European Central Bank Bets the Ranch

The European Central Bank has evidently been taking EU sovereign debt as collateral, even as it expands its balance sheet to a record size in order to finance the EU's banking system. Taking sovereign debt as collateral bets the solvency of the ECB on the solvency of the EU. In the event of a sovereign default, the banks borrowing from the ECB may well not be able to repay their debts to the central bank. The ECB might theoretically try to sell its collateral to recover its losses. But the very act of selling the sovereign debt would likely push down its value, impair European banks all the more, and further weaken the ECB. The ECB, for practical purposes, may be making uncollateralized loans when it takes EU sovereign debt as "collateral."

The ECB surely realizes this. But it may have little choice, since Europe's banks probably have limited amounts of other assets they could tender to the ECB as collateral. Without the ECB's loans, the European financial system would probably have to pull back on lending, forcing an economic contraction at a time when Europe desperately needs growth to escape the claws of the sovereign debt crisis. So the ECB probably has little choice but to bet the ranch. Its hopes of repayment rest primarily on whether or not Europe grows. Europe's prospects for growth depend heavily on whether or not its governments can institute effective fiscal policies. Given the EU's political dysfunction, one cannot help but wonder whether the ECB will lose the ranch.

The Sovereign Debt Crisis: Europeans To Live In Glass Houses

The latest EU proposal for resolving the sovereign debt crisis promises "automatic" consequences if member nations' annual budget deficits exceed 3% of their GDP. The European Commission, the executive arm of the European Union, can also impose additional requirements. All this is supposed to keep EU members on the straight and narrow, never spending excessively, texting while driving, or using any cuss words.

But there's a catch. EU members holding 74% or more of the union's voting power (votes are allocated among EU members by size, similar to the U.S. House of Representatives) can vote to lift the sanctions. Virtually all of EU members fail to comply with its requirement to keep total national sovereign debt at not more than 60% of GDP. Many have trouble meeting the 3% budget deficit requirement. In other words, the members of the EU are not without sin. If a fellow member nation needed dispensation from the "automatic" consequences and the EC's sanctions for going over the 3% limit, would the other EU nations be the first to cast a stone? When you live in a glass house, you will do unto others as you would have them do unto you. The 74% catch (we can call it "Catch-74") renders the "automatic" consequences semi-automatic and creates a go along, get along dynamic that is antithetical to the notion of fiscal discipline.

Only Britain dissented from the latest proposal, steering its own course in turbulent seas, Union Jack snapping briskly in the wind. It's unclear that Britain's tack makes economic sense. But if the EU fails to definitively resolve the crisis, there may be many on continental Europe who will think themselves accursed not to be among the happy few who chose to keep their monetary policy independent.

Will EU Members Learn to Share?

The latest leaks from high ranking EU officials concerning the sovereign debt crisis hint at the possibility of not one, but two bailout funds. Details are scarce; but maybe that's the idea. They can keep the palaver going as long as you don't ask what army of investors is supposed to step out front and center to fund this financial engineering. That's the key to making the bailout work--or not. Someone has to plop a lot of cold, hard cash money on the barrel head in order to truly end the crisis. S&P, however, is threatening to downgrade most of Europe. Whence will investors find the courage to buy the EU's financial engineering when they see the price of sovereign debt credit default swaps escalating?

This is something the leaders of Germany and other wealthy EU nations spend little time publicly admitting. Instead, they focus on how to impose discipline, austerity and clean living on the profligate. Greece, Ireland, Portugal, Italy, Spain and perhaps other nations would have to earn every Euro they spend, and would pay penalties for deficits, failing to wash behind their ears, and using cuss words. Somehow, enough righteousness is supposed to transport the EU to the utter bliss of true currency union.

