Friday, April 28, 2017

Edward Harrison — Why the euro crisis will happen again and Italy will be involved

This morning, as the data were coming in from Europe for Q1 GDP, I got a reminder from Twitter about the inherent deflationary nature of the euro area’s design.| And this goes directly to how to think about credit risk in Europe.

I followed a twitter post to a Charles Goodhart article from 1997, written before European Monetary Union. And he was saying things that the late British economist Wynne Godley was banging on about five years earlier when the Maastricht Treaty set out the terms for euro. Here’s the crux as it relates to credit risk in Europe:
Credit Writedowns
Why the euro crisis will happen again and Italy will be involved
Edward Harrison

29 comments:

Matt Franko said...

Why don't the Greek banks just simply go out and raise more capital in an hour and solve the whole thing over there?

If it's so easy as you guys say it is , this should not be a problem....

Matt Franko said...

"they switch BS funding around as needed on an aggregate basis, as Neil has been explaining."

Why don't the Greek banks just "switch BS funding around" in an afternoon and solve the whole problem over there?

Seems easy according to you guys.... should take maybe 15-20 minutes right?

Wonder what the holdup is......

Ryan Harris said...

The Greek banks are liquidity constrained, not capital constrained.

If the Greek Government doesn't meet fiscal goals, the ECB cuts off the Greek Government AND the banking system so the banking system can't buy government debt.

It's breaks the ECB rules by holding private banks responsible for the national government policy, but they justify the actions because otherwise the Greek government wouldn't reform.

Matt Franko said...

Well they could just switch the funding over to liquidity from capital then.... 1,2,3...

Noah Way said...

Or they could default, set the drachma at some fraction of the Euro and nationalize the real assets sold off to foreign creditors. Nobody could afford to buy imports but nobody can now anyway so what's the difference? Tourism would boom bringing in hard currency and the sovereign economy would be quickly rebuilt.

Nobody could invade to collect without causing NATO to implode ...

Ryan Harris said...

*sigh* We're waiting for the right leader to come along and stir up the passions of the never before employed under-30 majority in Greece. Then a Drachma will become real. And probably Grexit. And NATO-Exit. Who knows what else. My favorite black swan scenario is Erdogan starts to move on Greece.

Noah Way said...

The leaders are all globalist moles or stooges, or are immediately co-opted like tRump.

Penguin pop said...

Or they're completely full of shit to begin with and just say things to give people hope and then go for the kill anyway. I'm just gotten so cynical these days.

Noah Way said...

The power of accurate observation is called cynicism by those who have not got it.
-- George Bernard Shaw

Ryan Harris said...
This comment has been removed by the author.
Neil Wilson said...

"Why don't the Greek banks just simply go out and raise more capital in an hour and solve the whole thing over there?"

At what price Matt?

Banks will expand lending until they run out of creditworthy borrowers prepared to the current price of money.

Where are the creditworthy borrowers in Greece prepared to pay the currency price of money in Greece?

Greek banks are underwater. They are functionally insolvent and should be resolved. That lack of resolution - which forces creditors to take losses - is what is holding the entire Eurozone back.

Capitalism without bankruptcy is like Catholicism without hellfire. It doesn't work.

Ryan Harris said...

We aren't talking about a couple bad commercial real estate loans and an investor that needs to be bankrupted. The failure of the entire banking system can only occur in any economy that is mismanaged by politicians to intentionally force mass insolvency. Banks are chartered by the state to lend money to the citizens of the nation with the explicit guarantee that if they make responsible loans the state will backup the bank with central bank loans. This guarantee exists because the ability of citizens to pay back loans and the solvency of the bank is mostly determined by the levels of unemployment and inflation which are determined by the sovereign meeting economic targets within reasonable limits. No one else in the economy has the power to ensure economic targets are met and loans get repaid besides government.

Greece was governed with recklessness and irresponsibility unlike anything we've ever seen outside war or catastrophe in a western developed nation in modern times. The government failed to meet their growth, employment and inflation targets for decades intentionally -- the government should pony up money to make society whole whether citizen, bondholder, or banker. A capitalist democracy can only succeed when individuals are held accountable for their behavior. A reckless investor must lose their investment. A reckless bank must be resolved. A reckless politician must be jailed and prosecuted.

The citizens and bankers should revolt and demand immediate prosecution of political leaders. We need Merkel, Junker, Trichet and a few hundred Greek politicians brought to justice before a commission or court to examine their crimes. Politicians will shirk their economic responsibility and intentionally cause to destruction and needless suffering of millions of people until they are held accountable. Western democracy can not again prosper until this systematic defect is addressed.

Unfortunately, orthodox economics as taught in text books doesn't have a clear mechanism for politicians to operate an economy and meet targets. Until orthodox economics is purged, there is probably no way to hold politicians to account. It is wildly unpopular to jail economists because their work is viewed as complex and unknowable, mere opinions and entertainment.

Matt Franko said...

Here this from Warren:

https://twitter.com/wbmosler/status/858416071749062657


Thing rolls over on Jan 2013....

Here from wiki on QE3: "On 12 December 2012, the FOMC announced an increase in the amount of open-ended purchases from $40 billion to $85 billion per month."

Checkmate....

Matt Franko said...

"The failure of the entire banking system can only occur in any economy that is mismanaged by politicians to intentionally "

You have NO evidence of this intention....

Matt Franko said...

Ryan so you are saying that their intention is to bankrupt Duetchebank? They are intending to do this? C'mon....

Noah Way said...

