Greece Crowns Pentagram Devouring Whole Universe, Says Times (Subtly!)
Moderators: Elvis, DrVolin, Jeff
by JackRiddler » Mon May 24, 2010 6:56 pm
by JackRiddler » Mon May 24, 2010 7:25 pm
seemslikeadream posted in the other thread wrote:The Greeks Get It
By Chris Hedges
Here’s to the Greeks. They know what to do when corporations pillage and loot their country. They know what to do when Goldman Sachs and international bankers collude with their power elite to falsify economic data and then make billions betting that the Greek economy will collapse. They know what to do when they are told their pensions, benefits and jobs have to be cut to pay corporate banks, which screwed them in the first place. Call a general strike. Riot. Shut down the city centers. Toss the bastards out. Do not be afraid of the language of class warfare—the rich versus the poor, the oligarchs versus the citizens, the capitalists versus the proletariat. The Greeks, unlike most of us, get it.
The former right-wing government of Greece lied about the size of the country’s budget deficit. It was not 3.7 percent of gross domestic product but 13.6 percent. And it now looks like the economies of Spain, Ireland, Italy and Portugal are as bad as Greece’s, which is why the euro has lost 20 percent of its value in the last few months. The few hundred billion in bailouts for other faltering European states, like our own bailouts, have only forestalled disaster. This is why the U.S. stock exchange is in free fall and gold is rocketing upward. American banks do not have heavy exposure in Greece, but Greece, as most economists concede, is only the start. Wall Street is deeply invested in other European states, and when the unraveling begins the foundations of our own economy will rumble and crack as loudly as the collapse in Athens. The corporate overlords will demand that we too impose draconian controls and cuts or see credit evaporate. They have the money and the power to hurt us. There will be more unemployment, more personal and commercial bankruptcies, more foreclosures and more human misery. And the corporate state, despite this suffering, will continue to plunge us deeper into debt to make war. It will use fear to keep us passive. We are being consumed from the inside out. Our economy is as rotten as the economy in Greece. We too borrow billions a day to stay afloat. We too have staggering deficits, which can never be repaid. Heed the dire rhetoric of European leaders.
“The euro is in danger,” German Chancellor Angela Merkel
told lawmakers last week as she called on them to approve Germany’s portion of the bailout plan. “If we do not avert this danger, then the consequences for Europe are incalculable, and then the consequences beyond Europe are incalculable.”
Beyond Europe means us. The right-wing government of Kostas Karamanlis, which preceded the current government of George Papandreou, did what the Republicans did under George W. Bush. They looted taxpayer funds to enrich their corporate masters and bankrupt the country. They stole hundreds of millions of dollars from individual retirement and pension accounts slowly built up over years by citizens who had been honest and industrious. They used mass propaganda to make the population afraid of terrorists and surrender civil liberties, including habeas corpus. And while Bush and Karamanlis, along with the corporate criminal class they abetted, live in unparalleled luxury, ordinary working men and women are told they must endure even more pain and suffering to make amends. It is feudal rape. And there has to be a point when even the American public—which still believes the fairy tale that personal will power and positive thinking will lead to success—will realize it has been had.
We have seen these austerity measures before. Latin Americans, like the Russians, were forced by the International Monetary Fund and the World Bank to gut social services, end subsidies on basic goods and food, and decimate the income levels of the middle class—the foundation of democracy—in the name of fiscal responsibility. Small entrepreneurs, especially farmers, were wiped out. State industries were sold off by corrupt government officials to capitalists for a fraction of their value. Utilities and state services were privatized.
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What is happening in Greece, what will happen in Spain and Portugal, what is starting to happen here in states such as California, is the work of a global, white-collar criminal class. No government, including our own, will defy them. It is up to us. Barack Obama is simply the latest face that masks the corporate state. His administration serves corporate interests, not ours. Obama, like Goldman Sachs or Citibank, does not want the public to see how the Federal Reserve Bank acts as a private account and ATM machine for Wall Street at our expense. He, too, has helped orchestrate the largest transference of wealth upward in American history. He serves our imperial wars, refuses to restore civil liberties, and has not tamed our crippling deficits. His administration gutted regulatory agencies that permitted BP to turn the Gulf of Mexico into a toxic swamp. The refusal of Obama to intervene in a meaningful way to save the gulf’s ecosystem and curtail the abuses of the natural gas and oil corporations is not an accident. He knows where power lies. BP and its employees handed more than $3.5 million to federal candidates over the past 20 years, with the largest chunk of their money going to Obama, according to the Center for Responsive Politics.
We are facing the collapse of the world’s financial system. It is the end of globalization. And in these final moments the rich are trying to get all they can while there is still time. The fusion of corporatism, militarism and internal and external intelligence agencies—much of their work done by private contractors—has given these corporations terrifying mechanisms of control. Think of it, as the Greeks do, as a species of foreign occupation. Think of the Greek riots as a struggle for liberation.
Dwight Macdonald laid out the consequences of a culture such as ours, where the waging of war was “the normal mode of existence.” The concept of perpetual war, which eluded the theorists behind the 19th and early 20th century reform and social movements, including Karl Marx, has left social reformers unable to deal with this effective mechanism of mass control. The old reformists had limited their focus to internal class struggle and, as Macdonald noted, never worked out “an adequate theory of the political significance of war.” Until that gap is filled, Macdonald warned, “modern socialism will continue to have a somewhat academic flavor.”
Macdonald detailed in his 1946 essay “The Root Is Man” the marriage between capitalism and permanent war. He despaired of an effective resistance until the permanent war economy, and the mentality that went with it, was defeated. Macdonald, who was an anarchist, saw that the Marxists and the liberal class in Western democracies had both mistakenly placed their faith for human progress in the goodness of the state. This faith, he noted, was a huge error. The state, whether in the capitalist United States or the communist Soviet Union, eventually devoured its children. And it did this by using the organs of mass propaganda to keep its populations afraid and in a state of endless war. It did this by insisting that human beings be sacrificed before the sacred idol of the market or the utopian worker’s paradise. The war state provides a constant stream of enemies, whether the German Hun, the Bolshevik, the Nazi, the Soviet agent or the Islamic terrorist. Fear and war, Macdonald understood, was the mechanism that let oligarchs pillage in the name of national security.
“Modern totalitarianism can integrate the masses so completely into the political structure, through terror and propaganda, that they become the architects of their own enslavement,” he wrote. “This does not make the slavery less, but on the contrary more— a paradox there is no space to unravel here. Bureaucratic collectivism, not capitalism, is the most dangerous future enemy of socialism.”
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Macdonald argued that democratic states had to dismantle the permanent war economy and the propaganda that came with it. They had to act and govern according to the non-historical and more esoteric values of truth, justice, equality and empathy. Our liberal class, from the church and the university to the press and the Democratic Party, by paying homage to the practical dictates required by hollow statecraft and legislation, has lost its moral voice. Liberals serve false gods. The belief in progress through war, science, technology and consumption has been used to justify the trampling of these non-historical values. And the blind acceptance of the dictates of globalization, the tragic and false belief that globalization is a form of inevitable progress, is perhaps the quintessential illustration of Macdonald’s point. The choice is not between the needs of the market and human beings. There should be no choice. And until we break free from serving the fiction of human progress, whether that comes in the form of corporate capitalism or any other utopian vision, we will continue to emasculate ourselves and perpetuate needless human misery. As the crowds of strikers in Athens understand, it is not the banks that are important but the people who raise children, build communities and sustain life. And when a government forgets whom it serves and why it exists, it must be replaced.
“The Progressive makes History the center of his ideology,” Macdonald wrote in “The Root Is Man.” “The Radical puts Man there. The Progressive’s attitude is optimistic both about human nature (which he thinks is good, hence all that is needed is to change institutions so as to give this goodness a chance to work) and about the possibility of understanding history through scientific method. The Radical is, if not exactly pessimistic, at least more sensitive to the dual nature; he is skeptical about the ability of science to explain things beyond a certain point; he is aware of the tragic element in man’s fate not only today but in any collective terms (the interests of Society or the Working Class); the Radical stresses the individual conscience and sensibility. The Progressive starts off from what is actually happening; the Radical starts off from what he wants to happen. The former must have the feeling that History is ‘on his side.’ The latter goes along the road pointed out by his own individual conscience; if History is going his way, too, he is pleased; but he is quite stubborn about following ‘what ought to be’ rather than ‘what is.’
by seemslikeadream » Tue May 25, 2010 8:09 am
by JackRiddler » Tue May 25, 2010 8:02 pm
“The claim made in the IMF documents is that the “program” (including the inhuman austerity conditions and targets) is “achievable”, “feasible” and “sustainable”. On this point, however, the IMF of course has not been able to convince some of the most prominent economists and commentators (Krugman, Feldstein, Stiglitz, Rogoff, Eichengreen, Johnson, Roubini, Rodnik, Buiter, Reinhart, Fitoussi, Wyplosz, Wolf, Munchau, among others, mentioned here in no particular order.) All are saying in one way or another that the numbers do not add up. In other words, the arithmetic shows that even with this IMF/EU package, the Greek debt is not sustainable. (See in particular Buiter’s latest 65-page research report ‘Sovereign Debt Problems in Advanced Industrial Countries’.)”
SPIEGEL: The German government has said that there was no alternative to the rescue package for Greece, nor to that for other debt-laden countries.
Pöhl: I don't believe that. Of course there were alternatives. For instance, never having allowed Greece to become part of the euro zone in the first place.
SPIEGEL: That may be true. But that was a mistake made years ago.
Pöhl: All the same, it was a mistake. That much is completely clear. I would also have expected the (European) Commission and the ECB to intervene far earlier. They must have realized that a small, indeed a tiny, country like Greece, one with no industrial base, would never be in a position to pay back €300 billion worth of debt.
SPIEGEL: According to the rescue plan, it's actually €350 billion ...
Pöhl: ... which that country has even less chance of paying back. Without a "haircut," a partial debt waiver, it cannot and will not ever happen. So why not immediately? That would have been one alternative. The European Union should have declared half a year ago -- or even earlier -- that Greek debt needed restructuring.
SPIEGEL: But according to Chancellor Angela Merkel, that would have led to a domino effect, with repercussions for other European states facing debt crises of their own.
Pöhl: I do not believe that. I think it was about something altogether different.
SPIEGEL: Such as?
Pöhl: It was about protecting German banks, but especially the French banks, from debt write offs. On the day that the rescue package was agreed on, shares of French banks rose by up to 24 percent. Looking at that, you can see what this was really about -- namely, rescuing the banks and the rich Greeks.
SPIEGEL: In the current crisis situation, and with all the turbulence in the markets, has there really been any opportunity to share the costs of the rescue plan with creditors?
Pöhl: I believe so. They could have slashed the debts by one-third. The banks would then have had to write off a third of their securities.
SPIEGEL: There was fear that investors would not have touched Greek government bonds for years, nor would they have touched the bonds of any other southern European countries.
Pöhl: I believe the opposite would have happened. Investors would quickly have seen that Greece could get a handle on its debt problems. And for that reason, trust would quickly have been restored. But that moment has passed. Now we have this mess.
by JackRiddler » Tue May 25, 2010 8:26 pm
Truths and Myths about the "Greek Crisis"
18 May
The following is a guest post by Polyvios Petropoulos, a former university professor of economics and management in the US.
Petropoulos contends that the austerity package drawn up by the IMF is not credible and that everyone knows Greece cannot meet its commitments. He ends the post with a four-step scenario he deems actually plausible.
Petropoulos’ view differs considerably from the usual fare at Credit Writedowns. However, his is a good alternate view of the Greek situation from a Greek perspective. Pay particular note to his assertions about government salaries and the credibility of government finances in Greece and elsewhere.
Zeus (Dias), the Greek god, gave Europe the name of his beloved woman (Europa), hoping that she would be immortal. The question now is: Will the European dream end where it began, in Greece, or will it end in catharsis, as all Greek tragedies do?
It is only in the last few months that most commentators realized that this crisis is not about Greece only, that it is a European and, eventually, a global sovereign debt crisis, and that Greece is not even the worst case. Anyone who still thinks that this is only a Greek (or a GIPS) crisis should take a look at this table,
http://seekingalpha.com/article/188776- ... ook-so-bad
published three months ago, which shows that Greece is only 16th in external debt as % of GDP among developed countries, whereas Germany is 14th, with a slightly higher figure, believe it or not, France is 8th, and the UK is 3rd . As to structural deficit-to-GDP, it is higher in the US (7.8%) and the UK (7.6%) than it is in Greece (6.1%). See here.
https://ems.gluskinsheff.net/Articles/B ... 030410.pdf
Have the Greeks been “fiddling” with their statistics? Maybe they did. But we should also realize that no budget figures of any country can be dependable, credible, or comparable, and furthermore figures are easy to play with, as there are no standard, uniform, accounting rules for country budgets, and no surveillance whatsoever. Let me elaborate: Do the figures of any country include off-budget items, unfunded and contingent liabilities, future or deferred commitments, government guarantees, bank-insurance schemes, the debt/liabilities of public corporations, pension schemes and health systems? What about leasing and lease-backs? Are “top secret” expenditures for defence and intelligence activities included and shown in government budgets? Are expenditures presented when contracts are signed or when they will be paid for? Are revenues brought forward by factoring etc.?
What about swaps, securitisation and other gimmicks used to fiddle with the figures? Let’s look at the allegation that Greece used cross currency swaps to reduce its debt, and whether it is the only country that has used them. First of all, “swaps” and other “instruments of mass destruction” were not invented in Greece or promoted by Greeks. Secondly, the GS swap deal was not done before but after Greece had joined the EMU (in 2002). Thirdly, such swaps were at the time acceptable by the EU commission and the Eurostat, as the EU commission spokesman Amadeu Altafa declared in Brussels on Feb. 15th. Which other countries have used or were involved in swaps? Too many to even list them here, let alone to describe the boring details of the exact deals of each: Italy, Spain, Portugal, France, Belgium, UK, and Germany (yes), among others. Even Mr. Bernanke, in his testimony before the Committee on Financial Services on Feb. 10th, says that the Fed “entered into temporary currency swap agreements” and has used “reverse repos”.
A lot has been written about corruption in Greece. And surely there is corruption in Greece, as there is everywhere. I tried the Google search engine a few days ago, and typed “corruption in…(country)”. I got 28,600,000 links for the US, 8,930,000 for France, 8,490,000 for the UK, 6,910,000 for Germany, 4,720,000 for Italy and 2,680,000 for Greece. You may say that this is not necessary indicative and dependable about the amount of corruption in the different countries, but neither are the rankings of “Transparency International”. According to an opinion survey conducted in Nov. 2009 by the Eurobarometer, 78% of Europeans say that “corruption is a major problem in the EU”. A “fakelaki” in Greece is a sort of a tip in most cases. Like the “tip” you may give to the traffic policeman in some countries…(you know which one I mean) to avoid getting a traffic ticket (don’t ever try it in Greece by the way). Now, other more serious types of corruption, such as bribing, are also prevalent in Greece, primarily in tax revenue depts. Many foreign companies (particularly German) bribe Greek officials to get contracts. And I‘ll remind my German friends that it takes two to tango. A lot has been written about other types of corruption in major countries of the western world, such as campaign contributions, sponsoring, lobbying and regulatory agencies staffed by ex-managers of the organizations they are supposed to regulate. Does it remind you of anything?
Who is to blame? “Everyone is a sinner”, according to J. Stark, the ECB chief economist. I have also elaborated who some of the sinners are in this article. But the main sinners of course are the successive Greek governments. It is true that fiscal discipline has been lax. Steps to reduce the budget deficit should have been taken in the “good times”, i.e. in the years before the beginning of the Great Recession. Then, when the recession hit the country in 2007-8, stimulus measures were needed to prop up the economy, but they were not taken, perhaps because the country could not afford them. And now, in 2010, fiscal stabilization has to be carried out. Unfortunately, populist politicians did not realize what was happening or what they should be doing all these years, and they didn’t understand what the correct timing of each phase of economic policy should have been, and they did nothing to increase competitiveness, which is at the root of the problems. It was an unnecessary extravagance for Greece to organize the Olympic Games in 2004, at a cost that exceeded 10 b. euros. And Greece has a defense budget which is roughly one third of its deficit, primarily due to Turkish provocations in the Aegean Sea. One word to the supporters of speculators and naked CDSs: Nobody is saying that they have created the crisis, as most of them are trying to disprove. What sensible people are saying is that they are exacerbating the crisis.
Have the Greeks been living beyond their means? Here is the answer:
Average salaries in Greece are about 73% of the average eurozone salary. According to Eurostat and GSEE data, 60% of Greek pensioners receive less than 600 euros per mo. And 85% receive below 1050 euros per mo. Greek pensions are about 55% of the average eurozone pension, despite inaccurate claims about pensions made in the international media. The usual age for retirement of most people in Greece has been 65 yrs, except for some very special cases in the public sector, which are now being revised upwards –and rightly so- with a new pensions law.
Do Greek households spend more than they earn by borrowing a lot? No. In fact, German households owe more than Greeks. See here. Are Greeks not as hard-working as Germans, or others, as some are saying? Here are the facts. As you can see, Greeks are the most hard-working people in the OECD countries (with the exception of Koreans). The average Greek worker works 2120 hours per year – 690 more than a German worker. (Source: OECD).
Now let me turn to the IMF/EU package concluded with Greece recently. In a press conference published on the IMF website on May 9th, you may read (all bolds are mine):
http://www.imf.org/external/pubs/ft/sur ... 50910a.htm“Today, the IMF has demonstrated its commitment to doing what it can to help Greece and its people,” Strauss-Kahn said. “The road ahead will be difficult, but the government has designed a credible program that is economically well-balanced, socially well-balanced—with protection for the most vulnerable groups—and achievable. Implementation is now the key.”
Let me consider these claims one by one and be absolutely clear and precise:
First of all, the IMF/EU program (particularly the EU portion) is no “help” or “aid” or “rescue”, or even “bailout”, as the IMF, the EU and various commentators are saying. It consists of a series of loans, in fact non-concessional loans, as it is clearly stated in the Q&A session of the IMF here, with unprecedented draconian conditionality and the normal interest rate which is charged by the IMF in all cases. As to the EU portion, it is given at an even higher interest rate, which should be turned down by the Greek government. Paying 5-6% interest rate, when the country’s GDP growth is -4% p.a., clearly makes the country’s debt problem unsustainable, as has been shown by several economists. In judging interest rates, it should also be remembered that these loans are senior to all other Greek debt.
Second, it was not offered to help the “Greek people”. It was offered to help the bondholders, the bankers, the euro, and to avoid contagion with its nasty consequences for the EU and the global economy, as it is clearly stated elsewhere in the Q&A session mentioned above.
Third, there is absolutely no “protection for the most vulnerable”, as one would have expected from the “socialist” (or “ex-socialist”?) head of the IMF, or the “socialist” Greek government for that matter, and this claim is made several times in both of the documents mentioned above. The opposite is true. A mere listing of some of the austerity measures will suffice to prove my assertion:
-A meager so-called “social solidarity allowance” for destitute people was abolished, despite assurances in the IMF Q&A session that “the targeting of social expenditures will be revised to strengthen the social safety net for the most vulnerable”.
-Despite assurances in the Q&A session that “minimum pensions and family support instruments will not be cut”,all public and private-sector pensions and allowances have been cut, all the way down to meager pensions of 450, 500, 550 euros per month etc., which are well below the poverty line (making it impossible for old pensioners to survive), and this is what the majority of pensioners receive. This must be reversed for both human and economic reasons. On the other hand, nothing has been changed regarding the 300 Greek MPs, who receive a substantial pension after only 8 yrs in parliament!
-Reduction of the salaries of even the lowest-paid civil servants. The 13th and 14th bonuses, which are often mentioned as a sign of extravagance, should have been incorporated in the 12 monthly salaries, and Greek salaries would still be lower then the EU average. (See comparison of total Greek and EU salaries above.)
-Freezing of the lowest salaries and pensions for the next few years, although inflation is already galloping above 4% p.a., well above the EU average, and may go even higher, despite the IMF claim at the press conference that“inflation is expected to remain below the euro average.”
-VAT (value added tax), which was much higher in Greece than in Portugal and Spain, was raised by about 20% on all goods, including basic foodstuffs, which make up the majority of poor people’s purchases.