But the EU is missing an important point. The world's most successful currency union, the United States, exists perennially in a state of financial imbalance. For over a century, the wealthy states on the East Coast, more recently with the wealthy states on the West Coast, have subsidized less wealthy states in between. These imbalances have existed in the form of federal subsidies to farmers, ranchers, the mining industry, the railroads, and more. The Interstate Highway System was another big subsidy, benefiting large, thinly populated rural states more per capita than it benefited densely populated states. But none of the United States tries to hold others of the United States to fiscal rectitude. Imbalance is implicit in the structure of the Constitution, apportioning as it does two Senators to each state no matter how large or small. And imbalance runs the other way. On a per capita basis, the less wealthy states probably provide more people to serve in the military than the wealthier states, resulting in steeper non-financial costs on the former when America goes to war. Americans tolerate imbalance because national unity is more important to them than any rigorous reconciliation of ledgers.

To make the EU really work, Europeans need more than just their economic welfare. Financial self-interest isn't the superglue required for political union. Neither is sheer power. Rome's legions, Napoleon's armies, and the Third Reich's panzers all failed to hold Europe together. Angela Merkel, Nicholas Sarkozy and other proponents of the EU have shrewdly played their cards to keep the crisis from tipping over into financial panic. But the EU needs greatness in its leadership, calls to electorates to seek a new destiny. That's missing, and given the historical divisions among Europeans, a most tribal collection of peoples, it's not surprising that issuers of EU sovereign debt credit default swaps are selling their contracts dearly.

Retire By Making Your Dollars Last

Managing your money in retirement is often depicted as a problem of how to allocate your portfolio, how quickly to draw down your net worth, when to begin taking Social Security and whether or not to buy long term care insurance. But managing one's financial assets is only part of the picture. Consider how you spend--the less your cash outflow, the easier it is to afford retirement. And you don't necessarily need to become a connoisseur of cat food or learn the dozens of ways to prepare rice and beans.

Pay off the mortgage. One of the most surefire ways to reduce month expenses is to pay off the mortgage. Since your retirement income will probably be less than your income while working, offloading the mortgage will improve the quality of your sleep.

Take the auto mechanic off your speed dial. Buy cars that are reliable and known for longevity. With the increased computerization of cars, the cost of repairs is skyrocketing. You don't have to buy a tinny econobox. If you can afford a luxury car, choose an Acura or Lexus, not some other brands that enrich repair shops.

When it comes to appliances, spare your back. High quality in home appliances isn't, to borrow a stock market phrase, closely correlated with price. The most reliable and long lasting washing machines and dryers tend to be the traditional, modestly priced top loaders. Currently fashionable side loaders have their attributes, but at the cost of higher purchase prices and less longevity. Plus you have to bend over or kneel down to get access to them. Your back and knees may have an opinion as to whether or not that's a good idea. Cheaper, more reliable, longer lasting, and easier on the back and knees is a pretty good bargain.

Use generics whenever possible. Generic drugs can be much cheaper than name brands. Why pay for a fancy name when the medication is the same at a lower price?

Avoid credit card debt. The most expensive loans most Americans take are credit card balances carried over from month to month. If you use credit cards, only charge what you can pay off at the end of the month. That way, you earn rewards, cashback bonuses, etc., without paying any interest. Why enrich banks in your golden years?

The Federal Reserve and Its Petard

Even casual readers of today's financial news know interbank lending is drying up on an international scale, and that the world financial system is getting the shakes. That's why the Fed and other major central banks announced yesterday a currency swap program to ensure dollar liquidity in Europe and elsewhere. But even as the Fed mounts up and tries to lead the charge, we should remember that it is tripping over its own ultra low interest rate policy.

The Fed's principal monetary weapon is to control the fed funds rate. That's the rate banks charge each other for overnight loans. The Fed has targeted a rate of 0 % to 0.25%, and has promised to hold it there until Antarctica is covered by tropical rain forest. A bank with excess funds can't hardly make a plugged nickel when its lending rate is virtually indistinguishable from zero. And when you consider that many of the larger European banks that are now desperate for dollar funding are, by virtue of the EU sovereign debt crisis, not glowingly golden credit risks, it's no surprise that American and other banks with excess dollars are stuffing entire bulbs of garlic into their mouths any time an EU bank asks for a loan. In other words, the Fed's own zero interest rate policy is hampering interbank lending that could alleviate the very credit crunch it's now desperate to combat.

I leave it to you, dear reader, to decide what to say about the Fed and its petard.