EU must choose its lies wisely

December 16, 2010

You can lie to taxpayers or you can lie to creditors, European authorities are learning, but doing both at the same time is very hard.

The proposed policy that current senior creditors to troubled states will not face losses on their loans but future private lenders will be forced to share in losses with taxpayers is so irrational, so bound to fail that it falls out of the realm of economics and into the ambit of brain injury.

European Union member states will this week hold a summit at which they will create a permanent fund to lend to troubled members under co-called strict conditions of fiscal responsibility.

At the very same time, leaders of the 27-country European Union will sign on to a pronouncement by euro zone finance ministers saying that private lenders will have to share the pain, on a case-by-case basis, of any sovereign debt restructuring after 2013.

So let’s recap, because this is truly bizarre: Lenders to Ireland or the other troubled states won’t take a hit now but if they stick around until 2013 then they will take losses along with the taxpayers. Oh yeah, and the current round of bailouts are aimed at seeing Ireland and Greece through the next couple of years, at which point it will become extremely dangerous to lend to them, as their economies will have shrunk, their debt burdens bloomed and private lenders will be on the hook.

To add to this, the European Stability Mechanism, the name of the new fund, will be senior to all creditors except the International Monetary Fund, meaning that in the event of a bankruptcy it would be paid first. Ratings agency Fitch looked at this provision and quite rightly said that it might lead to lower ratings on shaky euro zone sovereigns.

The only way you could make this policy mix work was if you could find a very rich lender with no ability to conceptualize the future. Hmm, let’s seeĀ  a rich entity with limited ability to fully imagine a future state – it must be the European Union!

Few private lenders will stick around, they will sell their bonds and the only buyers will be the EU or ECB, which itself as it understands this predicament is hugely unwilling to play along.

Germany and France are both so unwilling to both have principles and pay for them that they are refusing to act on proposals for common European bonds and are expected to resist moves to increase the size of the European Financial Stability Fund, the vehicle now being used for bailouts.


Germany and France in October began to insist that private creditors would share the pain, thus touching off the current euro zone mini-crisis and bringing forward the ” rescue” of Ireland. I say bring forward because most rational observers realized that Ireland could not pay the debts of its banks, despite having pledged to do so.

Private creditors knew that Ireland is insolvent, as is Greece and very likely Spain, but also knew that since there is no escape hatch from the euro and no apparent will to end the union or bring down insolvent banks that their loans were reasonably safe.

German and French taxpayers know this too and are not happy, as it means their tax money will be flowing to the periphery for years to come. Hence, German and French tough talk and insistence that private creditors will pay in future, which in turn forces investors to act on their analysis of insolvency and sell.

Private money is quite happy to keep funding a bankrupt entity but only so long as the moral hazard play, the implied guarantee from on high, is still in force.

Why then haven’t spreads on weak euro zone bonds risen even higher? Well, besides the fact that the European Central Bank is actively buying, it is the fact that investors can’t quite believe that the European Union is serious.

They know that getting out will be a disaster and a humiliation but that forcing private creditors to take haircuts could cause a banking crisis. So, no haircuts and no reckoning.

Investors are betting, at least for now, that the EU is lying to taxpayers, or to itself, rather than to them.
My guess is that we go on like this for a while; periodic crises that force the EU to pledge ever more money to member states without ever acknowledging that they are insolvent or forcing their private creditors to swallow losses.

That ends only if one of three things happens; the market decides that it won’t lend to Germany and France anymore, the weak nations revolt from austerity or the taxpayers of Germany and France decide that euro-geddon is better than picking up every check.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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Posted by Presseschau zum EU-Gipfel | ecolot – Wirtschaft erlesen | Report as abusive

Great article, Jim. Thanks. This whole thing is painful to watch.

Posted by gramps | Report as abusive

Yeah, I concur. Great article, Mr. Saft.

At base of this entire problem is the reluctance of the French and the Germans – in reality, the French – to acknowledge the failure of the European ‘social model’ and the superiority/flexibility of the despised ‘Anglo-american model’. Sure the English-speaking countries are hurting, for now, but that’s quickly changing and America, the UK and Canada will be leaving the Eurozone far behind by this time next year. Too bad for the Eurocrats.

Posted by Gotthardbahn | Report as abusive

The european social model is just as well as the american capitalist model because right now the markets are staring at the european debt but sooner or later the american debt which is huge by the way will be on the crosshair of the market fears and this according to a great number of economists. Gottharbahn you dont know anything about living in europe all you know is what the news say about the economy but life here is just as well as before the late crisis and honestly better than in the US.

Posted by Dandelion | Report as abusive

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Of the three outcomes Saft mentions, I see “the weak nations revolt from austerity” as likely and likely soon.

