods and services from around the world because our dollars are so devalued our pain becomes the pain of the entire world and everyone's economy. Talk about "too big to fail," there isn't any country that could bailout the USA. If our boat sinks we're taking everyone to the bottom with us! But that's a BIG IF!!!!
We've been bad. We spent too much. We're virtually insolvent. But so is Japan, Ireland, the UK, Spain, Portugal, and dozens of other countries! Have you looked at the Debt to GDP ratios in France and Italy? Forget about Belgium, Denmark, Norway, and Switzerland! Euro zone Debt to GDP is higher than the USA! You have to wonder who's lending everyone the money cause we're all broke.
Sure there are some countries with a great debt to GDP ratio. Those are the countries supplying the world with natural resources or who have exploited their workers and kept their vast populations living in poverty. (Can you guess the names of these countries?) They have also been huge buyers of USA treasuries. Who's better off? Well, let's see what happens when we stop buying their stuff and their debt, valued in dollars, is nearly worthless as well!!
The bottom line is that if America goes bust we're taking all of these countries with us. So where would you like to be living the day America goes broke? If you ask me, I'd rather be living in America when it goes bust than in China!! Somehow the image of civil unrest in America seems less scary to me. And what will Saudi Arabia do with all that oil if American's start burning more gas and coal and conserving energy because we can't afford to buy OPEC oil?
What's the value of a dollar, or any currency for that matter? None of it (currency) is backed by anything more than faith & confidence in the financial system of the Nation that prints it. It's only worth anything if you believe it's worth anything! So, do you believe in the "worth" of America? Pick a country, any country! What's it worth? Seriously, what is the worth of a country? When I think about it, if you ask me, America is still very wealthy! I could give you a long list of reasons why but that's not the point of this blog post.
We are going go the edge of the cliff here. In financial terms, America and a slew of other countries are for all intensive purposes insolvent. If America goes over the cliff the rope tied to most of the developed world will take them over the cliff with us. It will be mutual financial destruction! Nobody wants that, so we all need to step away from the edge. The problem as I see it is that no body has figured how to "step back" in a way which will enable people around the world to believe once again in the value of the USA dollar or the Euro. But I am pretty much sure that we will find a way for the same reason that nuclear war has not happened yet. Most people and most countries are not suicidal.
It should be very interesting to listen to how Fed Chairman Bernanke, ECB President Trichet and China's Chairmen Hu all talk us off the ledge. Listen up people.
There's no question that IF this happens the world will be thrust into a great depression! The USA is the biggest customer on the planet and if we stop buying international goods and services from around the world because our dollars are so devalued our pain becomes the pain of the entire world and everyone's economy. Talk about "too big to fail," there isn't any country that could bailout the USA. If our boat sinks we're taking everyone to the bottom with us! But that's a BIG IF!!!!
We've been bad. We spent too much. We're virtually insolvent. But so is Japan, Ireland, the UK, Spain, Portugal, and dozens of other countries! Have you looked at the Debt to GDP ratios in France and Italy? Forget about Belgium, Denmark, Norway, and Switzerland! Euro zone Debt to GDP is higher than the USA! You have to wonder who's lending everyone the money cause we're all broke.
Sure there are some countries with a great debt to GDP ratio. Those are the countries supplying the world with natural resources or who have exploited their workers and kept their vast populations living in poverty. (Can you guess the names of these countries?) They have also been huge buyers of USA treasuries. Who's better off? Well, let's see what happens when we stop buying their stuff and their debt, valued in dollars, is nearly worthless as well!!
The bottom line is that if America goes bust we're taking all of these countries with us. So where would you like to be living the day America goes broke? If you ask me, I'd rather be living in America when it goes bust than in China!! Somehow the image of civil unrest in America seems less scary to me. And what will Saudi Arabia do with all that oil if American's start burning more gas and coal and conserving energy because we can't afford to buy OPEC oil?
What's the value of a dollar, or any currency for that matter? None of it (currency) is backed by anything more than faith & confidence in the financial system of the Nation that prints it. It's only worth anything if you believe it's worth anything! So, do you believe in the "worth" of America? Pick a country, any country! What's it worth? Seriously, what is the worth of a country? When I think about it, if you ask me, America is still very wealthy! I could give you a long list of reasons why but that's not the point of this blog post.
We are going go the edge of the cliff here. In financial terms, America and a slew of other countries are for all intensive purposes insolvent. If America goes over the cliff the rope tied to most of the developed world will take them over the cliff with us. It will be mutual financial destruction! Nobody wants that, so we all need to step away from the edge. The problem as I see it is that no body has figured how to "step back" in a way which will enable people around the world to believe once again in the value of the USA dollar or the Euro. But I am pretty much sure that we will find a way for the same reason that nuclear war has not happened yet. Most people and most countries are not suicidal.
It should be very interesting to listen to how Fed Chairman Bernanke, ECB President Trichet and China's Chairmen Hu all talk us off the ledge. Listen up people.
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