-Sales taxes were raised on –supposedly- luxury goods…such as gasoline (+50%), cigarettes, beer, wine etc. I say to the poor people of Greece: For heaven’s sake, don’t drive, and stay away from all these sinful products!
To be fair, according to an interview of Mr. Papaconstantinou, the Greek finance minister, a few days ago, the reduction of the pitiful pensions of the private sector was not imposed by the IMF officials in Athens, but by the EU officials. My guess is that it must have been decided at the insistence of an official appointed to the negotiating team by “Frau Nein”, who wants blood, sweat and tears imposed on the Greek people.
The agreement reached between the IMF, the EU and the Greek government says nothing about reducing the number of MPs and ministries, or the number of civil servants, says nothing about capital gains, about selling part of the real estate owned by the state and the church, and is vague about taxing the rich, reducing drastically the state’s expenses, making politicians accountable for corruption with strict laws, about privatizations, competitiveness and export-led growth. Greeks should be allowed to bring their deposits (over 200bn) back from abroad without the 5% penalty. Housing construction, which is the economy’s “steam engine”, was further penalized. Labor market reforms should have been more daring. For obvious reasons, nothing has been announced by the Greek government about the sensitive subject of military expenditures, although the IMF says that they will be reduced. I assume that Greeks will require proportional reductions from Turkey before actually implementing such reductions. Also Greece’s EU partners, from whom Greece buys most of the weapons, will not be thrilled about this. Nothing was said also about the great oil reserves waiting to be drawn from the Aegean Sea, worth several trillions. Implementation of the measures announced is also questionable. It’s indicative that dates by which income tax returns for 2009 must be submitted were again postponed recently until as late as May-June of this year. In the meantime the tax people are looking for swimming pools in the backyards of the Greeks, as if this were a sign of great wealth…
Regarding competitiveness, which is indeed of paramount importance, the IMF makes simplistic observations, as is the case with many other commentators. First of all, competitiveness is not only a question of unit labor costs, but depends on many other factors as well. Secondly, looking only at the comparative percentage increase of unit labor costs in Greece since 1999, as most do, is not enough, because absolute figures of wages and salaries, which are much lower compared to the EU average, as I have shown above, do matter as well, and are not mentioned in any of the IMF documents, or by the media. ULCs in absolute figures are lower in Greece than in any of the other GIIPS countries, as well as in the UK and Denmark.
Finally, nothing is said about the intra-EU imbalances, or about the divergences in competitiveness, trade balances and inflation, which were created in favor of the core EU countries of the north vis-à-vis the southern peripherals since 1999, as a result of the common market and pegged currency, as economic theory postulates that they are bound to.
Will the “program” work? The claim made in the IMF documents is that the “program” (including the inhuman austerity conditions and targets) is “achievable”, “feasible” and “sustainable”. On this point, however, the IMF of course has not been able to convince some of the most prominent economists and commentators (Krugman, Feldstein, Stiglitz, Rogoff, Eichengreen, Johnson, Roubini, Rodnik, Buiter, Reinhart, Fitoussi, Wyplosz, Wolf, Munchau, among others, mentioned here in no particular order.) All are saying in one way or another that the numbers do not add up. In other words, the arithmetic shows that even with this IMF/EU package, the Greek debt is not sustainable. (See in particular Buiter’s latest 65-page research report “Sovereign Debt Problems in Advanced Industrial Countries”.)
Nor did the IMF convince the markets with this package. In fact, I am beginning to believe that nothing will convince them.
Even though there was initially some improvement, not because of the IMF/EU package for Greece, but after the latest eurozone stabilization program of nearly one trillion, the latest ECB decision to in effect monetize the debt by buying government bonds (as all other central banks have been doing all along), the USD loan swaps, the laxity by the ECB with respect to accepting government bonds of a lower rating as collateral, and the plans to establish an EU rating agency, which were all announced very recently. Other factors which may, or may not, impress the markets are the imminent eurozone decisions regarding economic coordination and governance (see the EU commission proposals at http://ec.europa.eu/economy_finance/art ... 2-com(2010)250_final.pdf), and the impressive -40% reduction of the Greek deficit in the first quarter of this year.
Despite the theories of some ivory-tower economists, about the supposed “rationality”, “discipline” and “efficiency” of the markets, markets and speculators are not at all rational. Greece is not alone in the debt trap, not even the worst case, to be penalized by the markets so harshly. Recent EU figures show that total debt is 224pc of GDP in Greece, 272pc in Spain and 331pc in Portugal. Also the gross external debt of Greece is 168.2pc of GDP, Portugal’s is 232.7pc and Spain’s is the same as Greece’s (Ireland’s is a record 979.4pc). But the spreads on 10-yr debt were recently 7.75pc for Greece (after dropping from previous incredible heights), and only 3.92pc for Spain and 4.62pc for Portugal. Does this make any sense? And yet I do not wish to be overly suspicious or conspiratorial…
On “restructuring” or “rescheduling” of Greek debt, the IMF is adamant in both documents: No way. Again many of the economists previously mentioned are not at all convinced. The discussion which is now going on is whether to restructure with or without a haircut, or to do a “voluntary” rescheduling, as I have suggested as Option C here, and whether this should be done sooner or later, with or without IMF’s and eurozone’s consent, without a euro exit or with euro exit and drachma devaluation. Discussions of the Greek government with Lazard, the investment bank who are specialists in debt restructuring, make some people suspicious.
A plausible scenario could be as follows in this sequence of steps: (1) Start receiving IMF/EU funds in tranches, preferably after revising terms and EU interest rate, as I have suggested, and start selling bonds to ECB directly, or through Greek banks. (2) Evaluate progress of implementation and results every month, revising measures where needed. (3) If all goes according to plan, continue implementing. If not, reschedule debt with IMF/EU consent. (4) If no consent given, or, if still no progress is made, then exit eurozone and devalue the drachma.
Proposals for Greece - Let's Change the Discussion
April 29, 2010
Greece should not accept the part of the IMF/EU "package" which is being offered by the EU if the EU does not lower the interest rate to 3%, or at most 3.5%, as that is the maximum rate charged by the IMF. It is as if you can borrow from a stranger at 1.50%-3.50%, and your partner is asking you for 5%. Moreover, the calculations of several economists with respect to the so-called "snowball effect" indicate that if Greece borrows at a rate of 5% or more, her debt as a % of GDP becomes unsustainable. The interest rate, as has been shown by a number of economists, should be lower than the growth rate of GDP, and of course a Greek GDP growth above 5% is not very probable in the near future.
Apparently, the Greek government could have not waited to activate the so-called "bailout mechanism" (although “lending” is in my view a more precise description, rather than bailout) after the German elections on May 9th, which would have been preferable for obvious reasons. Greece should initially ask the IMF for its part of the lending (and anyone else who can lend her at the same rate as the IMF), and she should then ask Germany for its share (and other countries which must have the approval of their parliament) after May 9th. Greece should not give in easily to "Frau Nein" regarding the interest rate. This is a "poker" game played by this lady and her sympathizers (Axel Weber, Otmar Issing, etc.), but Greece also has a strong "hand": Somebody has said that if you owe a little bit of money, you have a problem. If you owe a lot, your lenders have the problem. One issue is of course the risk of contagion of the initial crisis, which will probably spread to other peripheral countries of the eurozone (I prefer calling them GISPIs), and then all across the eurozone, and eventually throughout the world, because –as it is now well understood- Greece is not the only country that has a large deficit and public debt. Another issue is the financial damage which will be suffered by German banks (among others) by a possible restructuring of Greek debt, and their bailout cost for the German government will be huge, much larger than the requested loan to Greece. Not to mention the threat of leaving the euro, returning to the drachma, currency depreciation, default, etc. The Greek Prime Minister should put these “guns” on the table, even if he does not intend to use them.
I do not wish to dwell at length on the responsibility of Germany (and the entire eurozone) for the rapid deterioration of the Greek crisis, the rise in spreads, the panic in the markets and the party of the speculators. Greece should remind her partners of the structural failures of the EU and the eurozone, the intra-European imbalances (for example, for Germany to export and to have a smaller deficit than Greece’s the Greeks should import their products and have a greater deficit as a result) and, finally, it is a well-established fact in economics that in a monetary-trade union most economic variables (such as exports, competitiveness, deficits, debt, etc.) of the countries in the union are bound to diverge over the years. Strong countries will get stronger and the weak weaker. Thus, the necessary solidarity is not a good-Christian-act, but an unavoidable necessity for maintaining the union. Nor should Greece let the Europeans forget that she has made two gifts to the eurozone: she has contributed to the depreciation of the euro, making eurozone exports cheaper, and she has helped EU leaders realize what leading economists have been saying for years, namely that a monetary union without common economic-fiscal policies and without solidarity cannot exist.
Those Greeks who demonize the IMF offer a poor service to their country. IMF is not a "bogeyman". And indeed, as proclaimed by well-known economists and former IMF officials (such as K. Rogoff, S. Johnson, etc.), the IMF has been offering loans on softer terms in recent years. See e.g. conditions imposed by the IMF on Romania and other countries. But one thing is certain: Greece should not accept the imposition of additional austerity measures for 2010, as “Frau Nein” has recently suggested. For 2011 and 2012, it’s a different story. It will depend on the results of the severe austerity measures already taken, which should be apparent by the end of 2010. Unfortunately, it is true that these harsh measures have not yet been applied with the rigor and speed they should have. And of course a deficit below 3% of GDP by 2012, when this threshold has now been exceeded even by Germany, is almost impossible for Greece to achieve, without strangling the economy of the country and its people, and should not have been promised.
However some steps to liberalize the labour market should not be taboo, particularly as the current restrictions are not being complied with in practice in most cases, nor can they be policed. On the contrary, such measures as freedom to fire employees with no restrictions and the abolition of a minimum wage-salary will improve the competitiveness of Greek firms and the economy (by reducing the average labour cost per unit of output), which is at the root of the Greek crisis, and will increase employment as well, as surely no government can possibly reduce wages in the private sector by decree, as some people are suggesting. But the government should indeed slash drastically expenditures of the sinful and bloated public sector. And Greece does not need more than 10 ministries at most. Also, if Greece sells half of the public properties (and I am not talking here about islands or monuments, as some Germans have suggested…), the country may pay off a third of its debt. Growth and economic export-oriented development should not be forgotten, because obviously it affects the denominator of the two fractions of deficit/GDP and debt/GDP. Regarding the numerator of the first fraction, which is revenue minus expenditures, the difficulty of course is to reduce those expenditures and to increase those revenues, which do not reduce private consumption and investment. Without going into a theoretical discussion here, this is related to the “negative multipliers” in some cases. And of course, people with low salaries and pensions should not be burdened further. Privatizations and other structural measures are also urgently needed. If the government does not watch out for these issues, then the economy will enter into the well-known vicious spiral. And I am afraid this is what the recent tax bill may do, which although it may well be in the right direction, some adjustments are needed (which of course I cannot deal with here).
Unfortunately, proposals such as the creation of a European Monetary Fund, or Insurance Fund, or the issuing of European bonds, etc. have not been adopted yet, due to indecision and lack of solidarity on the part of certain European leaders. However, there are other funding options that Greece could also consider:
Option A: The Greek government may issue bonds at a reasonable interest rate. They will be offered to Greek banks, and the banks will deposit them as collateral at the European Central Bank, withdrawing from the ECB inexpensive cash with which they will then pay the Greek government for the bonds.
Option B: The Greek government can issue bonds in Yen (which are of course convertible into any other currency) to be guaranteed by the JBIC (Japan Bank for International Cooperation), at a low interest rate, as dozens of countries have done, including Turkey.
Option C: As a last resort, there is the possibility of voluntary rescheduling of Greek debt, thus moving the loans, which expire in the short term, further away in time. This is NOT equivalent to default, as some commentators have suggested. In fact, a well-known UK bank has done this, without any problem.
Finally, the Greek government should deal with the vicious orchestrated attacks by certain international media and their paid commentators, the various lobbies and politicians, handsomely compensated by investment “banksters” who work together with some hedge funds, their blogs and think tanks, and those credit rating agencies that are being paid by companies and countries being evaluated by them. The lies and half-truths about Greece published daily are incredible, and they certainly add to the panic in the markets. “Country runs” (like what is now happening to Greece) are similar to “bank runs”. No bank or country can cope under these circumstances. All these inaccuracies should be answered on behalf of the government. (To be clear: I am not denying the responsibilities and mistakes of successive Greek governments, but Greece is not alone in this mess, and Truth should be respected above all.)
Moral deficit - not moral hazard - is at the root of the recent economic recession, which is now gradually becoming a severe sovereign credit crisis of global proportions.
by 2012 Countdown » Tue May 25, 2010 8:55 pm
by Joe Hillshoist » Wed May 26, 2010 12:37 am
by JackRiddler » Wed May 26, 2010 12:52 am
(Old News Dept.)
Greece debt crisis deferred, not cured
Investors have good reason to think Greece's debt crisis has not been solved by the IMF bailout package
Nils Pratley
guardian.co.uk, Tuesday 4 May 2010 21.09 BST
A protester is seen behind a banner during a rally in Athens. Greece's debt crisis may return to haunt it. Photograph: Thanassis Stavrakis/AP
There's a pattern here. European politicians stand up on a Sunday and declare that they have found a solution to Greece's financial crisis. A day or two later, investors respond by shouting "no, you haven't". Today's performance of this drama was the most alarming to date. The €110bn three-year bailout for Greece was meant to be the final word on the matter from the eurozone members and the IMF. It was greeted with big falls in stock markets around the world while the euro hit a 12-month low against the dollar.
Unfortunately, investors have good reasons to think the Greek bailout will succeed only in deferring pain. Even if the Greeks are eventually strong-armed into accepting austerity measures, it is hard to believe the economy can revive sufficiently over the next two or three years to make the public sector debts manageable. Nothing of similar scale has been attempted by a country denied the option of devaluing its currency. The fear of eventual default is not going to go away.
It now looks as if the story of the summer has been laid out – the battle by EU officials to persuade the markets that Greece need not cause contagion in other corners of the eurozone.
Neither Portugal nor Spain has debt problems as deep as those of Greece. But investors, having witnessed the shambolic progress of the Greek talks, want to know if the EU has the stomach to bail out other countries if necessary. Once the question starts to be framed that way, the demand for an answer can prove overwhelming. Lehman Brothers was too big to fail until it wasn't.
It is not too late to believe the plot could take a gentler turn. Portugal and Spain could yet surprise the market by setting out more aggressive savings plans. But they would have more time to assemble their defences if investors were convinced that a belt-and-braces answer had been provided in Greece. When a €110bn emergency package can't even produce a 48-hour rally, events are moving too fast for comfort.
guardian.co.uk © Guardian News and Media Limited 2010
Greece still has a choice
It could abandon the euro and default on the bulk of its debt. After all, it worked for Argentina
George Irvin
guardian.co.uk, Sunday 2 May 2010 20.00 BST
In truth, Greece does have an alternative. Instead of submitting to the ferocious and pro-cyclical conditionality imposed by Germany and the IMF – cutting its budget deficit by 11% over three years in return for a €120bn (£104bn) loan – it could follow Argentina's example in 2001-02, and default on the bulk of its sovereign debt. This would mean abandoning the euro, introducing a "new drachma" and probably devaluing by 50% or more.
Some weeks ago, I had a private exchange about this scenario with Mark Weisbrot of the Centre for Economic Policy Research in Washington. He favoured Argentinian-style default; I did not. But given Angela Merkel's politically motivated foot-dragging, the failure of the European Central Bank to deal with the problem at an earlier stage and the strongly pro-cyclical nature of the cuts required, I am having second thoughts.
Eight years ago, Argentina defaulted on the major part of its sovereign debt and survived quite well. Many economists predicted that Argentina's debt default would result in currency collapse, hyperinflation and even greater economic contraction than it had endured during its 1999-2002 recession. Instead, after the 2001-02 debt default and subsequent devaluation against the dollar (from 1:1 to 3:1), GDP grew at over 8% per annum over the period 2003-2007 and annual inflation fell from over 10% per month in early 2002 to less than 10% per annum. By 2005, Argentina had sufficient reserves to allow President Néstor Kirchner to pay off its remaining $9.8bn (£6.4bn) loan from the IMF in full and discontinue its programme with them.European leaders would do well to read up on the Asian, Russian and Latin American financial crises of 1997-2002. The Nobel laureate Joseph Stiglitz famously published an open letter citing his reasons for resigning from his post of chief economist at the World Bank. Among his criticisms of the bank and the IMF was the imposition of drastic deflationary measures on Thailand and Korea in 1997, and on Russia in 1998, mainly to protect the balance sheets of private western banks. The conditionality imposed was paid for dearly by cuts in economic and social expenditure thrust on ordinary citizens.
A central lesson of all this is that unless protective action is taken early, a country can rapidly be overpowered by the financial markets. Once traders start betting against a country's bonds or its currency, the herd instinct takes over. Greece's budget deficit is not particularly high by world standards – 13.6% versus 11% in the UK, and 12.3% in the US. But traders perceived its sovereign debt structure as too risky and prophecies of doom became self-fulfilling. There is a further problem. The spending cuts needed to meet the government's deficit target will undermine Greek government revenues. As an economist at London-based Capital Economics put it: "The key risk to its target is that deeper recession will lead to lower tax revenues, offsetting some of the savings that the government expects to make as a result of its fiscal tightening." In short, even though the bailout package has been agreed, the cuts may prove counterproductive and Greek recovery is far from assured.
The ECB could have nipped this crisis in the bud several months ago, both by continuing to accept Greek government bonds as collateral and by quantitative easing. Although the ECB had used quantitative easing to bailout the EU banking system, it refused to do so for Greece. There are clear signs that contagion is spreading to Portugal, and possibly to Spain and Italy. Can the ECB really be counted on in future to prevent the gradual unravelling of the euro?
As the French economist Jean-Paul Fitoussi argued in a recent interview in Libération, even if the Greek crisis is successfully contained for a time by an EU-IMF package, the financial markets will hope to profit by squeezing other European countries. Meanwhile, ordinary Greeks are taking to the streets to protest against further draconian austerity measures, while the EU's political class continues to focus entirely on its narrow domestic interests. Here in Britain, a bemused electorate apparently has not yet woken up to the nature and magnitude of the cuts we will almost certainly suffer as a result of the 2008 bank bailout. Most important, we have not begun to question seriously whether placating the financial markets by means of such cuts is unavoidable. Perhaps it's time to start thinking the unthinkable: namely, that financial markets should be our servants, not our masters.
guardian.co.uk © Guardian News and Media Limited 2010
No, no, no! For growth to happen, the size of government must be cut. Countries with lower government spending have been proven to economically outperform those with higher public spending.
They will end up defaulting anyway. There is no appetite amongst the population to change their way of life. Unfortunately for them this will involve other European countries taking an almighty hit on the outstanding oans which may push their respective economies back down the tubes. The Greeks will be utterly reliant on the tourist industry with the bulk of its customers coming from the EU. If Greece sticks two fingers up to its 'friends' then I would have thought a boycott of Greece as a holiday destination will be one of severalinformal measures that will come to pass to pay them back.
Yes, the monster Greek bailout has arrived. Now what are the Greeks giving/giving up in turn? Not much I'm afraid... Timid measures, they do not even give up on their (in)famous 13th and 14th salaries, there's only a cap on them. A bit of VAT increase on booze/fags, that is all about it. I can hear the Germans mumbling: the Greeks have conned the EU yet again...
There have been one or two articles on CiF painting Germany as the bad guys over the last couple of days but the truth is that it is Germany bailing Greece out and the Germans are the ones with the choice, they could kick Greece out of the Euro and watch as it defaulted on its debts and slid into economic chaos. Germans are perfectly entitled to ask for concessions in return for their help.
[[The above is clueless. Under the treaty terms a country cannot be kicked out of the euro, certainly not by German fiat.]]
Shameful. Defaulting sets an extremely bad example to the people of Europe. If the Guardian "defaulted" on the authors wages at the end of the month I'm sure he wouldn't be so sympathetic towards such actions. There was a time when people were expected to live up to their obligations, obviously that time is over in the Guardian.
Financial markets will always be our masters...your willingness to admit it notwithstanding. It's the same as saying oxygen will always be our master because we need it to live.
