Friday, August 3, 2012

Credit and Debt in the EU

Via Breitbart -- Professor Obama lectures the EU.  If I were Monsieur Hollande, I would say, "Le africaine appelle noir le francais." 

Or something like that.  My French is very rusty.  (The African calls the Frenchman black.)

Reuters also reported that U.S. Treasury Sec. Timothy Geithner took a bolder line with members of the EU, saying their actions must include "bringing down interest rates in the countries that are reforming and making sure those banking systems can provide the credit those economies need."
What those economies need is not credit.  They need to clear their debt load.  Again and again and again we see the same solution offered.  Credit card maxed out?  How about a new card?  Do balance transfers. 

This is clearly NOT a solution to the problem.  There is a difference between credit and capital.  Capital is either money that has been saved through generation of excess revenue in the past or the means of production purchased with that money -- i.e., equipment, stock, land, etc.

Capital is never a lien placed on future earnings or revenue via credit.  Money should be loaned only on capital of equal value.  To loan money on the fractional value of collateral is essentially counterfeiting.  Yet this is done all the time so that people have houses worth two-thirds or half of the principal owed.

Countries like Spain and Greece have lived high on government credit for years.  Because they were part of the EU, they could float bonds at low rates and run deficits, increase spending for social programs and government salaries and pensions.  They could hire more government workers.  Government jobs became the "good" jobs.  The private sector shrank under the burden of regulation -- those government workers have to have something to do -- and the cost of operating in an over-regulated, more expensive environment.  The cost of government is not simply the direct taxation, ever.  Compliance costs can and do put people out of business or reduce them to mom-and-pop operations, thereby raising unemployment.

The answer to the problem in the EU and here is to clear debt from the system by letting businesses -- especially banks, fail, and by drastically reducing the size of government.  It will be painful, and it will clearly be a global depression.  But it is going to happen voluntarily or involuntarily.  Obama and Geithner might even know this.  They just don't want it to happen before November.  


  1. Hi Mush,

    If you get rid of easy credit won't that also cause deflation because sellers can't ask as much for a house, car, or education? They have to drop the price to get buyers interested?

    I followed what you said except maybe the part about clearing debt by letting businesses fail. What happens there? The lenders take a loss on the difference of what was unpaid on the loan and what they resell the collateral for. But that will clear that particular debt from the system.

    Too many losses and the bank fails. Which, as an aside, will make property cheap because the banks will dump properties on the market and this is also deflationary.

    I agree, it's going to happen one way or another.

  2. Yes, tightening credit will be deflationary. And mainly the businesses I'm talking about are financial companies like J.P. Morgan, Goldman, Bank of America, etc., that made questionable, speculative loans and investments in things like derivatives.

    When I worked for a credit card company, our marketing people loved to look for "borderline" customers to send cards to. There's a FICO range of credit scores that they now call sub-prime where credit card companies are almost guaranteed extra revenue. Marketing would hook people with a low-limit card knowing they were going to get more money in over-limit and late-fee charges than we got in interest -- which was often like 15% anyway.

    These bad customers only have to pay for a while in order for the banks to make back their principle. They expect, in many cases, the customer to charge-off at some point or declare bankruptcy.

    When our company did stuff like that, we were solid financially. This was just a way to get some gravy. It's kind of disgusting, really. But we had our Risk Management department that throttled back Marketing. The Risk guys used to say that, if we would let them, Marketing would just mail out cash in envelopes.

    That was a joke to us, but it's not too unlike what has been done. Banks that do that deserve to fail.

    A non-bank company like GM can usually declare bankruptcy and clear itself out of whatever mess it is in. It gets the court to assign priority to various creditors such as bond-holders. In GM's case, that would have meant that the union pension funds would have been just another creditor. Had that been allowed to happen, GM could have re-negotiated all of its contracts and reduced the "cadillac" union benefits, possibly even gotten rid of the union. It could have streamlined its product line, becoming more focused on quality and customer satisfaction -- like non-union companies such as Toyota.

    A significant portion of the cost of a new Silverado goes to pay workers benefits to workers who tightened lug nuts on the assembly line for twenty years at $20 or $25 an hour then retired at fifty.

    When stock prices were rising and interest rates were higher GM could fund those pensions without cutting into profits. They haven't been able to do that for the last decade and they are hurting.

    It would be bad to cut a guy's pension after he had been promised a certain amount. But those promises were forced out of companies by the unions, and they were unrealistic and unsustainable in the long-term. GM, though, took the Keynesian approach that in the long-run we're all dead and just made it the problem of some future iteration of the company.

    That's just one example. I'm not sure I answered your question. If not, I will try again in a shorter form.

  3. Thanks Mush. That was a good, post-worthy response. Ok, clearing debt hammers the creditors and those invested in the creditors. So not just JPM, for example, take a financial hit but any pension fund investing in JPM. So the "little guy" can get financially hurt as well.

    For GM, clearing debt didn't liquidate the company. But it could for other companies and that would be disruptive, to say the least, to those whose livelihoods depend on that company.

    Coincidentally, I saw this arcticle on Zero Hedge today which covered this subject. You might like it.

    I'm kinda figuring it out.

  4. Thanks, that looks good.

    Yes, GM or the individual can file for bankruptcy to protect themselves and their assets from creditors in order to stay in business. Personal bankruptcy will let a person hang on to some property -- depending on how it is adjudicated.

    A year or so ago I gave a friend $650 to hire a lawyer to file for bankruptcy. He got it done and he's still living in his mobile home on his little acreage and has his truck. He just could not pay his bills. I don't know the details, but a lot of people do that.

    GM could have done the same thing and continued to make cars. They would have just reorganized.

  5. Wow, that is good. I particularly liked the example of the student loans:

    To see the debt as the problem is to ignore the system which created the "need" for that debt: in the education cartel, that is the entire system of "higher education," which is fundamentally a "skimming operation" not unlike its partner in crime, the financial industry and central State that creates and enforces the debt.

    I think you could say the same thing about the health care/insurance sector.