When someone else’s debt means losing YOUR money

I’ve been writing about the problem of debt for some time, and I’ll continue to do so, because it’s the single most important economic issue of our day.  It makes our present government spending unsustainable, and it holds out the promise of misery for most of us in the not too distant future, because our feckless politicians are simply too scared of the consequences to do anything about it.  They’re the ones who let things get this bad (aided and abetted by us, the voters, of course).  Now they’re riding the tiger, knowing they’re going to get eaten if they lose their grip or try to dismount.

The problem is, most people don’t realize that the debt of others is going to affect them, personally.  They think that as long as they have their own financial house in order, they’re OK.  I’m afraid that’s not true.  The bond- and account-holders of an Austrian regional bank are the latest to learn that lesson the hard way.

The Alpine region of Carinthia faces probable bankruptcy after Austria’s central government refused to vouch for debts left by a disastrous banking expansion in eastern Europe and the Balkans.

It would be the first sub-sovereign default in Europe since the Lehman Brothers crisis, comparable in some respects to the bankruptcy of California’s Orange County in 1994 or the city of Detroit in 2013.

. . .

Sources in Vienna suggested that even senior bondholders are likely to face a 50pc writedown, becoming the first victims of the eurozone’s tough new “bail-in” rules for creditors. These rules are already in force in Germany and Austria, and will be mandatory everywhere next year.

“We are at a very delicate phase when Europe’s banking system switches from a bail-out regime into a much tougher bail-in regime, and Austria has just thrown this into sharp relief,” said sovereign bond strategist Nicholas Spiro. The biggest bondholders are Deutsche Bank’s DWS Investment, Pimco, Kepler-Fonds and BlackRock. The World Bank also owns €150bn of Hypo debt.

. . .

William Jackson, from Capital Economics, said Austrian banks face a double squeeze as borrowers in Hungary and the Balkans struggle with both deep property slumps and a slide in their local currencies. “These foreign currency debts are a slow-burn issue. The non-performing loans emerge over time,” he said.

The International Monetary Fund said in its latest healthcheck on Austria that three large banks – Raiffeisen, Erste and Volksbanken – are vulnerable to any shocks. “Risks remain elevated. Bank profitability suffers from rising non-performing loans, risk costs and write-offs,” it said.

There’s more at the link.

How does this affect individuals, you ask?  Simple.  You have a bank account.  Your bank invests its money (i.e. your deposits) in bonds, in order to earn a return on its investments.  When it repays your money (i.e. you withdraw it from your account), it’s hopefully made a profit on it which it puts in its own back pocket.  If the bonds in which it’s invested don’t pay a return, it doesn’t make a profit.  Even worse, if the issuer of those bonds defaults and doesn’t repay them, it doesn’t get its (i.e. your) money back at all.  Therefore, the ‘knock-on’ effect from a regional bank default, like the one in Austria described above, will directly and immediately impact tens, possibly hundreds of thousands of account-holders in other banks and financial institutions that are bond-holders affected by the problem.  Since the government of Carinthia had issued guarantees to account-holders and investors in its regional bank, it’s on the hook as well – unless, of course, it defaults too.

The European Union ‘bail-in’ rules explicitly require that bondholders (and those who invest in the bondholders, which is exactly what you’re doing if you have a bank account with a bank that directly or indirectly holds the bonds of a defaulting bond issuer) ‘share the pain’ of a bond default by losing part or all of their investment.  It happened on a large scale in Cyprus recently.  Commentators (including yours truly) warned at the time that the same recipe would be applied more widely.  This has now happened, in the USA as well as in Europe.  Governments no longer have the money to bail out troubled banks.  Instead, investors will ‘bail them in’ – using your money.  Welcome to the twenty-first century, folks.

Jeremy Warner puts the problem into global perspective.

The world is sinking under a sea of debt, private as well as public, and it is increasingly hard to see how this might end, except in some form of mass default.

Greece we already know about, but the coming much wider outbreak of debt repudiation will not be confined to sovereign nations. Last week, there was another foretaste of what’s to come in developments at Austria’s failed Hypo Alpe-Adria-Bank International. Taxpayers have had enough of paying for the country’s increasingly crisis-ridden banking sector, and have determined to bail in private creditors to the remnants of this financial road crash instead – to the tune of $8.5bn in the specific case of Hypo Alpe-Adria. Finally, creditors are being made to pay for the consequences of their own folly.

