Europe has a debt problem.
A reluctant attender of Debtors Annonymous, Europe has been outed and forced to make the ignominious admission. The US however is still in denial. Who? Me? No I have a few debts, so what? Who doesn’t? Nothing I can’t handle. What’s a couple of trillion empties between friends?
But the US can’t hide for ever. Just as in Europe, debt in the US financial system. is getting worse not better. This is the essential dynamic that is whipping the markets up and down so erratically. There is growth in the stock market. We can argue whether it is real or syntheitc. But for the moment let’s believe its real. But the trickle of positive news stories and positive sentiment coming from that, is competing all the time with the persistent and dire signals coming from debt. And it’s a competition the good news touters are having difficulty winning. The probem is that Debt is getting worse faster, than growth is getting better.
I think Obama knows it and his advisors are telling him there is a clock on it now. Commercial Real Estate debt is not some mythic monster. It happens to be real. It is killing regional banks at a steady and soon to be increasing rate. A pace the FDIC cannnot contain for many more months.
The Big banks have their own rotting disease – called Second Lien loans. Lurking behind a vast percentage of defaulting mortgages there is another loan type, a second-lien loan or HELOC which is junior to it. These loans are much more disasterous for the banks than the defauting mortgage. Because as soon as a mortgage is finally defaulted, when it can’t be hidden any longer, not only does the primary mortgage lose most of its value ( it may get sold for a fraction of its face value and get some cash from a house sale) ) but behind it, the second lien loan, gets ZERO. The bank that holds the Second lien gets nothing at all. Not even a few cents on the dollar. Nothing from any sale of the house. That money goes to the holder of the mortgage.
It is the Big Banks who hold several hundred Billion dollars worth of these loans. None of the Big Banks will remain solvent if all the Second Liens are zero’d. And all that is preventing them being zero’d, at the moment, is the way the defualts are not being recognised. People are not being foreclosed at all. And when the process does start they are being delayed as long as possible. None of this is charity for the people. It is life support for the banks. But how much longer can it last? There are hundreds of thousands of mortgages techanically in default but not recognised. And a slow but engulfing wave of them has now detatched itself from the main bondy and is now on the move.
Nothing short of another binge of debt fuelled bail-outcan protect the banks from these new losses. The Head of the San Francisco branch of the FED advocated today holding the FED rate at zero or even reducing it to negative for as long as needed. AND starting to monetize/QE. He knows the debts will need to be bailed again. Question is, can the US bail again and not see their debt costs go through the roof? The thinking of those who advoicate more bail-out, is that however dire the US situation would become, even a crisis of American banks and American debt would actually scare money out of Europe and in to the US Treasury in a paradoxical ‘flight to safety’.
What would jeopardize this logic is if Europe had already started to default its own debt, dealing with the bank fall-out but trying to save its currency and cleanse the debt from EUrope. That would be a real and present danger to US debt levels.
And if it were only US bank debts, things might not be so bad for the US. But debt is seeping from lots of places. The Illinois Teachers Retirement System – their pension scheme, has been outed as being 61% underfunded. And worse those running the pension (the financial experts) decided some time ago to go for growth and to do so they made CDS bets which the pension is now on the wrong end of. With potentially collpase-to-actaul-zero sized losses quite possible for the fund.
Obama has to think what he does when thousands of pensions vapourize. Where does he get the money from to pay those debts? Bail out pensions or leave those people to drown? Banks or people? It’s the looming quesion not just in Europe but in America too.