Debtor Prisons? Is using leeches for treatment next?

The first great novel of modern Western literature - Don Quixote - was written by Cervantes in debtors prison. Debtors prisons were quite common in Europe of the age -- others like Moliere had also cooled their heels in the slammer. A surge of good new literature is the silver lining in the cloud from a quote reported in a nice post by Tim Iacono:

“Fannie wants to lock people up in a jail of negative net worth for much of the rest of their lives. They’re bringing back the debtor’s prison.”

Fannie Mae announced their intent to punish strategic default by homeowners who are underwater. Details are still scarce. Its nice to see Fannie attempting to manage its losses, but its hard to see how this aligns with US Government bailouts ($140 Billion + at this point, and growing) of Fannie, Freddie, etc to provide relief to struggling homeowners.

A different extreme for dealing with debt is being adopted by Iceland. Felix Salmon submits:

How many times can Iceland’s banks fail? More than once, it would seem, in the wake of an important ruling by Iceland’s Supreme Court. It regards loans which were disbursed in Icelandic kronur but linked to either Swiss francs or the Japanese yen; the court has now ruled that the indexing is illegal, and that the borrowers need only to repay the loans at their initial interest rate in kronur.

Effectively the Icelandic court has "stuck it to the banks" -- a very popular decision given the recent crisis in Iceland. 

What other mechanisms for debt management will we see in the coming months and years given the extreme indebtedness (private and public) in many advanced economies?

The Debt Crisis (in 2 pictures)

Getting ready to do a presentation on Global macroeconomic trends and forecasts. National debt across countries will be a significant theme -- so sharing a couple of powerful charts I will be using. The first one is easier to read; the second one highlights the problem areas visually -- and quickly shows the debt problem that advanced economies are facing. Only a couple decades ago we heard about Latin American debt crisis, the Asian crisis, etc -- how quickly the world has changed.

I have another post coming on dissecting the debt situation -- we don't quite need the knee-jerk austerity programs that some countries are advocating, but we do need to spend more time understanding why we are increasing debt in the first place? Is it to help the temporarily displaced? to build infrastructure? or simply to bailout politically important constituencies. Stay tuned..

In Touch with Voters

Note: The jedi light saber has entered the mainstream weapons category :-)

Return on ECB's $1 Trillion shrinking?

In only 3 weeks some of the PIIGS countries are finding their yields pushed up at levels higher than BEFORE the ECB intervened via quantitative easing. And for the first time -- in a long time -- demand for German bonds barely exceeded the supply. If Germany is having trouble, can PIIGS fly?

Various sources are reporting attempts at brokering a big quantitative easing plan for the Eurozone -- to be announced before the end of June G20 meetings. US Treasury Secretary Geithner suggested that European countries need a further stimulus plan, greater easing, and generally more measures that raised debt. The Atlantic Ocean is starting to represent a big ocean between the economic philosophy of the allies. Stay tuned.

Graph via he FT: 

What can you get for One Trillion Dollars? The European Central Bank's Shopping Basket

A nice graphic in the NYTimes on who stands to loose from defaults in European debt. Its no longer surprising that much of the (ECB) bailout is about preventing losses for banks. What perhaps is surprising -- 3 weeks after Le TARP, is how little $1Trillion buys you any more. US (and global) markets got a big bounce from the US TARP; every successive bailout from around the globe will have much less impact.

A New Greater Fool?

US news is abuzz with Q2 2010 earnings season. The asset bubble has been re-inflated. The policy makers Faustian deal needed to achieve the re-inflation has 2 critical levers:

1.       The Savings Tax – Drop interest rates to near zero. Given a horrible choice - consume despite your fears or find some way of saving for tomorrow at ~0%, individuals have chosen to invest in risky assets.  Find an asset, any asset – stocks, junk bonds, gold, commodities - and buy.

2.       The Greater Fool – And the confidence to buy was provided by ensuring a greater fool was available. The history of bubbles shows rational individuals continuing to trade in the belief that a greater fool will pay a higher price. In 2009-2010 that greater fool was the US taxpayer (and some others around the world). The Fed bought MBS > $1 Trillion, recently released AIG documents show other assets purchases at 50-1000% inflated prices, etc.

But, two significant events happened last week. First, March 31 was the official end of the Fed’s trash (MBS) buy back policy.  Second, Germany and the rest of the Europeans are hesitating on whether to fully support the greater fool charade – at least as far as Greek debt is concerned.  They will likely cave-in, but the unwavering solidarity of the global bankers is now in question.

So how do we get to a next jump up in asset prices?

From here forward, for all intensive purposes, we are back to looking for other fools to propel asset prices higher. Higher earnings are already priced in (Firing 5% of the country - and US government stimulus growing corporate revenue by 5+% of GDP - has to show up somewhere in profits!). Accounting mark-to-fantasy and other rules (Repo 105 is fascinating) will continue to let us sweep debt problems under the rug – but we don’t have any new accounting rules to count on.

My candidate: China. The US Treasury Secretary has taken the confidence game to China this week, pushing for currency devaluation.  The real question is whether the Chinese use their savings to buy up US (and other) assets -- as the Japanese did a couple decades ago--, since their economy is already over-heating. Will it be wisdom or folly?

Inspiration for my students!

There is more estimation and analysis (i.e Math!) in my class than some came ready for.. but I hope the practical applications -- and the humor below -- give you some pride and joy in your effort!