Monday, May 03, 2010

Bail-Outs for Screw Ups: Oil and Greece

In the not-to-distant future I wouldn't be surprised to read the following from the IMF: Negotiators over the weekend wrapped up details of the package, involving budget cuts, a freeze in wages and pensions for three years, and oil price increases to address British Petroleum's fiscal and debt problems as a result of the Gulf Oil Spill, along with deep reforms designed to strengthen BP's competitiveness and revive stalled corporate growth.

The above is paraphrased from the IMF's press release announcing the Greek Rescue Package. This, and other press releases, describe the crisis as "economic" when "financial' seems to me more apt (should we describe the oil spill as a "geologic" rather than "drilling" problem?), and proclaim the creation of a, fully funded, mind you, Financial Stability Fund. Greek Banks which failed to see the crisis coming are going to be shielded from the effects thereof.

Imagine if major Greek Banks, instead of investing anywhere from 2-3 times their equity into Greek Government Debt, had invested in safer securities. Just as deep-sea oil drillers have to devise safe (i.e. non-toxic) ways to extract oil, imagining some of the potential problems before they occur, shouldn't banks be devising safe (i.e. non-toxic) ways to extract profits from the seas of finance? If they fail in this task, should they be shielded from the effects of their failure?

One of the essential qualities of capitalist success, agreed upon after decades of careful study is the use of profits as arbiter for continued existence as a financial entity. Implicit in this view is belief that there will always be other competing firms/investors ready and willing to pick up the slack.

I'm pretty sure, just as there are many companies waiting to pick up the business slack caused by BP's error and potential financial distress, so too there are many Greek Banks with stronger balance sheets that would be willing to pick up the slack caused by the major banks' error in crisis forecasting.

Over at The Baseline Scenario Simon Johnson asks (of the decision to support too big to fail banks, instead of breaking them up): What is the basis for major policy decisions in the United States? Is it years of careful study, using the concentration of knowledge and expertise for which this country is known and respected around the world?

He suggests a possible (alternative) answer: I would not have a problem with the administration’s top officials saying, “we can’t take on the biggest banks because (a) they are too powerful in general, and (b) they would cut us off from the campaign contributions that we need for November.” This would at least be honest...

Honest, yes. Wise? not in my view.

BP's oil spill is horrific, but a fairly rare occurrence. Finance, at least in its current "liberal" form has a far worse track record. How long would the world tolerate current drilling techniques if such disasters occurred every couple of quarters all around the world? How long would public sector officials feeding from that trough survive?

Those in the public sector need to realize their interests are not aligned with TBTF finance. Can you imagine some BP-financed politician running in Louisiana any time soon?

Public sector monetization of financial sector errors coupled with support of the liberal banking techniques that created the problem will only accelerate currency devaluations in regimes that follow this policy and the brunt of the complaints will fall on the public sector and finance. In layman's terms, bail-outs for financial screw-ups will continue to cause higher prices, and higher prices will only inspire more anger.

Ideally, reward systems like capitalism should favor the prescient over the screw-up. Doing the opposite will likely have undesirable effects for all involved.

To wit; in an interesting irony, while the IMF is engaged in selling its gold it bails-outs the financial screw-ups who make it such a useful asset on a balance sheet.