Posts Tagged ‘Default’

George Soros on European Fiscal & Banking Crisis and EU Summit on June 28-29, 2012

Monday, June 25th, 2012

Here I present key take-aways from George Soros’ in depth Bloomberg interview on the current European fiscal and banking crisis, Angela Merkel, the Spanish bailout, and Greece leaving the Eurozone.

The video is also below:

Banking & Fiscal Issues

  • “There is an interrelated problem of the banking system and the excessive risk premium on sovereign debt – they are Siamese twins, tied together and you have to tackle both.”
  • Soros summarizes the forthcoming Eurozone Summit ‘fiasco’ as fatal if the fiscal disagreements are not resolved in 3 days.
  • There is no union without a transfer.
  • Europe needs banking union.
    • Germany will only succumb if Italy and Spain really push it to the edge (Germany can live in the present situation; the others cannot)
    • Europe needs a fiscal means of strengthening growth through Treasury type entity
      • What is needed is a European fiscal authority that will be composed of the finance ministers, but would be in charge of the various rescue mechanisms, the European Stability Mechanism, and would combine issuing treasury bills.
        • Those treasury bills would yield 1% or less and that would be the relief that those countries need in order to finance their debt.
        • Bill would be sold on a competitive basis.
        • Right now there are something like over €700bn euros are kept on deposit at the European Central Bank earning a 0.25% because the interbank market has broken down, so then you have €700bn of capital that would be very happy to earn 0.75% instead of 0.25%, and the treasury bills by being truly riskless and guaranteed by the entire community, would yield in current conditions less than 1%.
        • Governments should start a European unemployment scheme, paid on a European level instead of national level.
        • Soros’ solutions, however, are unlikely to prove tenable in the short-term as he notes “Merkel has emerged as a strong leader”, but “unfortunately, she has been leading Europe in the wrong direction”.
          • “Euro bonds are not possible because Germany would not consider euro bonds until there is a political union, and it should come at the end of the process not at the beginning.
          • This would be a temporary measure, limited both in time and in size, and thereby it could be authorized according to the German constitution as long as the Bundestag approves it, so it could be legal under the German constitution and under the existing treaties.
          • The political will by Germany to put it into effect and that would create a level playing field so that Italy and Spain could actually refinance debt on reasonable terms.

Scenario Discussion

  • LTRO would be less effective now
  • At 6%, 7% of Italy’s GDP goes towards paying interest, which is completely unsustainable
  • Spain may need a full bailout if summit is not successful
    • Financial markets have the ability to push countries into default
    • Because Spain cannot print money itself
    • Even if we manage to avoid, let’s say an ‘accident’ similar to what you had in 2008 with the bankruptcy of Lehman Brothers, the euro system that would emerge would actually perpetuate the divergence between creditors and debtors and would create a Europe which is very different from open society.
    • It would transform it into a hierarchical system where the division between creditors and debtors would become permanent…It would lead to Germany being in permanent domination.
      • It would become like a German empire, and the periphery would become permanently depressed areas.

On Greece

  • Greece will leave the Eurozone
    • It’s very hard to see how Greece can actually meet the conditions that have been set for Greece, and the Germans are determined not to modify those conditions seriously, so medium term risk
    • Greece leaving the euro zone is now a real expectation, and this is what is necessary to strengthen the rest of the euro zone, since Greece can’t print money
    • By printing money, a country can devalue the currency and people can lose money by buying devalued debt, but there is no danger of default.
      • The fact that the individual members don’t now control the right to print money has created this situation.
      • A European country that could actually default. and that is the risk that the financial markets price into the market and that is why say Italian ten-year bonds yield 6% whereas British 10-year bonds yield only 1.25%.
  • That difference is due to the fact that these countries have surrendered their right to print their own money and they can be pushed into default by speculation in the financial markets.

On Angela Merkel

  • Angela Merkel has been leading Europe in the wrong direction. I think she is acting in good faith and that is what makes the whole situation so tragic and that is a big problem that we have in financial markets generally – she is supporting a false idea, a false ideology, a false interpretation which is reinforced by reality.
  • In other words, Merkel’s method works for a while until it stops working, and that is what is called a financial bubble
    • Financial bubbles look very good while they are being formed and everyone believes in it and then it turns out to be unsustainable…
    • The European Union could turn out to have been a bubble of this kind unless we realize there is this problem and we solve it and the solution is there.
    • I think everybody can see it, all we need to do is act on it, and put on a united front, and I think that if the rest of  Europe is united, I think that Germany will actually recognize it and adjust to it.

On Investing

  • Stay in cash
  • German yields are too low
  • If summit turns out well, purchase industrial shares, but avoid everything else (consumer, banks)

Conclusion: We are facing conditions reminiscent to the 1930s because of policy mistakes, forgetting what we should have learned from John Maynard Keynes.

First Credit Crisis – Ricciardi Family (1294)

Monday, February 15th, 2010

Vox recently published this article on the first credit crisis recorded in history.  Many economists tend to think that this phenomenon is a recent development, but throughout history, sovereign debt and credit contagion have been major issues. ~I.S.

