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Invisible Hispanics

Felix Salmon and Walter Bagehot on the Greek Crisis

Felix Salmon:

Is it now too late to save Greece?: When Goldman Sachs noticed a pattern of regular losses in its mortgage book at the end of 2006, it decided to start going short, in a move which helped to position it as the most successful bank in the financial crisis. The markets have learned their lesson: now that Greece and Portugal have been downgraded, the rush to the exits is palpable: the flight to quality is on, and bond yields in the European periphery are going stratospheric. Greece’s bonds can still be used as collateral at the ECB: Moody’s hasn’t (yet) downgraded them. But S&P’s sovereign-ceiling principles mean that all of Greece’s banks now have a junk rating, and it’s surely now only a matter of time until Moody’s and Fitch follow S&P’s lead and Greek debt becomes a speculative credit instrument rather a government bond which is safe in anybody’s eyes. The trick about going short an imploding asset class, of course, is that it only works if you’re in the minority. If everybody is doing it, you just get overshooting asset markets and chaos — which is what we’re seeing now. As far as the financial markets are concerned, if any bailout comes now, it’ll be too late: no country can sustain Greece’s combination of funding costs and debt-to-GDP ratio, no matter how much German money it burns through. Plug 13% yields into my Greek debt calculator, and the results aren’t pretty, even if they don’t have any effect at all on all the other optimistic assumptions...

Walter Bagehot:

Bagehot: Lombard Street, Chapter 2: A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to 'this man and that man,' whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. 'We lent it,' said Mr. Harman, on behalf of the Bank of England,

by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.

After a day or two of this treatment, the entire panic subsided, and the 'City' was quite calm....

On the surface there seems a great inconsistency in all this. First, you establish in some bank or banks a certain reserve; you make of it or them a kind of ultimate treasury, where the last shilling of the country is deposited and kept. And then you go on to say that this final treasury is also to be the last lending-house; that out of it unbounded, or at any rate immense, advances are to be made when no one else lends. This seems like saying—first, that the reserve should be kept, and then that it should not be kept. But there is no puzzle in the matter. The ultimate banking reserve of a country (by whomsoever kept) is not kept out of show, but for certain essential purposes, and one of those purposes is the meeting a demand for cash caused by an alarm within the country. It is not unreasonable that our ultimate treasure in particular cases should be lent; on the contrary, we keep that treasure for the very reason that in particular cases it should be lent.

When reduced to abstract principle, the subject comes to this. An 'alarm' is an opinion that the money of certain persons will not pay their creditors when those creditors want to be paid. If possible, that alarm is best met by enabling those persons to pay their creditors to the very moment. For this purpose only a little money is wanted. If that alarm is not so met, it aggravates into a panic, which is an opinion that most people, or very many people, will not pay their creditors; and this too can only be met by enabling all those persons to pay what they owe, which takes a great deal of money. No one has enough money, or anything like enough, but the holders of the bank reserve.

Not that the help so given by the banks holding that reserve necessarily diminishes it. Very commonly the panic extends as far, or almost as far, as the bank or banks which hold the reserve, but does not touch it or them at all. In this case it is enough if the dominant bank or banks, so to speak, pledge their credit for those who want it. Under our present system it is often quite enough that a merchant or a banker gets the advance made to him put to his credit in the books of the Bank of England; he may never draw a cheque on it, or, if he does, that cheque may come in again to the credit of some other customer, who lets it remain on his account. An increase of loans at such times is often an increase of the liabilities of the bank, not a diminution of its reserve. Just so before 1844, an issue of notes, as in 1825, to quell a panic entirely internal did not diminish the bullion reserve. The notes went out, but they did not return. They were issued as loans to the public, but the public wanted no more; they never presented them for payment; they never asked that sovereigns should be given for them. But the acceptance of a great liability during an augmenting alarm, though not as bad as an equal advance of cash, is the thing next worst. At any moment the cash may be demanded. Supposing the panic to grow, it will be demanded, and the reserve will be lessened accordingly.

No doubt all precautions may, in the end, be unavailing. 'On extraordinary occasions,' says Ricardo, 'a general panic may seize the country, when every one becomes desirous of possessing himself of the precious metals as the most convenient mode of realising or concealing his property,—against such panic banks have no security on any system.' The bank or banks which hold the reserve may last a little longer than the others; but if apprehension pass a certain bound, they must perish too. The use of credit is, that it enables debtors to use a certain part of the money their creditors have lent them. If all those creditors demand all that money at once, they cannot have it, for that which their debtors have used, is for the time employed, and not to be obtained. With the advantages of credit we must take the disadvantages too; but to lessen them as much as we can, we must keep a great store of ready money always available, and advance out of it very freely in periods of panic, and in times of incipient alarm...