The Big Bailout: Where have we seen this before?

Posted by Marc Hodak on May 10, 2010 under Governance, Scandal | Read the First Comment

No, I’m not referring to TARP.  The bailout of America’s banks was counteracting what could credibly be considered a liquidity crisis.  The Europeans are providing the same medicine for a very different ailment:

The European Union agreed on an audacious €750 billion ($955 billion) bailout plan in an effort to stanch a burgeoning sovereign debt crisis that began in Greece but now threatens the stability of financial markets world-wide…

Immediately after the announcement, the European Central Bank said it is ready to buy euro-zone government and private bonds “to ensure depth and liquidity” in markets.

A liquidity crisis is when private banks generally refuse to lend money to anyone regardless of credit because they’re afraid that they might get caught short on their own cash needs.  When private banks refuse to give more money to a spendthrift borrower, that’s prudent lending practice.  When a collection of sovereign nations backs the loans of a spendthrift nation (especially knowing that they are inviting other spendthrift nations to continue their indulgence), they are simply shifting risk from private banks onto taxpayers.  In this context, the soaring stock market we’re seeing in response to this shift is entirely understandable.  But it would be paralleled by a similar decline in the value of taxpaying households, if that were being tracked in any kind of transparent market, since that is where this value is unarguably coming from.

That’s bad enough.  The real problem is with how the EU is proposing to execute this massive value shift:

The money would be available to rescue euro-zone economies that get into financial troubles. The plan would consist of €440 billion of loans from euro-zone governments, €60 billion from an EU emergency fund and €250 billion from the International Monetary Fund.

Those €440 billion of loans would be borrowed through a debt facility guaranteed by the euro states via a special purpose vehicle (SPV).  That’s like a company borrowing enough money to bet the whole firm via an SPV backed by its own shares.  Where have we seen this before?  If you’ve taken my History of Scandal course, would have guessed it.  It’s like having the house double-down on failure.

  • David Lee Berkowitz said,


    I understand the outrage but there was a liquidity crisis brewing. It wasn’t until Wednesday night that the crisis was just a solvency crisis – then interbank rates started to climb and all of sudden the banks in Germany wouldn’t lend to the French because noone knew who held what debt and more important, who sold insurance (CDS) on the sovereign debt back when all EU members borrowed at rates like they were Germany.

    The market crash in the US and the decline in euro stock markets was similar to “sell anything where there is a market kind of panic” – probably European banks (or US investment banks who knew) who figured that soon they would have a problem borrowing short.

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