Bailouts + Downgrades = Austerity and Pain
Tuesday, January 17, 2012 at 5:07PM The markets (read: traders with big books at mega financial firms and hedge funds) weren’t particularly shocked by last week’s wave of heavily pre-broadcast S&P sovereign debt downgrades. For months, the question wasn’t ‘if’, but ‘when.’ True to form, just as with the US downgrade, S&P’s reasons skated the surface of prevailing wisdom – governments have too much debt, and not enough income. That’s only a fraction of the story.
Nowadays, when any sovereign (including the US) gets downgraded by a rating agency, it's not just because its debt repayment ability is questionable (the publicized logic of rating agencies), but because it incurred more expensive debt to float its banking system. It chose to subsidize banks over people.
The S&P likes moving on Friday nights. It was on a Friday night that it downgraded US debt to AA+ from AAA. On Friday night, January 13, 2012, it downgraded France and Austria from AAA to AA+, and 7 other European countries, too; Cyprus, Italy, Portugal, and Spain by two notches; Malta, Slovakia, and Slovenia, by one notch. Portugal, Cyprus, Ireland and Greece are at junk status. Germany’s AAA rating is intact.
Nowhere in S&P’s statement about “global economic and financial crisis”, did it clarify that sovereigns were hit due to backing their largest national banks (and international, US ones) which engaged in half a decade of leveraged speculation. But here’s how it worked:
1) Big banks funneled speculative capital, and their own, into local areas, using real estate and other collateral as fodder for securitized deals with derivative touches. 2) They lost money on these bets, and on the borrowing incurred to leverage them. 3) The losses ate their capital. 4) The capital markets soured against them in mutual bank distrust so they couldn’t raise more money to cover their bets as before. 5) So, their borrowing costs rose which made it more difficult for them to back their bets or purchase their own government’s debt. 6) This decreased demand for government debt, which drove up the cost of that debt, which transformed into additional country expenses. 7) Countries had to turn to bailouts to keep banks happy and plush with enough capital. 8) In return for bailouts and cheap lending, governments sacrificed citizens. 9) As citizens lost jobs and countries lost assets to subsidize the international speculation wave, their economies weakened further. 10) S&P (and every political leader) downplayed this chain of events.
The United States
On Aug. 5, 2011, S&P downgraded US government debt to 'AA+'. This was four days after Congress voted to raise the US debt cap - to prevent a downgrade - proceeded by political squabbling and the US Treasury and Fed begging Congress to raise the debt cap. S&P, beacon of stamp-any-toxic-asset-AAA, accountability, claimed, “American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.” In other words, too much debt, too little income.
According to the US Treasury, the main reason for the debt increase was a stalling economy – lack of enough incoming tax receipts to pay US expenses, (which include interest payments on growing debt.) That’s not true. Tax receipts dropped $400 billion to $2.1 trillion in 2009 vs. 2008. Expenditures jumped to $3.5 trillion in 2009 from $3 trillion in 2008. Treasury debt ballooned by nearly $4 trillion from 2008 through 2010.
Where’s the money? About $1.6 trillion lies on the Fed’s books as excess reserves which banks - dealers for sovereign debt - put there. Nearly a trillion dollars went to backing Fannie Mae, Freddie Mac - which enabled banks to artificially overvalue related securities, and extra interest payments. There was $700 billion in TARP, which though mostly repaid, never manifested into debt reduction, and hundreds of billions of dollars of asset guarantees underlying big bank mergers. So, 75% of the extra debt went to saving banks. S&P didn’t mention this. The policy repeated across the Atlantic.
Ireland
The Irish government’s pain started when it guaranteed the bonds of Anglo-Irish bank in September 2008. By May, 2010, Central Bank head, Patrick Honohan, assured the world that he’d have ‘two big banks, fixed by the end of the year.’ Upon that endorsement, the government backed bondholders on the banks’ behalf. The economy deteriorated.
Six months later, nobody would lend to Irish banks. Irish austerity promises didn’t change the fact that Irish banks weren’t big enough to contain their waste. By November, 2010, banks paid for $60 billion Euro of maturing bonds with emergency ECB loans, and the ECB became the backbone for the Irish bank guarantee scheme, whose participants included Ireland’s big financial firms: Irish Life & Permanent p.l.c., Bank of Ireland, Allied Irish Bank p.l.c., Anglo Irish Bank Corporation Limited, and Irish Nationwide Building Society. Irish Government Debt doubled from 65.3 billion Euro to 118 billion Euro since 2009.
