Monday, 12 November 2012

Short-term lessons to be remembered

I have been so far bewildered by the Troika's proposals, although to be fair we should all be waiting for the actual proposals and not base our comments on the policies several media sources are surfacing. It has happened before to witness that the actual measures were much less severe than the ones presented by the media. (One wonders how the media got those excessively inflated stories in times where information is so widely available).

If however, what the media are stating is true, then Troika is pushing for a reform in Cypriot legislation which would allow banks to confiscate and sell the real estate fortune of those who cannot meet the needs of their mortgages. Given that Cyprus has a population of 838,000 people according to Wikipedia, the outcome of even 1000-2000 confiscations would be disastrous. What would happen would be analogous to the late 2000's recession in the US, where a large portion of the population could not repay their mortgage, banks confiscated their properties and then could not sell them in a falling economy. What then happened was the worse drop in real estate value since the Great Depression of 1929 and the banks were left with thousands of unwanted real estate in their balance sheets and no liquidity.

The same situation would happen in Spain as well had Mariano Rajoy's government not proposed a 2-year moratorium on evictions (for more details and an alternative solution read this). As banks become loaded with "useless" real estate, what usually occurs is what is called as a Minsky Moment. The Minsky Moment is in simple words, the wanting of investors (or banks in this case) to get cash for their illiquid assets, which results in a sharp decline in the value of the goods. The late 2000's recession was also coined as a Minsky Moment.

An increase in illiquid assets in addition to falling prices will wreck havoc to balance sheets. The simple case is that banks do not need houses or apartments or commercial blocks. They need cash

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