Banking Law

Daniel Goldman is senior editor of First Things, a journal that advertises itself as one that is concerned with the intersection of religion and the public square. Therefore, imagine my surprise when Goldman's Monday morning piece on the First Things blog (which I got around to reading only this afternoon) contained some cogent observations on the recent bailout of Greece by the European Union and how a "peek behind the curtain" indicates that not only is Europe in trouble, but so also are those of us who reside in the land of the free and the home of the brave (plus Wall Street, Chris Dodd, and a Boy Named Sue).

The market got a peek at the man behind the curtain. It wasn't the Wizard of Oz; it was the ghost of John Maynard Keynes. And it didn't like what it saw.

Keynes assumed that people have a very short-term view of things. If you inflate the currency, the workingman will see the same number of shillings in his pay-packet and spend more, he wrote in the first pages of the General Theory (1936). By the same token, if the central bank reduces the interest rate to zero, investors will shift portfolios to stocks, everyone will feel richer, and consumers will spend more ? which is more or less what happened during the past two quarters of putative recovery in the United States. They won't mind that government deficits have ballooned to 12% of GDP (or 18% of GDP in the United Kingdom, if unfunded pension liabilities are taken into account).

The fact is that Keynes was right, at least some of the time. Investors tend to focus on the next turn of the market, because professional investors are paid to follow the pack rather than work out what is a worthwhile investment and what is not. Keynes had contempt for investors; as he wrote in 1931, "A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him." Every banker in the world had to short the market on Friday, and every banker in the world had to buy the shorts back this morning ? which is why European stock indices are up nearly 10% as of 8:00 a.m. Eastern Standard Time.

The trouble, though, is that the long-term sometimes peeks in. Issuing lots of government debt is a good idea if the economy can support it. The trouble with Europe is that forty years from now, there won't be enough Europeans to pay the taxes to fund the government debt.

[...]

The elderly portion of Europe's population will rise from 24% to 49% of the total, an insupportable burden. Who would want to buy 40-year European bonds?

[...]

At every inflection point of the financial crash, governments stepped in and announced that they had solved the problem. The crisis began in July 2007; central banks stepped into provide liquidity in August, and the Fed cut interest rates in mid-September . The consensus then held that the crisis was over and that bank stocks were cheap. Then came the Bear, Stearns failure in March 2008, in which the remnants of the firm were sold to J.P. Morgan. Financials briefly soared, and the analyst consensus was that bank stocks were cheap?just before Lehman Brothers' failure in August 2008. The Bush administration announced a $700 billion bank bailout in September 2008, and financials rallied, before crashing again in early 2009, amidst rumors of a general bank nationalization. More bailouts followed, and this time, an extended rally.

Each bailout requires more leverage, and puts at risk a larger and larger compass of the financial system. The central banks with their combined muscle crushed all the short positions in the market this morning. But time is against them; and now that the market has had a peek behind the curtain, things will never be the same.

As one of the commenters to Goldman's post put it, "Here in Italy, I used to like to crack wise that the Euro is Monopoly money. Now? It's all Monopoly money, baby"

Let's boil this down to its essence, without all the "blah-blah-blah": we're screwed.

But have a great weekend anyway. Armageddon is still a ways off. Après nous, le déluge.