The ECB deemed the bailout a success. Yet, by the summer of 2011, Ireland was downgraded to a notch above junk and households (and foreigners) accelerated extracting money from Irish banks, weakening the banks’ funding base further. The Irish government now owes 110 billion Euros to the banks, the National Asset Management Agency (NAMA, aka “bad bank”) the EU, ECB and IMF, with no way to repay it.
Spain
According to a recent Business Week article, Spanish banks hold 30 billion Euros ($41 billion) of “unsellable” real estate loans. Just like in the US where smaller banks got hit hardest, small and mid-sized Spanish banks did too. In addition, about 308 billion Euros worth of Spanish loans are ‘troubled.’ Home prices in Spain are off 28% from their April, 2007 peak, with land values in the outskirts of urban areas, down by as much as 75%.
In economic desperation, the public elected conservative party leader, Mariano Rajoy, as Prime Minister in the end of 2011 who promised to lead Spain to economic recovery, by invoking austerity measures in return for backing to help the biggest Spanish banks.
Meanwhile, the top six Spanish banks sit on $33 billion of foreclosed assets having set aside 105 billion Euros in write-downs against bad loans since 2008, with another 60 billion Euros to come. The backdrop is a 23% unemployment rate, triple its 7.9% May, 2009 level. Property transactions continue to decline. Foreclosures keep ramping up. The gap between what banks want to sell foreclosed or troubled property at, and what investors are wiling to pay continues to widen, forcing more small and mid-size banks to buckle under larger than anticipated losses, which in turn squeezes liquidity out of local usage.
Greece
According to an SEC report from the National Bank of Greece (NBR) for the year ending 2010 – loans to businesses and households were expected to “remain under considerable pressure…[due to] “downward pressure on household disposable incomes and firms’ profitability from the austerity measures… are likely to impair further demand for loans.” They weren’t kidding. In order for the NCB (or any bank) to reduce its dependency on ECB funding, it has to reduce loans to its own economy.
The ECB agreed to accept worse collateral (with junk ratings), including bank issued bonds with Greek government guarantees (under a May, 2010 rule change for all member countries). The ECB bought Greek (and other) government bonds in the secondary markets, to support their value and thus, their value as loan collateral. As with the Fed’s QE measures, Euro-style – this only perpetuates a fantasy of demand.
After four rounds of austerity measures, nationwide protests, 110 billion Euros in IMF and ECB bailouts to keep bondholders (and banks) happy, escalating interest rates driving borrowing costs higher, a downgrade to junk, and a Prime Minister swap; Greece remains in tatters with more pain to come.
Italy and Portugal
Last summer, S&P warned it would downgrade Portugal if it didn’t play ball with the IMF and EU over a 78 billion Euro bailout. So Portugal towed the austerity line. Its economy deteriorated. S&P downgraded it to junk status.
The IMF and EU declared that Italy too, needed ‘structural reform’, meaning public austerity and privatization. National assets went up for fire-sale, as they did in Spain and Portugal, to the highest international bidder. Now, the high borrowing costs the government faces as a result of bolstering the banking system, paying bondholders and selling infrastructure, has resulted in more downgrades and dim prospects.
According to the Italian Central Bank, 500 Italian cities are facing losses on derivatives contracts. JPM Chase and Banco IMI are accepting Italian government bonds as collateral, rather than less risky US Treasuries or cash, certain that the ECB will step in to buy, and thus prop up, Italian bonds if needed, as they did in August, 2011.
As Greece showed, using high-cost sovereign debt as collateral leads to more bailouts to ensure big lenders get their money back. JPM Chase, having weathered the US subprime crisis with support from the US Fed, isn’t about to lose on that bet. Meanwhile, several Italian towns, the City of Milan and the Tuscan region, are suing the big American, German, Swiss and French banks over derivative losses and misleading asset purchases, who will likely get bailout money anyway.
Bailout Economics Doesn’t Work
ECB bailout money didn’t (and won’t) go towards helping any European country’s local economy, any more than it went to aiding the mainstream US economy. The ECB and IMF, at the Fed, US Treasury and US administration’s urging, camouflaged the insolvency of European banks, perpetuating losses with bailouts, and forcing cowardly governments to support them, while turning a blind eye to boosting core economies.
