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Hullabaloo


Sunday, August 28, 2011

 
The big choice
by David Atkins ("thereisnospoon")

This triple crisis post Digby referenced yesterday may be the most important thing anyone interested in politics and economics may read for a long time. There are too many important points in the article to summarize in a neat block, so I won't even try. Interested readers need to consume the whole thing several times. Those who aren't already knowledgeable about such things might require a brief primer on CDOs (collateralized debt obligations) and CDS (credit default swaps) to really understand it, but it's worth it.

The key upshot is this: European central banks took on increasing amounts of leveraged debt--partly from the same fiscal insanity that plagued the Anglosphere, and partly by buying up bonds from less stable economies such as Greece and Iceland. Pretty much every European nation except Iceland made the decision to socialize the financial industry's losses and turn the banks' private debt into public debt. The only problem is that there's far more banking debt out there due to leverage, than the collective economies of the Eurozone nations have to bail them out with. The Eurozone problems are not a result of overly generous social welfare systems, but rather of the combination of those systems with an attempt to take on debts of their banking institutions. Fairly soon, none of the Eurozone nations will be able to stand up under the weight of those needlessly undertaken obligations, in part because the inflexible structure of the Euro has made it such that the entire Eurozone sinks or swims together.

The nations of the Eurozone have two choices here: either let their big banks fail under the weight of their leverage, or radically restructure their societies and social compacts at the expense of their people, in order to protect their banks. So far, most Eurozone nations are choosing the latter.

The case of Iceland is particularly interesting here. Icelanders decided not to bail out their banks, but rather to let them fail, leave the bondholders who risked investment in the nation's banks out to dry. Icelanders have decided start over while taking care of their people first, and foreign bondholders last. That reasonable and moral approach has been met with outrage by most of the world's financial elites; Britain is now suing for remuneration on behalf of British investors in Icelandic banks.

The idea that investors in corporate or sovereign securities are owed a return on their investments has always struck me as amusing: part of the reason investors "earn" interest on invested money is because there is risk entailed, even in assets considered safe "AAA" material. The upside of "earning" money through investment is that the investor doesn't have to work to "earn" the money; the money does the work for the investor. The downside is the risk that the investor might lose money on the investment. If investors are guaranteed risk-free return, then they're essentially a special class of citizen who get to use their wealth to make more guaranteed wealth just by having it, as opposed to the dumb schlubs who actually have to do a day's work for their sustenance. Guaranteeing risk-free interest on invested income creates a de facto economic system of Morlocks and Eloi where the people who actually work for a living get thrown into the gaping jaws of the lucky "investors" who don't. So it's deeply satisfying on a certain level that Iceland is telling bondholders to stuff it, because the nation is more interested in protecting its people than in paying off foreign investors: that's risk for you. If you can't handle it as an investor, get out of the bond market.

But the problem is that that approach can work for Iceland because of the relatively small size of its economy. If a nation like France or Germany took that approach, it might crash the entire world's financial system, since the big banks and related financial institutions themselves are usually the biggest bondholders.

After all, the big banks provide liquidity. The big banks lend money to small business, corporations, communities large and small, and sovereign nations. If the world's banking system fails, it's like the heart ceasing to pump blood through the body. Liquidity dries up. Small business owners will fail to get loans to make payroll; their employees won't get paychecks. The system seizes in shock, the blood supply to the brain fails, and disaster ensues.

It's not just the Eurozone facing this problem, of course. America faced the same vexing question in 2008, which led to the decision to institute the bank bailout. Even most progressive economists tend to believe that the TARP bailout was necessary, even if it should have come with many more regulatory strings attached.

But as the financial sector continues to careen further and further out of control worldwide, the challenge faced by sovereigns worldwide is this: either become subservient entities to the global financial institutions that truly govern the fates of the world's citizens, or reassert their authority and independence while allowing reckless banking institutions to fail.

Most nations are choosing the former, both because they lack the courage to do the latter, and because they lack the vision to imagine what kind of system might need to be created in a post-too-big-to-fail world. The world's economies are now massively interdependent, with most of those interdependencies lubricated by liquidity provided by the big banks.

It's high time that economists worldwide begin to envision a different way forward: a way for sovereigns to bypass reckless financial institutions and survive in the interdependent global economy without their help. A way, in other words, to truly allow banks that are too big to fail, to fail. A way to allow nations to tell investors that they will have to accept the consequences of their having taken the risk that comes with making money off interest with no labor involved. If not, the moral hazard of an increasingly powerful and unaccountable global investor elite will continue destroy sovereign nations socially, economically and spiritually. It's only going to get worse from here.


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