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Waiting for Bastiat: The Curse Mutates to Austerity

Politics / Global Debt Crisis Oct 03, 2011 - 01:31 PM GMT

By: Andrew_Butter


Best Financial Markets Analysis ArticleThe smart-set Claude Frédéric Bastiat called the “sophisticates” are holding their breath, this time waiting for November when there is a glimmer of hope that the plan to make a plan to deal with the Euro-zone banking crisis will distil into a…Plan.

Which is a bit of a turnaround from what the elegant European monetary affairs commissioner Joaquin Almunia pronounced in February 2010…“There is no bailout and no "plan-B" for the Greek economy because there is no risk it will default on its debt”, oh dear, looks like the inevitable is just…inevitable, regardless of what King Canute said.

Almost as much of a classic as Hank Paulson’s declaration on 21 July 2008 “The US Banking System is a Safe and Sound one”…err…up to a point!!

Over the water the Republicans are distancing themselves from any blame for the Charlie Foxtrot and are behaving like thirteen-year old schoolgirls scoring election-candy-points in advance, such is what passes for “government” in the Land of the Free-Lunch. Meanwhile the Fed has finally admitted it ran out of ammo of any practical use with regard to creating jobs or jump-starting the US economy…as if it had any in the first-place outside of the ability to nurture financial bubbles, and those are passé these days.

No one has much confidence that the inevitable is not going to happen; the question now is when and how bad?

I noticed on 30th September ECSI said that a recession in the USA was either here already or on the way soon, echoing my thoughts six-weeks earlier, it’s good to see the sophisticates are finally catching up with the curve-ball.

Meanwhile, what many sophisticates forget in between their Nobel-Prizewinning theories and acronyms, is that the fundamental problem in Europe and also (still) in America, is too much money was lent by private-sector banks to fund private-sector speculative real estate, including but not limited to, private people speculating in private housing.

That’s it, really, trust me…this is a Real Estate crisis like S&L on Speed.

Everything else is incidental. Even the tiny 150 billion Euros of Greek public debt that will probably get vaporized, out of the 350 billion that’s currently stuck in their gullet, caused by them cheating on their GDP numbers and doing dirty-little side-deals with Goldman Sachs to get around Maastricht, is incidental.

By the way, it’s not hard to check GDP from proxies, I do it all the time; you don’t think that the Greeks were the first country to fiddle their National Accounts? If the rating agencies, the regulators and the analysts are saying they didn’t know, they are either lying or they are even stupider than they pretend to be.

Bastiat’s Curse, “The sophisticates focus on what is seen and neglect what is not seen”.

The real hit that will happen if Greece defaults is about exposure of French and German banks to the Greek private sector, much of it real estate related, that’s another 300 billion Euros, and no one is even talking about that. If the Greek Government was smart it should go after the collateral for those loans with crazy-high taxes, then when they foreclose line up as the primary creditor, that would put the cat amongst the pigeons.

The other thing no one is talking about is that the amount of loans handed out by Euro-zone private sector “credit institutions” is 250% of the Euro-zone GDP (i.e. 22 Trillion Euros), just like the amount of loans on the books of FDIC banks in USA plus bonds outstanding, is 250% of GDP ($35 Trillion Dollars), Greece looks like a distraction compared to that, and if they can’t sort out Greece – what can they sort out?

Then there was the bust.

That happened first in USA because structured debt blows up faster than traditional debt and 70% of the private sector loans that had been advanced in USA, had been re-packaged into structured debt (compared to about 10% in Europe: (Source SIFMA)). It’s a lot easier to extend and pretend with traditional debt because you don’t have an independent servicer in the loop with a fiduciary obligation; who is supposed to raise the red-flag when the wheels start falling off.

The first reaction by governments was denial of the scale of the problem, they attempted to muddle-through and treat the disease as a liquidity issue…open up the discount window, slash the base-rate, make brave announcements, “calm the market”; all standard Greenspan-stuff, and then wait for the storm to blow over.

But this time to storm got worse, because the problem wasn’t liquidity; it was solvency, of the speculative real estate borrowers, and their lenders.

Now the price that the collateral can be sold for is a lot less than the loans that were advanced, secured by that collateral, that’s called “underwater”, and if you ever ran a commercial diving company (I have) you will know that things cost ten times more to fix when they are underwater.  It will be a long-time before that changes, it will be even longer if nominal GDP doesn’t tick up, because that’s what drives the price you can sell real estate for.

Hank Paulson and Ben Bernanke “got” that, they acted swiftly, forget about TARP it was the $1.6 trillion TALF program to buy loans collateralized (mainly) by real-estate and put them into cold storage that created the temporary reprieve.

It wasn’t pretty, and amazingly no one really noticed Bernanke was doing that until he had done it (crafty bastard), but it did the trick; up to a point; the ATM’s still work  but the engine of securitization is stalled, and so is the market for the remaining $21 trillion of bonds outstanding;

The Europeans didn’t really “get it” and they still don’t.

It’s easy now to look back and say “how could anyone have been so stupid” not to notice the (monopoly) rating agencies were effectively taking bribes from investment banks to help them  peddling anything from collateralized debt obligation to hyped-up Greek Sovereign debt.