It is widely believed that the current credit squeeze, leading to bank failures, is a modern phenomenon arising from the interplay of a historically unique set of circumstances that could not have been foreseen. But a team of academics – a finance professor and two medieval historians – at the University of Reading’s ICMA Centre has documented a medieval credit crunch that bears remarkable parallels with the current crisis.

The Ricciardi & Edward I

Before 1272, English kings had occasional dealings with Italian merchant societies, mainly in purchasing luxury goods for the household and arranging for balance transfers overseas. During the reign of Edward I (1272-1307), however, the king entered into a close financial relationship with one particular merchant society, the Ricciardi of Lucca (Kaeuper 1973). From 1275, the Ricciardi collected the newly-created customs duty on exports of wool, hides and wool-fells, worth around £10,000 per year, as well as receiving money from other sources of royal revenue. In return, they advanced significant sums in cash to the king and made payments to third parties on the king’s behalf, as and when ordered by royal letters. In total, between 1272 and 1294, the Ricciardi were involved in the collection and disbursement of around £20,000 per year, equivalent to roughly half of the king’s ordinary annual income. We could perhaps compare this arrangement to a modern current account, complete with extensive overdraft facilities (interestingly, Edward was usually overdrawn by £10,000-£20,000).

This relationship had great advantages for both parties. It allowed the king to anticipate royal revenues and so smooth the seasonal fluctuations in his income. Edward also enjoyed regular access to credit, allowing him to respond to unexpected events or undertake expensive projects without the burden of maintaining a large cash reserve. In return, the Ricciardi received some financial return on their advances, although this is usually hidden in the sources because of the religious prohibition on usury. We have calculated that, before 1294, Edward was probably able to borrow at rates of around 15% per year (Bell, Brooks and Moore 2009). Furthermore, the Ricciardi benefited from royal favour in their business dealings.

How were the Ricciardi and other merchant societies in a position to make such loans and investments? Their initial funding came from the partners of the society, who pooled their capital and received proportionate shares of any profits. Such involvement could be risky, because the partners could be held personally responsible for any debts owed by the society. They also received deposits, mostly from wealthy citizens of the Italian city-states (Hunt and Murray 1999). In addition, the Italian merchants profited from the management of papal taxes collected in England, and we would argue that this played a vital role in capital formation. In 1274 the pope had levied a tax on the clergy across Europe to support a new crusade, which raised a total of around £150,000 in England alone. The Ricciardi were one of several Italian merchant societies to act as papal bankers and were responsible for holding a portion (worth around £10,000) of the monies collected in England (Lunt 1939). This would have covered much of the king’s overdraft with them.

At any one time, most of this capital was committed to various ventures, including loans to governments and private borrowers, as well as investment in goods for trade. This was normally profitable, since this money was earning a good return, but it meant that the merchants only retained a small buffer of liquid capital. This was not ordinarily a problem, since most transactions could be carried out through credit, offsetting or balance transfers between merchants. When actual cash was needed beyond their own reserves, it could be raised from other merchants, either as a loan or by selling assets. For instance, the Ricciardi often acted as brokers raising loans for the king from a cartel of their fellow merchant societies (Kaeuper 1973). We can perhaps describe this as an early variant of the ‘Northern Rock’ business model, in that the Ricciardi relied on wholesale or interbank lending to fund their loans to the king.


The trigger for the global credit crunch starting in 2007 has been traced to the ‘sub-prime crisis in the US, as the resulting uncertainty meant that banks were unwilling to lend to each other, thus removing liquidity from the market. In the early 1290s, there was a similar crisis of liquidity, as the papal tax discussed above was gradually called in by the pope and the French king exacted large sums from the Italian merchants in his kingdom, leaving the merchant societies under-capitalised.

Initially, it seemed as though the Ricciardi may have been escaped the worst of this. In 1290, Edward had finally agreed terms with the pope to lead a new crusade and, in return, was granted access to the proceeds from clerical taxation in England. As a result, the merchant societies with whom the tax had been deposited were ordered to deliver a first instalment of 100,000 marks (£66,667) to the Ricciardi on Edward’s behalf (see Lunt (1939) and Kaeuper (1973). It is unlikely, however, that any money physically changed hands, since it would have been more logical for the merchant societies simply to transfer their liabilities from the pope to the Ricciardi. On paper, the Ricciardi would have been credited with the extra money, but there was a corresponding danger should Edward seek to withdraw this tax revenue at short notice.