The third article by George Irivn, in which Germany is to blame for all this Greek mess. Seriously George, what's the bit you don't understand? If the Greeks defaulted, then the ordinary folk would pack their bags and go and stay with their relatives ... in Germany. Those that stayed behind, would set the rest of the Greek seaside forests on fire to build more luxury homes for the rich. Those nice German tax payer i.e. me, are actually saving the Greeks from a future of doom and gloom ... and yet somehow you continue to believe its all our fault. [sigh] And now, go and write an article about the flight of all the wealthy Greeks to London, where they are buying expensive properties. Go on, I dare you.
[[The problem is that the wealthy Greeks started going to London already somewhere around the time of the Greek Civil War.]]
What a marvellous solution!!!!! No-one has ever thought of it before???? OK, so they defaulkt on debt, drop the Euro, and make enemies hand over fist. In the meantime they carry on retiring at 53. Then they issue bits of paper with the picture of some famous Greek on it, write a nice big number on the bits of paper, and then they try to start trading. So they want to import some foreign goods, say a Japanese car shipment, and they send a big wad of this paper to the supplier in the belief that they share George Irvin's vision of solvency, or charity, or forgiveness. Let me ask you George Irvin, DO YOU TAKE THE JAPANESE FOR COMPLETE IDIOITS???? DO YOU REALLY THINK THAT GREEK TRADING PARTNERS ARE THAT STUPID???
[[And here comes the capper!]]
Proof - were any more needed - that the Greeks will never be suitable custodians for Britain's Elgin Marbles.
PhilipD
2 May 2010, 8:46PM
The problem - which you don't mention - is that any attempt to leave the euro will lead to massive capital flight and the collapse of the Greek banking system. Nobody will keep their money in any Greek institution if they think the Euro will be abandoned. Maybe there would be some way to engineer it (doing it overnight without an announcement?), but I doubt it very much. And if Greece did do so, it could well provoke a similar flight of capital from Portugal and Spain.
While I'm sympathetic to the argument that Greece is being held to completely unrealistic and counterproductive counter cyclical and deflationary policies by the EU and Germany (notable of course that when they needed it, the Germans were quite happy to borrow money to protect their jobs and industries, the painful reality is that there are fundamental structural issues in the Greek economy that will not be cured by leaving the Euro and devaluing. I posted it in Ilana Il Bets article below, but this very detailed analysis of post war Greek economic history by George Alogoskofis is well worth reading. It makes a convincing argument that while Greece grew very well up to the 1970's (ironically, under an authoritarian government), there has been a gradual loss of competitiveness and growth under both left and right wing governments for the last 30 years - this predates the Euro and can't be blamed on it, although it probably exacerbated existing problems. Greece will not recover until it creates a proper tax system (i.e. one in which people actually pay), and improves domestic productivity. It may be that this crisis will force the government into doing the right thing - just as the Asian crisis persuaded most Asian governments to abandon the Washington Consensus and adopt more mercantilist policies to their benefit.
The answer to the problem is neither the economically illiterate approach of forcing extreme cutbacks onto the Greeks, which seems to be favoured by the Germans and many commentators, nor a highly risky Euro exit and devaluation which might work in the short to medium term, but will just store up long term problems - it is a recognition that it is in all Europes mutual benefit to drive off the speculators, support the Greeks financially, but with external pressure (which many Greeks would welcome) to finally get to grips with the endemic structural problems within the economy.
German roots of Greek crisis remain
The rescue deal may have stopped the financial markets bankrupting Greece but the underlying problem stays unresolved
George Irvin
guardian.co.uk, Wednesday 14 April 2010 10.53 BST
On the face of it, the 16 finance ministers of the eurozone countries meeting on 11 April finally put a strong enough aid package on the table to stop the financial markets bankrupting Greece – and apparently to stop contagion from spreading to other indebted Club Med countries. Admittedly, the €30bn deal was done in such a way as to avoid both breaching European Central Bank's (ECB) anti-bailout statutes and burdening German taxpayers; the important thing though is that as a result of the eurozone agreement brokered by the Spanish presidency, Greece has seems to have been saved. Or has it?
Three things are important about the Greek saga. First, the conventional account of the crisis – that a spendthrift Greek government has taken the country to the edge of bankruptcy – is only a small part of the story. Secondly, while the deal buys time, it does not ensure the Club-Med countries against further speculative attack. And thirdly, the true lesson of the story is that it is the Eurozone in general – and Germany in particular – which must put its house in order.
Is Greece broke?
While stories of Greek government nepotism, ludicrously high pensions and the like abound, let us be clear that Greece is not broke. From the mid-1990s until 2009, Greek GDP per head grew faster than the EU average. Its government debt-to-GDP ratio is 113%, yes, but that is not much higher than the OECD debt ratio of 100% projected for 2011 and much less than Japan's 192%.
In essence, what has happened to Greece has happened to most other OECD countries; deep recession has caused a rise in government current transfer expenditure and a precipitous decline in tax receipts. Greece is too small to borrow much domestically, so funding the budgetary gap has meant going to the international market where, fuelled by speculation about debt default, the cost of borrowing has risen to over 7% per annum. Yes, it's true that the previous Greek government attempted to massage the deficit figures with a little help from Goldman Sachs. But Greece's recession-induced budget gap is no different from Britain's.
What is different is that the European Commission wants the budget deficit reduced by 10% of GDP over two years. In the words of Joseph Stiglitz: "With Europe's economy still weak, an excessively rapid tightening of its budget deficit would risk throwing Greece into a deep recession." Anyone in doubt about this principle should look at Ireland where as a result of self-imposed fiscal tightening, GDP in the fourth quarter of 2009 fell by a massive 2.3% (equivalent to 8% annually).
The speculators
"The hedge funds are operating very aggressively," says Hans Redeker, chief currency strategist at French bank BNP Paribas. Few people seem to realise that 95% of Greek sovereign debt is held mainly by European banks within the eurozone. Last year, before the crisis exploded, banks and hedge funds had bought up a large amount of Greek debt cheaply, insuring it by purchasing credit default swaps (CDSs). The crisis has enabled banks to make a killing by selling what is now high-yield Greek debt and issuing further CDSs at a huge premium.
Moreover, the ECB, by pouring liquidity into the European banks, helped spur the Greek debt purchasing spree. As a recent report in the Financial Times put it, a lot of smart traders saw the crisis coming – one only had to look at the amount of sovereign debt the ECB was pushing European banks to buy. The ECB further exacerbated the problem by refusing in future to accept Greek bonds as collateral. And during the two-month period when eurozone ministers have refrained from taking concrete action on the grounds that dallying would "force" the Greeks to clean up their act, these same smart traders have made millions.
Eurozone economic governance
While Greek mismanagement and speculation against Greek bonds are part of the story, the key to understanding the crisis lies not in Greece but in Germany. Germany insisted on a eurozone with a strong monetary authority (the ECB) focused on fighting inflation, but without a "euro treasury" to conduct countercyclical fiscal policy and to effect transfers to countries in need of support – in sharp contrast to arrangements in, say, the US. Germany also continued to pursue a "strong money" policy, promoting export-led growth by means of restraining public spending and private-sector real wage growth, and thus domestic demand. The eurozone version of this policy was the 1997 stability and growth pact requiring eurozone members to keep the budget deficit below 3% and the debt/GDP ratio below 60%.
There are two problems here. First, not all countries can be net exporters like Germany. Two thirds of its exports go to the eurozone, and since one county's exports must be another's imports, the German surplus is reflected by deficits elsewhere; inter alia, the Club Med countries. Second, the eurozone's monetary and fiscal arrangements are inherently deflationary. A balanced budget may be acceptable in "normal times" but it is positively harmful during a global recession. It is notable that current statistical indicators for the eurozone show the recovery weakening, particularly since the ECB in recent weeks has refused to offset tight fiscal policy with further monetary loosening.
In sum, while the deal agreed on 11 April may have stopped financial markets from bidding up Greek government bond yields to dizzying heights, the underlying problem remains unresolved. The current economic architecture of the eurozone puts intolerable deflationary pressure on its most vulnerable members at times of crisis, and if one member should be forced out of the eurozone, contagion could overwhelm many more member states, possibly toppling Europe's most important integration achievement since the creation of the Community in 1957. But Europe's current political leaders remain focussed on their narrow national interests; so far, they have lacked the vision required to chart the new course needed—not just for Greece but for Europe as a whole.
guardian.co.uk © Guardian News and Media Limited 2010
From Latvia to Greece
The IMF's Road to Ruin
April 30 - May 2, 2010
By MARK WEISBROT
Latvia has experienced the worst two-year economic downturn on recorde, losing more than 25 percent of GDP. It is projected to shrink further during the first half of this year, before beginning a slow recovery, in which the International Monetary Fund (IMF) projects that it will not reach even its 2006 level of output by 2015 – nine years later.
With 22 percent unemployment, a sharp increase in emigration and cuts to education funding that will cause long-term damage, the social costs of this trajectory are also high.
By keeping its currency pegged to the euro, the government gives up the opportunity to allow a depreciation that would stimulate growth by improving the trade balance. But even more importantly, maintaining the peg means that Latvia cannot use expansionary monetary policy, or expansionary fiscal policy, to get out of recession. (The United States has used both: in addition to its fiscal stimulus and cutting interest rates to near zero, it has created more than 1.5 trillion dollars since the recession began).
Some who believe that doing the opposite of what rich countries do – i.e. pro-cyclical policies -- can work point to neighboring Estonia as a success story. Estonia has kept its currency pegged to the Euro, and like Latvia is trying to accomplish an “internal devaluation.” In other words, with a deep enough recession and sufficient unemployment, wages and prices can be pushed down. In theory this would allow the economy to become competitive again, even while keeping the (nominal) exchange rate fixed.
But the cost to Estonia has been almost as high as in Latvia. The economy has shrunk by nearly 20 percent. Unemployment has shot up from about 2 percent to 15.5 percent. And recovery is expected to be painfully slow: the IMF projects that the economy will grow by just 0.8 percent this year. Amazingly, by 2015 Estonia is projected to still be less welloff than it was in 2007. This is an enormous cost in terms of lost actual and potential output, as well as the social costs associated with high long-term unemployment that will accompany this slow recovery. And despite the economic collapse and a sharp drop in wages, Estonia’s real effective exchange rate was the same at the end of last year as it was at the beginning of 2008 – in other words, no “internal devaluation” had occurred.
Yet Estonia is being held up as a positive example, even used to attack economists who have criticized pro-cyclical policies in Latvia. The reason is that Estonia has not had the swelling deficit and debt problems that Latvia has had in the downturn. Its public debt of 7 percent of GDP is a small fraction of the EU average of 79 percent, and its budget deficit for 2009 was just 1.7 percent of GDP. It is therefore on its way to join the Euro zone, perhaps adopting the Euro at the beginning of next year.
How did Estonia manage to avoid a large increase in its debt during this severe downturn? First, the government had accumulated assets during the expansion, amounting to some 12 percent of GDP; and it was also running a budget surplus when the recession hit. And it has received quite a bit in grants from the European Union: In 2010, the IMF projects an enormous 8.3 percent of GDP in grants, with 6.7 percent of GDP the prior year.
Greece, unfortunately, is not being offered any grants from the European Union or the IMF. Their plan for Greece is all about pain and punishment. And with a public debt of 115 percent of GDP and a budget deficit of 13.6 percent, Greece will be forced to make spending cuts that will not only have drastic social consequences but will almost certainly plunge the country deeper into recession.
This is a train going in the wrong direction, and once you go down this track there is no telling where the end will be. Greece – like Latvia and Estonia – will be at the mercy of external events to rescue its economy. A rapid, robust rebound in the European Union – which nobody is projecting – could lift these countries out of their slump with a huge boost in demand for their exports, and capital inflows as in the bubble years. Or not: Western European banks still have hundreds of billions of bad loans to Central and Eastern Europe from the bubble years. Some big shoes could still drop that would depress regional growth even below the slow recovery that is projected for the Euro zone. Germany, which has been dependent on exports for all of its growth from 2002-2007, could continue to soak up the regional trade benefits of a Euro zone and/or world recovery.
Now matter how you slice it, these 19th-century-brutal pro-cyclical policies don’t make sense. They are also grossly unfair, placing the burden of adjustment most squarely on poor and working people. I would not wish Estonia’s “success” on any population, simply because they avoided a debt run-up and are on track to join the Euro. They may find, like Greece – as well as Spain, Ireland, Portugal and Italy – that the costs of adopting a currency that is overvalued for a country’s level of productivity are potentially quite high over the long run, even after these economies eventually recover.
The European Union and the IMF have the money and the ability to engineer a recovery based on counter-cyclical policies in Greece as well as the Baltic states. If it involves a debt restructuring – or even a haircut for the bondholders - so be it. No government should accept policies that tell them they must bleed their economy for an indeterminate time before it can recover.
Mark Weisbrot is an economist and co-director of the Center for Economic and Policy Research. He is co-author, with Dean Baker, of Social Security: the Phony Crisis.
This article was originally published in The Guardian.
"Why Greece Will Default"
Greek Prime Minister George Papandreou announces Greece's decision to request activation of a joint eurozone-International Monetary Fund financial rescue plan, from the Greek Aegean island of Kastellorizo, April 23, 2010.
AP Photo
Op-Ed, Project Syndicate
April 28, 2010
Author: Martin Feldstein, George F. Baker Professor of Economics at Harvard University
CAMBRIDGE - Greece will default on its national debt. That default will be due in large part to its membership in the European Monetary Union. If it were not part of the euro system, Greece might not have gotten into its current predicament and, even if it had gotten into its current predicament, it could have avoided the need to default.
Greece's default on its national debt need not mean an explicit refusal to make principal and interest payments when they come due. More likely would be an IMF-organized restructuring of the existing debt, swapping new bonds with lower principal and interest for existing bonds. Or it could be a "soft default" in which Greece unilaterally services its existing debt with new debt rather than paying in cash. But, whatever form the default takes, the current owners of Greek debt will get less than the full amount that they are now owed.
The only way that Greece could avoid a default would be by cutting its future annual budget deficits to a level that foreign and domestic investors would be willing to finance on a voluntary basis. At a minimum, that would mean reducing the deficit to a level that stops the rise in the debt-to-GDP ratio.
To achieve that, the current deficit of 14% of GDP would have to fall to 5% of GDP or less. But to bring the debt-to-GDP ratio to the 60% level prescribed by the Maastricht Treaty would require reducing the annual budget deficit to just 3% of GDP - the goal that the eurozone's finance ministers have said that Greece must achieve by 2012.
Reducing the budget deficit by 10% of GDP would mean an enormous cut in government spending or a dramatic rise in tax revenue - or, more likely, both. Quite apart from the political difficulty of achieving this would be the very serious adverse effect on aggregate domestic demand, and therefore on production and employment. Greece's unemployment rate already is 10%, and its GDP is already expected to fall at an annual rate of more than 4%, pushing joblessness even higher.
Depressing economic activity further through higher taxes and reduced government spending would cause offsetting reductions in tax revenue and offsetting increases in transfer payments to the unemployed. So everyplanned euro of deficit reduction delivers less than a euro of actual deficit reduction. That means that planned tax increases and cuts in basic government spending would have to be even larger than 10% of GDP in order to achieve a 3%-of-GDP budget deficit.
There simply is no way around the arithmetic implied by the scale of deficit reduction and the accompanying economic decline: Greece's default on its debt is inevitable.
Greece might have been able to avoid that outcome if it were not in the eurozone. If Greece still had its own currency, the authorities could devalue it while tightening fiscal policy. A devalued currency would increase exports and would cause Greek households and firms to substitute domestic products for imported goods. The increased demand for Greek goods and services would raise Greece's GDP, increasing tax revenue and reducing transfer payments. In short, fiscal consolidation would be both easier and less painful if Greece had its own monetary policy.
Greece's membership in the eurozone was also a principal cause of its current large budget deficit. Because Greece has not had its own currency for more than a decade, there has been no market signal to warn Greece that its debt was growing unacceptably large.
If Greece had remained outside the eurozone and retained the drachma, the large increased supply of Greek bonds would cause the drachma to decline and the interest rate on the bonds to rise. But, because Greek euro bonds were regarded as a close substitute for other countries' euro bonds, the interest rate on Greek bonds did not rise as Greece increased its borrowing - until the market began to fear a possible default.
The substantial surge in the interest rate on Greek bonds relative to German bonds in the past few weeks shows that the market now regards such a default as increasingly likely. The combination of credits from the other eurozone countries and lending by the IMF may provide enough liquidity to stave off default for a while. In exchange for this liquidity support, Greece will be forced to accept painful fiscal tightening and falling GDP.
In the end, Greece, the eurozone's other members, and Greece's creditors will have to accept that the country is insolvent and cannot service its existing debt. At that point, Greece will default.
For more information about this publication please contact the Belfer Center Communications Office at 617-495-9858.
For Academic Citation:
Feldstein, Martin. "Why Greece Will Default." Project Syndicate, April 28, 2010.
When is a Fraud Not a Fraud? (Greece-Goldman Edition)
Wednesday, February 17, 2010
The short answer to the question in the headline is “When there are no rules.”
A headline in a current Bloomberg story illustrates the problem: “Goldman Sachs, Greece Didn’t Disclose Swap, Investors ‘Fooled’.”
“Fooled” is an unusual choice of words, particularly when applied to to presumed grown-ups like institutional investors and international overseers. Bloomberg seems to be mincing around the more obvious F-words, like “fraud” (as in defrauded) or “fleeced.”
Although there is a considerable amount of well-warranted consternation about how Goldman sold swaps to Greece that allowed it to mask how bad its deteriorating finances were from the EU budget police, there has been perilous little discussion of why the fact that this was permissible says there is something very wrong with the rules in place.
The latest twist is that Goldman managed $15 billion of debt sales for Greece after the debt-disguising swaps were in place, and (needless to say) there was no disclosure of the existence of the hidden debt (Bloomberg was able to obtain only six of ten prospectuses in question and found no mention of the swaps; it seems pretty unlikely that the others disclosed their existence). That means investors were hoodwinked. It goes without saying they would have seen Greece as a worse credit risk if they had been in full possession of the facts, and would presumably have required a higher interest rate.
Yet we get amazingly weak statements from the experts quizzed by Bloomberg:
Goldman could face legal liability “if it could be established that they were knowingly hiding risk, and therefore knew or had reason to know that the bond disclosure documents were misleading,” said Thomas Hazen, a law professor at the University of North Carolina at Chapel Hill. “But that would be a tough hill to climb, in terms of burden of proof. There’d have to be some sort of smoking-gun memo.”
Yves here. I’m not certain how much a US law professor knows about the securities laws that govern this particular offering (as in it most certainly is NOT US securities regs). But there seem to be three issues:
1. What disclosure standards would apply to the Greece bond offering. The offering memorandum, from a legal standpoint, is the issuer’s document, meaning Greece’s, not Goldman’s. So any shortcoming in disclosure is a liability issue for Greece (no joke, the deal manager makes the issuer sign a little letter acknowledging what portions of the offering memo were provided by it, and it is just a few sentences, like the selling price of the bonds, the underwriters’ spread, stuff like that. The description of the issuer and the securities themselves is most assuredly NOT the responsibility of the underwriters. Update: this is a simplification, and arguably an oversimplification; reader Brown Ram in comments describes how underwriters absolve themselves almost entirely from liability for the accuracy of offering documents).
2. OK, but what about this famous due diligence that investment bankers are supposed to perform? Well I have to tell you, even in good old SEC land, it’s less than you might think. In my day, the only thing that seemed to be required was visiting the major facilities of a new issuer (as in a company doing an IPO or first bond offering) and having outside counsel read board minutes (and tell the managers if they saw anything they found troubling).
3. But in this case, we have an interesting conundrum. Goldman clearly HAD TO KNOW the Greek offering documents were incomplete, right? They had arranged those swaps, they knew there was more debt than Greece was ‘fessing up to in its later offering memoranda.
Point 3 is where matters get a bit sticky. Under SEC regs, the failure to mention the swaps or their effect (that there was additional debt that had been deferred) would be a violation. This is a simplification, , but the concept is that the offering documents have to make a full and fair disclosure. That means not only do the statement made need to be accurate as of the date when they were made, but further more, they cannot fail to state a material fact if leaving that information out would be misleading. So question is whether under the regs governing this deal, whether an omission of this sort would also be considered a regulatory violation and/or an investor fraud.