The failure of the entire banking system can only occur in any economy that is mismanaged by politicians to intentionally force mass insolvency.

As if bankers are paragons of virtue ... Remember 2008 and the systemic corruption that led to it? Bribery, kickbacks, toxic "assets" rated AAA, bankruptcy "reform" enacted just before the crash, the massive public bailout, etc., etc.

Pump and dump is the game, and politicians are just tools that facilitate it. Pols lose their funding (sponsors) if banks go down. Follow the money ...

Matt Franko said...

"At what price Matt? "

Right Neil the terms are not good, so hence they don't want to do it...

So this is my point, if government policy forces trillions onto bank assets they are not going to go outside for more capital just to maintain the previous Leverage Ratio... so as a first reaction they eliminate loan growth and perhaps sell other assets instead...

They look at this as the better course rather than dilute their ownership... they wait and grow their capital endogenous...

But make no mistake the causation is the capricious govt policy.... banks just deal with it best they can and looks like they are sometimes over their heads...

Ryan Harris said...

Willful ignorance is intentional. Expansionary austerity is the only mechanism allowed by the political system to balance the economic system. That is intentional by design. The Troika demanded austerity vociferously and publicly. Refusal to adopt well known and understood alternatives is absolutely intentional, well documented in media. There was no way to keep a bank lending to ordinary Greek citizens and solvent under the extraordinary austerity and economic collapse imposed on Greece.



Deutsche Bank holds assets approved by German and ECB regulators. Their leverage ratio, capitalization, funding sources and overall size relative to the German economy are explicitly defined as acceptable by regulators. Those regulations are set with the assumption that government will adopt and meet economic targets, within reason.

Any bank that meets regulatory requirements and has made loans to credit worthy customers, have valuable collateral even if those assets are systematically diminished in market value through adverse government policy. A central bank should make loans to the bank if government policy causes a run on the bank. Period.

Noah Way said...

Government policy is set by bankers.

The US Treasury is often refereed to as the Departmental of Goldman Sachs. Obama's appointments were almost exclusively selected by CitiBank. Maybe it's different in the EU, but somehow I don't think so.

And sane government would have nationalized the banking system after the mortgage crisis, and various people worth hundreds of millions would now be serving long prison terms. Instead they all got bailouts and bonuses.

Ryan Harris said...

Not set by bankers, really, maybe influenced by bankers. Teachers, Tech, Environmentalists, Agriculture are all powerful too but we would not say they control government or set policy.

Matt Franko said...

I'm sure there are plenty of GS people who think "banks lend out the deposits!"...

Matt Franko said...

"the mortgage crisis"

It wasn't a mortgage crisis it was a deposit crisis....

Matt Franko said...

"Willful ignorance is intentional."

Nobody WANTS to be stupid....

Noah Way said...

Teachers, Tech, Environmentalists, Agriculture are all powerful too but we would not say they control government or set policy.

Because they are not powerful. As examples:

ObamaCare, written by the insurance lobby, carefully negotiated to prevent competition in any form including a public option. Also negotiated to preclude any controls or effects on pharmaceutical corporations.

Or environmental lobbies, who are outspent about 7:1 by industry groups.

Money = speech.

Neil Wilson said...

"if government policy forces trillions onto bank assets they are not going to go outside for more capital just to maintain the previous Leverage Rati"

You won't let this go will you.

Government policy can force trillions onto bank assets. But they are secure loans to the state - which is as good a bet as any. Unless they are at negative rates - which is just a tax.

We were talking about Greek banks, where no such activity is taking place. The ECB isn't buying Greek government bonds.

I will say it again - it is just a matter of price. Government can price private lending practically out of existence. That is the underlying policy of the 100% reserve crowd after all.

Neil Wilson said...

"A central bank should make loans to the bank if government policy causes a run on the bank."

Only to the extent that the bank is solvent. And since the central bank determines if a bank is solvent, then it should provide liquidity on demand to any bank it determines is solvent.

If the bank is insolvent - due to government policy or otherwise - then the bank should be resolved and capital owners take a cold bath. That is capitalism.

Don't invest in a public utility if you don't like the odds.



Ryan Harris said...

The government has a moral imperative to promote and support production.

Those who produce receive the support and protection of government because they provision the government and her citizens.

Environmental lobbies promote non-production and conservation and are at odds with government. The government doesn't support non-production, it promotes fair production and some resource conservation.

This isn't speculation or philosophy but the law and constitution and precedent actually explicitly state these principles. Various doctrines take slightly different approaches on capture, regulation, possession of production but in every jurisdiction government ALWAYS supports production over non-production. It has to.

Cornerstone concepts and doctrines in our government's legal system and how our society functions.

Chinese government and relationship to people, land, production, and resources is NOT the same as our western system though they have been integrating the two ideas more and more.

I think current debates about wealth and corruption take production for granted because our system has been so successful for so long in maintaining surpluses and avoiding resource deficits -- famine, inflation, etc.

Noah Way said...

But somehow not avoiding financial deficits ---

Sorry, but somebody had to say it. Of course deficits are irrelevant at the state level but on a personal level they can be devastating.

Government has a moral imperative to support citizens, and not just a few of them. In theory at least.

MRW said...

Not only a moral imperative to support citizens, but we sign a social contract with the federal government when we become American citizens, or when we're born here to behave as citizens, follow the laws ("outlaws" have no protection or rights, which is why people could whack them in the 19th C and not go to jail), and receive the benefits and protection of government for our general welfare. The Constitution and Bill of Rights are social contracts.