European Commissioner for Economic and Monetary Affairs Olli Rehn speaks to press about the Greek debt crisis
AS SPECULATION swirls as to whether the European Union (EU) or the International Monetary Fund will bail out Greece--a deal that in either case would stipulate crippling austerity measures on Greek workers--questions are emerging about the role that large banks played in making the crisis worse, and then profiting off it.
Specifically, the question is whether the banksters hushed up the scale of Greece's debt situation, and then used that inside information to speculate on a potential default.
Goldman Sachs is at the center of the scrutiny. Recent reports show that the firm consulted Greece as far back as 2000 on ways to take on more debt--and then hide it by packaging the liabilities into complex securities that were then counted as assets. It's the same kind of financial trickery that contributed to the massive housing boom and bust in the U.S.
By hiding its new debts, Greece could circumvent stringent conditions on government budgets that the European Union imposes on member countries.
And if that's not bad enough, it seems that Goldman used its insider knowledge of Greece's precarious financial situation to bet on a potential default by Greece. Thanks to its complicated financial maneuvers, the super-bank stands to make a killing in the event Greece defaults or needs to be bailed out.
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THE CULPRIT here is a familiar one. Goldman and other speculators are using credit default swaps as a way of gambling on the possibility that Greece will default--that is, it won't be able to repay its debts on time.
Credit default swaps are a kind of insurance policy that pays off if a particular bond or security defaults. The ostensible purpose of these credit default swaps--a form of the financial instruments that Wall Street calls "derivatives"--is for big investors to obtain financial protection against the possibility that a number of their investments could go bad. The idea is that the firms issuing credit default swaps agree to pay off what the original debtor owed.
These swaps were popular during the sub-prime mortgage boom--they were supposed to be insurance for investors who bought securities that were based on large numbers of mortgage loans being paid off on time.
It sounds fine in theory. But there are huge problems with credit default swaps.
For one thing, the market for swaps is completely unregulated, and they aren't traded on public exchanges. That means a lot of backroom dealing can occur.
Moreover, there's no limit on how many credit default swaps can be created and issued. So the market can swell to many times the size of the original assets or investments being "insured." Thus, the possibility that credit default swaps can turn from financial insurance to a gamble by speculators on whether homeowners or companies or whole countries will default on their debts.
The lack of regulation allowed the market for credit default swaps to swell to such an enormous size, so that movements in the prices of derivatives can have knock-on effects on the real economy. Since 2000, the market for such swaps has ballooned from $900 billion to more than $36 trillion.
Credit default swaps helped drive the insurer AIG into insolvency. AIG had issued so many swaps backing up securities based on mortgage loans that when the U.S. housing market collapsed, the federal government nationalized AIG and pumped billions of dollars into the company so it could pay off its swaps.
Because of all this, complex derivatives can have a massively destabilizing effect on the economy--which prompted super-rich investor Warren Buffet to call them "financial weapons of mass destruction."
Importantly, investors don't actually have to own the asset that they are arranging a swap to cover. Thus, swaps can become a tool for gambling on defaults occurring--and can even contribute to defaults taking place.
This is the equivalent of everyone else on a street buying fire insurance on one person's house--and then collecting when the house burns down. There's a reason that's illegal in the insurance business--the incentive is for all kinds of people to load up on insurance and then commit arson to collect. But on Wall Street, the same sort of activity applied to financial investments--called naked credit default swaps--is perfectly legal.
In the case of Greece, it seems that the speculators have pushed the country closer to default.
The growing demand for credit default swaps covering Greece have made it increasingly difficult for the country to raise money with newly issued bonds unless it pays a steep price--if it can find buyers at all. That increases demand for swaps still further, and so on, as the vicious cycle plays out.
These practices forced even Federal Reserve Chair Ben Bernanke--hardly a critic of Wall Street--to admit last week, "Using these instruments in a way that intentionally destabilized a company or a country is--is counterproductive."
In Greece's case, the firestorm began last October when the government revealed it had a budget deficit that amounted to 12.7 percent of its gross domestic product. Overall, Greece's debt stands at $300 billion. As a percentage of GDP, that's three times the limit for member nations of the European Union.
Concerns about Greece--along with Portugal, Italy and Ireland--have shaken confidence in the EU's currency, the euro, and prompted the EU to pressure Greece to get its books in order.
The Greek government promised to cut the gap to 3 percent of GDP by 2012 by freezing public-sector salaries and raising taxes. It raised taxes on fuel earlier this month and has announced a series of further measures, including making Greeks collect receipts for goods and services, like taxi rides, in an effort to fight tax evasion. But more painful cuts are in store.
Greece has until March 16 to convince EU finance ministers and the executive European Commission that the steps it has already announced are enough. It also needs to borrow or refinance $72 billion--with nearly half of that amount due in April and May.
