What If Europe “Marked-to-Market”?

“The now inevitable restructuring of eurozone debt…”

So writes Jim Millstein, Chairman of Millstein & Co. and former chief restructuring officer of the US Treasury Department. (link)

Have people really come to accept this fact?

The full sentence: reads “The now inevitable restructuring of eurozone debt will result in bank capital deficiencies that the IMF estimates could exceed €300 billion.”

Now, what if we added a European recession on top of this, a recession that would slow down government receipts and increase unemployment payments and so forth?

Just out this morning: “A rebound in German and French growth propelled a modest expansion of the eurozone economy in the third quarter of this year – but failed to dispel fears of a looming recession across the 17-country region.

Eurozone gross domestic product expanded 0.2 per cent compared with the previous three months – the same pace of expansion as in the second quarter, according to Eurostat, the European Union’s statistical office. But with the escalating debt crisis already feeding into falling factory production, growth may already have gone into reverse, economists warned.” (link)

Are we coming to the end game?

Angela Merkel, the German chancellor, is now calling for a political union of Europe as the only way to “underpin” the euro and help the members of Europe emerge from their “toughest hour since the second world war.”

Doom and gloom seem to be all around us. Just in the past two days we have articles like “New Austerity Incites a Bitterness the Postwar Generation Did Without,” (link) and David Brook’s “Let’s All Feel Superior,” (link). Also, this morning there is a review of Niall Ferguson’s new book “Civilization” whose subject matter is “the end of western civilization as we know it” (link).

Do these pieces of information point to the existence of a debt deflation cycle that is at the opposite end of the spectrum from the credit inflation cycle that we have been going through for the past fifty years? (link)

The solutions Mr. Millstein proposes for the writing down of European sovereign debt are focused on the banking system and the estimated bank capital deficiencies. But, part of the solution involves more debt: “a federal financial body, such as the European Investment Bank, must provide a capital backstop…” In other words, more debt!

But, “To give it the firepower it needs for the size of the problem, the EIB must be empowered to raise debt supported by a stream of new tax revenues dedicated to retire the debt incurred.” And, “the EIB’s capital backstop should be funded through a new federal tax on bank salaries and profits above defined levels.”

This does not seem like a solution to me. The solution to the problem of too much debt around is not more debt and more taxes. Yet that seems to be the best that many people can come up with. However, this seems to me to be more of the same “thinking” that got us into this situation.

This brings me back to the opening quote: “The now inevitable restructuring of eurozone debt…”

The European problem is not a new one; it has been growing for several years now. Government officials have just not been willing to accept the reality of the situation and economists have helped them to hide their heads in the sand by arguing that Europe’s problem has been one of “liquidity” and not one of “solvency.”

If the problem is one of “liquidity” then a bank…or, anybody else…does not have to mark down an asset because the bank will, they say, hold the asset until it matures. If the bank accepted the fact that the asset was experiencing difficulties then it would have to “mark” the value of the asset down. But, this admits that something might be wrong…and people don’t like to admit that a mistake might have been made.

And, as Steven Covey has stated, “if the problem is ‘out there’, that is the problem!” Even a month ago, European officials were still claiming that their problem was one of “liquidity” brought on by speculators and other “greedy bastards.” And, if the problem was someone else’s fault, real solutions could be postponed. And that is what these officials did.

“Solvency” problems, however, do not just go away. First, “solvency” problems have to be recognized…people have to “own” them before anything can be done about them.

I am still not convinced that we have arrived at that point. Yes, we have an editorial piece in the Financial Times that declares that “the inevitable restructuring of eurozone debt” must take place. However, eurozone governments, I don’t believe, generally accept this conclusion.

Until eurozone officials do accept the fact that “all” eurozone debt must be restructured, the problem will still be that these officials do not accept the fact that their debt must be restructured. And, this is no solution.

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