May 4, 2010
How do these financial crises normally end? Many people are asking when this Greek episode will end and how it will affect us.
There’s good and bad news on this score. The good news is that, if the state does the right thing, a financial crisis can usually be managed.
The bad news is that, if our government remains in denial, trying to avoid the hard decisions, there will be a run on our banks. Ordinary people will take their money out and put their savings somewhere safe.
At the centre of all this is that most precious of commodities -trust. Financial trust has been destroyed. No one trusts banks any more, and no one trusts our government’s ability to make us financially secure. Thus, we are in a precarious position. All it takes is a small shock to tip the whole thing over.
Let’s paint the bad picture before we examine the way out, which would ensure that we avoid this.
Think about what is happening in Europe at the moment. The simple story – one that is being peddled constantly, and shamefully hyped by our own government -is that the Greeks are a race who can’t be trusted.
The mainstream view is that Greece is a country that has run up huge deficits and is paying the price -and that it is, in some way, uniquely delinquent. This is only half the story. This is the lender’s story, which points the finger at the borrower.
Greece is the symptom of this crisis, but Germany is the cause. This is a crucial thing to understand and one that gets forgotten in the constant spin coming out of Brussels. It is only right that Germany pays for the Greek problem, because Germany is the reason for the crisis.
German banks and the German populace are no angels in this narrative and, despite their protests, they need to be reminded of this. For every loan for which there is a borrower, there is a lender.
This European crisis was created more by lenders than borrowers because, taken in the aggregate, Europe has more savers than borrowers. This fact is manifested by a large current account surplus with the rest of the world.
At the core of Europe and the euro is Germany -a country that prefers to save than spend or invest. So the German banks are stuffed with money that not enough Germans want to borrow. If the German banks don’t find a home for this cash, the banks start to make a loss, paying out interest on deposits without enough corresponding lending on the far side of the balance sheet.
So the German banks had to find someone to lend to. They found Greece and Ireland and others, Spain included.
They did little or no research on Greece or Ireland. They could get a margin over what they had to pay German savers, so they stuffed the periphery of Europe with money. The Germans bet on the notion that, because of the euro, there was no currency risk. Then they made the fatal mistake of confusing no currency risk with no risk. But of course there was risk. There is always risk.
The German bet was that the rest of Europe would never let Greece go under (or Ireland for that matter) so they were actually getting risk-free margin in Greece. So what did the German banks care if Greece’s borrowing was going through the roof? There was an EU backstop, so they could give the bill to someone else if things went pear-shaped.
Well, things have now gone pear-shaped and the German banks, the EU and the IMF have decided that the solution is austerity in Greece.
But many in Greece believe that the solution is an orderly default. After all, it takes two to tango, and why should the borrowers be uniquely culpable, when the lenders were greedy and did no proper due diligence?
The Greek position is understandable.
An orderly default is the only obvious way out. Greece can’t pay all these debts. We know that, the markets know that, and the German creditors know it too. So why the IMF/EU charade?
My view is that the charade is a failure of conventional wisdom. Conventional wisdom is always out of touch in a crisis.
The conventional wisdom is that countries don’t default. But this has never been true.
Dozens of countries do, particularly if they have been stuffed to the gills with money by reckless lenders who were in it for a fast buck.
If the world demands that Greece forces austerity through, the Greeks won’t be able to deliver, and there will be another crisis, even with the new â‚¬100 billion-plus deal expected to be announced today.
In this next phase of the crisis, Greek corporates will take their money out of their own banks, because they are not being paid for the risk of keeping their money in Greece when they could keep it in Germany. This is why there was a run on Anglo in January 2009 -corporates took their cash out.
This run by corporates will be followed by individuals who don’t want to be last at the ATM machine and find that there is no cash left. Panic will follow. When the bank fails, the crisis is over. The money comes back home from abroad into a new bank, and the country starts again. This is likely to happen in Greece.
The alternative to this, of course, is that The Greek government gets the creditors in a room and says: ‘‘Sorry, your gamble didn’t work, there is no money, let’s do a deal.” This would solve the crisis before a run on the banks and leave the small saver reasonably unscathed.
So what does all this mean for Ireland?
Contrary to popular belief, which says that if Greece defaults it would be a disaster, my contention is that, if Greece doesn’t default, there will be eventual and very serious panic in Ireland.
The real risk is that a bailout of Greece will fail, and the Greek people will be the first to abandon trust in their government.
The IMF and EU will continue to mouth platitudes about solidarity and the like.
Meanwhile, your average Greek will put his cash under the mattress. A Greek bank will fail and the contagion will no longer be limited to bond markets (that frankly means nothing to anyone on the street), but the panic will spread to depositors. We are in the same boat here and, unless something is done, will head in the same direction.
Our debt is unsustainable, just like that in Greece and other peripheral countries, such as Portugal. Thus, the great Irish financial/banking crisis will see us come under similar pressures to Greece -and head us in the same direction, with confidence evaporating, the state struggling to raise cash from reluctant lenders and our banks at risk of big outflows of cash.
This is the upshot, not just of the great Irish borrowing binge, but also the great German lending splurge. So now we have to hope that the Greeks put their hands up -and give us permission to do likewise.