Flash: European Finances Still Screwed Up

As I predicted, the various highly touted European debt and currency interventions last month did squat.  This is no surprise.  The basic plan currently is to have the ECB give essentially 0% loans to banks with the implied provision that they use the money to buy sovereign debt.  Eventually there are provisions for austerity, but I wrote that I don't think it's possible these will be effective.   It's a bit unclear where this magic money of the ECB is coming from - either they are printing money (which they refuse to own up to because the Germans fear money printing even more than Soviet tanks in the Fulda Gap) or there is some kind of leverage circle-jerk game going where the ECB is effectively leveraging deposits and a few scraps of funding to the moon.

At this point, short of some fiscal austerity which simply is not going to happen, I can't see how the answer is anything but printing and devaluation.  Either the ECB prints, spreading the cost of inflation to all counties on the Euro, or Greece/Spain/Italy exit the Euro and then print for themselves.

The exercise last month, as well as the months before that, are essentially mass hypnosis spectacles, engineered to try to get the markets to forget the underlying fundamentals.  And the amazing part is it sort of works, from two days to two weeks.  It reminds me of nothing so much as the final chapters of Atlas Shrugged where officials do crazy stuff to put off the reckoning even one more day.

Disclosure:  I have never, ever been successful at market timing investments or playing individual stocks, so I generally don't.  But the last few months I have had fun shorting European banks and financial assets on the happy-hypnosis news days and covering once everyone wakes up.  About the only time in my life I have made actual trading profits.

Thought problem:  I wish I understood the incentives facing European banks.  It seems like right now to be almost a reverse cartel, where the cartel holds tightly because there is a large punishment for cheating.  Specifically, any large bank that jumps off the merry-go-round described above likely starts the whole thing collapsing and does in its own balance sheet (along with everyone else's).  The problem is that every day they hang on, the stakes get higher and their balance sheets get stuffed with more of this crap.  Ironically, everyone would have been better getting off a year ago and taking the reckoning then, and certainly everyone would be better taking the hit now rather than later, but no one is willing to jump off.  One added element that makes the game interesting is that the first bank to jump off likely earns the ire of the central bankers, perhaps making that bank the one bank that is not bailed out when everything crashes.  It's a little like the bidding game where the highest bidder wins but the two highest bidders have to pay.  Anyone want to equate this with a defined economics game please do so in the comments.


  1. Jeff:

    The game will continue as long as the perceived political risk is lower than the perceived economic risk.

    What i don't understand is why the banks are playing the game. When it all falls apart, the politicians will blame the bankers. Either way, they lose.

  2. Bart Hall (Kansas, USA):

    "Jumping off" may not be voluntary for some banks. Uni-Credit in particular. UC have monumental exposure to the Hungarian mortgage market because millions of Hungarians thought they could essentially arb their interest rates by borrowing in Euros, primarily from Austria and Italy, meaning Uni-Credit.

    They never factored in their forex risk and like many carry trades it eventually blew up when all those Hungarians converting Forint to Euros drove down the EUR:HUF exchange rate. Hungary responded by increasing interest rates, which not only hurt business and employment, but also encouraged even more people to borrow in Euros. When monthly mortgage payments got to 50 or 60 percent of family income, or the wage-earner was laid off ... people began to default, but we are still in the "extend and pretend" phase, to no small degree because Uni-Credit and the other banks have no legal means to seize their purported collateral in Hungary.

    I have a number of in-laws living in Hungary and I speak the language fairly comfortably. My wife's cousin there has worked in international finance for 20 years but recently left that line of work because she believes it will be a "verfördö" -- a bloodbath.

    As an end-note, Uni-Credit is the modern successor to Kredit-Anstalt, the failure of which in May 1931 is what really triggered the depression in Europe. England was forced to abandon gold within four months. And what caused the failure of KA? Toxic Hungarian mortgages. This time around it's depressingly the same and the failure of Uni-Credit is quite likely to bring down Italian sovereign debt when it goes.

    Hang onto your hats, folks. Our current economic challenges are the result of too much debt, and such balance-sheet adjustments continue until all the bad debt is washed away. All of it. Hungary is only one small piece and we have a very long, dark, bumpy road ahead of us before things improve.

  3. Don:

    Jeff, the political risk is ALWAYS lower than the economic risk, because the populous is economically ignorant and will believe the pols when they blame the banks. Therefore, it will continue until it hits the wall, as it always has.

  4. Russ R.:

    To answer the thought problem, allow me to share the following game-theory demonstration given to my MBA strategy class by the professor:

    She simply auctioned off a $20 bill. Bidding started at $1 and rose in $1 increments. Sounds simple, but there was one important detail... the highest bidder won the $20 bill, but the second highest bidder also had to pay their bid while getting nothing in return.

    Bidding in the auction started normally at $1, and eventually ended at $39. This seems ridiculous, until you consider the immediate incentive facing the second highest bidder.

    Imagine that you've just bid $18 for the $20 bill, and are expecting a quick and easy $2 profit. Then somebody else bids $19. Your $2 profit will become an $18 loss, so it would appear that your best choice is to bid $20, to turn an $18 loss into a break-even exit.

    The problem is, the guy who bid $19 will then conclude that his best move is to bid $21, since a $1 loss is better than a $19 dollar loss, and so on...

    The only winning strategy is to not play.

  5. Ted Rado:

    The continual paper shuffling as a means of dealing with the debt crisis is idiotic. The problem will not go away until expenditures sre less than income. All the clever financial Titanic-deck-chair-rearranging schemes do nothing but obfuscate and simply put off the day of reckoning.

    It seems we have reached the point where the austerity required to deal with the debt will reduce the economic activity, and hence government revenue, and make things even worse instead of better. The Greeks are in this situation already.

    My father used to say "it is easier to stay out of trouble than to get out of trouble". How true!

  6. Benjamin Cole:

    Market Monetarism is the solution to European and USA economic woes.

    Theo-monetarism, as practiced, is resulting in recessionary deflations, and a Japan-like economy.

    Japan has an extremely strong yen. japan has had 15 percent deflation in the last 20 years. Japan's manufacturing output has fallen 20 percent in that time period, while stock and equity markets cratered by 80 percent. You call that theo-monetarism. A faith that tight money works, despite abundant empirical evidence to the contrary.

  7. Brian:

    "It’s a bit unclear where this magic money of the ECB is coming from – either they are printing money (which they refuse to own up to because the Germans fear money printing even more than Soviet tanks in the Fulda Gap) or there is some kind of leverage circle-jerk game going where the ECB is effectively leveraging deposits and a few scraps of funding to the moon."

    I think a fair portion of the money is being "borrowed" from the Federal Reserve.