Sunday, 15 February 2015

So this is a private debt crisis after all

 The return of the Greek crisis and its revelations

They want you to believe it’s all about public debt. Reckless spending by governments has caused a ballooning of debt, which can only be addressed, painful though it is, by years of austerity, and the drive to be more ‘competitive’. So the mainstream debate is confined to arguing whether national debt and deficits are being shrunk sufficiently. And if it turns out they aren’t, the logical conclusion is that austerity is not being applied with enough vigour. The condensed version of this argument is ‘this doesn’t work, so let’s have more of it’.

But the return of the Greek debt crisis has punctured a giant hole in this masochistic ideological construct. Because, contrary to the official narrative, Greece wasn’t bailed out at all; its creditors were.  Analysis reveals that around 89% of the bailout money has gone to creditors:

This is masked by the fact that, as a result of the 2012 restructure, Greek debt was transferred from the private sector to the EU/IMF/ECB Troika. So the debt crisis can now be presented as a generous bail-out by prudent, efficient Northern European countries to profligate, lazy Southern Europeans. This picture, eagerly lapped up by the mainstream media, such as the BBC, conspicuously omits the most important players.

So, in the interests of accuracy, they should be reinstated. Europe has followed the path trodden by the US, in that the private debt of highly leveraged (in plain language indebted), financial institutions has been transformed into the public debt of states. With the caveat that the indebtedness of European banks - and that includes the UK - is actually much higher. According to Mark Blyth, author of Austerity: The History of a Dangerous Idea, in 2008 the combined assets of the top six US banks came to 61% of US GDP. That’s about 10% of GDP per bank. When they fail you have a huge problem.

But in Europe, the situation was way more extreme. “In the same year,” he writes, “the top three French banks had a combined asset footprint of 316% of French GDP. “The top two German banks had assets equal to 114% of German GDP. In 2011, these figures were 245% and 117% respectively. Deutsche Bank alone had an asset footprint of over 80% of German GDP and runs an operational leverage of around 40 to 1. This means a mere 3% turn against its assets impairs its whole balance sheet and potentially imperils the German sovereign. One Dutch bank, ING, has an asset footprint that is 211% of its sovereign’s GDP … The top four UK banks have a combined asset footprint of 394% of UK GDP”.

If you’re seeking an example of profligacy and rash borrowing, here it is. And it’s not Greek coloured.

What happened, in a nutshell, was that these supposedly more conservative European banks borrowed like crazy to profit from the government debt of countries such as Greece, Spain and Portugal. Chronically overleveraged, when their investments in US mortgage-backed securities turned ugly in 2008, they swiftly became insolvent. In the words of Stephanie Kretz, private banking investment strategist with Swiss bank Lombard Odier, in 2012, “Germany, by lending money to the peripheral countries, is trying to prevent its fragile and leveraged banks from getting hit, effectively orchestrating a back-door recapitalisation of its own banking system.”

The result has been what I have described as a peculiarly one-eyed version of austerity. The penance of paying back debt is only applied to states, and states that have become indebted as a direct consequence of taking on private sector debt. Banks are not permitted to fail, or take responsibility for their bad debts. In contrast to the liquidationism of 1930s’ austerity, in which the insolvent firms were allowed to go to the wall, we have now the mirror opposite:  preservationism. None of the rottenness has been purged from the system, as early 1930s US Treasury secretary Andrew Mellon, advocated. Instead, it has become someone else’s problem. Namely, ours.

The official attitude towards state and private debt diverges wildly. The EU’s newly minted fiscal compact requires that the government’s deficit not exceed 3% of GDP.  Basel III, meanwhile, the rules governing banks’ capital reserve requirements, rewritten after the financial crisis because Basel II was retrospectively considered too lax, insists on a leverage ratio of 33:1. Lehman Brothers, whose collapse triggered the financial crisis, had a leverage ratio of 31:1. One law for public debt, quite another if it happens to be private.

It has fallen to faint and isolated voices to point out the real story of what happened; how the nationalisation of private debt led to huge problems for public finances. “A crisis of private finance, emerging in the financial system itself, was not ended but transformed into a burden for public finance,” says James Meadway, senior economist with the New Economics Foundation, “and through austerity, the immense cost of the transformation is now imposing itself on society.”

But the underlying problem is not solved by pointing out the evasiveness of the official account. However well-camouflaged, the crisis of private finance has clearly not been ended. The transformation of austerity, in this sense, hasn’t worked. It hasn’t erased private debts. “After the 2008 financial crisis and the longest and deepest global recession since World War II, it was widely expected that the world’s economies would deleverage,” says a February 2015 report by the consultants McKinsey. “It has not happened. Instead, debt continues to grow in nearly all countries, in both absolute terms and relative to GDP.” In Britain, total debt (of which government debt is a relatively small part) was 484% of GDP at the end of 2013, down from 507% in 2011, but still way above the 310% level it stood at in 2000.

The question is, does it matter? Austerity-mongers like George Osborne obsess endlessly about the evils of public debt, even as it continually rises, whilst managing not to mention private debt at all. If you reverse that attitude, do you not become an equally warped private sector austerian? However, there are sound reasons why private debt is a genuinely pressing issue. For a start it’s much larger than public debt. Secondly, many economists believe that beyond a certain level, which we’ve certainly exceeded, private debt makes a new financial crisis all but inevitable. Thirdly, it constrains economic growth and causes stagnating or declining real wages; problems that only exacerbate the original problem. Lastly, even without the assistance of austerity, private debt causes public debt to rise.

It is said that the overhang of private debt will cause a Japanese style ‘lost decade’, in which economic growth remains low, people are starved of economic opportunities and real wages fall. But, in truth, Japan, the most privately indebted country on earth, has suffered a ‘lost two decades’, and the Japanese government’s recent return to massive Quantitative Easing in an attempt to stimulate the economy indicates that, a quarter of a century on, the so-called lost decade is still not over.

One country, famously, did let its banks take responsibility for their bad debts and collapse. In 2008, Iceland decided to let its three biggest banks, with combined assets ten times the country’s GDP, fail. It is now thriving, advocates say. But the banks in question had almost exclusively “off border” debt, and Iceland’s domestic banking largely went on uninterrupted. In the monetary union of the Eurozone, bank debt is decidedly domestic, and much larger. Moreover, it is not just financial institutions who are indebted. Non-financial corporations, which pioneered the process of ‘disintermediation’ – lending between themselves and bypassing the banks, are also hugely indebted. Consumers may have paid down some of their debts in the aftermath of the financial crisis, but they are now rising again.

Recognising that austerity is, in the words of Mark Blyth, ‘the greatest bait and switch operation in modern history’, does not change the fact that we have an economy that exists on private debt. Writing down that debt will not be a painless process. Indeed it could cause a deep depression. But not dealing with the problem is far from painless either, and the pain that results seems to have no end in sight.