Is Germany factoring Mediterranean Europe

Factoring is a form of finance. Until the late 20th century the industry suffered the stigma that companies resorting to factoring were heading for liquidation.

Factoring is secured financing: the factoring house purchases the borrower’s receivables, advancing 75% of the invoice value up front, and the remaining 25% when the debt is paid. The factor manages the debtors, for which it charges a fee, usually 1% of invoice value, plus interest on the advance at 7% over prime (the best rate that banks charge to risk free clients).

It’s expensive finance.

Once the factor has control of the receivables, it has control of the company’s destiny. If debtors do not pay on time, the cost of funding becomes prohibitive and eventually destroys the company.

When that happens, the fully secured factoring house converts the client’s liquidation into a handsome profit, purchasing the company’s assets at a fraction of their real worth.

In his thesis on the subject, this correspondent proposed that both parties would benefit if the factoring house used economies of scale to manage the receivables efficiently, not only preventing liquidation, but also making the company a success. The factoring house is also more profitable as it turns its facilities over faster. The client’s funding requirements are reduced, minimizing the interest costs.

The factoring house that employed the young author proved the theory in practice.

Today, the Mediterranean countries are in financial distress. Greece is insolvent. Spain and Italy’s banks are in trouble, with both countries badly indebted. Spain is running deficits. Italy’s industries are no longer competitive.

Early in the crises a German tabloid suggested a solution to Greece’s crises: “Sell us your islands”.

The band-aid solutions that have been used so far provide secured loans to the three countries at high interest rates. The conditions of the loans demand austerity, to remedy the profligacy that precipitated each country’s crises. As the inflicted measures bite, their economies contract, reducing tax revenues, and making repayment of the loans and interest increasingly difficult. The accusations of profligacy are legitimate, but austerity is not the answer.

The solution is to create a European banking union, with a Europe-wide bank-deposit insurance scheme. A ‘fiscal union’ in which all or part of the national debts are mutualised as joint Eurobonds would stop markets pushing sovereigns into insolvency, and would create a European asset that banks could hold. Moreover, if these were financed through federal taxes Eurobonds would be even more of a safe asset.

The ECB should be given independence from the politicians to provide the kind of solutions that the Fed and the Bank of England provide to their respective economies.

The most recent Eurozone deal is another band-aid. Instead of lending money to the country, loans will be made to their troubled banks. While this is an improvement over previous arrangements, it’s not a real solution.

Germany’s resistance to Eurobonds and a fiscal union has financial logic. At present the country’s most recent bonds are offering a yield close to zero. That makes it very cheap for Germany to borrow money. And while the Euro looks at risk, instead of rising, the exchange rate remains low, offering Germany’s products to the world at a discount. As the world’s second biggest exporter, the German manufacturers are enjoying the windfall.

Apparently the German constitution prohibits a Euro fiscal union and Eurobonds. If the country’s leaders wanted to pursue that course, they could be promoting the necessary constitutional amendments. Angela Merkel has said “over my dead body”.

Should the Mediterranean countries fail, those islands and beaches, with the houses overlooking them could be on sale at a big discount to those with the money.

Whether it’s intent, or bad judgement, it will still be the same. The rich get rich and the poor get………. austerity.

More at:
First loss is the best loss
Austerity – what does that mean?
A glimmer of hope!
Merkel defends compromise deal on eurozone banks
The future of the European Union (part 1) Soviet collapse or Germanic reform?
The future of the European Union (part 2) Don’t count on a Hamiltonian moment
EUROPEAN COUNCIL Brussels, 29 June 2012
Babies and bathwater
Europe on the rack

Austerity – what does that mean?

The term austerity has been used a lot of late. It’s defined as “difficult economic conditions created by government measures to reduce public expenditure.”

It’s often made to sound like an unpleasant medicine, which if taken early and swallowed hard, will produce the cure, and all will be well. That really is an over-simplification. Producing a cure requires an accurate prognosis, and the appropriate medicine. Explaining to the patient (the voters) what could happen if the disease remains untreated is also a good idea.

Simply reducing expenditure is not the solution.

South Africa provides a number of useful examples. In the early 1980s, the recession and economic uncertainty in the rest of the world caused investors to take refuge in Gold, South Africa’s biggest export commodity at the time. The Gold price rocketed, and while the rest of the world suffered, the South African economy boomed. The success had nothing to do with anything the South Africans were doing right, and a sensible government would have invested the money into building a competitive economy. Instead it did the opposite.

Faced with a strong currency, South African manufacturers asked for protective tariffs, and the government obliged. Instead of learning to compete, and letting the citizens of the country benefit from the financial windfall brought by cheap imports, South African manufacturers developed the habit of looking for protection. They became less and less competitive and some industries eventually withered and died.

Education, one of the best long term investments a country can make, was also suffering. A generation’s education was lost demonstrating against the scourge of apartheid.

Greece, Italy, Portugal and Spain all have industries that are protected. Their economies are becoming less competitive, even as the developing countries are reaping the benefits of their investments in education, and are challenging in markets once dominated by the developed world. The changes that the IMF and Germany have insisted on include removal of the protection of vested interests. The resistance from the powerful lobby groups was to be expected. The governments’ failure to explain that they were complicit in creating the economic imbalances has made the situation worse.

The Portuguese are quietly fixing things. Italy, under a technocratic government, was making good headway, but has recently hit resistance. Spain, with a plethora of challenges is triaging.

So, austerity becomes an easy catch-all phrase, and when the whole economy suffers, the interest groups motivate the uninformed electorate to rebel. They have. The outcome of the Greek polls, and the expected vote for a government with little understanding of the cure required is symptomatic.

The sudden European funding of the banks in Spain provides a hint that a Greek exit is expected soon.

The financial hardship that the Greeks will suffer will be unfair. But perhaps it will provide an incentive for the protected interests in Italy and Spain to prevent the same from happening to their fellow countrymen.