You might have thought that a financial crisis as serious as that of the past seven years would have ended the world economy’s addiction to debt once and for all. It has not. If anything, the position has grown even worse since the collapse of Lehman Brothers.

According to recent analysis by McKinsey Global Institute, global debt has increased to the tune of $57 trillion, or 17pc, since 2007, with little sign of a slowdown in sight. Much of this growth has been in emerging markets, which were comparatively unaffected by the financial crisis. Yet even in the developed West, private sector deleveraging has been limited and, in any case, more than outweighed by growing public indebtedness. The combined public sector debt of the G7 economies has grown by 40pc to around 120pc of GDP since the crisis began. There has been no overall deleveraging to speak of.

Where the West left off, Asia has taken up the pace, with a credit-induced real estate bubble that makes its pre-crisis Western counterpart look tame by comparison, much of it fuelled, as in Western economies, by growth in the shadow banking sector.

. . .

Some economists claim not to be too concerned by the explosion in global credit. For them, it is merely the mirror image of rising output, asset prices and wealth … But you can also have too much of a good thing. Today’s global economy is plainly a case of it. The world has taken on more debt than it is ever likely to be able to repay, absent of implausibly high levels of output growth or contractionary fiscal consolidation. This, in turn, makes the global economy highly vulnerable to continued financial crisis and balance sheet recession. Too much capacity and too much debt make a poisonous combination.

. . .

Traditionally, governments have dealt with big debt overhangs through inflation and financial repression. In extremis debts are monetised via central bank money printing. It’s the legal, backdoor approach to default. Creditors get progressively squeezed by low interest rates and rising prices. Regrettably, it doesn’t work so well in a deflationary environment, and it doesn’t work at all when the credit is in a foreign currency, hence the apparently intractable debt standoff that afflicts the eurozone. Southern Europe has in effect been borrowing in a hard, northern European currency.

. . .

How might the present explosion in debt end? The only thing that can be said with certainty is “badly”.

Again, more at the link.

Michael Lewitt highlighted the effects of debt on our economy in his latest newsletter, cited by John Mauldin in the latest edition of his newsletter ‘Thoughts From The Frontline’.

After trillions of dollars of stimulus, U.S. GDP growth is still only 2%. People can point to the weather, lower oil prices and the strong dollar for why the economy cannot achieve escape velocity, but the primary reason is the suffocating weight of public and private sector debt. Even with low (or non-existent) interest rates, an enormous amount of financial and intellectual capital is devoted to debt service rather than more productive uses. The result is structurally slow growth … Only 44% of healthy adult Americans are members of the work force, the lowest number since the 1970s. This is hardly the sign of an accelerating or robust economy about to take off into the wild blue whatever.

. . .

Both the McKinsey and the Geneva reports demonstrate beyond a shadow of a doubt the unsustainable and dangerous path on which the global economy is set. The question is whether global leaders will let the train run off the tracks, or whether someone will demonstrate the necessary leadership to take action. The message for investors is that they and their money are living on borrowed time. The currencies in which their financial assets are denominated are being diminished in value every minute of every day.

More at the link.  Bold, underlined text is my emphasis.

Folks, for all the favorable comments about our economy from politicians and the Fed, the underlying reality is still the same.  All the powers that be can do is paper over the cracks.  The really important numbers are ghastly, and getting worse.  Prepare yourselves accordingly.



  1. It's getting really interesting, and NOT in a good way. I'm just waiting for them to start taxing 401K and Roth IRAs in addition to the bail in clauses.

  2. I have watched my income drop over the past three years by 4G. Maybe not a lot of money to some, but when everybody speaks 'how well the economy is going' I have to answer 'yeah, going'. Combined with higher prices….

  3. It actually happened here in the USA before anywhere else.

    Anyone remember MF Global and an Obama crony by the name of Jon Corzine?

    This happened in Oct/Nov of 2011.

    The whole thing smacked of corruption as a number of laws were broken in that the account holders went to the back of the line instead of the front went it came to getting any money back. account holders were frozen out and couldn't liquidate even though trading wasn't stopped….

    and it was all whitewashed

  4. The solution is simple – buy metal, and take delivery.
    Au, Ag, Cu, a brass and lead combo-deal :-), it's all good.

Leave a comment

Your email address will not be published. Required fields are marked *