Recovering from Neoliberal Disaster

[A_52]

http://wikileaks.org/wiki/Recovering_from_Neoliberal_Disaster

In a way the above article discusses debt that is beyond any reasonable way to repay.

I asked Thomas Woods about debt destruction and he referred me to this forum. My understanding is that capital put at risk [that is debt] is destroyed if the venture fails. So it appears necessary in a free market that debt is destroyed, and everyone has to move on. The FDIC is created supposedly to protect depositors from loss, but has the unintended consequence of also preserving debt. Failed banks are sold to solvent banks, and any debt is transferred to the books of the new bank less debt that is written off. FDIC insurance is to be paid by banks themselves, but it seems to the extent the financial conditions of many banks are at issue, a moral hazard is created for tax payers as well. Beyond FDIC, the government has created moral hazard in insurance, former investment banks, stock accounts and certain auto companies. Peter Schiff does a goo job in explaining how bad this is. This moral hazard is a horrible thing to be dumped on taxpayers, but if they have investments at risk, I suppose they don’t have a problem with it. If they don’t have investments, they should be livid.

If I am reading the article correctly, the central bank [or bankers] of England wants its money back from Iceland. Iceland complains that they can’t pay, and England uses all it power to coerce repayment. Iceland rejects this forced repayment. A solution is found in the debt will be repaid according to Iceland’s ability to repay. The author then declares neoliberalism dead and a new dawn in international banking has arrived.

To me, debt has been saved from the hands of destruction which it deserved. He seems to blame deregulation of banks as the culprit, and I suppose the Austrians would just say poor investing.

I’m with him on his observation that certain central banks took advantage of the sovereign funds of naive countries and then went on a spending spree with the capital. In the case of Iceland a narrow layer of Icelanders borrowed leaving the moral hazard to those that didn’t cash out. If that’s true, why would the citizens of Iceland feel any moral obligation to repay the debt at all if they didn’t borrow excessively?

I’m pretty sure the US is going to face this same debt problem, and I was wondering how the Austrians would deal with it, if at all. Would it be so bad if the international bank system absorbed their losses for once instead of trying to harness the people in a free market to pay bad debt back?

I assume the solution Iceland was given is what the international banking community will expect worldwide.

I hate to see free markets blamed when this is really an international banker’s problem with the help of government policies.

I discovered Mises.org a couple of months ago and am spending a lot of time with my Iphone listening to the audiobooks from the site. Thanks for providing these wonderful audios.

[liberty_student]

You’ve got a lot going on in this post, and the article you linked to is really long as well.

Maybe just narrow down to one specific question you have, and allow the conversation to open up from there.

[krazy_kaju]

Your post is a little hard to follow, so perhaps you should narrow it down as Liberty Student suggested. But here is my response:

@A_52

My understanding is that capital put at risk [that is debt] is destroyed if the venture fails

“Capital” in the true economic sense of the term is not being put at risk. Money is - that’s part of the reason why you have to pay interest on money you borrow.

Also, no money is being “destroyed” if a venture fails. If a venture fails, it simply means that it has operated at a loss - it has spent more than it has gained in revenues. The money lost by the said venture is in no way lost. It is simply somewhere else within the economy. In other words, someone else has that money, but not the failed venture.

@A_52

Failed banks are sold to solvent banks, and any debt is transferred to the books of the new bank less debt that is written off.

This process can happen in a free market too, if a bank fails and is bought up by another bank.

@A_52

FDIC insurance is to be paid by banks themselves, but it seems to the extent the financial conditions of many banks are at issue, a moral hazard is created for tax payers as well.

I’m not quite sure what you’re saying here.

This is what the FDIC does: it takes money from all banks to insure their deposits. Thus, banks are rewarded for taking higher risk, since they all receive the same insurance for the same price. This means that a high-risk, high-return bank gets the same insurance for the same price that a low-risk, low-return bank. The result is that more banks put more of their assets into high risk operations.

The nature of FDIC insurance also creates incentives for the average person to put their money into higher risk banks, since their deposits are covered at no cost to the depositor and since higher risk banks offer higher returns.

@A_52

If I am reading the article correctly, the central bank [or bankers] of England wants its money back from Iceland. Iceland complains that they can’t pay, and England uses all it power to coerce repayment. Iceland rejects this forced repayment. A solution is found in the debt will be repaid according to Iceland’s ability to repay.

The free market solution is to have the Icelandic debtors declare bankruptcy and have their assets divided among their British creditors. An alternative would be to have the Icelandic debtors repay only a portion of the debt they own to their British creditors.

@A_52

The author then declares neoliberalism dead and a new dawn in international banking has arrived.

What is the author’s reasoning?

@A_52

He seems to blame deregulation of banks as the culprit, and I suppose the Austrians would just say poor investing.

No. The true culprit is a combination of central banking and distorted incentives via subsidies and the regulatory powers of various countries.

@A_52

In the case of Iceland a narrow layer of Icelanders borrowed leaving the moral hazard to those that didn’t cash out. If that’s true, why would the citizens of Iceland feel any moral obligation to repay the debt at all if they didn’t borrow excessively?

I’m pretty sure the US is going to face this same debt problem, and I was wondering how the Austrians would deal with it, if at all. Would it be so bad if the international bank system absorbed their losses for once instead of trying to harness the people in a free market to pay bad debt back?

I’m not sure what you’re saying here, again.

