James Max - TV / Radio Presenter | Property Expert

Bailouts only work on boats…not banks

Another dreadful day on the markets. The Euro is spinning out of control. Sticking plasters are all over a massive and increasingly gaping wound. And most of the Eurocrats think they have done enough so they can go off on holiday. Wrong. They haven’t.

This is a crisis. A real crisis and it’s one that needs sorting out right now.

There’s nothing wrong with debt. Yet there’s everything wrong with spiralling debt. It might sound as if I am talking cross-purposes but to understand why the Euro crisis is so corrosive we need to get a grip on an economic fundamental. There is good and bad debt.

Good debt is money that is easily borrowed, paid for and paid back. Bad debt is money that is borrowed, where the servicing of that debt is difficult and paying back of the final amount is almost impossible. And that’s the situation in Europe at the moment.

There are those who think that all debt is bad. I don’t subscribe to that theory. After a long career in property, investment banking and private equity, debt used sensibly can free up capital for other things. It can also improve your returns and again, sensibly arranged can be a very tax efficient way of structuring a transaction. During the noughties many lenders forgot the art of making a good loan. They mixed a debt product with quasi equity and charged the same kind of rate for the whole debt without thinking about the consequences. It’s the same when applying debt rules to a country. Given the enormous earning capacity of a nation, some debt is actually a good thing.

Think about it this way. If you have a house that is worth £100,000. If I lend you £50,000 and you can pay off the interest because that interest rate is affordable then in essence that is a good loan. Why? Not only can you pay off the interest but you can also sell the property and pay back the debt if needs be. You can then use that £50,000 for other things. What if I lend you £95,000? Perhaps for a while you can pay the interest bills. What if you lose our job? Sell the property and you can pay off the debt. What if the property market has dropped 20% and your home is worth only £80,000? Then you are under water. That’s bad debt. The lender took a position that could never be repaid and you, the borrower over exposed your position. Now the economy may have had its fix from the extra money you spent but the benefit has vanished if there is a loss incurred from a bad loan.

And that’s what has happened in Greece, Spain, Ireland, Portugal and now perhaps in Italy too. All these countries have borrowed too much money. Instead of being loans in fact lenders have been making investments. Investments based on the continued economic performance of the country. As lenders realised what they have done so markets price in risk to the debt, putting up the interest rates. When the interest rates rise the debt becomes less affordable and so the spiral gains traction. Once one debt is rendered “bad” so lenders look at all their holdings and begin to mark to market. Contagion or the spread of concern affects the markets.

Europe has taken on these problems by guaranteeing loans. Artificially using strong countries to bankroll the borrowings of weaker ones. It cannot continue. Indeed for those politicians who say we should cut less, or spend through recession and borrow until the storm has passed – they had better wake up. You can only use debt to cushion the effects of a recession if debt is investing in the future and if that debt will be paid back in time.

For those advocating that we simply need to borrow more or print more money are simply looking to the next election rather than for future generations. When governments continue to pay for pensions and services that are not productive investment into the economy, then you are simply putting off the inevitable. As a country you need to live within your means. Like any household that means having debt that is manageable and an economy that encourages and rewards those who make money as opposed to earning it.

The Euro crisis is not going to go away. The EU has become a self-serving beast of an institution that looks after and feeds itself rather than the people it’s purported to serve. Similarly the Euro is a political dream that is turning into a nightmare. The realisation that the markets will price a product according to risk rather than political will or might.

Europe and America have been on a debt binge. This has led to an addiction. The addiction is being fed by the decisions of a centralised body that is feeding a habit rather than curing it. The first step to recovery is admission. Admission that you have a problem as opposed to denial. Deficit deniers had better wake up and wake up fast. For a while we will all have to get used to having a little less and making what we do have go a little further.

As we listen to the European politicians, one has to wonder whether they are capable of sorting out this problem. This is not just a markets problem. It isn’t just an economic one either. This is a political one too. The simple point is this. If economies are not growing, you cannot borrow your way out of a crisis. If you are seeking to grow your economy by borrowing, then spending that money on benefits, healthcare, public sector jobs and your political system, then you are simply creating a sugar rush. In the short term you might see a little growth off the back of this expenditure.

Is there a solution? Of course. Spend less. Borrow less. Tax less. Invest more, incentivise more and educate more. This is a long-term solution. Yet the Euro won’t survive until the Eurocrats face up to the reality of the problem. The currency is broken, the policies are not working and more debt is not the answer. Merely a stopgap solution.

In Britain we are saying the right things. But not doing enough. There is still far too much waste. We have allowed people to have too much say in important infrastructure and review processes which holds up investments and creates wastage in money allocated. The sooner we realise that money needs to be invested, wastage cut, public spending slashed and personal responsibility increased, the better. Sadly politicians of all sides are more interested in winning the next election and blaming others rather than dealing with the problem in hand.

 

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