Grasping the Nettle: The Banks Are Bust

by George_East on March 25, 2011

On Wednesday evening the Portuguese government resigned as a result of rejection by parliament of the latest austerity package, incredibly the fourth in the last 12 months.   As ever, the austerity package included cuts to healthcare, welfare spending and pensions.   Bond yields on 10 year treasury debt is now up to 7.3% and Portugal looks like it will almost certainly be the third Eurozone country, after Ireland and Greece, to be forced into negotiating with the EU and IMF for a bailout package, assuming the Germans are willing to fund it.

If this occurs what happens next is all too predictable, the EU and IMF will demand savage public spending cuts in return for bail out money. This will lead to higher unemployment, lower tax revenues and a worsening position in the Portuguese economy leading to the need for further austerity measures and an economic death spiral.   One only needs to look at that poster boy for how not to do things, Ireland, which despite now having unemployment at 13.5% as a result of extensive and successive austerity packages has seen 10 year bond yields rise to record highs for the Euro era of more than 10%. 

The irony is, of course, that those who argue that the austerity measures are needed to appease the markets which will otherwise be afraid that there will be sovereign debt default are now seeing the markets react to the increased prospect of sovereign debt default in the economy as a result of those very same austerity measures. If you decide to commit economic suicide it is not surprising that the markets do not have much faith in your long term mortality.

Yet despite this, as Paul Krugman details in a brilliant opinion piece in today’s New York Times, the deficit hawks and austerity mongers continue to sell their self-defeating wares. In the UK at least we have our own currency enabling a degree of countervailing economic sanity to emerge (so far at least) from the Bank of England to off-set the drooling Thatcherism of the coalition government.  In contrast in Portugal (like Ireland and Greece) there is no monetary option, nor can they achieve relative competitive advantage by devaluing their currency.  They are left with no option by the geniuses in charge but to impoverish their own people further in the hope that somehow Krugman’s confidence fairy will arrive and make everything better.

The evidence of the wrongheadedness of this economic approach is now overwhelming.  Everywhere austerity has been tried in the current economic conditions it has failed.   The bailout packages are simply kicking the problem further down the road and making it worse, as debt is piled on debt and as the economies of the effected countries get worse and worse.   And if Portugal finds itself in this position then how long before Spain and then Italy and then Belgium etc.

The consequences though are not simply economic misery for the many millions of people who were utterly blameless in the causes of the crisis, they also threaten the very future of the Euro.  If the former no longer appears to concern the arid technocrats of European policy making, the latter at least will.   At some point someone will have to grasp the nettle or otherwise the European periphery will become unwilling to bear any more pain or Germany will no longer be willing to finance the debts necessary to bail out the periphery.    The cause of the European crisis is the nationalisation of bad bank debt.   The taxpayer taking on board the debts that the creditors of the banks ought to have to write off – that isn’t how private business risk is supposed to be dealt with.  It was, after all, those creditors who loaned the money on dubious security in the first place.   It ought to be the creditors who are taking the hit for their poor business decisions not the poor blameless tax payer.  The problem, of course, is that those creditors are very largely the other big European banks (hence the reluctance to allow any restructuring of the debt or even the most modest of haircuts), which brings us back to where the whole crisis started and the unfinished business that is dealing with a rotten financial sector.  

In all truth many of the banks are insolvent in any honest business sense.  They are being kept alive by taxpayer money being used to service debts that are bad and ought never to have been loaned in the first place.   It is a casino which is completely rigged – the banks always win, the taxpayer always loses.   At some point this truth is going to come home to roost anyway.  The longer it takes to deal with it the worse the suffering of ordinary people will be in the meantime.   Debts need to be restructured as in Iceland (which has in contrast to Ireland and Greece begun to bounce back) and if banks are insolvent they need to be dealt with like any other insolvent company.  There is no sign though of this stark reality yet being faced and I suspect it may take a full blown crisis in the Euro or a second banking collapse before it is.   As time passes both of these outcomes become ever more likely.  It is all deeply depressing.

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