If so, it’s pretty clear Greece defrauded investors. But what about Goldman? Here, Prof. Hazen is far too charitable to Goldman. “Smoking gun memo?” No, you just need to understand how Goldman works. Even though my knowledge is dated, I strongly suspect the firm is still organized more or less the same way, because it was considered a competitive strength and was widely emulated in the industry (t had the effect of creating loyalty to the brand rather than individuals).
Goldman has centralized account management. One person, a relationship manager, is ultimately responsible for selling all products to particular corporate clients and government entities. His full time job is client coverage; he then works with product specialists as needed to get deals done (specialists are also assigned to particular accounts, but the relationship manager is always in the mix. Hank Paulson was one of these relationship managers, called investment banking services). So Goldman cannot pretend that somehow the team that handled the bond offering didn’t know about the swaps deal. That’s unlikely to begin with, given Goldman’s fetish about communication, but structurally impossible (the new business guy would have known about both sets of deals).
In addition, Goldman new business officers (the account managers) are required to document every meeting with the client (this is to protect the firm in case someone is hit by a bus or leaves the firm). This was also a long-standing fetish. In the 1980s, I as a junior account member could ask the library for the “credit memos” as these notes were called. On well-established clients, the meeting notes went back to the 1950s.
So I’m not certain you need a particular memo, even though such documents probably exist. All you need to do is walk through the structure of Goldman relationship management and their usual client communication protocols to establish that it is just not credible that the team working on the bond issues could not have known about the swaps. Then you just need to figure out a legal theory as to why what Goldman did was not kosher (presumably it was an investor fraud, but you’d need the relevant statutes and precedents).
Some people are willing to say in a pretty straightforward fashion that this sort of thing is not right. And if the regs really are so lax that this sort of omission is permissible, that is yet another bit of evidence that deregulation has gone too far (and I fail to understand why investor would be willing to buy paper in a disclosure regime that inadequate, but that is a bigger topic that we will hopefully turn to at another point).
From the Bloomberg story:
“Investment banks are guilty of being part of a wider collusion that fudged the numbers to make the euro look like a working currency union,” said Matrix’s [Bill] Blain. “The bottom line is foreign exchange and bond investors bought something sellers knew not to be the case.”
Even before this latest wrinkle, Simon Johnson was quite clear that these deals did not pass the smell test:
Faced with enormous pressure from those eurozone countries now on the hook for saving Greece, the Commission will surely launch a special audit of Goldman and all its European clients…
If the Federal Reserve were an effective supervisor, it would have the political will sufficient to determine that Goldman Sachs has not been acting in accordance with its banking license. But any meaningful action from this direction seems unlikely….
To preserve Goldman, on incredibly generous terms, in the name of saving the financial system was and is hard to defend – but that is where we are. To allow the current government-backed (massive) Goldman to behave recklessly and with complete disregard to the basic tenets of international financial stability is utterly indefensible.
Yves here. Goldman has made a science of being too clever by half, but it may have made a fatal mistake. Governments do not take well to being abused or made to look foolish, and Goldman appears to have done both.
A banker’s perspective of the Greece derivatives debt dodge
Wednesday, February 24, 2010
By Edward Harrison of Credit Writedowns.
Last week, Yves wrote her perspective on the Goldman-Greece cross currency swaps. Here’s a slightly different take. Comments are appreciated.
By now, you know about the much-discussed swaps that Greece used to conceal it’s debt load. While the amount of debt concealed is low relative to the total, the mere fact that Greece attempted to conceal its true fiscal position is damning in light of revelations in October that the government’s fiscal hole for 2009 is three times the original April estimate.
The problem is, in a word, credibility. Greece now has none – and this is why its bond yields have skyrocketed.
But what about the investment bankers like Goldman Sachs who helped Greece in its machinations – aren’t they to be vilified as well. What do we do about them? I was thinking about that after an interview I did this morning on Canada’s Business News Network (see clip here).
Last week, we got some pretty pointed views on this subject. Felix Salmon says “Goldman is a scapegoat.” Yves Smith takes a more negative view of Goldman’s culpability. So I decided to take a different tack and share some thoughts with you on how investment bankers think – and how it may have led to this. I am using this term ‘Investment Banker’ generically to refer to financial staff at broker-dealers whether they work in a sales & trading or an advisory role. This distinguishes the I-Banker from a commercial banker where incentives are somewhat different.
The first thing you have to realize about investment bankers is that it’s all about the money. Now I’m not talking about a greed is good mentality here. I’m referring to money as validation for achievement, success and self-worth.
Corporate hierarchies
In a normal corporate environment, there is a strict hierarchy in which those at the top earn more than those at the bottom. In order to rise to the top (and earn the salary and huge bonus – I might add), one needs to be considered successful. And that means putting in years of effort for which one receives performance reviews.
If you do well on these reviews, you might even receive accolades, awards and so on – the point being you are a rising star with talent. So you get promoted. “The way you’re going, you might even rise to CEO one day!” That’s the kind of praise you might hear. So the whole hierarchical apparatus is designed to align high achievement with other external signs of success: good evaluations, promotions, more money, more responsibility, more underlings, larger budgets, awards, and accolades and so on. All you need to do is look at an org chart and you get a pretty good sense of who’s supposed to be the stars. And by the way, this is how it works in commercial banking as well.
Investment banking hierarchies
But, that’s not how it works in investment banking at all. When one deal or a series of trades can mean billions in profit, even a relatively junior person can have influence on the bottom line far beyond what her title suggests. This is certainly true in the advisory business, but it is even more true in trading – especially proprietary trading, a major reason that proprietary trading is inherently risky and would be restricted under the Volcker Rule. By the way, this is also a major reason that investment banks that are public companies and not partnerships are risky companies with notoriously poor managers.
A slovenly 32-year old junior trader with terrible social skills, zero management ability and no one reporting to him can make millions of dollars a year. He’s the guy you read about in the newspaper making three times the CEO’s salary. He’s the guy that all the other firms are trying to poach. And he’s the guy that used to be referred to admiringly as a “big swinging dick.” You don’t see that at Acme Incorporated. That’s what I mean when I say it’s all about the money. You learn very quickly in investment banking that status is not all about the titles, it’s more about the money.
Read any account from investment banking like Predator’s Ball or Liar’s Poker you will quickly notice that even the higher level guys are driven to earn a lot of money, not only for the money itself but for what that money says about their status and value relative to their peers.
Advisory business
So, with that in mind, let’s think about the advisory business, Goldman Sachs and the infamous cross-currency swaps. The advisory business is more hierarchical than the sales & trading side of things. But, you can still make a shed load of cash by doing the right deals and being on the right team. Most people in the advisory business work in product or industry groups like Technology or Industrials or Structured Products. In those groups you have some professionals who are product experts while others are relationship managers.
Now, as an individual, your ostensible goal is to serve your clients by giving them the best advice on financial products and transactions to fit their short- and long-term goals. The payoff comes in the form a fee for capital raised, a merger completed or a financial transaction completed. The reality is you as an individual make more money – and hence have higher status – the more transactions you do, the more complex and bigger the deals you do.
So, as an individual there are two major conflicts you might have with your client.
- If your client wants to do a deal that you don’t think is advisable or ethical; or if you uncover damaging information about your client that makes you believe the terms of a deal need to be altered.
- If you can arrange a deal that you believe is not in your client’s best interests but which earns your company more money.
Greece wanted these deals
In the case of the cross currency swaps, all available evidence says that the Greeks were actively looking for ways to reduce their apparent fiscal debt levels and deficit numbers without having to reduce spending or raise taxes. It’s called having your cake and eating it too.
So, I imagine Goldman and other banks each had conversations with the Greek government about the government’s financial advisory needs. The Greeks probably said they wanted to have their cake and eat it too and asked if the investment bankers could help them. Now Goldman had a very good relationship manager in the form of Antigone Loudiadis, who had done valuable service for Greece before and had good contacts with the client (exactly what you want in a relationship manager). According to the Wall Street Journal:
Guided by Ms. Loudiadis in the 1990s, Goldman set up a series of currency "swap" trades for Greece, enabling the country to use favorable exchange rates to record some of its debts. By 2001, when those rates had become unattractive, Ms. Loudiadis helped Greece structure a different trade that enabled the government to continue using advantageous rates for accounting purposes.
So, there’s the basis of what occurred. All of this is well within the norm.
An alternate view of the deals
But, here’s the problem. There’s another way to look at these deals. Here is the definitive take from a 2003 article in Risk magazine, pointed out by Felix Salmon. I have bolded parts I want to stress: [[But I haven’t so follow the link to see - JR]]Ever since the deficit and debt rules for eurozone member states were drawn up in the early 1990s, there have been persistent rumours and allegations that governments have used derivatives to get around them. For some time, economists have argued that the combination of strict external targets with considerable local autonomy in sovereign debt management almost inevitably leads high-deficit countries towards derivatives.
It is now widely known that since 1996, Italy’s Treasury has regularly used swaps transactions to optically reduce its publicly reported debt and deficit ratios. Such trades remain controversial, and were the subject of fierce debate in late 2001, when Italian academic Gustavo Piga published a paper accusing eurozone countries of ‘window dressing’ their public accounts using derivatives (Risk January 2002, page 17).
Now, Italy has been joined by the Hellenic Republic of Greece, as evidence emerges of a remarkable deal between the public debt division of Greece’s finance ministry and the investment bank Goldman Sachs. The deal is not only likely to reopen an old debate on public accounting for derivatives, but also sheds light on the way banks charge clients for taking credit and market risk exposure.
So, Italy played this game as far back as 1996. And, that’s the crux of the matter. As a banker, you never re-invent the wheel. If a deal works and makes lots of money, you shop that deal around to everyone you can until it doesn’t. If you don’t, your competitors will. I reckon bankers at Goldman were very excited that Greece wanted to do these deals – and I wouldn’t be surprised if other bankers did the deals or other countries still.
The deal structure
Risk does an excellent job of outlining the structure of the actual swaps:The transactions agreed between the Greek public debt division and Goldman Sachs involved cross-currency swaps linked to Greece’s outstanding yen and dollar debt. Cross-currency swaps were among the earliest over-the-counter derivatives contracts to be traded, and have a perfectly routine purpose in debt management, namely to transform the currency of an obligation.
For example, an issuer with foreign fixed-rate debt might choose to lock in a favourable exchange rate move. To do this, it could swap a stream of fixed domestic currency payments for a stream of foreign currency ones, referenced to the notional of the debt using the prevailing spot foreign exchange rate, with an exchange of the two notionals at maturity. Because they are transacted at spot exchange rates, cross-currency swaps of this type have zero present value at inception, although the net value (and credit exposure of either counterparty) may subsequently fluctuate.
Here’s the thing though. As an individual you will always come to a point where a client is you begging you to do something that is legal, makes lots of money for your company, but that you feel is unethical. There had to be a moment in this transaction here.However, according to sources, the cross-currency swaps transacted by Goldman for Greece’s public debt division were ‘off-market’ – the spot exchange rate was not used for re-denominating the notional of the foreign currency debt. Instead, a weaker level of euro versus dollar or yen was used in the contracts, resulting in a mismatch between the domestic and foreign currency swap notionals. The effect of this was to create an upfront payment by Goldman to Greece at inception, and an increased stream of interest payments to Greece during the lifetime of the swap. Goldman would recoup these non-standard cashflows at maturity, receiving a large ‘balloon’ cash payment from Greece.
You get that? Goldman had been doing swaps with Greece in anticipation of Euro entry. These transactions allowed them to take U.S. Dollar and Yen-denominated debt and transfer them into Euros at exchange rates which made the level of Yen/Dollar debt look lower until the swap transaction came due and Greece was forced to make a balloon payment to Goldman.
The morality of all this
What other purpose can these transactions serve other than to mask the true indebtedness of Greece? Did anyone actually break the law? If these are legal transactions, does Goldman Sachs have any responsibility inform the EU of the deals? Should Goldman’s bankers have refused Greece’s wishes, knowing that some other banker would collect the fees? Why does this matter now other than in regards to Greece’s credibility in future sovereign debt deals?
These are all good questions. But, the Wall Street Journal article gets to the heart of things and why the deals happened.Even though the transaction occurred nearly a decade ago, it has come under scrutiny by European Union officials as they examine how Greece fell into such dire economic straits.
Ms. Loudiadis became a Goldman partner in 2000. A cerebral Oxford University graduate, she was eventually named co-head of the company’s investment-banking group in Europe, making as much as $12 million in annual compensation, according to someone familiar with the matter. She lives an exclusive neighborhood in West London known for its white stucco homes.
From a banker’s perspective, that’s what this is all about – money, and the status that goes with it.
Source
Revealed: Goldman Sachs’ mega-deal for Greece – Risk magazine
Also see Tim Iacono’s piece “Playing up to the edge of the line.”
by JackRiddler » Wed May 26, 2010 1:13 am
"Did Your Momma Tell You That?"
The Greek Crisis
May 5, 2010
By DEAN BAKER
Keynes quipped in the General Theory that the world is ruled by the ideas of long dead economists. I was reminded of this comment when I heard a member of Germany’s parliament scornfully dismiss the suggestion that the European Central Bank should target a somewhat higher rate of inflation. This suggestion had been put forward by Oliver Blanchard, one of the world’s leading macroeconomists. Furthermore, he had proposed a higher inflation target in his role as the chief economist for the International Monetary Fund.
There is nothing wrong with disagreeing with an economist, no matter how prominent they are or where they work. But what was striking was the nature of the dismissal. The parliamentarian just asserted that: “inflation never solved anything.”
That’s a strong statement. Did he get that information from his parents? Or, as we used to say growing up in Chicago, “Did your momma tell you that?”
Blanchard and others arguing for a higher inflation target actually have very good reasons as to why higher inflation might be very helpful in solving the world economic crisis. First, a higher inflation rate will erode the real value of debt. This will benefit all debtors, households, businesses and countries.
In the case of households, tens of millions of homeowners in the United States and elsewhere have seen much or all of their equity disappear with the collapse of the housing bubble. A modest rate of inflation should begin to lift house prices, restoring equity to these families. It will also reduce the burden of their monthly mortgage payments if wages rise in step with inflation. This will not only be beneficial to these families; a lower debt burden will allow families to spend more, helping to drive the economy.
The same story applies to many businesses that are now facing crushing debt burdens. Furthermore the knowledge the prices of the items they sell will be rising 3-4 percent a year will make investment more attractive to businesses.
Finally, a moderate rate of inflation can go far toward alleviating the debt burden faced by so many countries these days. After 10 years, a 3.0 percent rate of inflation will reduce the real value of a fixed debt by 26 percent; a 4.0 percent inflation rate will reduce it by 34 percent. The modest inflation of the 40s, 50s and 60s was a big factor in bringing down the huge U.S. World War II debt to a manageable level.
Inflation can also be enormously helpful in allowing the euro zone countries with excessive labor costs (e.g. Greece, Portugal and Spain) to get their costs more in line. If wages in more competitive countries keep pace or exceed average euro zone inflation, while wages in the troubled countries don’t rise as rapidly, then they should be able to restore their competitiveness more quickly.
These are the sorts of arguments that Blanchard and others have put forward for allowing a somewhat higher rate of inflation. But the German parliamentarian didn’t care, because he somehow already knew that “inflation never solves anything.”
Policy that rests on unexamined assertions (that emanate from the teachings of long-dead economists) will be every bit as destructive today as it was in the first Great Depression. In Europe, this drama seems to be playing out in the desire to really make Greece feel pain. Greece undoubtedly has to straighten out its fiscal mess. (Is there some reason that everyone is not pushing a tax amnesty program as a way to reduce the Greek debt and show that it is serious about ending wholesale tax evasion?) However, it can’t be expected to balance its budget in the middle of the worst downturn in 70 years.
The same applies to Portugal, Spain and other troubled European economies. Contractionary moves by these governments will worsen the downturn in these countries and in fact, make matters worse in the sound finance countries as well. Fewer imports in Spain and Greece mean fewer exports for Germany and France. Furthermore, enough downward pressure on these economies will likely require a debt restructuring at some point anyhow. The debt burden grows when economies shrink and that seems to be the plan coming from the economic center of Europe.
There might be some justice in the fact that the austerity plans designed by Germany will come back to bite them, but it would be much better to see the Germans design good economic policy. There was perhaps an excuse for bad policy in the 30s; after all Keynes didn’t publish the General Theory until 1937. But, there is no excuse today – the ideas of Keynes have long been known and widely disseminated. It is a tragedy and an outrage that the people deciding economic policy are mindlessly repeating tired clichés rather than seriously trying to design policies that address the crisis in front of our faces.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.
This column was originally published by The Guardian.
by JackRiddler » Wed May 26, 2010 2:05 am
Greek borrowing cost at new high
10:03 | 19/04/2010
The Greek government's cost of borrowing hit a new record high on Monday following delays to Greece's economic recovery plans, according to BBC News. The interest rate charged by investors for ten-year bonds hit 7.6% - the highest since the Euro was introduced.
European officials were due to meet in Athens earlier to agree the terms of a debt rescue package for Greece. But the widespread disruption to flights has delayed the meeting until Wednesday.
The interest rate charged to Greece compares with a rate of 3% charged to Germany - regarded as the safest economy to lend to in the European Union. Greece is still struggling with billions of Euros of debt, and has been forced to agree a rescue deal with the EU and the International Monetary Fund (IMF).
The deal, already agreed in principle, is designed to provide an alternative source of borrowing for Greece, should the bond markets continue to be too expensive. Details of the plan, including the rate of interest Greece will have to pay, have yet to be finalised however.
Meanwhile, the disruption caused by the cloud of volcanic ash drifting across Europe has hit European investor confidence. On Monday the Euro fell further against the dollar, dipping below $1.345.
Greece approves sweeping austerity measures
Bitter scenes in parliament and outrage on the streets as government wins vote aimed at unlocking €120bn in aid
Helena Smith in Athens
guardian.co.uk, Thursday 6 May 2010 20.14 BST
A woman shouts anti-government slogans in front of riot police outside parliament in Athens where MPs approved drastic austerity measures. Photograph: Louisa Gouliamaki/AFP/Getty Images
After a dramatic parliamentary debate, Greek politicians have approved draconian austerity measures aimed at unlocking €120bn (£102bn) of emergency loans deemed crucial for the debt-stricken country to avoid insolvency.
As thousands of outraged Greeks protested outside the 300-seat parliament, 172 MPS voted in favour of the controversial legislation, which paves the way to Athens adopting the harshest programme of fiscal and structural adjustment since the end of the second world war.
The IMF and eurozone nations had demanded tough economic reforms in return for the money ahead of a looming deadline on Greece's debt repayment.
"The only way to avoid bankruptcy is to take the money from our European partners and the IMF and to do that we need to enforce these measures," the finance minister, George Papaconstantinou, said before the ballot.
But piling the pressure on the prime minister, George Papandreou, a day after the country was rocked by its worst street violence since the debt crisis erupted, the conservative main opposition party voted against the unpopular policies.
Highlighting the depths of the passions aroused by the measures, Papandreou expelled three deputies from his Socialist party group of MPs who abstained in the vote.
The opposition New Democracy leader, Antonis Samaras, followed suit when Dora Bakoyiannis, a leading party apparatchnik and former foreign minister broke ranks and voted in favour of the reforms, saying they were for the good of the country.
The bailout had become unavoidable after Athens, staggering under a €300bn debt, found itself locked out of capital markets because of prohibitively high borrowing costs. The country faces a looming 19 May deadline to for the repayment of €8.5bn in maturing debt.
But the unprecedented €30bn of austerity measures over the next three years, which include wage and pension cuts and a steep rise in VAT, have ignited a storm of protests, not least among public sector workers who will bear the brunt of the cutbacks. Fifty thousand protesters marched in Athens yesterday.
Greeks woke in sombre mood today, numbed by the deaths yesterday of three employees killed when a hooded protester threw a petrol bomb into a bank branch in central Athens. Thousands paid tribute to the dead workers and by mid-morning, barely 24 hours after the neoclassical building went up in flames, its gutted remains had been turned into a shrine, encased by candles and flowers.
