Thursday, 27 October 2011

The Games of Banks and Governments

United in Ponzi since the Middle Ages

It was in the late middle ages when governments first realized that the practice of fractional reserve banking – at the time rightly regarded as fraudulent – could be put to very good use for their own goals.

After observing a number of boom-bust sequences in the period a.d. 1300 to a.d. 1500, complete with bank runs in which depositors lost most of their assets, a typical conversation between a politician and a banker in late medieval Spain or Italy may have gone like this:

Politician (mayor, archduke, king…take your pick): „Look, we know what you're doing. You're systematically defrauding your customers. This means (brief interlude: leafs through statute book, at the time still of moderate size…)….lemme see….ah, there it is. Public beheading for you. Some glory for me, for having made an example of the usurious thief we both know you are.” Pregnant pause.

Banker: “Aaaand?”

Politician: “Why don't we go into this business together?”
And so the banking cartel was born, the state-capitalistic combine that has been perfected in modern times with the creation of central banks and the adoption of fiat money. Banks were given the privilege of working with fractional reserves and in exchange helped finance the debts of governments. The essential features and the job of this system are still the same today as they were first conceived in late medieval times. Only, the system has certainly been perfected over time. It has e.g. been learned that stealing too much all at once is not a good method. It's better to boil the frog surreptitiously and slowly.

Alas, even though the system has been perfected, it can not escape economic laws. This means that in the long term, there will always come the point at which these laws catch up with the shenanigans of banks and governments.

This is the juncture which euro area bankers and governments have now finally reached. It is actually gratifying to see them at each others throats of late – it's a bit like a family feud you might say, a disagreement between different branches of the mafia.

Leverage and Regulations

As our readers know, we are always deeply suspicious of business regulations. It is a demonstrable fact that all of these regulations restrict production. The question is always what the costs and benefits are. As Ludwig von Mises notes in Human Action by way of example, regulations that are put in place to e.g. control fire hazards certainly impose an economic cost. Alas, they can be justified by the consideration that they help prevent potentially far greater losses at a later time.

So the pros and cons of regulations always have to be weighed in this manner: it is impossible to argue that regulations do not impose economic costs. They always do. The question is only if they help avert even greater losses down the road.

Let us rather say, that is what should be the question. In reality most regulations are actually designed to create privileges for politically well-connected established groups of producers to the detriment of consumers and society at large.

Regarding the debate over the banks in Europe, it has to be acknowledged that things are what they are: only 5.4% of all money substitutes in the euro area are actually covered. The remaining 94.6% are fiduciary media – claims to money issuable on demand for which no money proper actually exists.

Therefore, contrary to what the bankers claim, the demand that is now on the table, namely that they should at least increase their core tier one capital ratio to 9% of their assets is not an unreasonable demand at all. They are in fact getting off lightly – their leverage will still be enormous once this has been put in place.

The banks are arguing, at first glance not entirely unreasonably, that what lies at the root of their current problems is actually not their fault. After all, so they say, we were told that government bonds are so safe that they require that nothing be set aside in reserve against them. Governments however have not kept their end of the bargain: they have amassed such large debts and deficits that the capital position of the banks holding these 'absolutely safe' assets has become impaired. Now governments are trying to unfairly heap blame on us, so say the bankers, and impose unnecessary costs.

There is some truth to that assertion, but the bankers are forgetting something: they were playing this game voluntarily, in exchange for the privileges they enjoy. These are privileges that no other branch of business can even dream of. They can create money ex nihilo and profit from lending it out! They are backstopped by a central bank that can and does lend them unlimited amounts of money, likewise created from thin air.

And they have been in bed with governments all along – as noted above, since medieval times in fact.

They are also forgetting that they were instrumental in creating the many housing bubbles all over the world that have eventually turned into the mortgage credit crisis of 2008 – governments then bailed them out and the fiscal position of many governments deteriorated sharply as a consequence (the country where this is most obvious is Ireland).

Money TMS in the form of currency, covered and uncovered money substitutes in the euro area banking system. Uncovered money substitues available on demand amount to nearly €3.7 trillion, as opposed to a mere €211 billion in covered money substitutes as at September 2011. Data via Michael Pollaro – sorry, no better resolution available.

Hair Gets Cut

In addition to the demand for comprehensive bank recapitalization – a copy of the draft can be found here (pdf) – euro-group heads of state were up until today deadlocked with the banks over the 'Greek haircut' debate. It is quite comical, a 'Kabuki theater', as the WSJ avers.

What's so eminently funny is that although everyone knows for a fact that Greece is as bankrupt as one can possibly be – left to its own devices, it couldn't repay a dime of its debt and creditors would likely have to write off 90% or more of the value of the debt they hold – the 'haircut', regardless of how big it is, must be 'voluntary'. Otherwise it would be considered a 'credit event' (here one must ask: if a 50% or 60% haircut isn't a 'credit event', then what is it?) which would trigger CDS on Greek debt and be classified as an 'official' default.

This in turn would impair the debt now held by bureaucracies such as the ECB and IMF, which have climbed up the ladder of creditor seniority to the very top. This is one of the reasons why existing Greek debt trades so extremely poorly – with ECB and IMF representing the senior creditors that outrank all others, existing Greek debt is practically worth nil. Moreover it is held that an official default would create a much bigger shock to the system than the comical 'voluntary' haircut that the politicians are now forcing the banks to accept.

