On Sunday, the IMF and Euro zone approved its 957 billion Euro package for Greece et. al. A trillion bucks is a big commitment and shows just how worried they are about further contagion in the bond markets. The EU plan lends the scale of support that the TARP bailout lent to the US banking system in the fall of 2008. (Recall an 11% relief rally then for the stock market, led to a subsequent 30% decline before bottoming in March 2009). Stock markets have gone delirious on the initial news and the relief rally may well have some legs over the next few weeks. The more challenging question is how to responsibly position capital in the midst of what is likely to be a fleeting rally of some duration. Sober thoughts must acknowledge that this bail out does not “solve” the solvency problems of Greece or other teetering Euro zone members. Money manager John Hussman cuts to the rub in his market letter this morning:
Looking at the current state of the world economy, the underlying reality remains little changed: there is more debt outstanding than is capable of being properly serviced. It's certainly possible to issue government debt in order to bail out one borrower or another (and prevent their bondholders from taking a loss). However, this means that for every dollar of bad debt that should have been wiped off the books, the world economy is left with two – the initial dollar of debt that has been bailed out and must continue to be serviced, and an additional dollar of government debt that was issued to execute the bailout.
Notice also that the capital that is used to provide the bailout goes from the hands of savers into the hands of bondholders who made bad investments. We are not only allocating global savings to governments. We are further allocating global savings precisely to those who were the worst stewards of the world's capital. From a productivity standpoint, this is a nightmare. New investment capital, properly allocated, is almost invariably more productive than existing investment, and is undoubtedly more productive than past bad investment. By effectively re-capitalizing bad stewards of capital, at the expense of good investments that could otherwise occur, the policy of bailouts does violence to long-term prospects for growth. Looking out to a future population that will increasingly rely on the productivity of a smaller set of younger workers (and foreign labor) in order to provide for an aging demographic, this is not a luxury that our nation or the world can afford.
“Failure” and “restructuring” mean only that bondholders don't get 100 cents on the dollar. We can continue to bail out the poor stewards of capital who voluntarily made bad, unproductive investments, and waste our future productivity in order to make those lenders whole, or we can turn the debate toward deciding the best strategies for restructuring existing debt.