Why? Because the Greeks have already begun to see through what still eludes the French and German voters: that the “austerity programs” are not for Greek benefit, not even for EU benefit, but for the benefit of the reckless and irresponsible bankers and “bond vigilantes”, who manufactured these financial crises in the first place. And they are not happy about it. Columnists in “Ta Nea” have already started to use the word EPANASTASIS, i.e. ‘revolution’ or ‘uprising’.

I would not be surprised if the Red/Anarchist groups (such as “Revolutionary Struggle”) still lurking around parts of Europe finally decide to target these bankers instead of random citizens in their next terrorist attacks.

Posted by Syllogizer | Report as abusive

Good article but why isn’t anyone calling it what it really is: a global debt Ponzi. Period. The energy source for the Ponzi is none other than fiat currency and fractional reserve lending. These tools of the grift are used to steal the value associated with the labor of people. Let me ask you: should any man in good health not be able to provide himself a good living? I not asking if he should have the right to do so. I’m asking if, by virtue of his own labor, could he feed, clothe and shelter his family. Since men have been doing this thoughout time then one has to question by what magick (sic) people now find themselves unable to do so. The fact that they cannot means that someone else is stealing the value of their labor through guile. The mechanism of guile is fiat currency and fractional reserve lending. How can one man every work hard or smart enough to own a megayacht? The truth is that he can’t but still there are plenty of megayachts. How can that be? Because they leveraged up big time using fractional reserve lending and they won their bet so they get the yacht. Those who leverage up and lose don’t go to jail or anything, they just declare BK and start over like Donald Trump has done. The connected people get access to leverage which the common man could never dream of. All of these scams would collapse overnight if we returned to honest money. Trump would be pushing a broom or cleaning toilets because he has no real skills. Most corporate CEOs can’t do anything of value. In short, we have all been conned into accepting a completely dishonest money system and we will continue to get ripped off until we go back to honest money and eliminate all of the leverage. About 1 in 1 million actually understand this. Everyone else is discussing symptoms and completely overlook the underlying cause of it all.

Posted by DaveTo | Report as abusive

I’ll go with Euro-geddon! Otherwise, a re-balancing of the EU currency global inter-change value sharply downward is in order. The citizens would have to adjust to living much leaner, but it gives the EU the opportunity to become export competitive. Ditto for the USA. It has interesting consequences for Asian exports and great expectations for the Asian import side of the equation.

Posted by kaceltd | Report as abusive

Soon Germany will no longer be willing or able to pay everyones bills.
Sorry, but the war guilt thing aint gona work any more.
In fact, this will likely set up a “fourth Reich” to dominate Europe.
A strong man will soon arrive on the scene and right the ship.
All will welcome him and his iron fist.
Hmmmmm, here we go again.

Seek him, and Hail Him!

Posted by clearthinker | Report as abusive

In fact I see a German-Soviet power share and domination of europe coming.
Its all laid out in the bible as event to happen, and happen very soon.

Additionally, the things happening in Europe now will be happening here in the USA in a few years.
The whole social services, debt monitorization scam is about to collapse.
The collapse has already begun in California, and some east coast states.

Praise the lord and pass the ammo.


Posted by clearthinker | Report as abusive

lol lol, This leading line, “You can lie to taxpayers or you can lie to creditors” applies to every country.

Posted by diddums | Report as abusive

Well put Mr. Saft,

As an economic adviser in Eastern Europe, I fully agree with your assessment. I would however, include the possibility of letting go some of the unproductive and historically difficult “market entry” Eastern European countries that ascended into the EU membership in the last few years. The IMF and ECB are not interested in assisting in their economic development efforts and should be seen as an indicator why this whole EU project isn’t going to work as they had hoped in order to compete with the US market.

Furthermore, citizens of the well industrialized nations of Western Europe are loosing interest in being productive, since they already know that their taxes will continue to be channeled onto countries that are not willing to work hard to end corruption and discord among their politicians. Furthermore, Western European citizens are tired of flipping the bill to support new member state countries in order to hand out free pensions and street development projects to their citizens who are unwilling to cooperate in economic development within the country.

The European Union was stronger with the original few member Western European states membership.They should make joining the country club harder, with this new Lisbon Treaty.

top music

Posted by aliasi | Report as abusive

A good article. But it actually highlights another point. Without moral hazard the “modern economy” simply does not work. There is only one difference between Europe and the US and others: the Europeans have announced that at some point in the future private investors won’t be bailed out. Markets were shocked. And James is correct, most likely the EU are lying.

Posted by tk2 | Report as abusive

Enjoy the ride.

Posted by Tiu | Report as abusive

James is not able to interpret legislation.

Posted by Bruno_Duarte | Report as abusive

Whole thing called economy stinks. We watched as the housing market was pushed high making people go deeper into the debt. Now we have Europe being talked down, while USA runs deficit of 1.4 trillion….with wealth divide growing. The time is close when this will cross any “stress levels”.

