Home > Economics, Finance and money > Irresponsible borrowing and irresponsible lending

Irresponsible borrowing and irresponsible lending

Tensions in Greece are reaching melting point. And the debate is a clear and straightforward one. What we are witnessing is a propaganda battle between the forces calling for Austerity and those (perhaps indirectly) proposing Default.

Those calling for Austerity claim lazy workers, socialism and corrupt politicians created a dire fiscal problem that Greece must now pay up for. The sins of the past must be repented through public sector belt tightening (a squeezing of living standards) and large-scale land and infrastructure privatisations (i.e. asset sales).

Those calling for default state that the very Sovereignty of Greece is being challenged by external enforcement of debt peonage. Debt that was foisted on them without due care or consent.

The justification for Austerity is that Greece must own up to its responsibilities and pay back these debts. It is the honourable thing to do, we are constantly told. This mantra is voiced by many economists, politicians, the Prime Minister of Greece himself and would no doubt be the de facto position of the majority of citizens in Europe. Default is treated with emotive disdain, and the spectre of financial Armageddon is wielded around with fear-mongering fanaticism to scare any wavering spirits into submission.

The suggestion being is that default would reward the feckless and punish the prudent. However, this conclusion misses out some more profound behaviour re-enforcement which could be demonstrably more harmful.

Here are at least six very sound reasons why the implementation of Austerity would be morally, socially and legally reprehensible:

1) Shared responsibility

If a bank made a stupid loan to me or my business, who is the greater fool?

Surely, in cases of poor lending circumstances, an irresponsible lender should be just as much to blame as an irresponsible borrower. To enforce total accountability on the borrower is tantamount to supporting loan shark type tactics. In a civilised world, the lender of money has a duty of care to ensure the standard of lending, and this should manifest through the acknowledgement of accountability in times of poor judgement.

2) The symmetry of risk & reward

The voices calling for Austerity also seem to be the most vocal ones with a conservative / libertarian bent. Yet they don’t even realise the sheer hypocrisy of demanding such asymmetric punishment when the very mantra of the true Laissez-Faire Capitalist is the cure of poor investment stakes through default!

Hence the very principle of Equity Investment which correctly balances risk & reward. Debt peonage is not the symmetrical solution as defined under Libertarian principles. One has to be either deluded or an ignoramus to accept the blatant contradiction of extracting all reward (interest AND principal repayment) for no risk.

3) Incompetent lending

In addition to the concept of shared / symmetrical responsibility, it should be clear that in all respects a lender should be more accountable for bad investment decisions, as after all they are deemed to be specialists at lending. I am not a professional borrower of money, but my bank manager is a professional lender. They are deemed to be competent, qualified and professional stewards of investment capital.

So let’s review the performance of these lending professionals.

Taking the historical track record of Greek sovereign debt; it has spent 50.6% of years since 1824 in default or re-scheduling. It suffered a severe banking crisis between 1991 and 1995. This is not an auspicious start point, is it? The banking “professionals” may well proclaim that they relied on elaborate and professional risk assessment criteria using the very latest in sophisticated statistics. But a cursory examination of the situation using the techniques of one Rev’d Thomas Bayes would reveal that the Prior Probability of Greek default was in the order of 50%! And in fact, the course of events is no doubt going to support the accuracy of risk assessment by the humble Bayesian probability over the wildly naïve Gaussian statistics of high finance.

Therefore, it’s not just irresponsible lending that has happened, but incompetent lending!

Bear in mind that bankers justify very high salaries and bonuses because they claim to be very good at their job and that they perform socially beneficial activities. Clearly they are not using reliable tools for assessing levels of risk, and nor have they conducted appropriate due diligence on the country’s ability to pay. Not only this but their self-proclamations of societal benefactors is crumbling before our eyes.

4) Odious debt

So we have seen how the lender has to accept an element of responsibility, but now to turn to the borrower. What many voices seem to declare is that each of the people within Greece have been personally complicit in this excessive borrowing. But this is to accept the idea that all nationals are fully accountable for the conduct of their “representative” leaders. It is the notion of “borrowing by proxy”.

