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Daniel Wagner

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Stop the Delusion: The 'Double Dip' Is Here

Posted: 09/25/11 06:48 PM ET

Unless one is in the habit of considering night to be day and down to be up, there really can be no denying that the world is now formally entering a 'double dip' recession -- though it is better thought of as 'the continuation of the Great' recession, for that recession never ended. Yes, the economists will say that in fact we had a "V"-shaped recession and recovery since 2009, but some fundamental elements of a classic V-shaped recovery simply never materialized -- such as a meaningful reduction in the unemployment rate, a real recovery in the housing sector, and conviction in believing we actually just experienced a recovery. The fact is, much of the pain that has been endured since 2009 remains ever present in the lives and minds of many individuals, and the balance sheets of many businesses -- large and small. And as we are now seeing -- again -- in the financial sector, another round of painful layoffs and debt reductions are in full swing.

So all those talking heads on CNBC who appear with a straight face during a week when the market is tanking and declare that what we are witnessing is a 'breather' in a bull market, or that a sustainable rally is right around the corner, are either living in cloud cuckoo land or purposely deluding themselves and their viewers. After all that has happened to strengthen corporate governance and transparency over the past decade, nothing still prevents someone from getting on television and stating what any rational person would conclude is a bald-faced lie. I am mystified as to why economists and money managers insist on trying to predict what will happen next quarter or next year based on what has happened in the past. We simply haven't been here before -- ever -- and the truth is no one truly knows what will happen next.

What I do know is that we are indeed staring -- again -- at the edge of an economy abyss, and we got here -- again -- in part by a) deluding ourselves that everything will be fine if we just give it some more time, and b) believing that throwing good money after bad is a bet worth making. At least one ratings agency -- S&P -- had the guts to call a spade a spade and downgrade the U.S. If the U.S. government were a company, it would have been declared bankrupt a long time ago. Why should countries be treated differently than companies, I wonder? Are we doing ourselves some sort of favor by denying the truth and believing that printing money is either 'the answer' or a sustainable solution?

I now belong to the liquidationist theory of economics, which says that those companies and countries that genuinely deserve to fail should be allowed to do so. Painful as it would be, it would allow the dead wood to be cleared out of the forest and make room for the green sprouts that will ultimately permit revitalized economies and sustainable growth in the long-term. Merely putting a band aid over a gaping wound has proven to be foolish and ineffective. Can it be in our collective long-term interest to continue to do so? Is a system that is inherently flawed worth saving? No.

During the IMF's annual meetings this weekend, the Fund released an explosive report that has revealed a $200 billion hole in the European banking system. According to Britain's The Independent, IMF researchers did what Eurozone regulators refused to do, and calculated how much European banks would lose if European periphery states defaulted on part of their sovereign debt. The researchers calculated the write-downs that would be necessary on the sovereign debt of Greece, Ireland, Spain, Italy, Portugal and Belgium implied by the movements of the credit default swap market since 2009. Then they applied those write-downs to the stock holdings of European debt held by European banks. Some European banks have already made provisions for these losses, but many continue to value these bonds as if they are going to be paid off -- in full -- which they clearly are not.

So Christine Lagarde wants the European Central Bank to recapitalize the banks that need it -- in essence continuing to throw good money after bad, and in my view, simply delaying the inevitable and ultimately making the problem even worse. How does 'nationalizing' the problem solve it? And why should taxpayers 'eat' these tremendous losses, which are, in the end, based on bad investment decisions, spendthrift habits, and greed. If individual investors or companies make such decisions, are they bailed out by taxpayers? Certainly not. So why should a different set of rules apply to countries? Yes, I understand that the stakes are much higher, but, so what? The prescriptions that have been applied to date certainly haven't worked.

When last summer the European Banking Authority conducted stress tests of European banks, it found that although 16 of them were judged to be in danger of failing, no French banks were found to have inadequate capital reserves -- even though French banks hold more than 9 billion euros of Greek sovereign debt. Last week, eight Greek banks were downgraded by Moody's; two of them (Emporiki Bank and Generali Bank) are majority-owned by French banks Credit Agricole and Societe Generale. So, knowing everything the EBA knows about what is happening in Europe, how could it possibly have said that 'no' French banks will require recapitalization? The head of the French market regulator admitted last week that recapitalization will indeed be required.

I really don't understand why some governments, bank regulators and international policy makers continue to imply that continuing to print money and inject cash into a deathly ill financial system is going to resolve the extremely serious problems the global economy faces. I also don't understand why more people aren't saying this is simply ridiculous, and bordering on madness. Perhaps we deserve to head right into a depression. Maybe that will snap everyone out of their self-induced coma and force us all to address, in an honest manner, the very difficult questions that continue to stare us in the face.

*Daniel Wagner is CEO of Country Risk Solutions, a political risk consulting firm based in Connecticut (USA), and author of the forthcoming book Managing Country Risk (Taylor and Francis, March 2012).

 

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