by ETFguide | November 30, 2011 9:30 am
Although people around the world are focused on holiday shopping and vacations, the global financial epidemic of too much public debt isn’t taking a break.
Since the beginning of Europe’s financial crisis, its corporate and political leaders told us the problem was contained. But each step of the way, they’ve been wrong. Right now, all signs indicate that Europe’s financial crisis is spreading like gangrene. This is not a scare tactic, but an honest evaluation of the facts. Let’s analyze some of the reasons behind this.
European banks are facing a liquidity crisis, even though they’ve already received an emergency cash infusion from a coalition of world central banks. The International Monetary Fund in its “Global Financial Stability Report” estimates $408 billion in banks’ risk exposure to toxic government debt from countries like Greece, Ireland and Portugal. Because Europe’s crisis is moving so rapidly, even the IMF is having trouble estimating the true liabilities for European banks. In August, the IMF said it would take only $272 billion to cover banks’ capital shortfall.
Italy recently paid almost 8% to auction 7.5 billion euros ($10 billion) in three-year bonds, up about three percentage points from a month ago. The same thing is happening in France, who’s now paying around 1.5 percentage points more on its 10-year bonds compared to Germany. Why is France’s debt not trading like a AAA-rated country? What, besides everything, does the credit market know that credit rating agencies don’t? Rising borrowing costs are a worst-case scenario for already over-indebted borrowers.
We don’t advocate putting implicit faith in credit ratings, because history has taught us they are nothing more than financial opinions and, frequently, not very accurate ones. Still, a gander at the latest downgrading trend is troublesome. Intuitive observers will note this is not an isolated phenomenon, but a global trend. Sovereign debt from Greece and Portugal, after several downgrades, is now rated “junk,” Ireland has been downgraded, Italy has been downgraded and Japanese along with U.S. debt was lowered in August. The pace at which government debt is being downgraded is accelerating, and reversing this trend won’t be easy.
One of Europe’s problems in solving its crisis is its magnificent bureaucracy. Between the Economic and Monetary Union, European Banking Authority and EU finance ministers, everyone has an opinion on how to fix things, but nobody can execute. Layered on top of this melting pot are individual countries within the euro zone, each with its own distinct set of financial regulators with their own viewpoints. It’s a conglomeration of confusion and the perfect recipe for getting nothing done.
Financial regulators are prodigious at inventing new rules but much less proficient at enforcing them. In many ways, Europe’s crisis is just like the U.S.’s — a colossal failure by regulators to regulate. Rules are of no protection if they are selectively enforced or not enforced at all.
The Oscar-winning documentary film “Inside Job” was too angry of a film for me and badly missed at articulating the fourth-grade antics of Wall Street’s elite. Nonetheless, it explained how the U.S. financial services industry became too large too fast. What’s changed since then? More assets and power have been concentrated in fewer surviving firms, which has increased everyone’s risk — should one of these institutions fail. The problem of “too big to fail” still hasn’t been solved domestically or internationally.
Instead of letting troubled financial institutions or governments fail, regulators and quasi-regulators have thrown (and continue to throw) trillions of dollars trying to save them. In the U.S. it was a $700 billion bailout, and in Europe it’s already topped $1 trillion. These headline bailout figures, which are being funded largely by taxpayers, are probably much higher than reported. While financial bailouts in the name of saving humanity, or even a country, are excellent devices for delaying the inevitable reckoning day, they don’t completely stop its arrival. Furthermore, the financial liabilities associated with massive financial bailouts have already begun destabilizing the financial condition of world governments previously determined as “strong.”
Regardless of whether you believe in gold as an investment, its substantial rise has been fueled, in part, by the failure of governments to prudently manage their finances. As a result, money is flowing out of stocks and into assets deemed “safe” like U.S. Treasuries, gold, precious metals and Swiss Francs. As a side note, I grudgingly use the deceitful phrase “safe haven” because it suggests a false sense of security. In reality, no single investment security or asset class is technically “safe,” no matter what persuasive marketers argue. Everything is subject to rises and falls at any given moment.
Ron DeLegge is the Editor of ETFguide.com and Author of ’Gents with No Cents: A Closer Look at Wall Street, its Customers, Financial Regulators, and the Media’ (Half Full Publishing, 2011). The book is due out in early December.
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