In a way our Gvt in the UK has also done this covertly. It has taken private sector debt problems and soaked up the responsibility onto the nation’s balance sheet. How many people in this country are aware that our banks have liabilities 5 times our national GDP? Was I consulted on this? Did I vote for this? Did I sign a declaration of acceptance of these terms? No, I did not.

There is a term for this situation and one which may become more prominent in months to come. It is that of “odious debt”. Debt which was incurred for purposes that do not serve the best interests of the nation, and therefore should not be enforceable:

Zerohedge – Odious debt

Iceland serves as an example of this principle in action. The people of Iceland have refused to underwrite the extraordinary liabilities of private banking institutions. They understand all too well the morally unjust nature of letting a few wealthy people prosper during the good times, and the scarper when it goes bad (in fact they are charging their Prime Minister for financial negligence for tolerating such leveraged liabilities).

5) Debt for foreclosure

Returning to the national stereotypes mentioned above, then why in the world would anyone invest money in such a country and then expect to get it back? One can’t turn around and forcefully demand the repayment of debt from a nation, whilst at the same time claim that those peoples were never really good for it in the first place. This is an overt admission of not doing one’s homework, but then still demanding full and fair entitlement. It is nothing less than a deliberate intention to ensnare.

Economist Michael Hudson tells an intriguing story of this very strategy in action more than 200 years ago in the US:

“[In] colonial times, when British speculators eyed rich New York farmland. Their ploy was to extend loans to farmers, and then call in the loans when the farmer’s ability to pay was low, before the crop was harvested. This was indeed a liquidity problem – which financial opportunists turned into an asset grab. Some lenders, to be sure, created a genuine insolvency problem by making loans beyond the ability of the farmers to pay, and then would foreclose on their land.”

“They sued under the fraudulent conveyance law, which says that if a creditor makes a loan without knowing how the debtor can pay in the normal course of business, the loan is assumed to have been made with the intent of foreclosing on property, and is deemed fraudulent.”

In other words, it is a pre-planned strategy on the part of the lender to push the borrower into such a corner that they have to sell up at firesale prices. But, clearly this strategy needs some form of social compliance and legitimacy, otherwise it would / should be deemed legally fraudulent!

To socially and legally tolerate it is to explicitly legitimise loan sharking:

“high finance is seeking to turn public infrastructure into rent-extracting tollbooths to extract economic rent (the “free lunch economy”), while replacing labour unions with non-union labour so as to work it more intensively. This new road to neoserfdom is an asset grab.”

Michael Hudson: How Bankers are using the Debt Crisis to welcome in the Financial Road to Serfdom

6) And finally, but what if the devil turns on you?

There is a scene in the play “A man for all seasons” in which the young Roper is debating with Thomas More:

More: What would you do? Cut a great road through the law to get after the Devil?
Roper: I’d cut down every law in England to do that!
More: Oh? And when the last law was down, and the Devil turned ’round on you, where would you hide, Roper, the laws all being flat?

There is a stark warning for us all in the events in Greece. If you are happy to play along with the Neoliberal asset stripping and cheer the Austerity along in other countries – then don’t complain when they turn their sights on us. As highlighted above, the UK’s implicit sovereign liabilities are 5 times our GDP (and therefore more than twice our whole country’s national wealth).

Hudson’s article later extends the actions happening in Greece to the wider western world. He situates this as a general rolling back of progressive principles which were enacted primarily Post WWII:

”The asset stripping that Europe’s bankers are demanding of Greece looks like a dress rehearsal to prevent the “I won’t pay” movement from spreading to “Indignant Citizens” movements against financial austerity in Spain, Portugal and Italy. Bankers are trying to block governments from writing down debts, stretching out loans and reducing interest rates. “

Also from Zerohedge again:

“The war between liberals and conservatives is a false divide-and-conquer dog-and-pony show created by the powers that be to keep the American people divided and distracted. So before assuming that privatization is a good thing, read on.”

