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Remember 2007 when the subprime mortgage crisis began to unravel? If you recall, the cracks in the real estate market were exposed. And the problems kept spreading. First it was small mortgage lenders that went bust. Then it became evident the entire financial system was going down.
But contrary to the glaring evidence, the three most influential figures in the United States — President Bush, Treasury Secretary Paulson, and Fed Chairman Bernanke — stood before cameras, time after time, telling the public not to worry. “The subprime crisis is contained,” they professed.
Soon thereafter, Paulson went to Congress asking for $700 billion to avert a total global meltdown.
After that, the message from government officials changed on a dime. The big three stood before the people telling them it was time to worry! They declared that the massive emergency Troubled Asset Relief Program (TARP) was absolutely critical.
“Otherwise,” they warned listeners …
“More banks could fail, including some in your community. The stock market might drop even more, which will reduce the value of your retirement account. The value of your home could plummet. Foreclosures could rise dramatically. And if you own a business or a farm, you’ll find it harder and more expensive to get credit.
“More businesses will close their doors, and millions of Americans could lose their jobs. Even if you have good credit history, it’ll be more difficult for you to get the loans you need to buy a car or send your children to college. And ultimately, our country could experience a long and painful recession.”
Well, they got the $700 billion. And we still got all of the above, plus more!
Those who bought into the confidence-massaging campaign were led like sheep to walk off the edge of the cliff. Many were caught on the wrong side of a collapse in global financial markets, a freeze in global credit, and were sideswiped by the sharpest downturn in global economies since the Great Depression.
While the fallout from this crisis remains with us today and the economic outlook uncertain, there’s another act to this saga that is ongoing. And the script reads in a similar way.
This time, however …
Its Roots Are in Europe
But it’s not private debt that’s exposing the world to another wave of global crisis, rather it’s public debt. And for the past year, we’ve witnessed more government campaigns to shore up confidence by European officials who have:
- Said it was contained,
- Rolled out numerous plans to resolve the crisis, and
- Denied that any country in the euro zone would fail.
Yet we continue to see the dominoes of an unsolvable sovereign debt crisis in Europe fall, and the probability of the default of a European monetary union member country rise. They’ve managed to extend the timeline of the fallout, but they’ve done nothing to change what seems to be its inevitable fate.
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The fact is the euro-zone debt crisis could make the subprime crisis look like just the opening act. Euro-zone banks are heavily exposed to sovereign debt of weak euro members. And asking creditors to take a haircut on their investments means banks in Europe would have to eat losses.
That’s exactly what European officials are trying to avoid!
Instead, through the rules set by the EU and IMF for doling out rescue funds, it’s the people who are asked to absorb all of the pain through tough austerity measures. But the people are beginning to rise up and demand that the burden be shared.
Now we have …
Portugal, the Next Falling Domino
First it was Greece, then Ireland, and now Portugal looks like it’s days away from requesting a lifeline.
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This week, Portuguese Prime Minister Socrates presented his plan of tough austerity measures to Parliament, to reign in the unsustainable debt and deficits that have put the country on the edge of insolvency. Portugal’s parliament voted it down. Socrates promptly resigned.
Consequently, Portugal has sent a clear message to the EU/IMF leadership: The people are not willing to absorb all of the pain!
But if the weak countries reject a rescue, it would destabilize the financial system. And if the EU/IMF compromises its terms for rescuing the weak by making creditors share the burden, it would endanger the financial system.
Simply put: It’s a no-win all the way around.
The question is then: Will Portugal be the lynchpin that collapses the euro? If so, expect the reverberations to be felt across all markets.
Regards,
Bryan
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