Top three failures of common sense in the current credit crisis.

Although in vacation, I’m constantly keeping an eye on eurozone debt crisis. In this posting I’m not going to estimate the recession we all are soon to have, but instead I’ll bring out my opinion in the thinking failures associated with the subject.

1) Eurobonds.
The idea of Eurobonds is that when any eurozone country takes a loan (issues Eurobonds) then all other countries are mutually responsible for buying them back at maturity.

Just take a second to think here: do you really reckon that countries such as Greece and Italy would behave responsibly and take less loans just because they know that in case they are not able to, Germany would have to pay back that loan?!

Well, I don’t think so. Not only would Eurobonds not change the behaviour of irresponsible governments, the whole concept is faulty. It suggests that the solution to debt crisis is enabling troubled countries to take more loans.

2) Rating agencies (S&P, Moody’s, Fitch) and their ratings.
Rating agencies are private companies that rate the trustworthiness of organisations (including countries) to pay back their loans. The highest rating a credit agency (S&P) can give is AAA (virtually impossible for the creditor to default) and the lowest is CCC (virtually impossible that the creditor would pay back).

Now consider this example. You have two friends who want to borrow some money:
– friend A does not earn a lot but it is fairly certain he could pay back your loan on time from his reserves and incoming salary;
– friend B earns more than A, but he is so indebted that the only way he can pay back your loan is to take another, probably bigger, loan from someone else.

Which one you would you rather borrow money to?

If you are somebody with a brain and knowledge how to use it, you would lend your money to A. But the credit agencies think that you should lend to B.

Estonia, maybe the only eurozone country that is able to pay back the loans (6% of GDP) without taking a new one, has a rating of AA-. Eight eurozone countries with the highest AAA ratings have loan levels varying between 48-120% of GDP (let me remind you here that GDP is not government budget, the latter is usually much lower). It takes a lot of ignorance and wishful thinking to even consider that all those countries are worth the highest credit rating. Ratings agencies have plenty of both.

3) What the hell is Greece doing in the eurozone in the first place?!
Once upon a time, the EU spent lot of time and money to devise a set of measurable goals (called Maastricht criteria) a country had to meet to join eurozone. And then they ignored that criteria by letting Greece (that did not nearly oblige them) in. The rest is history.


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