America is being raped just like Greece

Certainly anyone for whom their personal interest will be clearly served through the enactment of Austerity will never even raise these points or acknowledge their legitimate discussion. But if we are to hope for an enlightened resolution to the mounting debt woes of the world, we must at least confront each one of these points with the full force of conviction. To have no debate on these points is to unconditionally surrender ourselves to economic genocide.

————————————–

Update:

This post is now available in Spanish, courtesy of Toponium.es!

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  1. David Lilley
    June 17, 2011 at 9:02 pm

    You are unwittingly making a case for no more loans to Greece.

    I have been making this case wittingly for some six weeks. Ultimately Ireland, Greece and Portugal will do a runner like Iceland. The debts are simply too big.

    Millions of people gambled that they had to get onto the property ladder before it became unaffordable. Interest rates were so low post the dotcom bubble bursting that even NINJAs could get mortgages. There was no risk in proving mortgages because (a) they were securitised as the lender could reposes the home and sell it to recoup his money and (b)the lender often sold the loan on to a very hungry market for securitised debt.

    When interest rates went up and house prices fell the property gamblers defaulted. As an example, a house buyer in Ireland gets a 100% 100,000 Euro mortgage thinking his new asset will double in value. But house prices tumble 60%. He has the choice of paying 300,000 Euro over 25 years to gain 100% equity in the house or default and let the lender take the 60,000 Euro loss. He chooses the latter. The result is that the banks assets turn into liabilities and they cannot sell the houses to recover their money. The banks turn to the state for help and the result is that mortgagee debt becomes bank debt becomes sovereign debt.

    Sovereigns turn to the IMF etc. The IMF is the world’s banker of last resort and must take this responsibility seriously. It has resued many countries including the UK in the past. We must not knock lenders.

  2. David Lilley
    June 17, 2011 at 9:26 pm

    My proposed solution to the Greek debt problem is to allow them to do what they are assured of doing. Default.

    There are no looser when it is inevitable anyway.

    The IMF, ECB and eurozone members cut their losses to that part of the 110b Euro already given. In decades to come they may get their money back just as Germany paid its WW1 debts only last year. The IMF etc will not have to throw good money after bad.

    Ireland and Portugal will go down the same route but at least their will be left in the kitty for bailouts for other countries but they shall only succeed in getting loans if they are collateralised.

  3. David Lilley
    June 17, 2011 at 9:42 pm

    The Greek people will have less debt to service and therefore less austerity. Austerity is of course their salvation as they will be the cheapest destination for holiday-makers.

    The Greek treasury note holders may not have to take a haircut and that ultimately means that you and I will not loose money. The Greeks may indeed decide to limit default to the IFM/ECB and neighbours to keep loan opportunities open from the sovereign bond market.

    The markets will take no time to recognise that the inevitable solution has been reached.

    The remaining Eurozone will rebound on the basis that it is without its poor neighbours. Germany will flourish.

    Spain and Italy will gain on the back of the knowledge that there is money left in the pot for collateralised IMF/ECB loans.

  4. john m
    June 19, 2011 at 5:33 pm

    Asset stripping seems to have moved up the scale from small family buisnesses through major manufactureers and now on to nations, all in my lifetime, [was it ever thus?] leaving a wasteland behind and always cheered on by the political class. What are the debts attatched to bhs or manu [for starters] if not odious? I can’t help but think of these operators as flees on an almost drained pig.
    michael hudson is right on the money but how to oppose when the realities are as taboo as the ownership of central banks

  5. June 20, 2011 at 8:02 am

    Hi David

    You make some interesting points in your first post. You say that “We must not knock lenders.” But my article clearly says that lenders must be at least equally complicit, if not more so, on the basis that they are deemed competent professionals to issue loans in the first place. See bullet point 3. I’m not clear from your 2nd and 3rd points, but in a way you then seem to agree that the lenders should take a hit.

