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Fried in Greece

Another big credit crunch is brewing, this one starting in Greece.  It may not be obvious how and why this has the potential to affect us across the Atlantic, but it does. In many ways, this is just a mirror of the Goldman grilling in the US House – a story of cavalier disregard for reality unraveling as the people nominally in charge of things try to get a grip on what is actually going on.  How this one is handled will resonate for at least the next few months as the developed world struggles to get a handle on what’s really happening and what they can do about it.

The first thing that needs to be understood is that this situation cannot be called a surprise by anyone.  Greece is one of a small number of Euro-zone nations that have been in serious risk of default and have been looking for a bailout from the larger Euro partners.  They simply cannot pay the tab for the debt they’ve incurred, about 115% of annual gross domestic product. The trouble is currently confined to Portugal, Italy, Greece, and Spain – PIGS, for short – but solving the problem will require their crushing debt to be absorbed by larger nations.  That falls heavily on Germany.  This is all assuming a package can be put together that will not result in riots across Greece and a more general collapse.

The German government has been slow to act because they are certain they have been and currently are being lied to about the size of the problem.  They might back the proposed bailout of €45 billion in a normal situation, but they do not believe it is the end of it.  Throwing away a lot of money without solving the problem would, simply, be a waste.

This may seem arcane and irrelevant to many Americans, but it isn’t.  When sovereign or national debt is defaulted on, money becomes scarce throughout the system.  In this case, the largest single economy in the world, the Eurozone, is threatened with the possibility of seeing a lot of money vaporize through a general crash unless they start printing a lot more quickly.  That would force those who rely on credit in Europe to look for money elsewhere, especially the UK and US.  More demand for our money would drive up the cost of borrowing here just as there are signs that our economy is beginning to turn around.

As difficult as it has been for us to get a handle on our situation and prevent it from falling down in a general collapse, this situation will make it even harder.  Politicians on both sides have started to question the lack of control over the Federal Reserve lately, but a situation like this takes a lot of control away from even Ben Bernanke.  That’s where the parallels with Goldman start to look interesting.

There is little doubt now that at least some of the pieces of paper the Goldman was selling had little to no underlying value.  While the young traders who conceived these “monstrosities” were responding only to the their own greed and personal incentives, somewhere at the top of Goldman there was a responsibility to understand what the firm was actually doing.  That’s where “too big to fail” is met and matched by “too big to understand” – the delusion endemic in the whole system allowed a lot of people that should have known what was going on to look the other way.  They didn’t understand just what was happening, nor did they care to.

Is it a lie or a cheat when you aren’t deliberately defrauding people but really just have no idea what the Hell you are doing?

The same basic problem is confronting the German government right now as they try to stem what could easily become a Euro-meltdown, followed closely by a world-meltdown.  If they were sure that they knew what was going on, they might act.  Without that knowledge, they have little to nothing to go on and reasonably believe that the potential liability might be nearly limitless.  It’s not as though they don’t have problems of their own, of course.  But achieving market stability means putting a reasonable cap on the risk that the market is going to be stuck with, and without good information you can’t do that.  The goal is to calm markets and keep it all orderly because it’s a sharp run for the exits that causes paper wealth to suddenly vaporize.

What is really going on?  The short version is that no one really knows.  The long version is that it’s clearly bad and has the potential to suck the whole world down with it.  Stay tuned to see how it developes.

17 thoughts on “Fried in Greece

  1. I don’t know about the rest of you, but globalization is starting to scare the s@@t out of me! I get the feeling that no one has any handle on any of this. People can rant about government trying to control their lives and all that but this is way more serious and out of control.

  2. If everyone saw this coming why is it a problem? How was this not solved back when you first talked about it or even before? It seems to me that they must not be able to do anything about it or else they would have.

  3. Dale: I’m with you on this. It’s all way out of control, and getting control means someone has to do something that will look like a major power grab. In a certain sense, we’re going to have to choose between economic upheaval and political upheaval right now. That’s a lot of what they are facing in Greece (and being rather cowardly with the politics, frankly).

    Anna: I think you hit the nail on the head. I’m certainly not going to allow anyone to make excuses like “we didn’t know!” this time around. It really is that scary.

  4. If the Democrats get their spin doctors working on this, they could use Greece’s problems as an incentive for the slush fund solution to “too big to fail” banks. The bank-funded reserves would become a liquid resource that would not upset the credit apple cart when a bank (or perhaps even a sovereign fund) gets in trouble.

    As for Goldman, there are too many issues to sort out. Credit Default Swaps play into the Greek crisis here too – once a large investment house gets that big, they can’t help but have conflicts of interest in their portfolios. To minimize risk, they have to bet against themselves. There are two likely results: 1) While one hand isn’t watching the other, investments are bid over their inherent value, and 2) Someone gets burned.

  5. Bruce takes the bad handoff … and scores! 🙂

    Yes, that’s what I mean when I’ve talked about an “insurance based” solution to this problem as much as regulation. If the FDIC could stabilize things back when we relied on traditional banks, a pooled fund can help do the same for the modern more flexible system. It’s a question of size, however … it may take a lot of dough, and that’s where some regulation comes in.

    I agree, it’s hard to make much sense of all the problems raised by Goldman. I go with “too big to understand” as an umbrella because I really do think that the way it was (and is) set up there is no way anyone can really understand what is going on, which is to say that they can never properly price risk. I can’t see a real market functioning without appropriate risk management, so that just isn’t good.

    I’ll leave the rest as just details. Details I admit I don’t really “get”.

  6. Greece’s debt problems are not complicated. There are no complicated financial interdependencies that need unraveling. Their government simply spent more than they have and can’t pay their bills. This is the same as if you or I spent on our credit cards and couldn’t refinance the debt. At some point, the bill comes due.

  7. You’re right Adam – what happened to Greece was a pretty simple case of a very standard delusion. Why we should all care about it is the only place it gets a bit complicated. How this all plays out now depends on a lot of other things. If the world’s economy was a lot healthier, it might not matter at all – but we’re in no shape for a major crisis in the Euro right now. Good correction, thanks!

  8. Where does this leave the ordinary person like you and me – scared, some of us jobless and “ripped” off. Whiles those interested to do, make excuses and we’re saddled with the burden of yet more debt.

  9. Gwei, that’s the biggest problem of all of this. Some of us were clearly left out of the big grab, generally because we have a sense of decency. But we’ll certainly pay as time goes on.

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