The European Debt Crisis dwarfs the problems of the US in 2008.
Here is how Forbe’s Magazine Editor-in-Chief writes, “Germany and France keep postponing the reckoning on Europe’s sovereign debt crisis. But their whistling past the graveyard approach is making a 1931/2008 crackup more probably. Their handling of this crisis will be a textbook example of timid, narrow-minded, intellectually bankrupt leadership. The Germans especially have taken the approach of simply throwing money at dicy debtors in the hope that the problem will magically disappear. They refuse to face the fact that Greece will default and that Portugal, Spain, and Italy are nearing the cliff’s edge.”
Here are five actions to solve the crisis right now:
1. End mark-to-market accounting on sovereign debt. Allow banks to use accrual or investment accounting on this debt. The question each bank has to ask themselves is whether or not the debt will be paid. They should argue that it will be as long as the debt payments are current. If debt payments are current, then the asset should be marked at purchase price. This means that the debt will not impact their balance sheets and they will stay solvent. But clearly Greece will default. The banks will then work out a repayment plan through changing the interest rate, amortization rate, or size of the loan to make it work out. This will cause a hair cut on the value of the loan but it will be far smaller and far more manageable.
2. Slash government spending. The UK is doing a remarkable job here. Greece is saying they are going to do it but never actually do. Government overspending is the cause of this crisis and this must happen to solve it.
3. Slash taxes. You get less of something when you tax it. So raising taxes on, say, income simply reduces the amount of reported income in a society. One solution to the crisis is to increase growth in society to create higher tax revenue and to support laid off government workers. Lower taxes to promote economic growth. But won’t that cut government revenue just when they need it most. No, experience shows that government income booms when taxes are cut.
4. Shift to a flat tax. One of the main problems in countries like Greece and Italy is not the level of taxes but that nobody pays them. Shifting to a flat tax solved this problem in many countries like Russian, Estonia, and Bulgaria. Flat taxes are much harder to avoid and people tend to be more compliant when the tax is small and fair. This will dramatically increase government revenues.
5. End Basel II. Basel II is the accord engineered by the Bank of International Settlements (BIS) which is usually called the central bank for central banks. This accord was and is a major cause of the debt crisis in the US and Europe. The accord is meant to be a unified agreement for major countries as to what is good capital and how much reserves should be posted for different asset classes. Basel II stated that the two best classes of investments that banks could own were mortgages and sovereign debt! So major global banks did what they were supposed to do: they rushed out and loaded the boat with mortgages and sovereign debt! So what are the most toxic investments that caused these two massive crises? Mortgages and sovereign debt! Thanks BIS! Stalinist central planning has never worked and this is just another example. Far better to let banks figure out what is safe and what is not. That allows the global banking economy to be far more diversified and therefore far less prone to systematic failures.
There are far more ways to solve this stupid crisis, but that is a start! Will they happen? I doubt any of them will happen because all of them require that governments give up power.