    Also regarding the IMF as lender of last resort, please outline where the IMF gets its “assets” to lend out to countries like Greece?

  6. June 20, 2011 at 8:12 am

    John

    Yes, that’s right, there is layer upon layer of parasitic wealth extraction, no better than criminal loan sharking. There is an excellent comment from the cross-posting of this article on the Golem XIV blog:

    “The IMF’s solution is to follow the UK/US model of lower wages, outsourced jobs, fewer benefits and worse conditions. Then having exported/outsourced the wealth creating ability of these people they get blamed for being unable to service debts they never asked for in the first place.”

    As a parasite, the loan shark has to tread a careful line and not cause too much damage to it’s mark. If the parasite goes too far and kills the host, then it kills itself.

    The only constructive advice I can offer to prevent this sinister outcome is to educate the public on what is really happening. Many Greeks actually understand these dynamics, they were sold the promise of perpetual growth, but it was just a bear trap. Less than 1% of people in the UK fully understand this so will cheer on the Austerity.

    June 30th protests will be interesting for the UK, as we may well see the country divide into two; public vs. private sector, where the “libertarian” right will cheer on the Austerity here too.

  7. June 20, 2011 at 8:46 am

    Here’s another articulation of the issue, mainly from an “austrian” school perspective:

    http://www.zerohedge.com/article/guest-post-only-way-forward-accept-reality-default-not-end-world

    This is in-line with bullet points 1 & 2 above, whereby bad debts should be purged from the system, as the alternative (e.g. Austerity to try and make the debt payments) will only be worse:

    “Regardless of the shrill cries that civilization will end if lenders go belly up, life goes on. “Extend and pretend” only prolongs and deepens a crisis.”

  8. GeorgeS
    June 20, 2011 at 1:01 pm

    I can only think of, or liken, our current Western banking/financial system to the relationship between a drug dealer and his addict client – both aim to survive but who is to bankroll this game?
    I concur with majority of what you’re stating in the piece above but will Grecian’s [et al] comprehend and “look in the mirror”.
    From this current situation, what are the solutions and what is it we should be really planning for in the future?

  9. June 20, 2011 at 1:14 pm

    George

    Yes, there is a clear sign of “debt pushing / pimping” by the representatives of the lending class (rentiers).

    As with Michael Hudson, I see this as a desperate asset grab, to annex what remains of dwindling resource supplies on the planet. If it carries on as it is, the outcome is likely to be as follows:

    http://golemxiv-credo.blogspot.com/2011/04/guest-post-by-hawkeye-wall-street.html

    “Ultimately, every penny of every debt must be paid — if not by the borrower, then by the lender.. Inflationists and deflationists implicitly agree on this point… we differ only on the question of who, borrower or lender, will take the hit.. someone will pay. But there is a third option that is missing…the hit can be socialized.”

    The Greeks certainly seem to understand this better than us in the UK. At the moment we are bending over and taking the fiscal sodomy with only a little social discomfort. Perhaps because Cameron / Clegg / King have a slightly better bed-side manner?

  10. john m
    June 20, 2011 at 4:46 pm

    I may be wide of the mark but if the banks are allowed down this road for another year or so the time may be ripe for a general economic collapse and the abandonment of the current central [private] banking system as all the ‘member’ banks will be hopelessly bankrupt, and we could all reboot with a debt free government issued means of exchange which I thought should have been done in 2008..
    Setting aside the localised human misery caused by shifting production abroad[from anywhere to anywhere] the fundamental problem I have with it is that the production of goods is an honest cultural response to the privations and poverty imposed by the complacency and insularity of even the most benign establishment and that technological culture is in many ways the only heritage of working people anywhere and its removal leaves the fabric of wider society without a framework. Not to mention that the people who process these things are usually bereft of any useful ideas to add to the general welfare, rather like the current crop of parasites waiting to suck the nhs dry.
    when does Tyler Durden get anything done? I’m off to mine oftwominds.com blog

  11. David Lilley
    June 20, 2011 at 11:19 pm

    You don’t know where the IMF gets its money from? I,m a mechanical engineer but I know. Please check their site.