The employees – a man and two women, one of whom was four months pregnant – were the first to lose their lives since the crisis hit the country six months ago.
With tensions running high in the wake of the violence – which also saw protesters try to storm the parliament – President Karolos Papoulias warned that the nation was "on the brink of the abyss".
"I have difficulty finding the words to express my distress and outrage," said the widely revered head of state. "Our country came to the brink of the abyss. It is our collective responsibility to ensure that we don't go over the edge."
Amid mounting concerns at the violence, the Foreign Office urged visiting Britons to stay away from protests and public demonstrations.
But as police rounded up suspects among the self-described "anti-establishment" youths widely blamed for the deaths, there were fears that the financial, and increasingly social, turmoil shaking Greece is unlikely to end soon. Entrenched resistance to the reforms has been reinforced by the European commission's publication of data showing that Greece's economy shrank by 4% this year.
Olli Rehn, the EU's economic and monetary affairs commissioner, acknowledged this week that the three-year austerity programme would deepen the contraction. Greeks had hoped their dire public finances would begin to recover next year.
The opposition New Democracy party's refusal to endorse the cuts – saying they will only exacerbate the country's recession – will make it harder for Papandreou to win public approval. Analysts say it will also open the way for further opposition from trade unions, already pledging more street protests and strikes.
"Washington [where the IMF is based] and the EU want to see a plurality of serious Greek politicians supporting the measures," said one well-placed insider. "As a member of the former government that helped get Greece in this mess, Samaras has a duty to support the measures. Failure to do so will show him as the opportunist that he is."
guardian.co.uk © Guardian News and Media Limited 2010
Two British Bank Chiefs Voice Concern on Greece
May 7, 2010
By JULIA WERDIGIER
LONDON — Two British bank chiefs said Friday they were closely monitoring the effect of the Greek credit crisis on their businesses — even though their banks had little direct exposure to the highly indebted country.
The chief executives of HSBC and Royal Bank of Scotland, both of which gave updates of first-quarter performance Friday, said that even though the British economy started to recover in the first quarter, threats to earnings from Europe remained.
The cautionary remarks on Greece reflect the increasingly nervous mood worldwide of stock market investors and policy makers, who are concerned that the Greek debt crisis could spread.
HSBC said profit in the first quarter was “well ahead” of that in the same period last year after its business in the United States turned to a profit. By contrast, R.B.S., in which the British government holds an 83 percent stake, was the only publicly traded British bank to report a loss in the quarter.
“We remain alert to the impact of strains being seen in Europe,” HSBC’s chief executive, Michael Geoghegan, said in a statement.
In a conference call later, Mr. Geoghegan said that the aid package coming from the European Union and International Monetary Fund for Greece “should assist cash-flow,” and added that he thinks “all efforts will be done by politicians to contain” the debt crisis.
He admitted that the situation remains uncertain but said that it needs “to be managed by politicians.”
“Clearly all these economies have to adjust,” he said.
Stephen Hester, chief executive of R.B.S., said in a statement that he was “conscious of the economic imbalances still to be tackled globally and the risk of specific events (such as those affecting Greece) with the associated danger of contagion.”
British banks have been less directly affected by the Greek debt crisis because they hold less Greek government debt than their German or French rivals. But some analysts said that general uncertainty in the credit markets could lead to a rise in the interbank lending rate, which had spiked when Lehman Brothers collapsed in September 2008, making it more difficult and expensive for all banks to raise funds.
HSBC said that “credit quality improved faster than we anticipated in U.S. consumer finance, and more generally across the group.” Even though the U.S. business reported its first quarterly profit in three years Mr. Geoghegan said it was “too soon to declare victory.”
SNIP
Sovereign Woes Trigger ‘Lehman II’ Concern for Europe’s Banks
May 18, 2010, 6:02 PM EDT
By Aaron Kirchfeld, Niklas Magnusson and Elena Logutenkova
May 19 (Bloomberg) -- Europe’s banks are facing déjà vu as fresh tremors in the debt markets threaten to shake the financial system less than two years after the collapse of Lehman Brothers Holdings Inc.
This time the concern isn’t about subprime mortgages or exotic derivatives, it’s about banks’ holdings of bonds sold by European Union governments including Greece, Portugal and Spain. Pledges of $1 trillion in EU aid have failed to shore up the euro or dispel doubts about the region’s finances.
Investors have punished the shares of European financial firms and driven up the cost of insuring against default by banks and insurers on concern measures aimed at reducing the region’s budget deficits will choke economic growth. In a worst- case scenario, government debt restructurings could erode capital and spark another credit crunch, analysts say.
“There’s a concern this may be Lehman II,” said Konrad Becker, a Munich-based banking analyst at Merck Finck & Co. “The direct risks of writedowns and loan defaults combined with indirect ones such as mistrust between banks could lead to a systemic crisis.”
The rate banks say they charge each other for three-month loans in dollars rose yesterday to a nine-month high. The three- month London interbank offered rate in dollars, or Libor, reached 0.465 percent, the highest since Aug. 5, according to the British Bankers’ Association. The euro fell to its weakest against the dollar since 2006 on May 17.
Subprime Survivors Struck
Banks in Greece, Portugal and Spain, which mostly dodged losses from the financial crisis of 2008, have suffered the biggest share declines. National Bank of Greece SA, the country’s largest bank, dropped 43 percent in Athens trading this year. Spain’s Bankinter SA and Banco Bilbao Vizcaya Argentaria SA, Portugal’s Banco Espirito Santo SA and Italy’s Intesa Sanpaolo SpA each fell more than 28 percent.
The latest debt concerns spread across Europe just as EU economies were returning to growth and banks were emerging from the worst financial crisis since the Great Depression.
The credit crunch that began with the collapse of the U.S. subprime mortgage market and swept away New York-based Lehman in September of 2008 led to $542 billion of writedowns and credit losses for European financial companies, data compiled by Bloomberg show. UBS AG of Zurich and Edinburgh-based Royal Bank of Scotland Group Plc were among financial firms that needed government help to survive.
‘$1 Billion Question’
Greece’s public finances began rattling investors late last year, when the country more than tripled its budget deficit forecast for 2009 to 12.7 percent of gross domestic product. The shortfall prompted European Monetary Affairs Commissioner Joaquin Almunia to say Greece’s finances had become a “concern for the whole euro area.”
On April 22, the EU made an even higher estimate of Greece’s budget deficit for last year: 13.6 percent of GDP.
Standard & Poor’s cut Greece’s credit rating to junk on April 27, and also lowered Portugal to A-. It trimmed Spain one step to AA the following day.
The EU and International Monetary Fund cobbled together a 110 billion-euro ($136.4 billion) rescue package for Greece on May 2 to prevent contagion. About a week later, European leaders drew up an unprecedented emergency fund of as much as 750 billion euros to back countries facing instability and a program of bond purchases by the European Central Bank.
“The $1 billion question is will this money be enough to stabilize the market and entice investors to continue to put money into sovereign debt and also into bank funding,” said Dirk Hoffmann-Becking, an analyst at Sanford C. Bernstein Ltd. in London.
Strangling Growth
Europe’s banks had $2.29 trillion at risk in Greece, Italy, Portugal and Spain at the end of 2009, according to figures from the Bank for International Settlements in Basel, Switzerland. French banks had the most claims, at $843 billion, followed by Germany at $520 billion and the U.K. at $227 billion.
“The first problem is if the sovereign-debt crisis continues, European banks and insurers are going to have to write down their exposure at some point,” said Daniel Hupfer, who helps manage 32.3 billion euros at M.M. Warburg in Hamburg, including shares of Deutsche Bank AG and BNP Paribas SA. “The second is the economy: if European countries focus on saving, that could strangle growth.”
Leaving the Euro
One or more European economies may default on their debt and Greece and other “laggards” in the euro area may have to abandon the common currency in the next few years to spur their economies, New York University professor Nouriel Roubini said in an interview on Bloomberg Television on May 12.
The crisis engulfing the euro area is not over yet as Greece remains the “tip of an iceberg,” Roubini said in an interview with BBC radio broadcast yesterday. “What we’re facing right now in the eurozone is a second stage of a typical financial crisis.”
A restructuring of Greece’s sovereign debt could lead to as much as 75 billion euros of losses for European banks, based on estimates from Frankfurt-based Deutsche Bank.
Josef Ackermann, the chief executive officer of Germany’s largest bank, said in an interview on ZDF television last week that it’s imperative to avoid a restructuring of Greece’s debt for now, even as he expressed doubts about the country’s ability to pay back its borrowings in full.
An Overreaction?
Some analysts say the threat to Europe’s banks is overstated and that the EU’s rescue package will eventually bolster confidence. There’s little evidence so far that sovereign concerns are cutting into profits for most lenders. The 10 biggest banks by market value in the euro region earned almost $15 billion in the first quarter, company reports show.
“Almost all banks beat earnings estimates, but that’s been neglected because of the sovereign-risk issue,” said Johan Fastenakels, an analyst at KBC Groep in Brussels. “Markets are overreacting.”
European stocks gained for the first time in three days yesterday as concern eased that measures to control the region’s debt crisis will curb economic growth. The Bloomberg Europe Banks and Financial Services Index rose 1.8 percent.
Deficit Cutting
Europe’s debt-ridden governments are pushing forward with austerity plans to appease investors and avoid a contagion. Greece agreed to budget cuts amounting to 13 percent of GDP. Spain announced the biggest reductions in at least 30 years on May 12, and Portugal followed a day later, pledging to slash wages and raise taxes. Italian officials said the government may make an extraordinary reduction in public spending. France is slated to submit its latest tax and spending plans to the European Commission, the EU’s executive arm, this week.
European finance ministers said Greece’s debt crisis won’t unleash a continent-wide austerity drive and tip the economy back into a recession. Only high-deficit countries including Spain and Portugal will be ordered to make additional deficit cuts, while budget policies will remain untouched in better-off nations such as Germany and Finland.
“Not everyone will accelerate consolidation in a very uniform way,” European Union Economic and Monetary Affairs Commissioner Olli Rehn told reporters in Brussels after a meeting of ministers from the 16 euro countries yesterday. “That would lead to a very restrictive fiscal stance for the euro area as a whole, which would risk depressing economic growth.”
Political leaders are trying to put to work lessons learned in the subprime debacle.
“The advantage to the subprime crisis is we now are much more aware of how fragile our financial system is and we’re much more aware of what needs to be done to stabilize it,” said Hoffmann-Becking. “On the negative side is just the sheer scale of the sovereign debt problem: it’s larger than subprime. And whilst in subprime you could argue that a government will have to come and step in and save us, there is no government to save the government.”
--With assistance by Jana Randow in Frankfurt, Abigail Moses in London, Pierre Paulden and Shannon D. Harrington in New York. Editors: Frank Connelly, Steve Bailey
To contact the reporter on this story: Aaron Kirchfeld in Frankfurt at akirchfeld@bloomberg.net Niklas Magnusson at nmagnusson1@bloomberg.net Elena Logutenkova in Zurich at elogutenkova@bloomberg.net
To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net; Edward Evans at eevans3@bloomberg.net
Slash-and-Burn Economics
Merkel's Savage Blitz Through Euroland
May 25, 2010
By MIKE WHITNEY
Angela Merkel has let a minor brush-fire on the periphery turn into a raging inferno that's sweeping across the continent. Absent Berlin's fumbling diplomatic effort and its ferocious attachment to Hooverian economics, the Greek matter would have been over by now. Instead, the fire continues to burn while the German Chancellor pushes the eurozone closer and closer to the cliff. And what for; to prove that prodigal spending by the member states (Greece) mustn't go unpunished?
Is that what this is all about? Is Merkel really willing to break up the EU just to prove her point and to accommodate her towering sense of self righteousness?
There is a fix for the EU's problems, but it will require cooperation, vision and a supra-national government institution capable of implementing sensible fiscal policy. It's all very doable, but not in an atmosphere that is charged with acrimony and divisiveness . As the most powerful member, Germany has a special role to play in maintaining cohesion; it's the glue that holds the EU together. Unfortunately, Merkel and Co. appear to be less interested in building bridges than settling on new ways to punish nations that stray from the 3 per cent -maximum deficit rule. The German Chancellor wants to make sure that countries that exceed the limits will be stripped of E.U. subsidies and voting rights. The Austrian Finance Minister summarized the policy perfectly when he opined, "Countries that are lax with budget planning must be able to be rapped on the knuckles."
None of the countries in the Euro-project joined because they wanted to be lectured by arrogant German/Austrian bureaucrats whose Stone Age grasp of economics has thrust the 16-state confederation to the brink of disaster. Besides, the markets have already voted thumbs down on Merkel's "hair shirts and thin gruel" remedy. They want stimulus, growth and liquidity; none of which are provided in "Frau Nein's" plan for economic contraction.
It's worth reviewing some of the details of the so-called "Greek bailout" to get a handle on how debilitating the EU's austerity measures really are. Here's an excerpt from an article by Polyvios Petropoulos, former economics professor in the US, which outlines some of the harshest cutbacks:
So the debts of the bankers and speculators are being hoist onto the backs of the working poor and aged. Where have we heard that before?
Greece's deficits are not the problem anyway. The real problem is the underwater EU banks (that hold Greek debt) that will capsize if Greece doesn't get a lifeline. This is from Reuters:
"European banks have an estimated $2.8 trillion exposure to Greece, Spain, Portugal, Ireland and Italy -- debt-heavy euro zone nations that have worried investors. These banks may be hit with losses ranging from $350 billion to $700 billion, Neela Gollapudi, a Citigroup interest rate strategist wrote....
"The EU stabilization package helps towards refinancing of sovereign debt, but does not address private sector debt," Gollapudi said." (Reuters, "US 3-month Libor seen rising above 1 pct-Citigroup")
So Merkel can stop pretending that the bailout is an act of selfless charity. No one is buying it. Nor are they confused about the $1 trillion pile of euros that the EU gathered together to ward-off speculators. Short-sellers saw through that sham in less than 24 hours and sent the markets plunging again. Do the Euro leaders really think they're smart enough to pull the wool over Wall Street's eyes? Wall Street invented fraud.
Will someone in the EU at least show that they understand the basic problem? European integration is more than just a common currency and a Treaty. It requires politics, governance and unification. Currency is not politics and treaties are no substitute for government institutions. The charade has gone as far as it can go without more concessions from the individual states to establish a central authority to implement fiscal policy.
The Merkel view is that Germany should maintain its sovereign independence--along with its gigantic surpluses--while reaping the benefits of a currency that serves its own economic interests. But the flaws in that plan have already been exposed. The smaller non-export dependent countries (aka--Greece, Portugal, Spain) need fiscal accommodation or be they'll forced from the Union. It's not a matter of profligate Greek spending versus German thriftiness. It's a practical matter of economic reality.
So, how can the EU get ahead of the markets before the euro vaporizes and the economy is pushed back into recession?
First, Brussels needs to change its counterproductive, punitive tone with Athens and strengthen friendly relations. No more condescending talk of "knuckle rapping", please. Greece needs to restructure its debt (everyone agrees on this point) while the ECB initiates a quantitative easing program (purchasing Greek corporate and government debt) to increase liquidity so Greece can grow its way out of the slump. That means that German and French banks (and bondholders) will have to take a haircut which could lead to bankruptcy. If that's the case, then the ECB will have to establish a lending facility to provide a (temporary) backstop to get troubled financial institutions through the rough patch while regulators check to see if they are sufficiently capitalized to stay in business.
The markets are jittery because the proposed remedies are all deflationary and will lead unavoidably to recession. So the EU needs to enact alternative policies that will increase employment, stimulate demand and restore confidence. Here are a few recommendations:
The ECB needs to be willing to spend whatever is needed to avert another meltdown.
Policies should be put in place for the orderly withdrawal of countries that don't fit within the EU's economic schema.
Regulations on shadow banking, derivatives, and repo transactions should be drawn up to avoid another market crash.
The EU should develop a strategy for providing long-term fiscal stimulus throughout the eurozone until unemployment falls, aggregate demand picks up, and household balance sheets show signs of improvement.
Mike Whitney lives in Washington state. He can be reached at fergiewhitey@msn.com
by JackRiddler » Wed May 26, 2010 2:38 am
Former Central Bank Head Karl Otto Pöhl
Bailout Plan Is All About 'Rescuing Banks and Rich Greeks'
05/18/2010 03:54 PM
The 750 billion euro package the European Union passed last week to prop up the common currency has been heavily criticized in Germany. Former Bundesbank head Karl Otto Pöhl told SPIEGEL that Greece may ultimately have to opt out, and that the foundation of the euro has been fundamentally weakened.
SPIEGEL: Mr Pöhl, are you still investing in the euro -- or has the European common currency become too unstable of late?
Pöhl: I still have money in euros, but the question is justified. There is still danger that the euro will become a weak currency.
SPIEGEL: The exchange rate with the dollar is still close to $1.25. What's the problem?
Pöhl: The foundation of the euro has fundamentally changed as a result of the decision by euro-zone governments to transform themselves into a transfer union. That is a violation of every rule. In the treaties governing the functioning of the European Union, it explicitly states that no country is liable for the debts of any other. But what we are doing right now, is exactly that. Added to this is the fact that, against all its vows, and against an explicit ban within its own constitution, the European Central Bank (ECB) has become involved in financing states. Obviously, all of that will have an impact.
SPIEGEL: What do you think will happen?
Pöhl: The euro has already sunk in value against a whole list of other currencies. This trend could continue, because what we have basically done is guarantee a long line of weaker currencies that never should have been allowed to become part of the euro.
SPIEGEL: The German government has said that there was no alternative to the rescue package for Greece, nor to that for other debt-laden countries.
Pöhl: I don't believe that. Of course there were alternatives. For instance, never having allowed Greece to become part of the euro zone in the first place.
SPIEGEL: That may be true. But that was a mistake made years ago.
Pöhl: All the same, it was a mistake. That much is completely clear. I would also have expected the (European) Commission and the ECB to intervene far earlier. They must have realized that a small, indeed a tiny, country like Greece, one with no industrial base, would never be in a position to pay back €300 billion worth of debt.
SPIEGEL: According to the rescue plan, it's actually €350 billion ...
Pöhl: ... which that country has even less chance of paying back. Without a "haircut," a partial debt waiver, it cannot and will not ever happen. So why not immediately? That would have been one alternative. The European Union should have declared half a year ago -- or even earlier -- that Greek debt needed restructuring.
SPIEGEL: But according to Chancellor Angela Merkel, that would have led to a domino effect, with repercussions for other European states facing debt crises of their own.
Pöhl: I do not believe that. I think it was about something altogether different.
SPIEGEL: Such as?
Pöhl: It was about protecting German banks, but especially the French banks, from debt write offs. On the day that the rescue package was agreed on, shares of French banks rose by up to 24 percent. Looking at that, you can see what this was really about -- namely, rescuing the banks and the rich Greeks.
SPIEGEL: In the current crisis situation, and with all the turbulence in the markets, has there really been any opportunity to share the costs of the rescue plan with creditors?
Pöhl: I believe so. They could have slashed the debts by one-third. The banks would then have had to write off a third of their securities.
SPIEGEL: There was fear that investors would not have touched Greek government bonds for years, nor would they have touched the bonds of any other southern European countries.
Pöhl: I believe the opposite would have happened. Investors would quickly have seen that Greece could get a handle on its debt problems. And for that reason, trust would quickly have been restored. But that moment has passed. Now we have this mess.
SPIEGEL: How is it possible that the foundation of the euro was abandoned, essentially overnight?
Pöhl: It did indeed happen with the stroke of a pen -- in the German parliament as well. Everyone was busy complaining about speculators and all of a sudden, anything seems possible.
SPIEGEL: You don't believe in the oft-mentioned attacks allegedly perpetrated by currency gamblers, fortune hunters and speculators?
Pöhl: No. A lot of those involved are completely honorable institutes -- such as banks, but also insurance companies and investment- and pension funds -- which are simply taking advantage of the situation. That's totally obvious. That's what the market is there for.
SPIEGEL: You really think that pension funds should be gambling with high-risk debt securities?
'Totally Normal Market Behavior'
Pöhl: No. They should be investing their investors' money as securely as possible. Should the credit rating of a debtor worsen because that debtor has been living beyond his means for years, then it is completely rational for these institutions to get rid of these bonds -- because they have become insecure. Then other investors buy them at a lower price. They receive a higher return, but also have greater risk. That is totally normal market behavior.