That’s Bastiat’s Curse, the curse of “seeing” the wrong thing, but it’s easy to say that now, but in 2000 when this all started Moody’s & Co were guru-god-sophisticates, now they say “you should have done your own due diligence”.

But that’s just “lawyer-talk” they know and everyone knows that it’s impossible to value a piece of structured debt from the information that was provided to investors back then; which is why the new rules on securitization mandate that more information is provided, although it’s not nearly enough. Remember PPIP, that was Timothy Geithner’s Big Idea, he was going to get Bill Gross of PIMCO to value all the toxic debt, great idea, that guy can’t even do a proper valuation on US Treasuries, let alone something complicated.

And in any case how was a junior analyst supposed to stand up in a room full of suits and say that Moody’s had got it wrong and so had the ECB and EUROSTAT, and that the National Accounts of Greece were in gross violation of the Maastricht Treaty?

The way it worked, the smart guys got hired by the “Relationship Managers” and your job was to pull the wool over the eyes of the self important 24-Year-old economists working for Moody’s on lousy money so that perhaps “someone” might “notice them”…easy meat.

But I know what it feels like to go up against the sophisticates, in 1996 I stood up in a room full of guru-god-sophisticates and suggested (politely) that my boss in Arthur Andersen was taking kickbacks to change the story line I had prepared, and instead of killing the deal he was pushing the client to make an investment. Guess what? Two calls from New York and the “loose-cannon” story, and I got fired (with malice), the $120 million investment was made, and soon after ENRON, the Arthur Andersen’s client lost every single cent of that $120 million. Oh well, he could afford it, and the way it works is you used to get great money putting together deals, but there was no money stopping your client from shooting himself in the foot.

Bastiat’s Curse, what the sophisticates see, is what the sophisticates see.

On top of the money (newly printed and otherwise) that governments lashed out to “save” their banking systems, their revenues went down because the way taxation is designed in Western economies, they take a percentage of nominal GDP, and if that goes down, revenues go down. But the costs were fixed by past election-candy, Big Problem, so now the sophisticates decided there has to be “austerity”.

Suddenly everyone noticed that over-paid and over-pensioned union workers, with monopoly power in both the public sector and the private were a luxury they couldn’t afford. Quite right too, as Margret Thatcher said, “socialism is great until you run out of people to pay for it”, the same applies for crony capitalism.

So “lazy” government workers sucking at the socialist teat, parasites of “free enterprise” are going to get “let-go”, in droves; including by-the way teachers in USA, nurses in UK, and utility workers in Greece.

So let’s get this straight, the sophisticates screwed up gambling on real estate, and so now the “social contract” has to be torn up, and no one is going to collect the garbage?

There is no doubt that the past ten years have seen an explosion of government sponsored waste, from the trillions of dollars America spent imposing their unique brand of “kick-the-can-down-the-road” democracy on Iraq and Afghanistan, to the huge pay increases for doctors in the NHS in UK, to lifetime employment contracts for Greek utility workers, but is that what caused the problem?

Think about it, was this crisis caused because grade-school teachers in USA were paid too much?

A Bastiat schizophrenia has infected the paralyzed sophisticates, the answer for bloated public spending, which has proven to work, is busting the union monopolies and de-regulation; opening up markets to competition; Gerald Ford did that in USA (although the next guy got the credit), Margret Thatcher did it in UK.

And by the way, that doesn’t necessarily mean you have to export all your jobs to China by imposing silly regulations at home and crippling corporate tax, which is a form of double taxation. But then on the other side of the coin, de-regulation caused the problem didn’t it?

Except there is a huge difference between busting unions and de-regulating airlines, telecoms, health care and so on, and de-regulating banks. If you deregulate airlines, that doesn’t mean you allow them to cut their safety standards so they fly their planes into the ground, it means you insist on a level playing field, it’s about breaking up monopolies wherever they are, whether that’s because of unions, or crony capitalists, same difference.

De-regulating banks means promoting competition, that’s different from promoting gambling on safety standards with the risk that the planes fly into the ground; imagine if airlines could buy all-risk-insurance as an option to planned maintenance, so they could “manage” their risk, just like the gamblers can buy credit default swaps to manage theirs?

Yet what’s happened now is a huge new burden of regulation, and a weeding out process that has increased the size and the power of big banks, and decimated small banks.

And the only way out of the hole is economic growth, nominal or “real” it doesn’t matter, except that everyone knows now that does not come from easy-debt. It won’t come from union bashing and slashing public sector employment either, at this juncture, that is disruptive, and doing that properly takes time, plus the best way to persuade public-sector workers to leave the free-teat, is to facilitate the creation of better jobs in the private sector.

In the interim, real estate in Europe is still grossly over-priced, protected by the union of sophisticates who made tons of money riding up the wave. That’s where the money to fix Europe has to come from, in the first instance, the rest can wait.

Real estate caused the problem, real estate has to fix it, open up land for development (the big cause of sky-high real estate prices in Europe), and tax property ownership; plenty of people would prefer to move into a smaller house, or rent, if the option was that or lose their jobs.

That’s the option; suicide–by-austerity is the other option, take your pick.

By Andrew Butter

Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2011 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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