Monday, August 15, 2011

"Nothing is as inevitable as a mistake whose time has come!"

EU-politicians are called upon to prove that the above Tussman’s Law (taken from Murphy’s Law) can be proven false for once!

It seems inevitable that EU-politicians are about to decide either on the issuance of Eurobonds or on a gigantic bond repurchase program on the part of the ECB. Both measures fall into the category of “kicking the can down the road”. The time, indeed, seems to have come for this mistake. It is up to EU-politicians to make it evitable.

Eurobonds would not only lower the interest expense for problem countries, they would also put the full faith and credit of every Euro-taxpayer behind their debt. As a result, a central authority would need to determine the amount of Eurobonds which an individual government can issue. What will EU-politicians do when an individual government needs more cash but the central authority does not permit the issuance of new Eurobonds? They would be in the same situation as they are now.

Repurchasing bonds of problem countries is not the same as the monetary easing on the part of the Fed. The Fed is just printing money when it buys Treasuries but it does not incur credit risk. The ECB is doing both (and it is the credit risk which will bankrupt the ECB and not the printing of money).

Common sense would suggest the following: when things get as bad as they are now in Euroland, one has to cut one's losses, turn the clock back to zero hours and start all over again, this time not making the same mistakes as the first time around. How could this work in practice?

Require the current investors (in whatever legal manner one can do that; in the extreme case allow default) to accept new 30-year bonds as prepayment for current bonds with interest on the new bonds payable at maturity. Then, make a secondary market for these bonds. This would economically be equivalent to a temporary 50% haircut (at least for the next 30 years). Those bonds would probably trade significantly below 50% for the next number of years. Whether they ever gain value again depends on whether the governments make the same mistakes the second time around, or not. To supervise that mistakes are not repeated would be the responsibility of EU-politicians.

Require the investors to mark these bonds to market. New legislation would have to allow the investors to make these write-downs of their bonds over several years (no dividend payment during this time). Investors who cannot absorb these write-downs even during a 10-year period should be liquidated in orderly fashion.

The world-wide financial system would break down in chaos? That should be doubted because all the financial system wants is transparency, and transparency it would get. The governments would quickly make the same mistakes again as they made in Round 1? Possibly, but not certainly. If they did not, these bonds would regain value again until their maturity. They would probably never return to 100% but if they returned to 60-75%, it would already be a master stroke.

Here is one irrefutable argument why one simply must discontinue the policies of the last 2 years: taking the example of Greece, 65 billion EUR have so far been disbursed under the Rescue Plan; allegedly 50 billion EUR (or more) have been invested in Greek bonds by the ECB; and the ECB has lent roughly 100 billion EUR to the Greek banking sector. That makes a total of roughly 215 billion EUR. Just imagine what would have happened if only half of that amount, say roughly 100 billion EUR, had been made available for private sector investments in Greece instead of bailing out the investors?

EU-politicians have to attack the problems at the source and not at the symptoms. If they want to bail out investors, they should do so directly: force them to take losses; replenish their equity if this is necessary and later sell this equity in the market, hopefully at a profit (example of Citigroup).

If they want to help the problem countries, they should use the money to stimulate their private sector economies.

But stop throwing good money after bad!

No comments:

Post a Comment