The libertarian/capitalist/free market response is to have the debtors either repay their debt or to go bankrupt. This would clear the market and allow economic growth to resume.

[A_52]

The libertarian/capitalist/free market response is to have the debtors either repay their debt or to go bankrupt. This would clear the market and allow economic growth to resume.

I guess I would ask who exactly declares bankruptcy. I am not trying to be difficult. Iceland privatized its banks, and now its government is being held accountable for losses by its citizens, many of whom are innocent. If the banks were privatized or purchased by London, where is the government liability.

I realize capital is not destroyed, it is transferred to someone else. The debt is liquidated through sale of assets and the remaining debt is destroyed as there is no way to recover it. The accounts balance out.

In Iceland there is no way London can force bankruptcy or liquidate the debt to recover capital without the cooperation of the government and the people. It’s a little strange that London doesn’t recognize that the debt can not be liquidated without a big destruction of the debt. They want their full debt back, without this market adjustment.

I’m just thinking ahead with wondering about this issue. I sure don’t want to pay higher taxes because the banks used money from China or accepted moral hazards they shouldn’t have.

It boils down to this economist attacking the free market for the problem and that it needs to be corrected by the governments. The free market has already solved it as debt that can not be repaid. Now government by use of force is trying to recovering these losses anyway. I was wondering if the Austrians had anything else to say on the subject.

Thanks for the responses, I’ll study the issue further to see if I can come up with a better question.

[krazy_kaju]

@A_52

I guess I would ask who exactly declares bankruptcy.

The debtor declares bankruptcy when s/he can no longer make ends meet and pay back their debt.

I am not trying to be difficult. Iceland privatized its banks, and now its government is being held accountable for losses by its citizens, many of whom are innocent. If the banks were privatized or purchased by London, where is the government liability.

I realize capital is not destroyed, it is transferred to someone else. The debt is liquidated through sale of assets and the remaining debt is destroyed as there is no way to recover it. The accounts balance out.

In Iceland there is no way London can force bankruptcy or liquidate the debt to recover capital without the cooperation of the government and the people. It’s a little strange that London doesn’t recognize that the debt can not be liquidated without a big destruction of the debt. They want their full debt back, without this market adjustment.

I’m just thinking ahead with wondering about this issue. I sure don’t want to pay higher taxes because the banks used money from China or accepted moral hazards they shouldn’t have.

It boils down to this economist attacking the free market for the problem and that it needs to be corrected by the governments. The free market has already solved it as debt that can not be repaid. Now government by use of force is trying to recovering these losses anyway. I was wondering if the Austrians had anything else to say on the subject.

Thanks for the responses, I’ll study the issue further to see if I can come up with a better question.

The way you present the situation, I understand that one of these three situations is currently happening:

1. The government of Iceland owes money to the government of England and is refusing to pay it back.
2. Icelandic individuals/businesses owe money to the government of England, and the government of Iceland is protecting them and allowing them to not pay back their debts.
3. Icelandic individuals/businesses owe money to British individuals/businesses, the English government is trying to get these individuals to pay back their debt, whereas the Icelandic government is trying to prevent this process.

Either way, the debtors need to somehow repay their creditors, either by paying back their debts or by declaring bankruptcy. If they do not, it is the British government’s legal duty to declare war on Iceland and recoup the assets of debtors and distribute them to their creditors.

[pcrider]

krazy kaju wrote:

Either way, the debtors need to somehow repay their creditors, either by paying back their debts or by declaring bankruptcy. If they do not, it is the British government’s legal duty to declare war on Iceland and recoup the assets of debtors and distribute them to their creditors.

Oh Really? That doesn’t sound like a very Austrian or free-market perspective. I’m surprised this has gone unanswered.

If the debtor can’t repay, the creditor should simply repossess (retain) the property that was pledged as collateral. Like any other secured loan, when the borrow can’t repay, the bank takes the asset (car, house, etc) back and resells it. The difference between what they get in the sale and the amount owed is the creditor’s loss. Why does bankruptcy even enter the discussion?

If the creditor made an unsecured loan (without collateral), and the debtor is unable to repay, and the creditor is unwilling to renegotiate more favorable terms in exchange for a partial repayment, then the creditor takes the full loss. That would be a good example of malinvestment. Again no need to consider “bankruptcy”.

As for the state of Britain declaring war on the state of Iceland, this is not justified in the least. Even in the worst case where the loan was fully secured and the British creditor was prevented with force by the Icelandic government from repossessing their property (the collateral) it still does not justify war. If the state of Iceland prevents foreign creditors from taking possession of their rightful property within Iceland, this is a trade dispute, perhaps a treaty violaiton - either way it is a form of protectionism applied by Iceland. For the creditor who loans money to foreign countries, it must be part of the calculated risk they take. If they are unable to collect on the loan for this reason, it is another example of malinvestment. No state intervention is needed by Britain.

[JamesB]

“Either way, the debtors need to somehow repay their creditors, either by paying back their debts or by declaring bankruptcy. If they do not, it is the British government’s legal duty to declare war on Iceland and recoup the assets of debtors and distribute them to their creditors.”

Surely not if we’re talking about government debt though. If the government has to raise revenue through either taxation or inflation, two alternative forms of theft, then no creditor to the government should be considered to have a legitimate title to anything. Especially if paying it back would involve more taxing/inflating in the process.