It's no surprise then that these talks were still not going anywhere as of yesterday. However, as Bloomberg reports, the banks have now 'bowed' to 'Angela Merkel's last word' on how much they will have to write off:

“The world’s biggest banks bowed to what German Chancellor Angela Merkel called the “last word,” agreeing to write down their Greek government debt by half in the pivotal piece of the euro area’s bid to stem the financial crisis.

The Institute of International Finance, which represents financial companies, agreed to “develop a concrete voluntary agreement on the firm basis of a nominal discount of 50 percent on notional Greek debt held by private investors,” Managing Director Charles Dallara said in a statement e-mailed at 4:26 a.m. in Brussels.

Euro-area leaders who called Dallara into a meeting at about midnight, forcing a break in their 10-hour summit, said that while the bond transaction will be voluntary, the decision resulted from an offer he couldn’t refuse.  
“It was the fiercely delivered wish by Merkel, Sarkozy, Juncker, that if a voluntary agreement with the banks was not possible, we wouldn’t resist one second to move toward a scenario of the total insolvency of Greece,” Luxembourg Prime Minister Jean-Claude Juncker told reporters. That “would have cost states a lot of money and would have ruined the banks.”
(emphasis added)

Professional bank robbers in the EU might want to take note and perhaps take a leaf out of the politicians' book in the future: put a gun to the head of the bank cashier and let him sign a piece of paper that states that he handed the money over to you 'voluntarily'. Presto, it can no longer be considered a bank robbery. Instead you have arrived at a voluntary agreement with the bank to relieve it of the burden of having so much money lying around.

It is actually unfortunate that the salutary event of a 'total insolvency of Greece' was avoided in favor of more extend and pretend. Given the bailout-induced structure in creditor seniority, a 50% haircut does almost nothing to help Greece after all. A few ruined banks? Worse things have happened and last we looked, the world was still turning anyway.

It also emerged that aside from the 50% Greek haircut, the EFSF has now been boosted to € 1 trillion via the previously discussed leveraging schemes. Observant readers may recall that we first heard such gigantic numbers being thrown around well over a year ago, in May of 2010 (back then the EFSF was declared to come into possession of € 750 billion, a complete fantasy number as it turned out).

Overall the outcome is better than we anticipated one week ago,” [say what?, ed.] Laurent Bilke, global head of inflation strategy at Nomura International Plc in London, said in an interview. “There are several issues left open, but I do believe that getting a more necessary debt relief for Greece is a pretty important step.

Last-ditch talks with bank representatives led to the debt- relief accord, in an effort to quarantine Greece and prevent speculation against Italy and France from ravaging the euro zone and wreaking global economic havoc. Greek Prime Minister George Papandreou will address the nation at 8 p.m. in Athens to outline the summit’s ramifications for the country at the eye of the two-year sovereign debt crisis.

“The world’s attention was on these talks,” German Chancellor Angela Merkel told reporters in Brussels at about 4:15 a.m. “We Europeans showed tonight that we reached the right conclusions.”
“It’s long on words, short on detail,” said Peter Dixon, an economist at Commerzbank AG in London. “The solution that’s been put in place now gives us enough ammunition to stave off any immediate problems but we may well run into other problems down the track.”

We find it interesting that Nomura has a 'global head of inflation strategy'. That sounds like an interesting job, very much in keeping with the Zeitgeist. Otherwise we fear we have to agree with Mr. Dixon – the 'long on words, short on detail' accord has done nothing but buy a little bit more time.

In fact we believe now that the 'Greek haircut' is out of the way, the markets will immediately begin to concentrate on the next default candidate, namely Portugal. There may be far less time before the crisis becomes acute again than the eurocrats think. The belief that Greece can be 'ring-fenced' will soon be put to the test. We believe it will once again turn out that it won't be possible to keep all the plates spinning in the air.

No More Airbuses

In their struggle to prevent recapitalization to become too onerous, the bankers now warn of a credit crunch. Again, this is not at all unreasonable – we believe there already is a credit crunch and it is likely going to get worse.

Alas, the question is actually whether this is good or bad. In the short run a credit crunch means that economic activity will come under pressure. All the false economic activities that could only flourish while more and more fiduciary media were thrown on the loanable funds market will wither and die.

Contrary to the superficial impression the associated economic downturn will create, this is actually a good thing. It will free up resources for economically viable activities that actually generate wealth. Life will in fact become easier for those engaged in genuine wealth creation, as the competition for scarce resources from bubble activities will diminish. Their profit margins should accordingly improve.

Click HERE to read the whole article.

by: Pater Tenebrarum

1 comment:

  1. One thing I have to say about the whole Europe Crisis thing is this: I agree with you wholeheartedly that Europe did not do its homework to keep government bonds safe, and as such, I question the leaders of our countries. We take our governments for granted, we believe they are almost superhuman, but they're not. They make mistakes, they are foolish, and some of them are plain corrupt. If our neighbor or one of our friends went around with that attitude, we wouldn't want to be with them. But for some reason we treat governments and politicians differently. Why? For every bad decision they make, we try to create deniability by trying to find a "but"..."but he did this, but he did that". The system is flawed. And thank god people are noticing now.