The European Union’s $1 trillion rescue plan will reassure financial markets for a while.
But at some point the bond markets are going to ask “So how are they going to pay for this?”
In the coming days you’re going to hear lots of comparisons between this $1 trillion plan and the $700 billion rescue package that the U.S. government put together to stabilizer the U.S. financial system after Lehman Brothers collapsed and American International Group threatened to head down the same path.
But there is one critical difference. The U.S. bailout transferred risk from the balance sheets of private companies to the balance sheet of such public entities as the Federal Reserve and the U.S. Treasury. The ultimate backstop, of course, was the U.S. taxpayer.
The European Union rescue transfers risk from public balance sheets at fiscally challenged periphery countries such as Greece, Portugal, and Spain to public balance sheets for the European Union as a whole.
In some ways this reminds me of the financial engineering Wall Street practiced during the subprime mortgage boom.
If you took enough risky debt, Wall Street argued, and packaged it all together you would reduce the risk of the whole deal. Not risky assets would go down at the same time.
Well, that turned out to be wrong.
And I have to wonder if the idea of packaging the risky debt of Portugal, Greece, Spain, Italy, and Ireland all together will ultimately work any better.
The final backstop for this rescue is composed of the taxpayers of France and Germany. They are the countries that have pledged the most to the rescue. They are the strongest economies of the European Union. And they’re really the only countries that might conceivably have the resources to actually pay off on the guarantees of this package.
But France and Germany aren’t exactly swimming in cash. The French budget deficit hit 7.5% in 2009 Public debt climbed to 78% of GDP in 2009. That’s up from 68% in 2008. In March Insee, the French national statistic office, projected that debt levels will rise again in 2010, hitting 83% of GDP. Debt levels, Insee calculates, won’t begin to fall until 2013 from a level of 87% reached in 2012.
That leaves the German taxpayer to carry a huge share of the burden. And it’s pretty clear that even if the German economy, the strongest in the Euro zone, could, the German taxpayer isn’t in a mood to pony up.
Over the weekend, voters in the German state of North Rhine-Westphalia dealt a stunning defeat to the Christian Democrats and their leader Chancellor Angela Merkel. The vote cost the Christian Democrats their majority in the upper house of the German legislature. Politicians in Germany pin the defeat on voter anger over the bailout package for Greece. The state is part of the historical industrial heartland of Germany and has been hard hit by the decline of German industries such as steel.
With that as a first indicator, I wouldn’t say that the leaders of the European Union can count on German taxpayers to go along with rescuing the rest of the troubled economies of Europe.
In other words, I think that today’s package will produce relief in global financial markets and will buy time for the European Union to work on a solution, but I don’t think it marks the end of this crisis.
And it would behoove the United States and other deficit nations to use the time to put together their own plans for a return to fiscal responsibility.
Think that’s likely?
Where does this $1T bailout come from? Printing machine! Like uncle Sam, EU owns one too, doesn’t it? They are going to inflate their way out. US banks will be paid by devalued Euro.
Jim,
I am regular follower of your posts. You have unique way of making us understand complexities of the financial markets.
Isn’t this crisis exacerbated by these bets that traders place on chances of greece soverign debt defaulting and then cost of ensuring these bets going through the roof..in effect greece cannot borrow money at all.
These unregulated bets can bring any entity to the point of brankruptcy
Jim,
Nice post! I was thinking about the same thing all day. My lucky guess is that for now (make it till July 4) nobody cares about those tiny details. Everyone is exhausted and is getting ready for the Summer (in Europe summer vacation is much-much longer). So, until Europeans start coming from their vacations, where they will have plenty of time to think about it, we are somewhat safe.
However, I put sale orders for all my positions. I hope I can ride this wave and cash on it.
@OffTheBeatenPath
To clarify, I was speaking of Citi Group, BofA, etc.
My opinion is both GM bondholders and the unions were given a TARP beating. Together they could have owned 100 per cent of a debt free company, but instead big brother got the majority equity while the bondholders’ claims were usurped. Union and pensioner democratic support is quite ironic here.
