Too Big to Bail

From the IMF, the long awaited September 2011 Global Financial Stability Report Chapter One comments on China.  Highlights from Box 1.5, shown in its entirety below:

• projecting significant write-downs of public sector liabilities, which amount to 27% of GDP
• total debt 173% of GDP
• rapid growth in off-balance sheet and non-bank loans
• 60%+ surge in property prices since YE 2006, yet many new projects unoccupied
• authorities' efforts to cool property speculation might induce sharp correction
• real estate correction = more pressure on local govts, which rely heavily on land sale revenue
• Chinese bank stocks have fallen from 2.8 X book value in late 2010 to 1.6 X
• Property developers funding costs have shot up as high as 16% in offshore market
• Growth in sovereign CDS and renminbi put options reflects growing investor concern

These are not the qualities one usually seeks in a rescuer...

As I've observed many times in these pages, the entire global financial recovery has been built on bailouts.  The Fed bails out banks and sovereigns; the ECB bails out Greece; China bails out the US and Euro zone.  Wash, rinse and spin until, finally, there's no one left to do the bailing.   Perhaps China will inspire a new moniker:  "Too Big to Bail."

At some point, recoveries require growth and employment.  Underlying growth has been negligible, as families here and abroad have been left to their own devices to deal with devastating unemployment, plummeting property values, rising inflation and, now, cutbacks in social services.

Reimbursing banks for losses from bad investment decisions has done little to improve the financial stability of everyday people.  Families in Greece, Ireland, Iceland, Portugal, Italy and Spain have learned they're expendable, collateral damage in a war over collateral.

Now, Americans are learning they're next.  Bernanke's trillions may have delayed the day of reckoning for bankers.  But, for the millions who've lost a home to foreclosure or a job to a Chinese day laborer; it's here (and, cutting Medicare, Social Security, Veterans Benefits and unemployment compensation won't help -- at least not in the short run.)

The boot on the necks of those afflicted is debt, plain and simple.  There's way too much of it, and it often exceeds the value of the underlying collateral, not to mention the ability of the debtor to pay it off.   It's true for American families, and it's true for the country.

source: CBO

The U.S. takes in just over $2 trillion annually in taxes.  We spend around $3.5 trillion, including $200 billion in interest payments.  But, that's with 10-year treasury's at 2% and 90 day bills at 2 bps.  

What happens if we go back to 1980's conditions, with the 10-year at 10% and bills at 15%?  If debt remained at only $15 trillion, annual debt service would skyrocket to over $1 trillion, dwarfing expenditures on defense, medicare/medicaid and social security.  Even at 2000's rates of around 6% for bills and notes, debt service would triple -- rivaling every other category.  Which of those categories can we afford to replace with interest payments?

Instead of dealing with our budget shortfalls we've turned to counties like China to finance them (with money Americans have paid for their cheap crap produced by an army of dollar-a-day laborers.)  Now, like the snake who's discovered it is eating its own tail, we learn that the cycle might just be broken.  

Instead of continuing to recycle those dollars back to us, China has squandered them on an American-style real estate and development binge.  We're heading toward a cliff on a bus that's losing its wheels.

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The remainder of the report is equally interesting, and well worth the time.  The full text of the China Section, Box 1.5: