Monday, May 10, 2010

The State Racket

So lately, it's all about the government.  This is the next stage in our version of the Great Depression.  Back then, they didn't have the big governments we are using as a fire break to contain the contagion in the financial system. Now, we'll see if ours are big enough.  Today the pages are filled with Greece and Spain, and tomorrow you can be sure the Tea Baggers will claim that the US is next.  And really, they are right.  Just about any way you look at it, the developed world is bankrupt. 

Yeah, there you go, I just said it.  Superficially, it matters a lot whether Greece or Spain or Ireland formally restructure their bonds.  But on a deeper level, all that we are seeing with any of this is the initial stages of a bankruptcy proceeding.  The acute liquidity crisis has passed (though it can always come back).  We've got the Fed and the ECB playing the part of daddy DIP (debtor in possession, for those non financial types).  And now we have to get to the dirty work of sorting out which creditors get what.  The real question is how do we split the pain. 

Consider the European case a little more closely.  Should they just let Greece formally restructure the debt?  How is this any different, you might ask, from cramming further loans down their throat and then demanding that they take a massive pay cut in order to make good on them?  Well, let's look at it as a typical corporate bankruptcy proceeding.  It's really a question of who owns the post re-organzation value of the nation.  Does the creditor (Germany) end up owning the whole company, or do the equity holders (the Greeks) have the upper hand?  Donald Trump's famously serial bankruptcy negotiations were an example of the latter -- if you want there to be any value, Mr. Creditor, you will take a big haircut now.  The bank forclosing on your house is a simple illustration of the former.

These are important questions with real consequences.  And it's not just a question of dividing a fixed pie, as the Trump thought experiment shows.  But if you step back for a second, you will realize that all of this is actually secondary.  The primary thing is facing up to the fact that we're bankrupt.  Maybe the Greek people get stuck with it.  Maybe the German people do the bailing out.  Maybe the Greek government forces a haircut on the creditors.  Maybe this causes banks runs in Greece.  Maybe it causes bank runs in Germany.  Maybe the Germans don't directly bail out the Greeks, but they have to bail out their own banks.  Maybe this time they stick it to the bank equity holders.  Pay your money and pick your color, this is what the big casino we call international finance is all about. 

But don't lose sight of the fact that one group worked because they were promised that they wouldn't have to in the future.  And another group consumed now and promised to work later.  Now they have to get together and sort out whose going to make the donuts.  And there's simply no way around this.

UPDATE:  I wrote this last week after reading some of these related articles.  Superficially, things are completely different now, as the EU put together a massive fiscal bailout and quantitative easing bailout over the weekend.  The division of pain progresses at full speed, even if the realization of how much it will hurt only dawns gradually.  How fast we run to stay in place! 

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