SPIEGEL: With the exception that speculators are now carrying no risk at all because euro-zone members have agreed to guarantee Greek debt.
Pöhl: Yes, and that is harmful. It means that the basic balancing mechanism in the market economy is out of sync.
SPIEGEL: Is it possible that politicians invented the specter of rampant speculation to legitimize a break with the Lisbon Treaty and with the ECB's rules?
Pöhl: Of course that's possible. In fact, it's even plausible.
SPIEGEL: What will be the political consequences of this crisis?
Pöhl: The whole mechanism of the European community will change. The EU is a federation of nations, not a federal republic. But now the European Commission will have a lot more power and more authority as well as the potential to interfere in national budget law. That, however, is constitutionally problematic in Germany.
SPIEGEL: But this could also be construed as a positive development. For a long time, critics have been saying that before we can have a genuine currency union we need common fiscal and economic policy. Surely this crisis has brought the EU closer to that goal.
Pöhl: Yes, that is the logical next step of our union, but we must bear the burden. You only have to look at what it is going to cost us Germans. I would have preferred that things hadn't gone quite this far.
SPIEGEL: In the past, the bankers at the Bundesbank, Germany's central bank, were vehemently opposed to any political interference -- for example, when the government wanted to take control of gold stocks. At the moment even larger taboos are being broken -- yet there has been little outcry. Why is that?
Pöhl: The president of the Bundesbank, Axel Weber, is in a bind. He has been issuing warnings about these kinds of developments for some time and he continues to do so. But of course it is difficult to keep this up in the face of a political majority.
SPIEGEL: Especially when he aspires to the presidency of the ECB and is therefore dependent on political goodwill.
Pöhl: That may also play a role.
SPIEGEL: In the run up to the currency union that was formed when Germany was reunified in 1990, it was said that, if something is economically ill-advised, it is also a political mistake. Does the rescue package for teetering euro-zone countries make sense?
Pöhl: It depends on what one wants to achieve. If the point was merely to calm the markets temporarily, then yes. But that can't be the only reason.
SPIEGEL: Because the side effects will be too large, you mean?
Pöhl: Absolutely. Just imagine if claims were made. Germany would have to pay countless billions, which is dreadful. And, it could lead to the euro becoming a weak currency.
SPIEGEL: If you were president of the Bundesbank today, would you be ordering the printing of German marks just in case they became necessary?
Pöhl: No, no, we have not gone that far quite yet. In my opinion, the euro is in no danger. Perhaps one of the smaller countries will have to leave the currency union.
SPIEGEL: How should that work?
Pöhl: It would involve Greece, if we stick with the case we were discussing, reintroducing the drachma.
SPIEGEL: But Greece doesn't seem to have any interest in doing that -- and it would be against European agreements to force Athens to leave the currency union.
Pöhl: That is correct. As long as a country receives such massive support, it would, of course, have no interest in turning its back on the euro.
SPIEGEL: You think that could change?
Pöhl: On the mid and long term, I wouldn't rule it out.
Interview conducted by Wolfgang Reuter
URL:
http://www.spiegel.de/international/ger ... 45,00.html
RELATED SPIEGEL ONLINE LINKS:
The Hollow Euro: Specter of Inflation Haunts Europe (05/17/2010)
http://www.spiegel.de/international/eur ... 11,00.html
European Central Bank President Jean-Claude Trichet: A 'Quantum Leap' in Governance of the Euro Zone Is Needed (05/15/2010)
http://www.spiegel.de/international/eur ... 60,00.html
Slide Continues: Doubts Remain Despite Efforts to Shore Up Euro (05/14/2010)
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© SPIEGEL ONLINE 2010
Compare and Contrast Venezuela and Greece
May 7 - 9, 2010
By MARK WEISBROT
With Venezuela’s economy having contracted last year (as did the vast majority of economies in the Western Hemisphere), the economy suffering from electricity shortages, and the value of domestic currency having recently fallen sharply in the parallel market, stories of Venezuela’s economic ruin are again making headlines.
The Washington Post, in a news article that reads more like an editorial, reports that Venezuela is “gripped by an economic crisis,” and that “years of state interventions in the economy are taking a brutal toll on private business.”
There is one important fact that is almost never mentioned in news articles about Venezuela, because it does not fit in with the narrative of a country that has spent wildly throughout the boom years, and will soon, like Greece, face its day of reckoning. That is the government’s debt level: currently about 20 percent of GDP. In other words, even as it was tripling real social spending per person, increasing access to health care and education, and loaning or giving billions of dollars to other Latin American countries, Venezuela was reducing its debt burden during the oil price run-up. Venezuela’s public debt fell from 47.5 percent of GDP in 2003 to 13.8 percent in 2008. In 2009, as the economy shrank, public debt picked up to 19.9 percent of GDP. Even if we include the debt of the state oil company, PDVSA, Venezuela’s public debt is 26 percent of GDP. The foreign part of this debt is less than half of the total.
Compare this to Greece, where public debt is 115 percent of GDP and currently projected to rise to 149 percent in 2013. (The European Union average is about 79 percent.)
Given the Venezuelan government’s very low public and foreign debt, the idea the country is facing an “economic crisis” is simply wrong. With oil at about $80 a barrel, Venezuela is running a sizeable current account surplus, and has a healthy level of reserves. Furthermore, the government can borrow internationally as necessary – last month China agreed to loan Venezuela $20 billion in an advance payment for future oil deliveries.
Nonetheless, the country still faces significant economic challenges, some of which have been worsened by mistaken macroeconomic policy choices. The economy shrank by 3.3 percent last year. The international press has trouble understanding this, but the problem was that the government’s fiscal policy was too conservative – cutting spending as the economy slipped into recession. This was a mistake, but hopefully the government will reverse this quickly with its planned expansion of public investment this year, including $6 billion for electricity generation.
The government’s biggest long-term economic mistake has been the maintenance of a fixed, overvalued exchange rate. Although the government devalued the currency in January, from 2.15 to 4.3 to the dollar for most official foreign exchange transactions, the currency is still overvalued. The parallel or black market rate is at more than seven to the dollar.
An overvalued currency – by making imports artificially cheap and the country’s exports more expensive - hurts Venezuela’s non-oil tradable goods’ sectors and prevents the economy from diversifying away from oil. Worse still, the country’s high inflation rate (28 percent over the last year, and averaging 21 percent annually over the last seven years) makes the currency more overvalued in real terms each year. (The press has misunderstood this problem, too – the inflation itself is too high, but the main damage it does to the economy is not from the price increases themselves but from causing an increasing overvaluation of the real exchange rate.)
But Venezuela is not in the situation of Greece – or even Portugal, Ireland, or Spain. Or Latvia or Estonia. The first four countries are stuck with an overvalued currency – for them, the euro – and implementing pro-cyclical fiscal policies (e.g. deficit reduction) that are deepening their recessions and/or slowing their recovery. They do not have any control over monetary policy, which rests with the European Central Bank. The latter two countries are in a similar situation for as long as they keep their currencies pegged to the euro, and have lost output 6 to 8 times that of Venezuela over the last two years.
By contrast, Venezuela controls its own foreign exchange, monetary and fiscal policies. It can use expansionary fiscal and monetary policy to stimulate the economy, and also exchange rate policy – by letting the currency float. A managed, or “dirty” float – in which the government does not set a target exchange rate but intervenes when necessary to preserve exchange rate stability – would suit the Venezuelan economy much better than the current fixed rate. The government could manage the exchange rate at a competitive level, and not have to waste so many dollars, as it does currently, trying to narrow the gap between the parallel and the official rate. Although there were (as usual, exaggerated) predictions that inflation would skyrocket with the most recent devaluation, it did not – possibly because most foreign exchange transactions take place through the parallel market anyway.
Venezuela is well situated to resolve its current macroeconomic problems and pursue a robust economic expansion, as it had from 2003-2008. The country is not facing a crisis, but rather a policy choice.
Mark Weisbrot is an economist and co-director of the Center for Economic and Policy Research. He is co-author, with Dean Baker, of Social Security: the Phony Crisis.
This article was originally published in The Guardian.
Greek Wealth Is Everywhere but Tax Forms
May 1, 2010
By SUZANNE DALEY
ATHENS — In the wealthy, northern suburbs of this city, where summer temperatures often hit the high 90s, just 324 residents checked the box on their tax returns admitting that they owned pools.
So tax investigators studied satellite photos of the area — a sprawling collection of expensive villas tucked behind tall gates — and came back with a decidedly different number: 16,974 pools.
That kind of wholesale lying about assets, and other eye-popping cases that are surfacing in the news media here, points to the staggering breadth of tax dodging that has long been a way of life here.
Such evasion has played a significant role in Greece’s debt crisis, and as the country struggles to get its financial house in order, it is going after tax cheats as never before.
Various studies, including one by the Federation of Greek Industries last year, have estimated that the government may be losing as much as $30 billion a year to tax evasion — a figure that would have gone a long way to solving its debt problems.
“We need to grow up,” said Ioannis Plakopoulos, who like all owners of newspaper stands will have to give receipts and start using a cash register under the new tax laws passed last month. “We need to learn not to cheat or to let others cheat.”
On the eve of an International Monetary Fund bailout deal that is sure to call for deep sacrifices here, including harsh austerity measures, layoffs and steep tax increases, many Greeks say they feel chastened by the financial crisis that has pushed the country to the edge of bankruptcy.
But even so, changing things will not be easy. Experts point out that ducking taxes is part of a broader culture of bribery and corruption that is deeply entrenched.
Mr. Plakopoulos, who supports most of the government’s new efforts, admits that he and his friends used to chuckle over the best ways to avoid taxes.
To get more attentive care in the country’s national health system, Greeks routinely pay doctors cash on the side, a practice known as “fakelaki,” Greek for little envelope. And bribing government officials to grease the wheels of bureaucracy is so standard that people know the rates. They say, for instance, that 300 euros, about $400, will get you an emission inspection sticker.
Some of the most aggressive tax evaders, experts say, are the self-employed, a huge pool of people in this country of small businesses. It includes not just taxi drivers, restaurant owners and electricians, but engineers, architects, lawyers and doctors.
The cheating is often quite bold. When tax authorities recently surveyed the returns of 150 doctors with offices in the trendy Athens neighborhood of Kolonaki, where Prada and Chanel stores can be found, more than half had claimed an income of less than $40,000. Thirty-four of them claimed less than $13,300, a figure that exempted them from paying any taxes at all.
Such incomes defy belief, said Ilias Plaskovitis, the general secretary of the Finance Ministry, who has been in charge of revamping the country’s tax laws. “You need more than that to pay your rent in that neighborhood,” he said.
He said there were only a few thousand citizens in this country of 11 million who last year declared an income of more than $132,000. Yet signs of wealth abound.
“There are many people with a house, with a cottage in the country, with two cars and maybe a small boat who claim they are earning 12,000 euros a year,” Mr. Plaskovitis said, which is about $15,900. “You cannot heat this house or buy the gas for the car with that kind of income.”
The Greek government has set a goal for itself of collecting at least $1.6 billion more than last year — a modest goal, Mr. Plaskovitis believes. But European Union officials were so skeptical, Mr. Plaskovitis said, they would not even allow the figure to be included in the budget forecast used in negotiations over the bailout package.
“They said, ‘Yes, yes, we have heard that before, but it never happens,’ ” he said.
Over the past decade, Greece actually lost ground in collecting taxes, even as the economy was booming. A 2008 European Union report on Greece tax shortfalls found that between 2000 and 2007, the country’s average growth in nominal gross domestic product was 8.25 percent. Its taxes grew at just 7 percent.
How Greece ended up with this state of affairs is a matter of debate here. Some attribute it to Greece’s long history under Turkish occupation, when Greeks got used to seeing the government as an enemy. Others point out that, classical history aside, Greece is actually a relatively young democracy.
Whatever the reason, Kostas Bakouris, the president of the Greek arm of the anticorruption organization Transparency International, said that Greeks were constantly facing the lure of petty corruption. “If they go to the mechanic, it is one price without a receipt and quite a bit more with it,” Mr. Bakouris said.
He said his own sister had recently told him that she was uncomfortable asking her doctor for a receipt. “I said that’s crazy,” he said. “But still, that feeling is out there.”
Various studies have concluded that Greece’s shadow economy represented 20 to 30 percent of its gross domestic product. Friedrich Schneider, the chairman of the economics department at Johannes Kepler University of Linz, studies Europe’s shadow economies; he said that Greece’s was at 25 percent last year and estimated that it would rise to 25.2 percent in 2010. For comparison, the United States’ was put at 7.8 percent.
The Finance Ministry believes that the new tax laws, which also increased the weight on income and value-added taxes, have laid the legal groundwork for better enforcement. In the past, the tax code gave many categories of workers special status. Entire professions were allowed to file a set income. For instance, newsstand owners could simply claim that they earned an income of 12,000 euros (about $15,900) and no questions were asked.
Now, most of these exceptions have been eliminated and the tax code has been simplified. It also offers various incentives to make people collect receipts — an important step, officials say, in shrinking the off-the-books economy.
In addition, the tax department is being reorganized so that regional offices will have far less autonomy.
Mr. Plaskovitis said that tax collectors had already begun using technology to crosscheck claims and that they had taken steps like asking luxury car dealerships for list of their clients. A lot of Greeks, he said, listed luxury cars as company cars, a practice that would be challenged in the future. “We do not believe you need a Porsche to sell Coca-Cola,” he said.
Soon, Mr. Plaskovitis said, people will see results. “In the coming weeks,” he said, “we are going to be closing down companies, restaurants and doctors’ offices because they have not paid taxes.”
But how fast progress will come is an open question. The changes have provoked protests and deep resentment in some circles. For instance, the president of the union for doctors who work in state hospitals, Stathis Tsoukalos, 60, calls the loss of a special tax status for his doctors wrongheaded and unfair. He contended that the special low tax rate was given to make up for the fact that doctors received very low pay.
Speaking of the doctors in the Kolonaki neighborhood who claimed small incomes, he said, they may have just opened their practices or bought real estate there with help from their parents.
Whether the country’s tax collectors are up to the task is also unclear. Many Greeks say tax collectors have a reputation for being among the easiest officials to bribe. Some say tax troubles are usually solved in a three way split: You pay a third of what you owe to the government, a third to the collector and a third remains in your pocket.
Froso Stavraki, who has been a tax collector for 27 years and is now a high-ranking official in the union, readily concedes that there is some corruption in the ranks. But she contends that the politicians never wanted toughness.
“The orders from above were to do everyday tax processing,” she said. “We were busy going over forms, checking on those who pay taxes, not those who didn’t.”
by JackRiddler » Wed May 26, 2010 3:37 am
Lehman's Liar's Loans and Other Cons
William Black Charges "Massive, Fraudulent Transactions"
April 23 - 25, 2010
By MIKE WHITNEY
Prof. William Black submitted a 24-page report on the Lehman bankruptcy to the House Committee on Financial Services on Tuesday. It is the best analysis of the underlying causes of the financial crisis to date. Black, who is a former government regulator and white-collar criminologist, shows that the crisis was not an unavoidable disaster, as Wall Street apologists suggest, but the result of large-scale fraud perpetrated by financial institutions like Lehman Brothers. The incidents of fraud were numerous, blatant, extreme and premeditated. In making his case against Lehman, Black exposes the omissions, failures and negligence of the primary regulators, particularly the Fed. Had the Fed not been derelict in its duties, the cyclical downturn would not have turned into a near-Depression.
"Lehman’s failure is a story in large part of fraud," Black said in his testimony before the House. "Lehman was the leading purveyor of liars’ loans in the world. For most of this decade, studies of liars’ loans show incidence of fraud of 90per cent. ... If you want to know why we have a global crisis, in large part it is before you."
As the Litigation Director of the Federal Home Loan Bank Board during the S&L crisis, Black knows what he's talking about. He was so dogged in his investigation that Charles Keating "directed his chief political fixer that his ‘Highest Priority’ was to ‘Get Black … Kill him Dead.’” But Black didn't buckle or give ground. He shrugged off the threats and continued to expose unsound practices and illegal activity. His team faced the same challenges that regulators face today, "elite frauds" by powerful institutions that wield tremendous political power.
Black's statement cuts through much of the ideological claptrap surrounding the crisis and shows that deregulation is really the decriminalization of fraud. The notion that the market can "regulate itself" has been jettisoned altogether and public support for reform is gaining momentum.
"It is insane to withdraw accountability for negligence," says Black. "Doing so encourages negligence."
Financial institutions have used "laisser faire" dogma for their own aims. It's the mask behind which the voracity and predations remain hidden. To a large extent, that's the story of Lehman, an institution that paid no attention to rules and regulations. Anything went. It's a philosophy that was embraced by the nation's chief regulator, Alan Greenspan, former chairman of the Federal Reserve.
"Lehman’s nominal corporate governance structure was a sham," says Black. "Lehman was deliberately out of control with regard to “risk” in its dominant operation – making “liar’s loans.” Lehman did not “manage” the risk of making liar’s loans. It engaged in massive, fraudulent transactions that were “sure things”.
Black notes that sleight-of-hand accounting assures that institutions will "report superb (fictional) income in the short-term and catastrophic losses in the long-term," which is exactly what happened. The head honchos skimmed off billions in fat bonuses and stock options, while their companies were fed to the dogs.
Black again:
"Lehman’s principal source of (fictional) income and real losses was making (and selling) what the trade accurately called ‘liar’s loans’ through its subsidiary, Aurora... Liar’s loans are ‘criminogenic’ (they create epidemics of mortgage fraud) because they create strong incentives to provide false information on loan applications. The FBI began warning publicly about the epidemic of mortgage fraud in 2004.” (CNN)
The proof of criminal intent could not be clearer. The FBI reported what they'd found to the regulators, but nothing was done. Bush had filled all the supervisory posts with Wall Street loyalists who simply looked the other way. Thus, lending standards were relaxed, profits exploded, housing prices soared, the bubble mushroomed, and Lehman raked in record profits, knowing full-well that the eventual implosion would inflict massive damage on the system and severe hardship on everyone else.
Black again:
"Lehman’s underlying problem that doomed it was that it was insolvent because it made so many bad loans and investments. It hid its insolvency through the traditional means – it refused to recognize its losses honestly. It could not resolve its liquidity crisis because it was insolvent and its primary source of fictional accounting income collapsed with the collapse of the secondary market in nonprime loans. If Lehman sold its assets to get cash it would have to recognize these massive losses and report that it was insolvent."
This requires some explanation. Prior to the meltdown, the depository "regulated" banks were mainly funded through repurchase agreements (repo) with institutional investors. (aka---"shadow banks"; investment banks, hedge funds, insurers) The banks would post collateral, in the form of bundled "securitized" bonds, and use the short-term loans to maintain operations. When the banks collateral became suspect -- because no one knew which bundles held the subprime mortgages -- then intermediaries (primary dealers) demanded more collateral for the loans. Suddenly the banks were losing money hand-over-fist as the value of their assets tumbled. Lehman got trapped in this revolving door and couldn't roll-over its debt using its shabby collateral, which, by now, everyone knew was garbage. There was a bank-run on the shadow system; the secondary market collapsed. In truth, the market was traumatized by a radical repricing event, where asset prices were revalued overnight. Lehman could not survive in this new tight-credit environment.
Black continues:
"There is no way to ‘manage’ the ‘risk’ of making massive amounts of liar’s loans. Lehman was the world leader in making liar’s loans.........If Lehman admitted that its liar’s loans were often fraudulent it could not sell them – cutting off one of its largest sources of income."
Low-documentation "liar's loans" were Lehman's bread and butter. Ironically, its own auditors discovered that up to half of them "contained material misrepresentations". It didn't matter; everyone was making gobs of money and the bonus packages continued to shower wealth on the front office. Lehman responded to the auditors’ findings as expected, by boosting the volume of liar's loans. "Damn the torpedoes". This increased the likelihood of contagion and systemic risk. Lehman's activities now threatened the whole system.
The SEC didn't have the manpower to supervise Lehman, but the same can't be said of the Fed.
