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Prudence Punished. A Defense of Germany

German households are understandably deeply offended by Syriza’s initial “screw-you” approach to debt negotiation. But on a deeper level, that just do not relate. The perception is that their money promotes behavior that they do not engage in by choice. Germans live in a self-imposed state of austerity more than any other country in Europe.

The EU has a conundrum. They are trying to do a debt rework which is always acrimonious, between Greece and ostensibly the rest of the EU,. Such matters have to lay bare ugly truths. Debtors never want to accept about their past actions and present situations. Creditors must be made to realize just how reckless they have been. And because this delicate situation is being played out on a global stage with an EU mandate to be transparent given the public money involved, I can’t see how this is going to work.

The facts are these.

  • Greece is deeply underwater on an uncollateralized debt they cannot service without restructuring.It makes sense for them to walk if they can’t get terms reworked to make the debt burden serviceable.As I have said before, Greece is like a subprime borrower with no collateral down:they have an in-the-money put on their loan.

  • In the adrenaline rush of their election victory, Syriza acted like clowns.Espousing nationalization of the economy, the threat of chumming up with Russia as a bargaining chip, and saying “austerity” is over, and having a decided anti-German tone in all matters.I cannot imagine a more destructive approach leading up to a necessary renegotiation.

  • The Troika, a true creditor in this situation, is understandably keeping a low profile.They are letting the EU, under German leadership, do he heavy lifting.Make no mistake that the EU has no truck with the likes of the Syriza approach to burning bridges.The EU nations are acting as an agent for some of the real creditors.There real creditors are the large banks domiciled in their countries with exposure to Greek debt.The plan, super tough to pull off, is to protect these banks by using public (taxpayer) money to absorb the rework.

  • German households are understandably deeply offended by Syriza’s initial “screw-you” approach to debt negotiation.But on a deeper level, that just do not relate.The perception is that their money promotes behavior that they do not engage in by choice.

Have a look at household debt reduction from 2007 to 2014, courtesy of the World Economic Outlook, BIS, and the IMF. German, Irish, Spanish, and Portuguese household debt is reduction mode, real meaningful sacrifice with the goal of balance sheet repair. Greece has not. You are also seeing that there are a number of EU countries, particularly in the north, that have growing household debt. Well and good, if coming from a low level. But when household debt problems do erupt, the equation always entails a transfer of private debt to public debt in terms of relief. This is the strongest proof of democracy, as an aside. The problem we have in the EU is that this transfer occurs across national borders, each with their own incentives and behaviors. And the public backstop encourages even more reckless creditor behavior.

german household debt.jpg

Countries like France, Belgium, and Finland (just to name a few) will likely have future problems. Here’s why. With debt levels like these, there is a need to deleverage before Mr. Market makes you do it.

german debt levels.jpg

Who’s likely to be asked for help? The prudent. Always the prudent. What possible reason do they have to support it given that it creates the expectation of future requests for assistance.

I’m not saying austerity using an inflexible, narrowly defined, bail-out-the-creditors template is the complete silution. It isn’t. Shared sacrifice is key, having done the heavy lifting for millenia. And maybe some transparency about the players and their incentives isn’t such a bad idea. This isn’t an EU problem, it is the global problem.

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