Thinking About Debt

Lurking behind the good news of last Friday's employment numbers is the long running concern over sovereign debt problems in the developed world. Europe, the US, and Japan have unsustainable levels of national debt that get worse daily and there are no plans anywhere to deal with growing debt levels. There is conversation, but only conversation. No politician anywhere is willing to risk their political career by providing an honest assessment of the spiraling debt situations that the developed world faces.

Does this mean we are doomed and we should be storing up canned food in nearby caves?

The fear, of course, is that much of this sovereign debt will prove worthless and the collapse in values of the debt will be disastrous for the developed world.

Imagine the collapse of a stock market. In that case their is a real wealth loss of significance (just as a market bubble can create, if only temporarily, a real wealth gain).

But, debt is different. Debt is a zero sum game in a way in which other assets are not. If you owe money and can't pay it, sit down with your lender and restructure your debt, the gain to you is offset precisely by the loss to the lender. In the event of bankruptcy the bankrupt entity no longer owes the debt once legal bankruptcy is established. So, with defaulted debt, there is always a winner and a loser and one cancels out the other. There is no real net worth loss.

The only way that defaulted debt can lead to a net worth loss is if the lender has been pretending that there is no chance of a default -- not marking-to-market.

In the case of Greece, for example, the debt is trading well below 50 cents on the dollar, so that a default of 50 percent doesn't even penalize current bond holders, since the market would not give them 50 cents on the dollar anyway. But, one advantage of doing a workout for Greece is that now they don't owe the amount of debt eliminated in the restructuring. That is a plus for Greece and offsets the loss to its lenders.

Debt is different.

The point here is that if sovereign debt is restructured, the outcome need not be as disastrous as all the pundits think. It is only if these countries bury their head in the sand and refuse to proceed with restructuring, which is the route that Merkel and Sarcozy seem to be pursuing, will the exploding sovereign debt lead to catastrophe.

Pretending to have wealth that you don't have seems to be a national pastime in France. That should stop and the realities should be recognized for French and German banks who hold much of increasingly less valuable sovereign debt of Greece, Portugal, Spain and Italy. Germany and France will be forced, eventually, into nationalizing most of their major banks. Why not recognize the liabilities of these these banks now and proceed instead of a policy of "extend and pretend," patterned after the absurd policy antics of the the US government in 2008 and 2009.

As in most things, honesty and candor will lead to a good outcome, while obfuscation and hubris will only lead to disaster.

The realities of sovereign debt should be faced squarely in the developed world and the sooner that debt can be structured the better. Then, the developed world can rebuild their sagging economies and provide economic prosperity for their citizens, instead of the current plans for austerity and retrenchment.


Popular posts from this blog

"You Can Keep Your Existing Health Insurance"

5 Unusual Tricks to Help you Save Up

Things We Now Know