Black again:
"The Fed had unique authority under the Home Ownership and Equity Protection Act of 1994 (HOEPA) to regulate all mortgage lenders and had unprecedented practical leverage during the crisis because of its ability to lend and convert investment banks to commercial bank holding companies. The Fed is supposed to be an experienced ‘safety and soundness’ regulator."
But the Federal Reserve Bank of New York (FRBNY) had no intention of overseeing Lehman or of assisting the SEC in carrying out its mission. In fact, Geithner's Fed "stood by while Lehman deceived the public through a scheme that FRBNY officials likened to a ‘three card monte routine.’”
Black blasts Geithner and the FRBNY:
"The FRBNY knew that Lehman was engaged in fraud designed to overstate its liquidity and, therefore, was unwilling to loan as much money to Lehman. The FRBNY did not, however, inform the SEC, the public, or the OTS ... of the fraud. The Fed official doesn’t even make a pretense that the Fed believes it is supposed to protect the public. The FRBNY remained willing to lend to a fraudulent systemically dangerous institution (SDI). This is an egregious violation of the public trust, and the regulatory perpetrators must be held accountable."
Geithner (apparently) did everything in his power to assist Lehman in hiding its true financial condition and may have deliberately misled investors by facilitating repo 105 transactions which concealed up to $50 billion off-balance sheet liabilities. In his testimony this week before the House Committee on Financial Services, Lehman CEO Richard Fuld said that the Fed was aware of everything that was going on at the bank. If that's true, than the case against Geithner should be airtight.
Geithner and Fed chairman Ben Bernanke had good reason to mask Lehman's financial situation. If Lehman's mortgage-backed assets were "marked to market", it would have forced a systemwide repricing which would have triggered huge firesales of financial assets and severe deflation. So, instead of demanding fair-value disclosures, Geithner and Bernanke assisted in the ongoing accounting cover-up. The debt-instruments and toxic assets are now hidden in Fannie Mae, Freddie Mac, the Fed's balance sheet, and financial institutions that use "mark to fantasy" accounting trickery. The debts have not gone away; they've merely been removed from public view.
Black again:
"The FBI warned in Congressional testimony in 2004 of an "epidemic" of mortgage fraud.....The Fed deserves special criticism for its failure to respond to these warnings by taking any effective action to stop liar's loans. The Fed had unique authority under HOEPA to ban liar's....loans, which would have prevented the bubble from hyper-inflating and contained the rapidly growing epidemic of mortgage fraud."
As early as 2000, consumer groups were urging the Fed to use its authority under HOEPA to address predatory lending. But the Fed refused to respond.
According to Elizabeth MacDonald, the Fed also brushed off "One of the nation’s biggest mortgage industry players". In an article titled "Housing Red flags Ignored" MacDonald states:
"One of the nation’s biggest mortgage industry players repeatedly warned the Federal Reserve.....that the U.S. faced an imminent housing crash....But bank regulators not only ignored the group's warnings, top Fed officials also went on the airwaves to say the economy was ‘building on a sturdy foundation’ and a housing crash was ‘unlikely’...”
As it pleaded with bank regulators to stop subprime lending abuses, the Mortgage Insurance Companies of America [MICA] pointed out the red flags in analysis from the bank regulators' own staffers as well as the likes of Bear Stearns and Lehman Brothers, three years before these two Wall Street giants collapsed under the weight of bad mortgage bets."
Mortgage insurers are “deeply concerned about increased mortgage market fragility, which, combined with growing bank portfolios in high-risk products, pose serious potential problems that could occur with dramatic suddenness."... Failure to adjust bank underwriting, reserves and capital to account for this growing risk “means that downturns from credit and/or interest rate events–let alone shocks–will be far more severe than” if precautions are taken." (Elizabeth MacDonald, "Housing Red flags Ignored", FOX Business News)
There were others, too, like former New York governor Eliot Spitzer who warned of a "predatory lending crisis" and lambasted the Bush administration for blocking the prosecution of mortgage fraudsters. Spitzer's article appeared in the Washington Post in 2003. Here's an excerpt:
"But the unanimous opposition of the 50 states (Attorneys General) did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation."(Washington Post)
These incidents show that the problem wasn't "deregulation" as much as "refusal to regulate". But, why? Why did the Fed refuse to respond to the many warnings it had gotten from reliable professionals? And, why did Bush take such a hostile approach to consumer protection? Was it a conspiracy or was there merely a tacit understanding between high-ranking members of the political and financial establishment, that predatory lending and mortgage fraud were an acceptable way to fatten the bottom line, with a wink and a nod.
Either way, it's clear that the crisis was not "natural disaster" or even a "system malfunction", but the result of widespread corporate larceny engineered and executed by the nation's largest financial institutions.
Black again: "Criminologists refer to entities that spread fraud epidemics as "vectors"...Lehman was one of the largest vectors that spread the fraud epidemic. ....The Fed, due to its unique HOEPA authority, and the SEC, because it has jurisdiction over every publicly traded company, were the only entities that could have shut down the vectors spreading the fraud epidemic... yet the Fed and the SEC took no effective action until after virtually every major originator of liar's loans had failed."
Indeed. The Fed and SEC knew exactly what needed to be done and they refused to do their jobs. The S&L crisis established the precedents for dealing with “low doc” loans back in the 1990s. So there was a blueprint for acting preemptively to protect the public from the economic fallout. But nothing was done because all the "right people" were getting rich gaming the system, selling garbage loans to vulnerable applicants, and inflating a enormous credit bubble that would leave the economy in a shambles.
Black's statement leaves no doubt that the hanky-panky at Lehman was deliberate and that the fraud was abetted by friends in high places. Now it's up to Congress to appoint an Independent Counsel to follow the evidence and make sure that the criminals are brought to justice.
William Black's full "must read" statement can be seen here: http://www.house.gov/apps/list/hearing/ ... .20.10.pdf
Mike Whitney lives in Washington state. He can be reached at fergiewhitney@msn.com
Goldman Sachs implicated in shorting Lehman shares
Goldman Sachs has been drawn into a fresh controversy as lawyers demand to know whether it was partly responsible for triggering Lehman Brothers’ downfall by shorting its rival’s shares.
By James Quinn, US Business Editor
Published: 6:00AM BST 20 Apr 2010
Goldman has filed 8m documents with the SEC in relation to the investigation Photo: AP
The Wall Street behemoth is already being investigated by a number of financial regulators around the world in addition to the US Securities and Exchange Commission’s fraud charges over derivatives mis-selling. It has now been named in a court filing seeking information about short-selling Lehman shares.
Goldman has been subpoenaed to hand over documents to Lehman’s Bryan Marsal, the man responsible for winding up the bank’s affairs and repaying creditors. Goldman was named in the court filing along with four other firms, including hedge funds SAC Capital and Citadel. Goldman declined to comment on the Lehman case.
In a further potential legal case, it emerged that AIG is considering suing Goldman over about $2bn (£1.3bn) of losses it incurred from past derivatives instruments. The troubled insurer is understood to be considering action as a result of protection it was forced to pay to buyers of credit-default swaps when collateralised debt obligations (CDOs) in Goldman’s Abacus programme lost their value.
The new worries came as Goldman hit back against the SEC’s charges, which it said are “completely unfounded both in law and fact”.
Questions were last night being asked as to why the bank had not publicly disclosed the regulator’s probe. It is understood Goldman was first contacted by the US financial watchdog over its examination of mis-selling in the mortgage-backed securities industry two years ago, and that it received what is known as a “Wells Notice” – an intention to file charges – as early as July last year.
Goldman has filed 8m documents with the SEC in relation to the investigation, and five of its staff were interviewed as part of an exchange which saw the bank attempt to defend its point of view. Lloyd Blankfein, the bank’s chairman, has been attempting to boost staff morale ahead of today’s first-quarter results, which are expected to show a profit of as much as $3.8bn. “The extensive media coverage on the SEC’s complaint is certainly uncomfortable, but given the anger directed at financial services, not completely surprising,” he said in one voicemail left on an employee’s phone.
Fabrice Tourre, the bond trader at the heart of the SEC’s probe, has begun an undetermined period of absence. The bank maintained that while he has done “nothing wrong” and remains an employee, he had made a “personal decision to take a bit of time off”.
President Barack Obama is to make a landmark speech on financial regulatory reform which is expected to draw on Goldman’s current problems.
Both BaFin, the German regulator, and the European Union are looking into the situation.
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Former Bear Stearns boss Jimmy Cayne blames conspiracy for bank's collapse
Jimmy Cayne says Bear Stearns liabilities were too high, but suggests conspiracy caused a run on the bank
Andrew Clark in New York
guardian.co.uk, Wednesday 5 May 2010 20.08 BST
Article history
Jimmy Cayne, former chairman and CEO of Bear Stearns, waits to testify at the US inquiry into the financial crisis. Photograph: Kevin Lamarque/REUTERS
The bridge-playing, cigar-smoking former Bear Stearns chairman Jimmy Cayne today accepted that the defunct Wall Street firm's liabilities were too high on his watch, although he suggested a conspiracy may have contributed to rumours that caused a run on the 85-year-old Wall Street bank.
In his first formal public appearance since Bear Stearns's demise in March 2008, Cayne emerged from retirement to admit to the US financial crisis inquiry commission that the bank's 40-to-1 ratio of equity to risk-weighted assets was excessive.
"That was the business and that was, really, industry practice," said Cayne. "In retrospect, in hindsight, I would say leverage was too high."
The 76-year-old Wall Street veteran, who was criticised during Bear's final days for taking time out of the office to play in world-class bridge tournaments, attributed much of the blame for Bear Stearns's demise to an "unjustified and irrational" evaporation of confidence in what was, at the time, the smallest of Wall Street's five major investment banks.
"Rumour, innuendo. I'm not going to use the word 'conspiracy', but it's part of it," said Cayne.
When asked by members of the non-partisan panel in Washington whether a deliberate plot by outsiders could have contributed to the firm's downfall, Cayne's response was equivocal.
"I heard the same rumours that everybody did – that hedge funds had gathered together, that there was an uptick rule‚" he said. "It was all part of a picture of a big, bad goose walking down a lane that's about to get eaten up."
In answers that ranged from terse monosyllables to rambling monologues, Cayne said he wished the Securities and Exchange Commission had looked into the way rumours about Bear were spread: "Regardless of whether there was a conspiracy or not, the bottom line is the firm came under attack."
He was unspecific on possible perpetrators: "Whether it's competitors, people angry with it [Bear], whatever, I don't know."
A portly, bespectacled figure sporting a plum-coloured tie, Cayne swigged from a plastic bottle of water while answering questions. Asked whether he could have done anything to save Bear, he offered little tangible response: "That's a question I've asked myself for close to three years since I retired and I don't have an answer."
Two months before Bear's collapse, Cayne gave up his day-to-day role as chief executive to Alan Schwartz, who gave evidence alongside him. Schwartz drew a picture of mounting panic in 2008 as the US housing market collapsed and Wall Street realised that highly sophisticated mortgage derivatives did not deserve the high ratings bestowed on them by credit rating agencies.
"There was a reliance on ratings to work out balance sheets," said Schwartz, who suggested that it became impossible to work out the risk profile of any bank. "There was a lack of transparency in these instruments. It became impossible to determine which ones were risky or not risky."
When trading partners stopped doing business with Bear and investors began removing their assets, the US government stepped in and organised a hasty buyout of the bank by JP Morgan for a knockdown price of $1.2bn (£0.8bn). Over the following months, the credit crunch worsened, leading to the collapse of scores of other US institutions, including Lehman Brothers and Washington Mutual.
Bear's failure came at a personal cost to Cayne, who had worked at the firm for 39 years. In Bear Stearns' final days, he sold his stake, once valued at $1bn, for a relatively modest $61m.
Many commentators have pinpointed the origin of the firm's failure in the collapse of two Bear hedge funds in the summer of 2007, following heavy investments in sub-prime mortgages, at a cost to investors of $1.8bn. Cayne, who was playing bridge during the week the funds went under, denied that the funds were a significant cause of the bank's failure, pointing out that they amounted to less than 0.5% of Bear's assets.
He praised JP Morgan's subsequent stewardship of Bear Stearns, saying he was pleased that a good number of his firm's 14,000 employees had been given jobs: "The outcome was the best that could be anticipated when the world ended for a lot of us."
Profile: Jimmy Cayne
Jimmy Cayne, a former scrap iron salesman, forged a reputation as a brash, often prickly Wall Street titan. Cayne joined it as a broker in 1969 and quickly became a protege of Alan "Ace" Greenberg, who ran the bank in the 1970s and was a fellow bridge-playing enthusiast. Cayne became chief executive in 1993 and chairman in 2001.
During his later years, he was criticised for taking a hands-off approach, sometimes leaving the office to play golf on Fridays and routinely competing in world-class bridge competitions. The Wall Street Journal once alleged that he smoked marijuana at certain tournaments – a claim Cayne strenuously denied.Bear Stearns' demise hit Cayne's personal wealth to the tune of $900m. It came just after he had bought a luxurious apartment in New York's Plaza hotel for $27m.
Cayne has expressed anger to those who, he feels, let down Bear Stearns. In a book on Bear's collapse, author William Cohan quotes a profanity-laced tirade in which Cayne describing the US treasury secretary, Timothy Geithner, as a "clerk" for failing to help Bear: "This guy thinks he's got a big dick. He's got nothing. I'm not a good enemy. I'm a very bad enemy."
John Paulson Acquires an Alan Greenspan
1/15/08 at 12:45 PM
God help us to survive this unholy love.
Photo Illustration: Everett Bogue; Photos: Getty Images, Reuters
For sub-prime sufferers who blame Alan Greenspan for setting off the collapse with his low-interest-rate policy, today's announcement that the former Federal Reserve chairman has joined up with John Paulson, the Queens native and hedge-fund manager who famously made billions of dollars betting against the mortgage market, must especially sting. Paulson & Company, which has assets of $28 billion, have hired Greenspan to be their own personal Nostradamus — they're the only hedge fund he will advise on the direction of the economy and for whom he will assess, according to the Financial Times, "the potential for and severity of a US recession," so that next time there's a giant bust (credit cards! Auto loans!), they can roll around in piles of filthy lucre while the rest of us rubes wail and tear our garments in the streets. Although not if we're canny. According to the Journal, Paulson, who recently gave a presentation titled "The Worst Is Yet to Come," has been known to tell investors "it's still not too late" to bet on economic troubles.
Trader Made Billions On Subprime [WSJ]
Greenspan Joins NY Hedge Fund [FT]
Goldman CDO case could be tip of iceberg
Sat, Apr 17 2010
By Aaron Pressman and Joseph Giannone - Analysis
BOSTON/NEW YORK (Reuters) - The case against Goldman Sachs Group Inc <GS.N> over a 2007 mortgage derivatives deal it set up for a hedge fund manager could be just the start of Wall Street's legal troubles stemming from the subprime meltdown.
The U.S. Securities and Exchange Commission charged Goldman <GS.N> with fraud for failing to disclose to buyers of a collateralized debt obligation known as ABACUS that hedge fund manager John Paulson helped select mortgage derivatives he was betting against for the deal. Goldman denied any wrongdoing.
The practice of creating synthetic CDOs was not uncommon in 2006 and 2007. At the tail end of the real estate bubble, some savvy investors began to look for more ways to profit from the coming calamity using derivatives.
Goldman shares plunged 13 percent on Friday and shares of other financial firms that created CDOs also fell. Shares of Deutsche Bank AG <DB.N> ended down 9 percent, Morgan Stanley <MS.N> 6 percent and Bank of America <BAC.N>, which owns Merrill Lynch, and Citigroup <C.N> each declined 5 percent.
Merrill, Citigroup and Deutsche Bank were the top three underwriters of CDO transactions in 2006 and 2007, according to data from Thomson Reuters. But most of those deals included actual mortgage-backed securities, not related derivatives like the ABACUS deal.
Hedge fund managers like Paulson typically wanted to bet against so-called synthetic CDOs that used derivatives contracts in place of actual securities. Those were less common.
MORE LAWSUITS?
The SEC's charges against Goldman are already stirring up investors who lost big on the CDOs, according to well-known plaintiffs lawyer Jake Zamansky.
"I've been contacted by Goldman customers to bring lawsuits to recover their losses," Zamansky said. "It's going to go way beyond ABACUS. Regulators and plaintiffs' lawyers are going to be looking at other deals, to what kind of conflicts Goldman has."
An investigation by the online site ProPublica into Chicago-based hedge fund Magnetar's 2007 bets against CDO-related debt also turned up allegations of conflicts of interest against Deutsche Bank, Merrill and JPMorgan Chase.
Magnetar has denied any wrongdoing. Deutsche Bank declined to comment. Merrill and JPMorgan had no immediate comment.
The Magnetar deals have spawned at least one lawsuit. Dutch bank Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., or Rabobank for short, filed suit in June against Merrill Lynch over Magnetar's involvement with a CDO called Norma.
"Merrill Lynch teamed up with one of its most prized hedge fund clients -- an infamous short seller that had helped Merrill Lynch create four other CDOs -- to create Norma as a tailor-made way to bet against the mortgage-backed securities market," Rabobank said in its complaint filed on June 12 in the Supreme Court of New York.
Regulators at the SEC and around the country said they would be investigating other deals beyond ABACUS.
"We are looking very closely at these products and transactions," Robert Khuzami, head of the SEC's enforcement division, said. "We are moving across the entire spectrum in determining whether there was (fraud).
Meanwhile, Connecticut Attorney General Richard Blumenthal said in a statement his office had already begun a preliminary review of the Goldman case.
"A key question is whether this case was an isolated incident or part of a pattern of investment banks colluding with hedge funds to purposely tank securities they created and sold to unwitting investors," Connecticut Attorney General Richard Blumenthal said in a statement.
(Reporting by Aaron Pressman and Joseph Giannone. Additional reporting by Dan Wilchins and Rachelle Younglai, editing by Leslie Gevirtz)
© Thomson Reuters 2010. All rights reserved.
U.S. Said to Open Criminal Inquiry Into Goldman
April 29, 2010
By LOUISE STORY and MICHAEL J. de la MERCED
Federal prosecutors have opened an investigation into trading at Goldman Sachs, raising the possibility of criminal charges against the Wall Street giant, according to people familiar with the matter.
While the investigation is still in a preliminary stage, the move could escalate the legal troubles swirling around Goldman.
The Securities and Exchange Commission, which two weeks ago filed a civil fraud suit against Goldman, referred its investigation to prosecutors for the Southern District of New York, which has now opened its own inquiry.
Goldman has vigorously denied the accusations by the S.E.C., which accused Goldman of defrauding investors involved a complex mortgage deal known as Abacus 2007-AC1.
Federal prosecutors would face a higher bar in bringing a criminal case against Goldman, whose role in the mortgage market came under sharp scrutiny this week during a marathon hearing in the Senate. In contrast to civil cases, the burden of proof is higher in criminal ones, where prosecutors must prove their case beyond a reasonable doubt.
The stakes are high for Goldman, but they are also high for the United States attorney’s office. Prosecutors from the Eastern District of New York lost a case last year filed against two hedge fund managers at Bear Stearns, whose collapse presaged the turmoil on Wall Street.
Prosecutors built much of that case around internal e-mail messages at Bear Stearns, much the way the S.E.C. and senators have pointed to e-mail at Goldman in which employees had disparaged investments that they were selling to their customers.
In the end, however, prosecutors were unable to prove to a jury any criminal wrongdoing by the Bear Stearns employees.
A spokesman for Goldman declined to say whether the bank knows about a criminal case, but he said “given the recent focus on the firm, we’re not surprised” to learn about a criminal inquiry. The spokesman said Goldman would cooperate with any investigators’ requests for information.
A spokeswoman for the Southern District also declined to comment.
The opening of the Justice Department investigation was first reported Thursday evening by The Wall Street Journal’s Web site.
Goldman has said it will defend itself against the S.E.C.’s accusations. The firm’s executives discussed the case last week during their quarterly earnings call, and this week, they testified about their mortgage operations in a nearly 11-hour hearing in Washington before a Senate subcommittee.
That hearing focused broadly on Goldman’s mortgage operations, and the Senate subcommittee released reams of new internal documents from Goldman. The Senate Permanent Subcommittee on Investigations is looking into many other mortgage deals beyond the one cited by the S.E.C.
The deal at the heart of the S.E.C. case was one of 25 mortgage securities that Goldman created in a program it called Abacus. The agency has hinted that it may expand its inquiry to other Wall Street firms.
