How likely is it that the eurozone will solve its debt problems in three weeks?

Posted on 15 October 2011 with 1 comment from readers

Stock markets are rising again. This time on what would appear to be the most unlikely event in the universe. Namely that the eurozone will somehow solve its utterly intractable and highly complicated debt problems in time for the G20 meeting in three weeks.

Now stock market fortunes can be made by betting on highly probable events. But by betting on the highly improbable? That’s a madness every bit as unreal as the debt crisis itself.

Bank insolvency

How did eurozone banks come to lend to insolvent sovereigns thereby rendering themselves insolvent? Well, the banks were handed out money from the 2008-9 bailouts by the sovereigns and lent it, often under compulsion, back to the same governments.

With interest rates on ’safe’ sovereign debt comfortably higher than bailout funds it was a slam dunk. Only as with all cannot-lose schemes it went wrong. For a whole clutch of eurozone nations’ sovereign bonds have now plummeted in value and their interest rates have soared.

For the banks who count these bonds as assets on their balance sheets that leaves them insolvent. Now what can governements do? It was their lending to the banks that got them insolvent, so will more lending to them help or make things worse?

Can the banks raise new funds from the markets? Not with their share prices at current levels for very good reasons. No they are bankrupt.

What is needed is for a whole series of banks to go bankrupt. Then you lose the bad debts and level the playing field. But you do risk an awful lot of collateral damage, so to speak, in the process. Not just the bank’s collateral but the public purse will be exposed.

But if you go along with the US solution to the eurozone you just pump up an unsustainable bubble of bank debt for one last time. Then the bubble will be even bigger when it blows up.

G20 meeting

Instead of bankrupting Greece, Portugal and Ireland, you will also have Spain and Italy facing national ruin with France on the brink. Could a body as amorphous as the G20 meeting of world leaders actually agree something like this?

Obviously not, they want a consensus on a bailout not a controlled implosion of global debt. But perhaps we are looking to the wrong place for a decision on this. It is the same markets that are currently moving a bit higher on some odd hopes about the future and low volumes that will cast their vote.

A mad panic meltdown is the classic response to a total loss of confidence.