And careful, Christopher, the fringe Euro-Socialism Apologists are going to come out of the wood works now. They’re as bad on here as their opposite, the Reptilian Freemason Illuminati Alex Jones fanatics. It’d be pure comedy to lock these fanatical socialists into a room with David Icke. The incoherent ramblings would never end.
Sigli good comment.
In a system that they touted as a free market, the US companies first postioned themselves so they were the keystones of the financial system. They then engaged in high risk behavior to reap huge profits from the public. When the cards eventually fell, they had the US taxpayers by the cojones. If the the taxpayers let them fail, the way free markets are suppose to work to eliminate dysfunctional companies, their bankrupcy would bring down the whole system along with them and the taxpayers would suffer ten fold. So the government(taxpayers) paid up with rescue funds. But to add insult to injury the management of the companies paid themselves multi million dollar bonuses for being so “smart”.
As you point out, the holders of Greek bonds knew the risks of the bonds and were being paid a high interest rate for it. There was no guarantee that there would be no default. Now that the EU/ECB/IMF seem to be guaranteeing the bonds, logic would say that they should go back to AAA with less interest payment to drag down the country’s economy.
My fantasy solution to the problem: Use the money to back say BMW to build a hybrid plant in Athens; Du Barry (fantasy French lingerie corp/competitor of Victoria’s Secret) plant in Madrid; Wienerwurst (fantasy Wiener schnitzel corp.) plant in Evora, Portugal; etc. each creating 300,000 jobs for the people in those countries. This might be a step toward allowing them to grow out of their problems. I know. It is a fantasy.
@sigli
I think the former GM bondholders would disagree with you. Guess they were on the wrong side of those “bought and paid for” politicians. Hard to get a leg up on the unions in that regard.
NB and sigli,
I would add that do you really want your government deciding who should be propped up? The government was basically deciding who should fail and who shouldn’t. Where is the free market in that, which is suppose to give us good businesses instead of lousy ones run by a government?
@sigli – thanks for the explanation. agree.
can we assume that the USD will go higher, with a ( debt lead ) decline in the Euro, thus negating a need to drive up interest rates in USA, and that means more easy money flowing into the stock market.
do we think this was a multi-day/week pop or a sell while you can pop? i am 50% cash/stocks at this point.
@NB
First off, TARP has not been paid back. Some companies made US taxpayers whole, with interest, others have not and some likely never will. GM lied in their commercials. They paid back “loans” but not the equity side. Same with BofA. Will AIG ever repay $200 billion?
The 2 main arguments against bailouts is 1) you are rewarding bad investment, and 2) they’re completely unnecessary. We have a system that’s taken care of the problem for a couple hundred years, but now, bondholders and their bought and paid for politicians think they deserve 100 cents on the dollar for making terrible decisions. Do you want to spend your hard earned money to make sure the bondholders are paid in full? They could have taken a 20 % cut and a couple points in lower interest and the problem would have went away already. But they’re too greedy to take a loss, especially when the common taxpayer is around to bailout the million/billionaires.
Jim’s post reminded me of a recent podcast that I listened to from Rick Steves on traveling through Bavaria. One of the things that was discussed was the reunification of Germany. The German that was participating mentioned that they are still paying off their “reunification tax” which helped try and bring the east up to the west’s standards by dumping in money for infrastructure, etc. If they are still paying for reunification, I can see how paying for Greece could be a deal-breaker.
$ 1 trillion , $2 trillion, $3 trillion, 4
What’s next… I’ll tell you… Spanish riots, then German riots, then where else.. who knows…
This seems temporary to me since everyone is talking about where the money is coming from to pay for this…
Seems ironic that after WW1 and WW2 that we all are relying on the Germans to get the EU out of this mess….
Great post. I’ve been saying similar for a while now.
In the USA, we DIDN’T have the large government participation going INTO this crisis so THAT bullet was ready to fire with TARP, Stimulus, etc. In Europe the government role and debt was ALREADY LARGE, they are essentially going back to the SAME well. They don’t have ANYWHERE else to go at this point. I think that Europe has averted the CRISIS, but has guaranteed a new RECESSION in Europe at least.
I don’t mean to be political, but the bleek picture painted in this post spelled out the nature of France and Germany’s socialism which some consider as ROLE MODEL! It turned out that the generous French and German social benefits (pensions, health care, etc.) are sand castles built on borrowed money that are 70 or 80% of their GDP! And these are the BEST of European socialism.
