Rescuing Creditors?! ... Setting An Empty Table

I read two interesting commentaries today. There is a piece in the Financial Times by George Soros titled "How to Capitalize Banks and Save Finance." There was also a piece by Michael Hudson over on Counterpunch. The Soros piece argues that the US Treasury should ask banks how much money they need to reach their capital reserve requirement of about 8%. Then, trusting that the bankers have not gilded the lily, send them some cash post haste in exchange for special company shares of stock that would protect shareholder value by not really counting as normal shares. The idea behind this and similar schemes (a similar scheme is, in fact, in the works) is to get the financial institutions to a place where they can extend more credit to a troubled economy.

Michael Hudson essentially covers the same ground in terms of describing the assorted and sundry "rescue operations" currently in the works. But Hudson is not happy about any of these schemes. They are, in effect, schemes to allow those who have profited hansomely over the past few decades to either (1) reflate the debt pyramid and profit some more using a business-as-usual bag of financial tricks, or (2) allow these same high-fliers enough cover to sell the toxic crap in the bank vaults to a greater fool and send the profits into various private accounts and leaving the remaining smoking heap to whatever fool takes it off of their hands (in this case, the United States Treasury -- and its tax payer).

But, Hudson adds more than just about anyone in the financial press has been discussing in the past several weeks. Hudson summarizes his reading of the schemes,

Making banks and insurers in the zero-sum derivative game whole, so that winners can collect their bets while losers can sell their bad investments to the Treasury, is supposed to re-inflate the credit pyramid. The idea is to solve the debt problem with yet more debt to prop up housing prices once again to unaffordable levels! This is not a long-term solution, but it would give insiders enough time to arrange a do-over and get out of the game more quickly, to sell out their junk mortgages and junk bonds to the proverbial “greater fool” – in this case, the “greater fool of last resort,” the U.S. Treasury.

But, and this is the part no one else talks about very often outside of the financial blogs,

The banks are to “earn” their way out of their negative equity position by selling more of their product – credit – to increase the economy’s debt levels and hence receive more interest payments. The problem is that most families are already “loaned up.” They have no more discretionary income to pledge to carry more debt. Without writing down their debts, there will be no fresh lending, and hence no source of credit and purchasing power for new autos, appliances, goods and services in general.

So, the idea is that we need to "make the banks whole" so they can start reflating the global debt bubble by offering minty fresh new credit to consumers around the world. Soros even suggests that once the treasury has recapitalized the solvent financial institutions to the 8% statutory capital requirement, that regulators allow them to lower minimum capital requirements so that they may once again loan out all of their capital and then some. The main goal, it seems is to get the credit out there and get it out there soon!

Ah ... but Hudson has thrown a wet blanket on the whole scheme. Debtors can not swallow more credit. Bankers can pretend that if they hand out credit to over leveraged borrowers, that the debtors will take on new debt, but wishing cannot make it so. So, the inevitable situation is that some creditors will be willing and able to extend the credit ... but the amount of new debt that borrowers take will not out pace the rate of credit destruction that occurs naturally when borrowers pay down their debts. New credit must constantly be introduced into the system to (1) replace the credit that is removed when borrowers make their payments and (2) cover the amount of interest owed on past credit extended. But, when borrowers cannot or will not take additional risks in betting on their future prosperity, new credit cannot bet turned into new debt at levels that will sustain the system at its peak, much less keep it growing. Doug Noland estimates that 2 trillion dollars of new credit must be created this year alone to keep the party from cratering. He's not optimistic (but hopeful). So, debt deflation is the inevitable outcome.

Ah ... so there's the 800 pound gorilla on the bankers table. They scream for any sort of state support to prop up their business, refusing to take any more losses after a decade on mindless financial shenanigans. They hope the consumer can swallow more of their junk to keep the current business model in place at least long enough to keep their net worth positive while off loading their bad bets onto the state. But, the real economy cannot possibly cooperate with the fantasy economy known as global finance. I suppose reality does bite after all.