Meanwhile, banks with access to the ECB’s ‘window’ are taking the money and immediately putting it back into the ECB as reserves. Overnight deposits at the ECB continue to break records, currently hovering around 500 billion Euro ($640 billion). As in the US, European banks aren’t using that liquidity to help fix local economies, but hoarding it to preserve themselves. The amount on reserve is 98% of the total made available in emergency 3-year loans in late December at 1% interest; banks get 0.25%, which means they are paying 0.75% interest for the loans, far less than the market would charge them.
The die has been cast. Central entities like the Fed, ECB, and IMF perpetuate strategies that further undermine economies, through emergency loan facilities and bailouts, with rating agency downgrades spurring them on. Governments attempt to raise money at harsher terms PLUS repay the bailouts that caused those terms to be higher. Banks hoard cheap money which doesn’t help populations, exacerbating the damaging economic effects. Unfortunately, this won't end any time soon.
Reader Comments (14)
Isn't this entire deal about Banksters pushing debt on sovereign countries so Banksters can steal the gold and high quality assets owned by debtor countries and the people. Hopefully the loans will be nullified and the collateral returned to the borrowing country and their people. Horse thieves were hung. IMO, what the Banksters' are doing to countries and their citizens is to the nth degree worse than stealing horses.
Hey Nomi good post and great details.Dont know where and how you leave regulators in USA(FASB) off the hook which allow banks to mark to nonmarket fantasy accounting) as well as european and english equivalent regulators?!Also fraud with rehypothecation/leverage not monitored in equity,real estate and bond markets.Note same old same old as with AIG and other derelict financial entities in2006,7 and 8)Sure glad Dodd-frank is working and SEC and CFTC doing their part also.
One of the best books i ever read...The Creature of Jekyll Island by G. Edward Griffin i believe describes the oligarchs secret sauce.Fiat money,debt enslavement,.too big to fail,bailout...rinse repeat and if that dont work go to war.Hmm seems like the same script,eh?
Fantastic post. As always, great insight, thanks Nomi.
We need more of you out here. I will circulate this
Randy, banks have been involved in extracting local assets from the weaker countries, it doesn't hit the news as much, but entire companies - financial and infrastructure - have been sold to international investors, funds, banks, conglomerates at rock-bottom prices, so those countries can raise money to pay their higher-cost debt - which is then pushed higher, because they've sold pieces of themselves at lower prices. It's a nightmare.
David C - I don't leave them off the hook at all - see my most recent MF Global piece - I'm just not always good an - 'multi-tasking' all the culprits into each piece, so different thoughts focus on different culprits - but, yes - regulators, central entities, politicians, banks, leveraged funds, rating agencies- all the gate-keepers of financial and economic policy have a role in this.
David - thanks!
Can't we figure out exactly what the Banksters are doing by looking at the Debt Limit and the amount of interest paid in the budget? Doesn't the Debt Limit represent the amount of money the USA owes the FED and the amount of interest in the budget what the USA pays the FED? If correct, shouldn't the USA default on the debt to the FED and in one fell swoop get rid of our debt and the interest we pay on it?
Anyone who wants to know what is going to happen to the EU should Google "Kyle Bass Hard Talk" and watch parts 1 and 2 of that interview.
Thanks for the link. Kinda weird. Been wondering what Richard Rainwater is up. We did the math. Yeah, bet they did. His daughter did a tribute from his Stanford classmates. The foundation of RR's pyramid goes back to math at the University of Texas.
Sorry Nomi not to be one of your admirers: this article is poor and uninformed. As an example to say that , "the high borrowing costs the (italian) government faces as a result of bolstering the banking system" is completely wrong. Italian banks were little impacted by the 2008 crisis because for the good and for the bad they were very little exposed internationally (with the exception of Unicredit in Germany).
On the contrary, in Europe (maybe with the exception of Ireland) banks are in trouble because of their profligate government who have been wasting money for decades suiciding themselves out of ever increasing taxes.
And to spur the banks to buy the flooding flow of their bonds, governments have made sure that their bonds would be considered risk free (even today)! so as to not eat up the scarce bank capital!.
As a result today european banks are drowning under the deluge of their government bonds.
This type of article is what people want to read or hear today so it is what journalists are serving even if the true picture has to be shown upside down. It is an article like so many articles today and political speeches that blows on the fire of populism because people need a scapegoat in these difficult times and these well paid banksters are a convenient target.
NB: I am not working in a bank.
Nomi,
Another erudite and eloquent piece, thank you (I notice this is posted on ZeroHedge as well).
