Why Euro Countries Won’t Punish Investors, Only Taxpayers

Banks and countries in the shared euro zone (16 countries)have run into difficulties in the credit markets lately.  Greece, Ireland, Portugal and Spain have all had difficulties issuing bonds (getting loans) at what they call ‘reasonable’ rates. Apparently, when lenders think of the governments and banks in these countries as bad credit risks, they ask for more interest.  How awful! 

In response, Greece and then Ireland (with Portugal and perhaps Spain not far behind) have been force to accept bailout measures from the European Central Bank.  These bailout measures punish the governments of these countries for being profligate spenders and poor savers, as well as their banks for lending ridiculous sums around the world and getting into trouble when the loans went bad.  Unfortunately the governments in these countries first bailed out thier own banks using government funds, and then had to be bailed out themselves.

The austerity measures required by the bailouts call for dramatic cuts in social services and increases in taxes.  When you look at the social structure in Greece and Ireland, it’s not hard to see where more taxes might be levied and less benefits provided, but there is something interesting about these austerity measuers – they do nothing to punish the lenders.

If you make a loan to someone and they cannot pay, you might think it likely that you would not get your money back, or at least not all of it.  After all, that’s the risk in lending, right?  The greater the risk , the more interest you might charge the borrower.  This is pretty simple stuff.  The problem is, it gets complicated when the people who lent you money are the large banks in OTHER countries.  Hmmm.  Now it gets murky.

Those at the helm of the ECB – Germany and France – are citizens of countries where banks have a lot at stake.  You see if the people who bought Greek bonds and Irish bonds suffered a loss of any size (say, 10-20% of their investment), then that would mean that the banks in Germany and France, along with many others, would be taking losses, causing their own problems.  The Bank for International Settlements (BIS) released information on exactly what exposure banks had to other banks and governments at the end 0f June (as reported by the WSJ 12/13).  The numbers speak for themselves:

German banks own $65 billion of Greek bonds, $186 billion of Irish bonds, and $216 billion of Spanish bonds.

French banks own $83 billion of Greek debt, and $201 billion of Spanish debt.

The Spaniards have the greatest exposure to Portugal, holding roughly $98 billion of Portuguese debt.

So, if the Irish can only pay back 80% of what they owe, then the German banks take a collective $37 billion loss.  If the Greeks only make good on 80%, then the Germans lose $13 billion and the French lose $16 billion.  You can see how this plays out.  If the weak countries lower the amount they will repay to the banks that lent them all that money, then the banks in stronger countries will take losses.  What is a bank to do? 

Obviously you instruct your bankers at the European Central Bank to create ANY DEAL that does not include write downs of bonds.  This includes printing more euros out of thin air, which is a tax on all euros in existence, and also crushing individual populations like the Greeks and Irish under austerity programs.  The logic of this is sound, even if the justict of it is questionable.  The profits and bonuses earned and paid by these large banks remain in their pockets, but all the risk of their actions is being carried by populations far and wide.

When states such as California, Illinois, and others that are under crushing debt, remember all this.  It will sound depressingly familiar. 

Read more at H. S. Dent