Unfortunately, this was precisely the situation that arose in 1294, when war broke out between England and France. As he had before, Edward turned to the Ricciardi for money to fund his armies. Although, in theory, the Ricciardi should have been well-capitalised, it seems that, in reality, the greater part of their resources was tied up and, fatally, the wider lack of liquidity meant that they could not raise money on the interbank market. These difficulties were exacerbated by the Anglo-French war, which effectively cut communications between Italy and England and left the merchant societies unable to update the account books of their various branches across Europe.
In their defence, the Ricciardi, much like banks today, would argue that their difficulties resulted from a short-term liquidity squeeze and that, overall, their assets matched their liabilities. In practice, however, the Ricciardi were unable to provide the English king with the financial support that he desperately needed. In response, Edward removed the Ricciardi from their position as collectors of the wool custom and ordered the seizure of the assets (mainly wool but also loans to private individuals) held by the Ricciardi and other merchant societies. This dealt a mortal blow to the Ricciardi’s finances and effectively marked the end of their long-standing relationship with the English crown.


The Ricciardi initially sought to recover their position through a series of ‘credit swaps’ and netting between their creditors and debtors (Kaeuper 1973).1 They requested a new accounting with Edward, in the belief that his ‘overdraft’, combined with the proceeds of the confiscated wool and debts, would offset most of the outstanding papal tax. Their other main creditor was the pope, and the merchants tried to persuade him to take over the debts owed to them in France and in Italy, on which he was better-placed to collect. To draw another parallel with more recent events, we can compare this to government intervention, exchanging Treasury-backed bonds for the more illiquid assets held by the banks.

Unfortunately for the Ricciardi, they were unable to convince governments to support them.

In the short term, Edward’s decisive actions succeeded in recovering around £50,000 from the Ricciardi. However, the fall of the Ricciardi had significant costs in the medium-term, since Edward still needed to raise huge sums of money to pay for his armies, now fighting in Gascony, Scotland and Wales, as well as the subsidies that he had promised to his allies in the Low Countries and Germany. As a result, Edward was forced to turn to moneylenders who both lacked the resources of the Ricciardi and charged much higher rates of interest (we have found examples of annual rates at 40% and 150%) (Bell, Brooks and Moore (2009).

Applying this experience to the current crisis, it is clear that taking punitive action against the banks today would have much more serious economic consequences, given modern reliance on credit. Edward himself may have come to the same conclusion. By 1299 he had entered into another long-term financial relationship with the Frescobaldi of Florence. When the Frescobaldi complained that news of this had led to a run on their bank, Edward promised them £10,000 sterling in compensation.2 Relative to the English crown’s ordinary annual income of about £40,000, this commitment is in fact greater than the initial £50 billion bank recapitalisation proposed by the British government in 2008.

Furthermore, deprived of access to credit, Edward was forced to rely on heavy taxation and his prerogative rights of purveyance and prise (compulsory purchases of goods). He also over-issued wardrobe bills (essentially government IOUs) to pay for wages and supplies. All of these measures aroused political opposition in England, and contributed to a major constitutional crisis in 1297 (Prestwich 1988). By contrast, Edward’s opponent, Philip the Fair of France, sought to raise money by debasing the French currency, reducing the silver content of the coins by as much as two-thirds. The income (seigniorage) received from these recoinages meant that Philip did not have to resort to direct taxation to the same extent as Edward or incur the same level of debt (Favier 1978). It is possible, however, that the long-term consequences of the expanding money supply for the French economy were more damaging that the medium-term pain of high taxation and debt in England. We would argue that this has considerable modern resonance, as today’s governments begin to grapple with the problem of how to pay for the obligations that they are currently undertaking.


This essay arose from the findings of an on-going three-year research project with the aim of investigating the credit arrangements of a succession of English monarchs with a number of Italian merchant societies.The study, based at the ICMA Centre, Henley Business School, University of Reading, is funded by the Economic and Social Research Council (ESRC) under grant RES-062-23-0733. For more information see:


1 This is based on a number of internal Ricciardi letters that survive in The National Archives (TNA E 101/601/5) and have recently been edited in Lettere dei Ricciardi di Lucca ai loro compagni in Inghilterra,1295-1303, A. Castellani and I. del Punta (eds.) (Rome, 2005).

2 The original letter survives in the National Archives, TNA SC 1/47 no.120 and has been translated in R. J. Whitwell, ‘Italian bankers and the English Crown’, Transactions of the Royal Historical Society, New Series, 17 (1903), pp.198-9.


Bell, A. R. C. Brooks, and T. K. Moore, ‘Interest in Medieval Accounts: Examples from England, 1272-1340’, History (forthcoming, Oct 2009).

Favier, Jean (1978), Philippe le Bel, Fayard

Hunt and Murray (1999) A History of Business in Medieval Europe (Cambridge, 1999)

Kaeuper, R. W. (1973) Bankers to the Crown: Edward I and the Ricciardi of Lucca (Princeton).

Lunt, W. E. (1939) Financial relations of the papacy with England to 1327 (Cambridge, Mass.), pp.311-46.

Prestwich, M. (1988) Edward I, London

Whitwell, R. J. (1903) ‘Italian bankers and the English Crown‘, Transactions of the Royal Historical Society, New Series, 17 (1903), pp.198-9.

For more information, please visit VOX…


Mega Deals in Default

Saturday, November 7th, 2009
Courtesy of Moodys & ZeroHedge

Courtesy of Moodys & ZeroHedge