The Road to Serfdom

Published on the New Economic Perspectives Blog, by Marshall Auerback, November 09, 2011.

… At least the Alice in Wonderland quality of the markets has finally dissipated. It was extraordinary to observe the euphoric reaction to the formation of the European Financial Stability Forum a few weeks ago, along with the voluntary 50% haircut on Greek debt (which has turned out to be as voluntary as a bank teller opening up a vault and surrendering money to someone sticking a gun in his/her face).  

To anybody with a modicum of understanding of modern money, it was obvious that the CDO like scam created via the EFSF would never end well and that the absence of a substantive role for the European Central Bank ECB would prove to be its undoing.

As far as the haircuts went, the façade of voluntarism had to be maintained in order to avoid triggering a series of credit default swaps written on Greek debt, which again highlights the feckless quality of our global regulators being hoisted on their own petard, given their reluctance to eliminate these Frankenstein-like financial innovations in the aftermath of the 2008 disaster.

What is required is a back to the future approach to banking: In the old days, a banker hedged his credit risk by doing (shock!) CREDIT ANALYSIS.  If the customer was deemed to be a poor credit risk, no loan was made … //

… The ECB also has a mandate to maintain financial stability. It is buying government bonds in the secondary market under the financial stability mandate. And it could continue to do so, or so one might argue that it could. True there is now great disagreement about this within the ECB. It has been turned over to the legal department, which itself is in disagreement, which ultimately suggests that this is a political judgement, and politics is what is driving Italy (and soon France) toward the brink.

In fact, given the 50% voluntary haircut imposed on holders of Greek debt, arguably the ECB is the only entity that can buy these national government bonds today. As Warren Mosler has noted, it is hard to see how anyone with fiduciary responsibility can  buy Italian debt or any other member nation debt after EU officials announced the plan for 50% haircuts on Greek bonds held by the private sector:

  • Yes, all governments have the authority, one way or another, to confiscate an investors funds. But they don’t, and work to establish credibility that they won’t.
  • But now that the EU has actually announced they are going to do it, as a fiduciary you’d have to be a darn fool to support investing any client funds in any member nation debt.
  • The last buyer standing is and was always to be the ECB, which will now be buying most all new member nation debt as there is no alternative that includes survival of the union.
  • And when this happens there will be a massive relief response, as the solvency issue will be behind them, with the euro firming as well.

Of course, we will still have to deal with the reality of a major recession in Europe so long as the faith based cult of Austerians continues to dominate policy making. Sadly, that’s unlikely to change until people are shot on the streets of Madrid or Rome. But at the very least, let’s get this silly national solvency problem addressed once and for all in the only credible way possible. Mario Draghi, you have the chance to redeem yourself and your country. Don’t waste the opportunity. (full text).

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