There are many debts that will not be repaid at face value. Better to recognize those realities now, and seek a compromise. What’s that, you say? Banks that lent the money won’t survive at the current market quote for the debts? Best to take the bank into conservation NOW, and strike deals with their creditors. Mark-to-market accounting should be the friend of regulators, letting them act to conserve institutions that have financed illiquid assets with liquid liabilities.
Where do we need compromises?
- In Europe, Germany, France and the Netherlands need to realize they will not get full payment from Portugal, Ireland, Italy, Greece and Spain.
- China and OPEC need to realize they will never get full payments from the US.
- Japanese citizens need to grasp that their government will never make good on all of its obligations.
- US citizens need to understand that Medicare is out of control and must be reduced, somehow.
- US citizens need to get that promised benefits to municipal pension plans are too high.
- Many mortgages are deeply under water, in the US and abroad.
- Many loans made by Chinese banks to Party projects are not money good.
If the creditors will realize that the odds of getting par are close to nil, then a real negotiation can begin where the true value of the asset can be recognized.
Our world can be productive again, once we wipe clean all of the bad debts. One thing that I admire about credit default swaps, when a credit event occurs, the process is clean and rapid, and relatively little cash changes hands. Would that it could be the same for clearing debts in our more complex world.
In one sense, this is just recognizing reality before one is forced to do so, which is an admirable discipline. The alternative is extend and pretend. Loan more money, because for some reason unknown, it will recover.
That is no relief; it only increases the burden. There needs to be reductions in principal, rather than rates. Banks that don’t agree with this need to be handed over to the FDIC.
Don’t get me wrong, this is complex, but banks need incentives to shore up their balance sheets, so that they can lend once their position is solid.
As I have said from the beginning, if you want to solve this crisis, one must reconcile all of the bad debts. Lenders need to take their hits. Governments should liquidate bad banks, but make creditors as whole as possible.