The bills are finally due. Let’s not even mention the long-term decline these two BEST European countries are facing in today’s world. France’s unemloyment is said has been 20% for years. It’s only matter of time before these two become the next PIIGS. This is what happens when countries spend=promise more than they have.
As a a former New Yorker and part business owner in the NRW:
The NRW (North Rhine-Westphalia) traditionally votes for the SPD (which is little like the democrats (pro labor) if compared to the US but more socialist). The CDU (Merkel’s party – a little like the Republicans – e.g. pro big business) has traditionally done badly in the NRW. That they did well the last time around was more a vote against their favored SPD party for having moved to the right. The smaller more left parties were the big winners in the current election. It was not so much against a Greece bailout (as the SPD has attacked the CDO for not doing enough or quickly enough).
The NRW is not a downtrodden area but one of the most prosperous in Germany.
The few big German companies have a great deal of political power in Germany and are happy to have these countries that need propping up as customers for there big ticket products and were largely behind the Euro creation. But these countries also unlike in the US are not states and Germans do not identify with them.
Jim, so do we sell and get back to cash? No time to be wish-washy, what’s your call?
Dear All,
this decision has been taken only to buy time and allow, the European bank system, (German and French in particular) to recapitalize in order to withstand, later, the beating. This is at least my humble opinion. If (and that is a big IF) the periphery of Europe will repay the money will repay eventually with a devaluated Euro.
Off topic: Droid market share passes iPhone (as I would call it, the power of VZ):
http://www.marketwatch.com/story/android-market-share-passes-iphones-npd-data-2010-05-10
Great analogy to the structured debt products. This certainly cannot end well. I believe you are correct, there is no history of political will toward fiscal responsibility. Contrary to populist sentiment, politicians and voters alike are perfectly content to leave payments for the future, convinced that their children will somehow be protected from rough times by magic. It’s going to be an interesting Summer!
Question for this forum (and pardon my ignorance if this is a stupid q).
When the TARP and other bailouts were implemented, my understanding was that they were sort of “loans” and “guarantees” to the creditors of the troubled institutions. Now that their balance sheets are stronger, some of them have returned the loans back and that probably means that the $750B TARP is already lesser than that and the govt probably even made some $ in the deal via interests paid. So the q is – why is TARP (and other such bailouts) all that bad? I understand the near term dilutaroy effects and such, but over the longer term, is it really such a massive disaster if it helps someone tide in the near term, gets investor confidence back (after all, its all about it – right?) and get money flows again, injecting a health in the economy. Will be great if JJ or other knowledgeable folks could help me understand the ill effects of TARP and like bailouts.
This is a classic short squeeze. Lot of late comers on thursday and friday tried to go short and are out on a limb now. Also, stocks that got sold because stop loss orders got unintentionally triggered have to be bought back. What a joke. My MSFT and VALE got sold on thursday and now I have to buy them back at a loss. I am not in a rush, but i bet lot of financial advisors have to save their faces and get them back asap.
I have a feeling that the shorts won’t panic and will ride this out.
I’m just a normal guy, but when I read about this package this morning, I thought the same thing. Where in the world does the money really come from? Isn’t just a huge shell game by the EU, while they “hope” for a real recovery to pay for it all later?
Has anyone noticed the euro has been dropping all morning? I guess everyone is finally waking up…
Jim
Are you adding to gold investment? Gold stocks or GLD. I am voting for GLD.
I love your last 3 lines, Jim! The US govt has been “simmering” in the juice of their own stupidity for quite a while. The Obama administration, with cooperation with the democrats, have added herbs and spices to the concoction to guarantee the resulting brew won’t have a drop of fiscal responsibility in it at all! ….No, not likely at all.
No, I don’t think that is likely…(fiscal responsibility that is…)
I think this is enough to power the market for a while though, the larger trend still point up for now. If we are in a secular bear market, and the fundamentals does point that way, this is one EPIC bull rally, enjoying it while it lasts!
Jim…
Great post from a great teacher! I have learned more about Europe and other foreign countries from hanging out on this site than I ever did from a textbook while in school!