Whilst I don't condone the FASB, my understanding is that Congress TOLD FASB to change its accounting rules in 2008 to permit marking-to-fiction (sorry, model) as opposed to market, and that if the FASB didn't, then Congress would change the law. Last year the FASB went to Congress and said 'OK, if we're on the road to recovery can we change the rules back?' only to be told no. So, basically FASB was over a barrel.
I always look forward to your posts Nomi, keep them coming - enjoyed your piece on Max Keiser's show last week as well!
DavidC
Brilliant post, Nomi Prins, brilliant blog post!
And in that FCIC report, handed over to President Obama (the very same president who has falsely publicly proclaimed that the banksters broke no laws) was plenty of ammunition to go after them, plus those three rating agencies (especially S&P).
Clayton Holdings.....Vicki Beal......all in that report and most damning against the rating agencies and should have already led to arrests??
Obviously, as the Canadian social economist, R.T. Naylor said, the problem in America isn't individual corruption, the problem is the entire system is absolutely corrupt! (My paraphrasing)
And it was interesting that Mitt Romney stated on Jan. 19th that he believes Adam Smith (Wealth of Nations) was right.
“I think Adam Smith was right.”
--- Mitt Romney, Jan. 19, 2012
Adam Smith was against speculation.
Adam Smith was against the inequitable distribution of income and ownership.
Adam Smith was against trade secrets and patent monopolies (referred to as intellectual property today).
Adam Smith was against foreign investment (and by extension, he would have been aghast at the massive jobs offshoring over the past forty years in America).
Adam Smith was against every action Romney took to increase his vast wealth; the destruction of companies and jobs, the increasing of the national debt and the destruction of the national tax base by fictitious tax avoidance.
Clearly, Adam Smith would not think Mitt Romney was right!
Clear, well written and easy to understand for more economy journalists I think. The bigger crux of the story though is why the mainstream media in Europe absolutely refuses to print/publish/host any information that goes contrary to the accepted official story? Reading European media these days (and as a European I have quite the smorgosbord of TV-stations and newspapers to chose from) is like watching a boxing match with only one boxer. All media contrary to the official story gets labeled to be in the tin foil camp. Take the story of Assange hosting a show for RT for example, every single European major news media ran this but in almost every sentence they made sure to point out that RT was Kremlin sponsored. It got to the point where it became difficult to read.
Ms. Prins, what is your experience of getting exposure in mainstream media, especially in mainstream European media with your contrarian viewpoints?
I think everyday, the mainstream media tends to focus on one version of the story with even more intensity for the bigger picture stuff. I think that's ultimately to its own detriment, because people will find other sources of information from with to draw their own conclusions or fill in questions they have.
Also, I've done a number of mainstream media shows (see www.nomiprins.com/media) as well, but the format is of very short segments, generally interspersed amongst several people, so there's literally no time by design to expand on any point. If you have a host + 3, sometimes 4, others on a 5 minute segment, you're talking maybe a minute per person - not really enough time to delve into anything, especially that differs from a more commonly accepted view - you'd have to split your minute - which is divided into 30 seconds for two segments within the minute - into discussing the topic at hand and dispelling the commonly accepted view, and somewhat saying why if you want to be cognizant of teaching viewers something (which I try to do). it's tough maneuver. throw in certain show formats where you're expected to 'argue' with opposing points and talk over each other - and it's near impossible.
Hi Nomi,
Great articles, you are among the few that either sees the truth or is willing to admit it.
There is so much hope and little denial of the real state of our economy & the EU.
It seems like the Fed, Obama and many economists are waiting , hoping for a miracle. In the late 1990's we had the Internet bubble, mid 2000's housing bubble. And now we have the Uncle Ben's bubble.
Fortunately the last two bubbles created jobs (not lasting). All we hear lately from almost everyone is we need to create jobs over & over again, with no plan. The reality is the only time we had unemployment under 6% in the last 15 years was during the last 2 bubbles so why do most believe we can get back to those levels. Mathematically it does not add up. In the last several years the USA has been losing jobs to the East and in parallel our population has grown, simple math.
Anyway I think you are dead on with your analyses of the real state of our economy, the EU & the change that is needed and Obama's BS, promising & just repeating himself with no action for 3 years.
I'm not sure if you have been on Charlie Rose but it would be a great place to have your knowledge expressed. And Rick Santelli would be a great side kick. I believe he shares the same point of view almost to the T.
Again great articles and interviews.
Thanls,,,,,,,,,,,,Danny
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