The interest rate that Greece would have to pay on bonds that can raise this money is currently being valued at 7 percent--nearly double what Germany has to pay to borrow and 3 percentage points higher than Greece's borrowing costs before this crisis.
This is the result of investors betting in various ways against Greek bonds. The problem has become so vexing that the German government is trying to identify speculators in Greek debt to prevent them from profiting from any bailout.
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HERE IS where Goldman Sachs' damaging influence comes into play. In 2001, Goldman advised Greece to turn some of its debts into derivatives that could then be counted as assets rather than liabilities, thus hiding the real level of debt. As the New York Timesdescribed:
As in the American sub-prime crisis and the implosion of [AIG], financial derivatives played a role in the run-up of Greek debt. Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere...Critics say that such deals, because they are not recorded as loans, mislead investors and regulators about the depth of a country's liabilities.
A report in the German newspaper FAZ indicates that AIG sold the credit default swaps on Greece. Ultimately, these transactions enabled Greece to borrow 1 billion euros without adding to its official debt--and according to Bloomberg, Goldman was paid $300 million for arranging the deal.
And that was just one deal. According to the New York Times, a legal entity called Aeolos, created in 2001, gave Greece cash upfront in return for pledging future landing fees at the country's airports. A similar deal in 2000, called Ariadne, did something similar with revenue from Greece's national lottery. Similar deals were structured by Goldman and other banks, including from Europe.
In late 2009, Goldman came calling again. A team, led by Goldman President Gary Cohn, proposed that Greece push debt from its health care system into the future by creating another set of derivatives. The proposal was rejected. But Goldman wasn't done. It had loaded up on credit default swaps covering a default by Greece.
"Wall Street, led here by Goldman and AIG, helped to create the debt, then helped to create the hysteria about possible defaults," Marshall Auerback, a professor of economics at the University of Missouri-Kansas City, wrote. "As [credit default swap] prices rise and Greece's credit rating collapses, the interest rate it must pay on bonds rises--fueling a death spiral because it cannot cut spending or raise taxes sufficiently to reduce its deficit."
The overall amount of swaps on Greek debt hit $85 billion in February, up from $38 billion a year ago, according to the Depository Trust and Clearing Corporation, which tracks swaps trading.
As a result of these activities, the Securities and Exchange Commission and Federal Reserve Bank are investigating the role that Goldman played. But given the kid-gloves treatment that Goldman has received--not to mention the extent that it's already been bailed out by the government--it seems highly unlikely that anything will come of these inquiries. As Gretchen Morgenson wrote in the New York Times:
If the past is prologue, we might see a case or two emerge from that inquiry five years from now. The fact is that credit default swaps and other complex derivatives that have proved to be instruments of mass destruction still remain entrenched in our financial system three years after our economy was almost brought to its knees.
Worse, it's now clear that the U.S. government will do whatever it takes to bail out financial firms out and keep them solvent, even when their gambling blows up in their faces. This implicit guarantee is only encouraging more reckless behavior.
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WHILE GOLDMAN cashes in and likely gets off scot-free for helping to cause the crisis, the Greek working class stands to be punished brutally.
Over the past month, the Greek government has already announced wage freezes, bonus cuts, tax crackdowns and pension reforms meant to save about $6.7 billion. New measures that could be part of a bailout plan engineered by the EU could include a 2 percent increase in the country's value-added tax--already at 19 percent--higher fuel prices and the possible abolition of one of two additional months of pay received by public-sector workers and employees at many private firms.
In other words, the costs of Greece's default are being passed on to workers.
What's more, Germany's involvement in the bailout is creating a race to the bottom across national borders in Europe. "Germany has, in the last 10 years, been through very painful social reform, which means curtailing rights and social benefits, and pushing back the retirement age," Thomas Klau of the European Council on Foreign Relations told the New York Times. "The argument in Germany is 'Why should our workers work to the age of 67 to enable Greeks to retire earlier?'"
The harsh measures in Greece will ultimately make things worse. As economists Simon Johnson and Peter Boone wrote, austerity programs in Greece and other countries with high debt loads could "massively curtail demand, lower wages and reduce the public-sector workforce. The last time we saw this kind of precipitate fiscal austerity--when nations were tied to the gold standard--it contributed to the onset of the Great Depression in the 1930s."
In addition, privatizations--also done at the behest of financial firms like Goldman--mean that former sources of government revenue, such as toll roads, are no longer in the state's hands--leaving it even less able to pay its public debt.
Thus, the pay cuts and austerity programs could end up exacerbating defaults and necessitating another round of reductions--exactly when governments should be running up deficits to hire unemployed workers, pay out benefits and stimulate economic activity. That's the cost of the vicious cycle that the banksters set in motion.
