The World Yearns for Debt Relief

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.

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About David Merkel 145 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website ( Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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