The Dutch call it, “Doing-an-English”. That’s when someone takes a liberty real soft and sweet and so-so-polite you hardly even noticed…until you find out you’re pregnant, or worse.
Looks like the Europeans finally noticed. Jose Manuel Barroso’s news at the G-20 summit was… "This crisis was not originated in Europe".
It’s unfair of Jose to blame America for all of Europe’s debt problems, although it is true that over seven biblical years leading up to the collapse of Lehman, foreigners, mainly European foreigners, shelled out $5.4 trillion buying U.S. debt, other than U.S. Treasuries, i.e. from Wall Street.
That’s how come Dr. Doom’s prediction that the world was going to end in 2004 because the Current Account Deficit could be endlessly financed by selling U.S. treasuries; did not come to pass (and when Armageddon did finally arrive, it was nothing to do with current account deficits).
That’s also how the European banks, including the British ones, got hammered on the first round of the credit crunch. No one knows what that $5.4 trillion is worth now, probably not more than $2 trillion, so that represented loss of about $3.4 trillion to European banks, pension funds and insurance companies, partially bailing them out of that round of stupidity was when the ECB lost her virginity.
And the important thing there, which is where this article is leading, is that debt was non-recourse.
That’s a different thing completely from recourse debt such as sovereign debt, where you can trash the borrower’s credit score if they don’t pay you back, and then all of the banks in the world will gang up with you to squeeze that last drop of blood, just when they need a transfusion most.
Non-recourse is just that, you get the keys in the mail, and that’s it…you are a proud owner of a street full of fixer-upper suburban houses in East-Side Detroit.
Technically speaking the $3.4 trillion of money that European banks paid over to Wall Street to buy synthetic collateralized debt obligations and other exotic toys is not an outstanding obligation by anyone in America, and particularly not the American government, towards Europe.
Effectively Wall-Street “exported” $3.4 trillion of pretty pieces of paper to Europe, and Europe bought them. And sorry to say, the warranty expired, and there is no returns policy. That’s no different from exporting a boat-load of Chrysler Concorde’s whose wheels all fall off on the day-after the warranty expires.
That was the start of the rot, and the hit banks and the slumbering bureaucrats in the ECB took from that, is probably the reason they have been so slow to react to Europe’s home-grown Charlie Foxtrot.
The details are different, but causes of both crises were similar. In America the politicians decided a long-time ago to underwrite home mortgages, the idea was a sort of public-private partnership that evolved into crony capitalism where the rich got richer at the expense of the middle-class and the poor, all supported by a nod-and-a-wink of implicit guarantees, that in the end became explicit.
What the politicians got out of that was votes. When 65% of the population “own” their own homes, and you ask them “would you like higher house prices” they say, “You Bet…Jose”. And on top of that, the bubble created by credit loosens up cash to be spent on an easy-lifestyle, so the GDP goes up and everyone is a winner, until the easy money runs out.
In Europe they had crony socialism instead, when 65% of the population is directly or indirectly employed by or supported by the State, and you ask them “would you like higher wages, stronger unions, and better benefits and pensions”, they say…you got it in one…they all said, “You-Bet…Jose”.
In Europe the money also came from an incestuous public-private partnership, aided and abetted by the lunacy of Basel II and plenty of nods and winks about implicit guarantees, which had European banks lending vast sums to PIIGS so they could live the socialist dream…until the money ran out.
Europe will sort out their mess one way or another, just like America kind of sorted out its mess; it won’t be clean and it wont be pretty, just like Ludwig the Von said, after a credit induced sugar-rush, what’s next is a slow process of recovery as the mal-investments of the past, in speculative housing, in unaffordable social benefits and pandering to public-sector unions, get washed clean.
The issue, in both America, and in Europe is where will the debt come from in the future, to pay to move on from yesterday’s stupidity, and to fund growth in the future?
The lesson learned in America, is that non-recourse debt gets wiped clean real fast, sovereign debt, or any debt that relies on the premise that the lender can hurt the borrower when he does not repay the debt, whether it’s by cutting out a pound of flesh close to the heart, or by breaking legs if you are a loan-shark, is a less attractive type of debt, for the borrower.
That’s why America is in a much better position now than Europe, the big money they owe to foreigners, is non-recourse. So the lenders did not value the collateral properly, and they are paying for their mistakes.
Sovereign debt should be reserved for internal borrowing; a country can pay that back by simply printing money. Money in that regard; is simply the promise to accept the same money as payment for taxes, the U.S. Treasury gives $100 to someone to pay them for a service to the U.S. Government, and they promise you can use that $100 to pay your taxes, the extent to which the government’s expenditure is funded by taxation or printing money, is a political decision.
Where the Euro went wrong was that the people printing the money; didn’t have the right to collect taxes in the places the money went. That was a recipe for disaster.
The solution, intriguingly, probably lies in securitization. Notwithstanding it was securitization that funded the excesses of the U.S. Housing boom, and that the process has been completely discredited thanks to the incompetence and the corruption of the rating agencies, that doesn’t mean the model can’t be improved, and re-launched.
There is a misconception that securitization is about spreading risk, that is completely wrong. When you buy a AAA security, you should be able to sleep at night without doing a due diligence on the complex algorithms and value opinions that were supposed to have been checked by the rating agencies, and were not…although as a buyer you should have access to that data in a standardized computer format in the public domain…which is currently not the case either.
What securitization ought to do; is to provide sellers of debt a market where there are buyers. That’s nothing to do with risk.
The sooner that penny drops, and serious efforts are made on both sides of the Atlantic to reform the process of securitization, the sooner the process of recovery can start, and the sooner the buyers of debt who these days have a choice between staying in cash or buying 10-Year Treasuries at stupid prices, because there is no other investment grade debt available for sale, can return to fund economic recovery.
About the Author - Andrew Butter is Managing Partner of ABMC, an investment advisory firm based in Dubai that he set up in 1999, and has been involved advising on large scale real estate investments, primarily in Dubai. (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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