Posted by johny2 | Report as abusive

This article assumes these financial rescues will fail, which is just as wrong as assuming they won’t. Besides, if the risk is too great, the lenders are free to stay away.
And while we argue about which system is “superior”, we might just see Asia pass us by.

Posted by MDan | Report as abusive

I go for the euro-geddon scenario – I wouldn’t be surprised to see this bastard currency rip the 4th Reich apart. Sorry “Clearthinker” we’ve had the 4th Reich for years – just based in Brussels & not Berlin!

Just make sure you folks get stocked up on gold & silver bullion.

The west has had its day & the damage is too far gone to be reparable. Unlike post 1945, Europe & other “developed” economies can’t just go on a resources grab from the subservient colonies et al – too late China is in there already & has been for some time.

The so called emerging economies don’t need the west – long term they will leave us behind as they have sufficient markets within their own populations. China has a 1.3 billion within its borders, never mind those living on their borders…who needs the US/Europe?

Posted by randburg100 | Report as abusive

I think the EU and Europe is great. Its brought the continent together without war for over 60 years, created a common goods, labor and service (market). As an American I’ve really enjoyed the benefits of integration.

But this is no US and the design of the Euro has always been flawed as countries no longer can compete on socialist policies. Used to be you could take your pick and then pay the bill if it went wrong. Some countries were more socialist, some less, some better run, some living off tomorrow. That whole system now is interconnected through the Euro. Sure Europe is inefficient with 27 currencies but it is equally inefficient with one. The answer always has been strong regional currencies that work in smaller integrated countries that have similar tax, income and social support structures Groups like 1)Scandanavia 2) Spain Portugal 3) German, Austria, NL or 4) The Baltic States

Posted by John2244 | Report as abusive

I talk to my old Dad who has been a small investor for years and he knows the US is bankrupt as well. So who isn’t lying to keep up the appearance of economic health?

The British have never wanted to give up their pretensions that they are still a global empire. Isn’t Great Britain itself still a country with the landed wealthy money men all living in the southern half of the country and the northern half barely making it at all and where on the dole? Who just transformed the social structure of their country by drastically raising the cost of higher education for the majority of its students? Are the guys in their southern estates looking for gardeners and housemaids?

Someone isn’t admitting to the tottering state of his own “green and pleasant” land.

An old New York expression – “Keeping up with the Joneses” has been transformed into a game of trying to keep up the Joneses bluff of solvency. In other words, who can claim loudest that the other guy is in worse fiscal shape than he is?

Portugal – I have read in these Reuters pages not even a year ago – is actually less indebted compared to GDP than the US. And how devastating can the fiscal woes of economies of countries as small as Greece and Ireland actually be in comparison with their much larger neighbors?

Posted by paintcan | Report as abusive

Thank YOU! Its about time that someone starts telling and writing the truth. I was wondering how long it would take. Any way I am currently visiting Greece and if what I see here is any indication then option two (revolt) might be the most likely. It might have already started. The citizens are slowly becoming aware of the scam and the lies its being fed by the government. The common Greek does not want to bail out German and French banks or the greek tycoons who took must of the money at his cost. A better credit rating on the international debt markets will not help Mr.Papandreou. Ask a cat to do the math and it will tell you that short of the intervention of Zeus there is no physical possibility for Greece to repay its debt. EVER.

Posted by georgesmiley | Report as abusive

I have no use for liars. However, I do admit to having a perverse fascination with politicians that can look you right in the eye and lie through their teeth without sending off so much as one intuitive “alarm” in me. Do they give politicians top-secret training at MIT or some other major university on how to lie to even a pro?

Posted by DisgustedReader | Report as abusive

James Saft, in answer to your conundrum, twisted tax rules and other deviant laws make it quite profitable for lenders to bailout Ireland now, knowing very well they will get the shaft in a few years downstream (near the edge of the falls).

The taxpayers of the EU and US will have a big military helicopter waiting to pick them up before they go over the falls, complete with stewardesses showing lots of cleavage fettering them with martinis and caviar crepes.

Global warming is even profitable, don’t you know? Melt the ice caps and you can cover the poles with drilling platforms.

Posted by DisgustedReader | Report as abusive

Well, on medium and long term anything could happen. Politically speaking, there’s quite a few interesting options on the table…

As for economics, the longer it takes to find true solutions the more matters are going to turn political.

Posted by mdiavaro99ro | Report as abusive

I think that the debt is not real to the government or to business when all you have to do is run the card through the slot. Piling up debt never has worked. The problem, to me, is that the US is worshiping technology and profits. There is no base of truth.

Posted by fred5407 | Report as abusive

not one person (is there anyone in Western societies accepting this harsh reality?) concedes that just because you are used to living on 500 Euros a week doesn’t mean that you can’t live on 100 Euros a week (half the world is still living on one US dollar a day now). so bring on the austerity measures. the sooner one swallows one’s medicine the sooner one get back to living what one used to be able to do.

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