Thursday, October 27, 2011

European Debt Agreement Is the Right Medicine

The agreement reached by European governments to address the sovereign debt crisis is the sort of responsible collective action that is lacking in the U.S.  Getting the heads of 17 governments to agree on a plan for painful spending and benefit cuts while the relatively strong (Germany) agree to contribute more is more than the U.S. can do within its own country.

A crucial component that was lacking in the U.S. financial crisis in 2008 is forcing bondholders to take large writedowns to reflect the impaired market value of their holdings of Greek government debt (for the U.S., it was holdings of subprime mortgage securities).  There will be a 50% writedown of Greek bonds, which will ease the debt burden of Greece and make the reported financial statements of European banks more realistic.

The failure of U.S. regulators to force writedowns of subprime mortgages (and other arcane securities) led me to have no confidence in the veracity of the financial statements of banks and other securities firms.  (Even before the crisis, I had a bias against investing in banks and other financial firms because of a lack of confidence in their financial statements.)

Granted, European banks have been in much weaker financial condition than those in the U.S. over the last several years--as I have noted a number of times--and the requirement that they raise their core capital to 9% of assets will be onerous.  It will cause massive dilution of existing shareholders through the issuance of more stock.  But this tough plan will cause a huge boost in confidence in "Old Europe."  Now if the elected officials and Wall Street in the "Old USA" could muster up the courage to do something like this.

Steve Lehman

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