    We live on a small planet and a dissaster in a far away place affects us. The IMF, World Bank and UN are institutions created after WW2 to bring peace and stability to the world. So for that mattter is The Treaty of Rome/Common Market/EU. All have been highly sucessful in doing exactly what they were created for.

    The UK contributed about 3% to the Greek 110b euro bailout via its contribution to the IMF. I think the IMF can multiply its loan book relative to deposits in the same way that RBS managed to achieve liabilities equal to 15 time the Scotish GDP. Contributing members to the IMF fund vote on every loan and the first thing that they look for is repayment.

    The IMF is the world’s lender of last resort in that you only go there when you have so screwed up that you cannot borrow via the conventional channel of selling IOUs/Treasury bonds.

    You only have whatever the general election gives you for leadership and if they screw up the balance sheet because they are innumerate and have to go cap in hand to the IMF, then you get accountants in charge who generally sort things out pretty quick, recover their bailout funds and go forth to rescue the next basket case.

  12. June 21, 2011 at 8:08 am

    Hi David

    It was a slightly rhetorical question. The IMF gets its funding from sovereign nation accounts. The largest 5 are as follows:

    United states: 17.73 (pledged by Messrs Geitner & Bernanke)
    Japan: 6.58
    Germany: 6.13
    France: 4.52
    UK: 4.52 (pledged by Messrs Osborne & King)

    Source: http://www.imf.org/external/np/sec/memdir/members.aspx

    So, IMF funding is coming from nations which, in varying degrees, are in fact substantially in debt. So, sovereign debt is pledged by various (indebted) nations to help “bail out” indebted nations.

    Does this seem sane to you, as an engineer? And what on earth has been pledged by these nations as assets to underwrite their commitments to IMF lending? And if the US finances are so dire, why doesn’t Geitner & Bernanke reign in their IMF spending to help out the economic woes at home?

    The role of the World Bank & IMF might not be as prissy and altruistic as you describe:

    http://www.gregpalast.com/the-globalizer-who-came-in-from-the-cold/

    “Stiglitz greatest concern is that World Bank plans, devised in secrecy and driven by an absolutist ideology, are never open for discourse or dissent.”

    Are you fully confident that you understand their motives and methods?

  13. john m
    June 22, 2011 at 8:23 am

    Having read the Pallast link it’s hard not to see the greek situation as an “imf riot” or indeed the so called arab spring as the same. It must be of great comfort to the puppet masters that their control mechanisms and machinations have been rehearsed and refined over the last few decades. Now it’s Europes turn to have the social insect model society imposed.

  14. June 22, 2011 at 9:26 am

    Addendum to comment from yesterday. It seems that US defaulting to IMF is plausible:

    http://www.economicpolicyjournal.com/2011/06/stockman-warns-on-us-bond-armageddon.html?spref=tw

    “They’re attempting to go turn the prudent Europeans of the north into permanent tax slaves in order to bail out the big banks in France and Germany and elsewhere who don’t deserve a bailout,” he said, adding that, “In order to accomplish that, they will attempt to turn the millions the of people who live in southern Europe into permanent debt slaves in order to pay the piper from the guarantees coming from the north.”…“The IMF is an absurd institution,”

  15. June 26, 2011 at 8:20 pm

    I’ve tried to look at the roots of the Greek crisis in a wider context.
    Let me know what you think http://duvinrouge.org/?p=49

  16. June 29, 2011 at 2:57 pm

    Hi DVR

    I´ve posted a comment on your blog. Will spend some time going through all your posts at some point. On holiday this week so might be tricky for me to spend much time on this. In the meantime I´ve put up a link on here to your site.

    Keep up the great work.

