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Personal Finance Blog By MoneyRates - June 2012

Bailout fatigue takes hold

June 19, 2012

| MoneyRates.com Senior Financial Analyst, CFA

A meeting of leaders from the world's largest economies wrapped up this week with a unified pledge to act in support of the world's troubled economic and financial systems -- but no breakthrough strategy that offers a clear path out of these difficulties.

Representatives of the G-20 nations met in Los Cabos, Mexico amid concerns about slowing economic growth around the world and an immediate crisis surrounding some of Europe's debtor nations. G-20 representatives issued a statement saying they would "act together to strengthen recovery and address financial market tensions." The difficulty is that achieving those goals is much easier said than done.

Already, the central banks of Europe and the U.S. have taken extensive action to promote growth and shore up the financial system. Now, the International Monetary Fund is effectively passing the hat, securing billions of dollars in pledges of support from China, Brazil, India and Russia. Still, the world's markets seem unimpressed. Their skepticism reflects a number of issues:

  1. Inflated expectations are a sign of bailout fatigue. Already, extraordinary measures have been taken to stimulate an economic recovery and prevent a series of loan defaults. Signs are everywhere, including bailout packages for key U.S. industries, record-low mortgage rates and debt assistance deals for countries like Greece. Each solution has not only failed to solve the crisis, but is met by market expectations for bigger and more dramatic actions -- a sign that the world is suffering from bailout fatigue, having seen too many emergency measures to be impressed any longer.
  2. Bailouts are only temporary solutions. All of this is a reminder that bailouts are only a means of buying time. They can only help a company or a country regain its footing if there was a reasonably solid financial basis to begin with.
  3. The euro zone does not have a bottomless well of resources. The popular cry in recent weeks is that the rest of the euro zone, and Germany in particular, should spend more to help Greece, Spain and other debtor nations grow their way out of trouble. However, even Germany and the other rich nations have limited resources, and they have every right to be concerned that too much spending will simply drag them into the quicksand of debt.
  4. Bailouts may be rewarding irresponsibility. It's not just that debtor nations have borrowed irresponsibly -- those who bought their bonds made unsound investments. Bailouts don't just rescue nations; they help investors who made those bad choices. Until investors stop having their mistakes backstopped by government resources, there is no reason for the cycle of irresponsible borrowing and lending to end.

As the G-20 wrapped up its meeting, attention turned to the U.S. Federal Reserve, whose Open Market Committee was due to release a statement at the conclusion of its latest session. However, as much as the world keeps turning to its economic leaders for miracles, it seems unlikely the solution will be so easy.

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The diminishing returns of Europe's bailouts

June 13, 2012

| MoneyRates.com Senior Financial Analyst, CFA

News that the European Union had arranged a bailout for Spain's embattled banks brought little cheer, as nervous investors quickly shifted to the next string of obstacles.

It's becoming clearer that each new bailout, emergency deal or central bank intervention, while often reached after much difficulty and drama, is just another anti-climax. None of these stopgap measures is a solution to the real financial problems facing Europe, which represent a series of challenges that may take years to play out.

As the markets start to face up to the gravity of the problem, bailouts are increasingly having a diminished impact on investor behavior.

A series of crises

By extending credit to Spain's banks, Europe helped stave off the immediate threat of a run on those institutions. However, with its 24 percent unemployment rate, Spain has problems that won't be solved by a quick extension of credit. Plus, Spain is not Europe's only trouble spot. Even after that credit deal, markets looked forward warily to a pivotal election in Greece that coming weekend, and then at lingering debt problems in Ireland and Italy.

The pattern here is that politicians and central bankers have been forced into taking emergency actions to head off a series of crises, but since none of these actions addresses the underlying, fundamental problems in Europe, it is only a matter of time before another crisis bubbles up.

Pressure on Merkel

What can change the pattern of continual crisis management? A growing chorus of commentators is calling on German Chancellor Angela Merkel to take bold actions to stimulate Europe's economies. Fiscally conservative Germans look at out-of-control debt in parts of Europe and feel austerity is the natural solution, but outside of Germany there is support for the more aggressive austerity measures that could help the region grow its way out of difficulty.

That sounds good, but it's not so easy. Germany is in good shape because it has achieved growth while managing its affairs responsibly. One can forgive the Germans if they look on more profligate nations and wonder if a massive stimulus package would only encourage more excess spending without creating the resolve for fiscal responsibility.

Echoes from the U.S.

Besides the fact that Europe is an important market for the U.S., the difficulties across the Atlantic resonate over here. The U.S. is a prime example of how stimulus doesn't always succeed in helping borrowers grow their way out of debt. Current mortgage rates are at record lows, but they haven't revived the housing market. Low refinance rates have had a limited impact in helping current home owners because many have bad credit or their mortgages are underwater. On the flip-side, low rates on savings accounts have robbed savers of income that could have been put constructively to use in the economy.

There may be a game-changer out there, but until one comes along, people on both sides of the Atlantic are going to be increasingly unimpressed by the latest emergency tactic.

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Horror sequel: Echoes of 2008 in Europe's crisis

June 11, 2012

| MoneyRates.com Senior Financial Analyst, CFA

It sounds like the set-up for a horror film, but it is today's financial reality:

A man sets up a reunion with a few friends to celebrate their survival of a traumatic experience a few years back. At the same time though, eerily similar incidents start to play out before the man's eyes, as if an updated version of the same trauma is about to take place…

This is not material from Stephen King. This was actually financial news earlier this week, as U.S. Treasury Secretary Timothy Geithner held a reunion of key players who helped respond to the 2008 banking crisis. Around the same time, he was participating in an emergency conference call about Europe's banking crisis with finance ministers and central bankers from the world's seven leading economies.

Deja vu

First, the reunion: Geithner hosted a dinner with Henry Paulson, his predecessor as Treasury Secretary, and other key figures who helped address the 2008 banking crisis. Reportedly, Geithner has long felt that the service of this group in averting a broader financial crisis deserved acknowledgement.

However, any warm and fuzzy feelings of nostalgia were probably overshadowed by Geithner's other big meeting earlier this week: an emergency conference call with G-7 financial leaders regarding Europe's financial crisis. U.S. Central Bank Chairman Ben Bernanke, who was also an active participant in the 2008 crisis management, joined Geithner on the call.

Beyond any feelings of deja vu that Geithner may have felt during all this, his experience from the 2008 financial crisis may prove valuable in advising European finance officials on their current problems. At issue in each case is a relationship between borrowers and lenders that is both destructive and symbiotic to some degree.

Borrowers have taken on too much debt, but lenders have been guilty of lending irresponsibly. Now, borrowers cannot afford to repay that debt, but lenders cannot afford to acknowledge a default, because that would jeopardize their own financial standing. As was the case in 2008, unwinding that complex relationship can be as delicate as defusing a bomb.

The ongoing interest rate bailout

Front and center in the discussions over the European crisis are possible measures to prop up Europe's banks, such as a bailout fund and centralized deposit insurance. Significantly, this would not solve Europe's broader economic crisis, but it would help avoid a bank run that would deepen the crisis.

Again, this carries some familiar echoes of 2008. Geithner, Paulson and others succeeded in heading off a chain-reaction failure of U.S. banks, but the U.S. still is struggling to recover from the underlying economic fundamentals that caused the crisis in the first place.

Meanwhile, another similarity between the U.S. and Europe is the ongoing de facto bailout of borrowers by keeping interest rates artificially low. U.S. CDs, savings accounts and money market accounts have been paying the price for this bailout, as have their European counterparts. It still remains to be seen whether that price will prove worth it.

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