    Hawkeye

  17. July 7, 2011 at 1:28 pm

    Hi David

    I recall that you mentioned George Soros on another thread. Here is an interesting quote from Jim Rogers, co-founder with George Soros of the Quantum fund, arguing on the BBC’s World at One that Greece should default:

    “Capitalism without bankruptcy is like Christianity without God or Jesus”.

    http://www.bbc.co.uk/iplayer/console/b0124qtk (NB: just before 27mins in). (Courtesy of blogger on Golem XIV)

  18. David Lilley
    July 7, 2011 at 11:55 pm

    Thankyou. It is always good to hear Jim. He looks like a cowboy and sounds like a cowboy. He never hesitates to answer a question with an unequivical answer off the cuff and he is always right.

    I will remind you of the Quantum Fund, an average of 35% every year for 20 years. And George always boasting that he never invested but rather sold a position before he even had to pay for it. Gaining massive wealth and giving it all away to the promotion of the Open Society, some £500m per year.

    We should all read Popper’s “The Open Society and Its Enemies”.

  19. David Lilley
    September 21, 2011 at 8:58 pm

    Today’s news from the biggest lender of last resort, The FED.

    The full transcript is on the Telegraph site.

    If any one thought there would be QE3 they were wrong. Central Banks
    don’t make surprise moves as that leads investors etc to think they
    know something terrible. They always trail their moves well in advance
    and on this occassion the trail was sell short term bonds and buy long
    term bonds, advise that low interest rates were here for another two
    years and put pressure on legislators to do something as it was now
    entirely in their court (reduce the deficit, raise taxes and reduce
    entitlements).

    The market reaction was to wait all day in negative territory, rise a
    touch on the announcement and then crash 2.5% in the last two hours of

    trade.

    An impass in Europe, the US and now little from the FED.

    The only solution now is for the G20 to agree global QE. Without it we
    face a Leman 2 and a second Great Depression, protectionism, civil
    unrest and wars without the funding of UN and US peace keepers..

    The IMF is getting heavy with Greece and that is because its members
    have to put up the money and cannot afford to loose their money just
    like the Germans cannot. German hostility to further funding will be
    multiplied by the fact that German pension funds have just lost 30% as
    the DAX fell from 7400 to 5400 in the last few weeks.

    I have argued that Greece is not too big to fail as it is only a tiny
    economy, any future loans should be collateralised and we will all get
    over a Greek default in a week and everyone will benefit including the
    Greeks. Any one with a Greek position has had two years to reduce it.

  20. September 22, 2011 at 9:46 am

    David

    Yes, the smart money has probably pulled out of Greece long ago, leaving the tax payers and pension holders to carry the can. The savings and investments of the average person are heavily wedded to the mainstream optimistic assumption of the future. Whereas the big guns are probably going defensive (hard assets and currency & equity hedges).

    If you’re interested in following the technical developments of this crisis then I wholeheartedly recommend Zerohedge:

    http://www.zerohedge.com/

  21. October 8, 2011 at 8:52 am

    An interesting narrative of excessive personal indebtedness in the UK dating back to 2005:

    http://news.bbc.co.uk/1/hi/business/4426222.stm

    So who is really at fault? The debt junkies or the debt pushers?

  22. June 29, 2012 at 11:55 am

    This chart of Bond Yields just goes to show that the 1998 – 2008 era was unusually “optimistic” in terms of Gvt finances:

    http://i.imgur.com/w8aAS.png

    The “market” believed that these were “safe” investments and that they must have presumed that Gvt finances were ship-shape. The yields prior to 1998 clearly demonstrate that this was a completely false premise.

    - Did Gvts suddenly become saints in the 2000′s?

    - Was the market completely confident that it could ignore historical rates (and in Greece’s case a severe banking crisis in the early 1990s)?

    - Did Gvts have legitimate reasons to be complacent about borrowing levels, given that the market was confidently lending to them at historically low costs?

    Clearly Bond yields are only going to move in one direction. At least back to early 1990s levels, if not higher.

    Is this a clear-cut case of Trojan Horse “Teaser Rates”, used to take-out European economies?

    http://en.wikipedia.org/wiki/Teaser_rate

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