Those securities were synthetic collateralized debt obligations, which are bundles of derivatives that mimic the performance of mortgage bonds. The securities allowed people who believed that the housing market would collapse to buy insurance against certain mortgage bonds they thought might fail. When those mortgage bonds did fail, the investors in the Abacus deals suffered major losses.
The Abacus deals were, however, very profitable for the parties that were negative on the housing market. In the Abacus 2007-AC1 deal, the hedge fund manager John A. Paulson raked in about $1 billion when the bonds he helped select hit trouble.
Mr. Paulson has not been named in the S.E.C.’s case because he was not involved in marketing and selling the deal.
Many in Congress have been pressing for a criminal inquiry. This week, 62 House members sent a letter to the Justice Department asking it to conduct an investigation into Goldman’s actions.
Charlie Savage contributed reporting.
Bosch Blacklists Goldman, AIG Plans to Sue
Author: Sandip Sen (ecothrust)
Published: April 23, 2010 at 7:58 am
As per a Financial Times report German automobile and engineering major Bosch snapped ties with Goldman Sachs, in what could be a beginning to a spate of corporate action against the embattled Bank.
A few months ago Mr. Fehrenbach CEO of the $40 billion european conglomerate who runs one of the world’s largest and most respected engineering companies, was reportedly upset with the reckless profiteering in the banking business and had warned...“We will act very selectively. We will refrain from doing any more business with those banks that think their main objective is to maximize bonuses.”
Earlier this week Britain commenced regulatory action against Goldman to cater to popular sentiment following the liberal democratic party’s call for a blanket ban on Goldman Sachs participation as an advisor / banker to the nation. This comes days after the SEC charges were filed against Goldman and a week after Greece shut out Goldman as transaction managers from its bond issue.
Insurance major AIG which played the sucker, as Goldman switched roles in a classical "Jekyll and Hyde" encore to short the housing market is also contemplating to sue Goldman, on a $6 billion ABACUS issue.
It is now a open secret that Goldman made billions shorting AIG's cheap insurance on pools of subprime mortgage loans. So when the subprime market crashed, Goldman still remained liquid, while AIG had to be rescued by the taxpayer.
Also planning legal action is IKB the German Bank which lost $150 million, after buying the ABACUS 2007-AC1 bundle issued by ACA , under Goldman's advice. Goldman while selling the ABACUS 2007-AC1 bundle to IKB, ABN Amro among other big investors, reportedly hid the fact, that Paulson had created it to place negative bets on its BBB mortgages.
The Goldman Brand had already taken a beating earlier this year following accusations that its humungous bonus payouts were the result of its hedging and shorting operations.
It is widely believed that Goldman and other Wall Street banks have once again made superprofits this year by hedging and shorting at the ICE exchange, in similar fashion to that which had brought down the housing market in 2008.
The SEC charge against it merely confirmed the markets suspicion, that Goldman used to habitually short the issues of clients it promoted and underwrote, thus earning not only twice the commissions, but super profits from its CDS hedging operations.
After Goldman Sachs decided to reduce its mortgage holdings, the sales force was instructed to try to sell some of its mortgage related assets, and the risks associated with them, to Goldman Sachs clients. In response, Goldman Sachs personnel issued and sold to clients RMBS and CDO securities containing or referencing high risk assets that Goldman Sachs wanted to get off its books.
[T]his list might be a little skewed towards sophisticated hedge funds with which we should not expect to make too much money since (a) most of the time they will be on the same side of the trade as we will, and (b) they know exactly how things work and will not let us work for too much $$$….
Real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is very significant. Aggregate loss of our clients on just these 5 trades along is 1bln+. In addition team feels that recognition (sales credits and otherwise) they received for getting this business done was not consistent at all with money it ended making/saving the firm.
I met with 10+ individual prospects and clients … since earnings were announced. The institutions don’t and I wouldn’t expect them to, make any comments like UT good at making money for urself but not us. The individuals do sometimes, but while it requires the utmost humility from us in response I feel very strongly it binds clients even closer to the firm, because the alternative of take ur money to a finn who is an under performer and not the best, just isn’t reasonable. Clients ultimately believe association with the best is good for them in the long run.
Follow-ups:
1. Reduce exposure, sell more ABX index outright, basis trade of index vs CDS too large
2. Distribute as much as possible on bonds created from new loan securitizations and clean previous positions
N.Y. case against Greenberg "devastating": judge
Tue, Apr 20 2010
By Grant McCool
NEW YORK (Reuters) - New York state prosecutors have "a devastating case" against Maurice "Hank" Greenberg, the former American International Group Inc chief executive accused of fraud over a reinsurance transaction 10 years ago, the presiding judge said in court on Tuesday.
After four hours of oral arguments, New York State Supreme Court Justice Charles Ramos reserved ruling on Greenberg's motion to dismiss the case or the office of New York Attorney General Andrew Cuomo's request for summary judgment. The judge did not indicate when he would rule.
Greenberg's attorney David Boies argued that much of the attorney general's case relies on hearsay disputed evidence regarding two conversations Greenberg had with onetime General Re Corp Chief Executive Ronald Ferguson that purportedly sealed the deal.
The judge told Boies that David Ellenhorn, a lawyer in the attorney general's office, "has put together a devastating case, a very strong case, and we both know it. I am very, very much focused on those two conversations Mr. Greenberg had with Mr. Ferguson."
Brought in 2005 by former Attorney General Eliot Spitzer, the case involves a 2000 reinsurance transaction with General Re, a unit of Warren Buffett's Berkshire Hathaway Inc, that boosted AIG's loss reserves by $500 million without transferring risk.
Federal prosecutors have obtained five criminal convictions and two guilty pleas of former General Re and AIG officials over the transaction, including a conviction of Ferguson. He was sentenced to two years in prison.
Robert Morvillo, another Greenberg attorney, told the judge that there was "no independent, non-hearsay evidence that Mr. Greenberg became part of a conspiracy."
He argued that out of 50 depositions in evidence, only the testimony of convicted former GenRe executive Richard Napier said there was an oral side agreement on the transaction. Napier pleaded guilty to a conspiracy charge and was sentenced to probation.
The transaction at issue long preceded taxpayer bailouts of about $180 billion for AIG after it nearly collapsed from mortgage-related losses. The revelation of the GenRe case contributed to Greenberg's ouster in 2005.
"This transaction is material because it was designed to, and did in fact, mislead investors about AIG's reserves," Ellenhorn told the court.
He said that when he deposed Greenberg two weeks ago, 90 percent of his answers were "I don't know," despite the now 84-year-old's fame for knowledge of the insurance business and attention to detail.
"He drills down so deep, to the Arctic ice, and yet he tells us he doesn't know the details of what he discussed with Ferguson," Ellenhorn said. "It's ridiculous."
Greenberg is trying to rehabilitate his reputation by settling lawsuits over the transaction and his departure from AIG.
Former AIG Chief Financial Officer Howard Smith also was charged in the civil lawsuit, which seeks to hold the two former executives of what was once the world's largest insurer liable under the Martin Act, New York's powerful securities law.
Last August, Greenberg agreed to pay $15 million to settle U.S. Securities and Exchange Commission charges that he altered AIG's records to boost results between 2000 and 2005.
Three months later, Greenberg and AIG resolved years of litigation that followed his exit. AIG agreed to reimburse him and others for as much as $150 million of legal expenses.
Investigators have questioned Buffett about the General Re transaction, but the billionaire has not been accused of any wrongdoing in respect to the transaction in question.
The case is New York v. Greenberg et al, New York State Supreme Court, New York County, No. 401720/2005.
(Reporting by Grant McCool, editing by Gerald E. McCormick)
© Thomson Reuters 2010.
Goldman Sachs' Fabulous Fabrice to Use Derivatives Law Firm for White Collar Defense
April 19, 2010
The Death of a Salesman
By PAM MARTENS
It was only a matter of time before the hideously disfigured face of U.S. financial services would gaze into the mirror and see the reflection of legal counsel from a parallel universe. The thoroughly discredited one-stop-shopping-mega-bank-securities-casino has spawned a new era law firm: one that lends its legal imprimatur to complex financial derivatives that blaze a scorched earth from Jefferson County, Alabama to the Arctic Circle, then offers up white color criminal defense to investment bankers snared in the fraud aftermath.
The news last Friday that Fabrice Tourre, a 31-year old Vice President at Goldman Sachs had been charged with civil fraud by the Securities and Exchange Commission (SEC), together with the firm, for failing to advise investors that he was knowingly peddling a custom-tailored package of mortgages handpicked for failure by John Paulson, a hedge fund manager that planned to short them, was half the story. The eyebrow raiser in the story went unnoticed; the lawyer and law firm that would be representing Mr. Tourre (who referred to himself as the Fabulous Fab[rice] in an internal email), was Pamela Chepiga of London’s derivatives powerhouse Allen & Overy: the law firm that signed off on the Structured Investment Vehicles (SIVs) that blew up Citigroup and made it a ward of the taxpayer.
Back on November 6, 2007, I wrote the following here at CounterPunch in an article titled “Wall Street Metes Out Street Justice to Citigroup”:
"Now, once again, one of the most troubling aspects of the current Citigroup debacle that has gone unreported is the extent to which these opaque and convoluted debt instruments managed by Citigroup, called CDOs (collateralized debt obligations), got dumped into Cayman Islands SIVs, transmuted into AAA-rated commercial paper, landed in the so-called safe money market funds in the U.S., including an astonishing amount at Citigroup's competitor, Merrill Lynch.
"According to Standard & Poor's Structured Finance research reports, Citigroup is managing the following Structured Investment Vehicles (SIVs), incorporated in the Cayman Islands and not consolidated on Citigroup's balance sheet: Centauri Corp., Beta Finance Corp., Sedna Finance Corp., Five Finance Corp., and Dorada Corp. In addition, according to press reports, Citigroup created two more SIVs as recently as November 2006: Zela Finance Corp. and Vetra Finance Corp. These SIVs contain approximately $80 Billion in what is increasingly being viewed as toxic debt.
"Knowing the history of Citigroup and knowing the safety and liquidity requirements for money market funds, how did one of the oldest and most sophisticated firms on the street, Merrill Lynch, end up with a boatload of this SIV paper in its various money markets? The most troubling of its money market exposure as of its July 31, 2007 filing with the SEC is its Citigroup managed SIV commercial paper positions in what one would think would be the safest of all its money market funds, the Merrill Lynch Retirement Reserves Money Fund. Merrill's SEC filing shows $52.9 Million in Beta Finance, $53 Million in Five Finance, $10 Million in Sedna Finance, and $10.7 Million in Zela Finance."
On April 7 and April 8, the Financial Crisis Inquiry Commission conducted two days of hearings attempting to get to the bottom of how these SIVs ended up back on Citigroup’s balance sheet, what these super senior tranches were created for in the first place, and how senior management could have possibly not known about the so-called “liquidity puts” that obligated Citigroup to bring toxic waste back unto its balance sheet without adequate capital to buffer the losses. The two days ended with little enlightenment.
Surprisingly, or perhaps not since this Commission has not seen fit to issue one subpoena, the name of the law firm, Allen & Overy did not come up once; the fact that this toxic waste was sitting in money market funds did not come up once; and the fact that 58 per cent of this off-balance sheet debt was financial institution debt, not mortgage debt, also did not come up.
Allen & Overy also had their hand in the ill-fated effort to bail Citigroup out of its SIV nightmare by attempting to create the ill-fated Master Liquidity Enhancement Conduit (MLEC) that envisioned Wall Street competitors chipping in billions to bail out Citi. This is how Elizabeth Collett describes on Allen & Overy’s website that 2007 summer and fall of financial hell:
"The summer of 2007 was a fascinating time for those of us involved in the structured credit markets. Since I joined A&O's derivatives and structured finance group as an associate in 2004 the capital markets had been growing very fast. With the onset of the credit crunch, however, our work changed from advising investment banks setting up complex finance structures to focusing on how existing structures would be affected by reduced liquidity and falling asset values.
"Structured Investment Vehicles (SIVs) were particularly hit hard given that they rely on constant funding and high credit ratings (which were, in part, reliant on the value of their assets). At its peak, the SIV market was worth around $400 billion (held by 30 vehicles), so it was not long before concern arose that these vehicles might start selling billions of dollars of assets into an already volatile market. In the early Autumn of 2007 the US Treasury called in a number of the biggest US investment banks and asked them to come up with a solution to the problem. Citibank, the largest of them, and the market leader in terms of managing SIVs, took on the challenge. Given A&O's wealth of experience in advising on SIVs and, in particular, as Citibank's English counsel on all the SIVs managed by them, we were the natural choice to advise and were therefore the first to be instructed.
"Although by the time the transaction ended there were six law firms (A&O being the only English law advisers), three structuring banks and an investment manager involved, I was fortunate enough to see the deal progress from the beginning. What came out of Citibank's proposals, developed with our advice, was the Master Liquidity Enhancement Conduit (MLEC or, as the press dubbed it, the 'Super-SIV'), I was the lead associate in the A&O team, working with five partners and a number of other associates. I was involved at every stage including co-ordinating the A&O team, drafting parts of the term sheet, participating in conference calls to brainstorm the structure, reviewing and commenting on transaction documents and preparing draft agreements. Over the following two months the media coverage of the transaction gathered momentum (unsurprisingly since it was intended as a $100 billion solution to the SIV crisis) until there were almost daily reports on its progress in the Financial Times and the Wall Street Journal. It was fascinating to be working on such a high profile and politically sensitive transaction, and the media attention highlighted the fact that Allen & Overy is at the very forefront of the legal world in capital markets."
Why would Fabrice Tourre want a law firm that is so closely aligned with the dubious derivatives that he is charged with fraudulently misrepresenting to investors to be his defense lawyers. It is possible that criminal charges could also be brought. And, his interests and those of his employer, Goldman Sachs, may diverge. (Allen & Overy also lists Goldman as a significant client.)
It may well be the background of Ms. Chepiga that Mr. Tourre finds comforting and has landed her as a white collar defense lawyer in a firm specializing in derivatives and debt markets with clients like Citigroup and Goldman Sachs: Ms. Chepiga worked in the 70s and 80s in the U.S. Attorney’s Office of the Southern District of New York. From 1982 to 1984, she was the Chief of the Securities and Commodities Frauds Unit in that office where she coordinated criminal prosecutions with the SEC.
Pam Martens worked on Wall Street for 21 years; she has no security position, long or short, in any company mentioned in this article. She writes on public interest issues from New Hampshire. She can be reached at pamk741@aol.com
Computerized Front-Running
How a Computer Program Designed to Save the Free Market Turned Into a Monster
April 23 - 25, 2010
By ELLEN BROWN
Market commentators are fond of talking about “free market capitalism,” but according to Wall Street commentator Max Keiser, it is no more. It has morphed into what his TV co-host Stacy Herbert calls “rigged market capitalism”: all markets today are subject to manipulation for private gain.
Keiser isn’t just speculating about this. He claims to have invented one of the most widely used programs for doing the rigging. Not that that’s what he meant to invent. His patented program was designed to take the manipulation out of markets. It would do this by matching buyers with sellers automatically, eliminating “front running” – brokers buying or selling ahead of large orders coming in from their clients. The computer program was intended to remove the conflict of interest that exists when brokers who match buyers with sellers are also selling from their own accounts. But the program fell into the wrong hands and became the prototype for automated trading programs that actually facilitate front running.
Also called High Frequency Trading (HFT) or “black box trading,” automated program trading uses high-speed computers governed by complex algorithms (instructions to the computer) to analyze data and transact orders in massive quantities at very high speeds. Like the poker player peeking in a mirror to see his opponent’s cards, HFT allows the program trader to peek at major incoming orders and jump in front of them to skim profits off the top. And these large institutional orders are our money -- our pension funds, mutual funds, and 401Ks.
When “market making” (matching buyers with sellers) was done strictly by human brokers on the floor of the stock exchange, manipulations and front running were considered an acceptable (if morally dubious) price to pay for continuously “liquid” markets. But front running by computer, using complex trading programs, is an entirely different species of fraud. A minor flaw in the system has morphed into a monster. Keiser maintains that computerized front running with HFT has become the principal business of Wall Street and the primary force driving most of the volume on exchanges, contributing not only to a large portion of trading profits but to the manipulation of markets for economic and political ends.
The “Virtual Specialist”: the Prototype for High Frequency Trading
Until recently, most market making was done by brokers called “specialists,” those people you see on the floor of the New York Stock Exchange haggling over the price of stocks. The job of the specialist originated over a century ago, when the need was recognized for a system for continuous trading. That meant trading even when there was no “real” buyer or seller waiting to take the other side of the trade.
The specialist is a broker who deals in a specific stock and remains at one location on the floor holding an inventory of it. He posts the “bid” and “ask” prices, manages “limit” orders, executes trades, and is responsible for managing the uninterrupted flow of orders. If there is a large shift in demand on the “buy” side or the “sell” side, the specialist steps in and sells or buys out of his own inventory to meet the demand, until the gap has narrowed.
This gives him an opportunity to trade for himself, using his inside knowledge to book a profit. That practice is frowned on by the Securities Exchange Commission (SEC), but it has never been seriously regulated, because it has been considered necessary to keep markets “liquid.”
Keiser’s “Virtual Specialist Technology” (VST) was developed for the Hollywood Stock Exchange (HSX), a web-based, multiplayer simulation in which players use virtual money to buy and sell “shares” of actors, directors, upcoming films, and film-related options. The program determines the true market price automatically, by comparing “bids” with “asks” and weighting the proportion of each. Keiser and HSX co-founder Michael Burns applied for a patent for a “computer-implemented securities trading system with a virtual specialist function” in 1996, and U.S. patent no. 5960176 was awarded in 1999.
But things went awry after the dot.com crash, when Keiser’s company HSX Holdings sold the VST patent to investment firm Cantor Fitzgerald, over his objection. Cantor Fitzgerald then put the part of the program that would have eliminated front-running on ice, just as drug companies buy up competing patents in order to take them off the market. Instead of preventing front-running, the program was altered so that it actually enhanced that fraudulent practice. Keiser (who is now based in Europe) notes that this sort of patent abuse is illegal under European Intellectual Property law.
Meanwhile, the design of the VST program remained on display at the patent office, giving other inventors ideas. To get a patent, applicants must list “prior art” and then prove that their patent is an improvement in some way. The listing for Keiser’s patent shows that it has been referenced by 132 others involving automated program trading or HFT.
Since then, HFT has quickly come to dominate the exchanges. High frequency trading firms now account for 73% of all U.S. equity trades, although they represent only 2% of the approximately 20,000 firms in operation.
In 1998, the SEC allowed online electronic communication networks, or alternative trading systems, to become full-fledged stock exchanges. Alternative trading systems (ATS) are computer-automated order-matching systems that offer exchange-like trading opportunities at lower costs but are often subject to lower disclosure requirements and different trading rules.
Computer systems automatically match buy and sell orders that were themselves submitted through computers. Market making that was once done with a “specialist’s book” -- something that could be examined and audited -- is now done by an unseen, unaudited “black box.”
For over a century, the stock market was a real market, with live traders hotly bidding against each other on the floor of the exchange. In only a decade, floor trading has been eliminated in all but the largest exchanges, such as the New York Stock Exchange (NYSE); and even in those markets, it now co-exists with electronic trading.
Alternative trading systems allow just about any sizable trader to place orders directly in the market, rather than routing them through investment dealers on the NYSE. They also allow any sizable trader with a sophisticated HFT program to front run trades.
Flash Trades: How the Game Is Rigged
An integral component of computerized front running is a dubious practice called “flash trades.” Flash orders are permitted by a regulatory loophole that allows exchanges to show orders to some traders ahead of others for a fee. At one time, the NYSE allowed specialists to benefit from an advance look at incoming orders; but it has now replaced that practice with a “level playing field” policy that gives all investors equal access to all price quotes. Some ATSs, however, which are hotly competing with the established exchanges for business, have adopted the use of flash trades to pull trading business away from the exchanges. An incoming order is revealed (or flashed) to a trader for a fraction of a second before being sent to the national market system. If the trader can match the best bid or offer in the system, he can then pick up that order before the rest of the market sees it.
The flash peek reveals the trade coming in but not the limit price – the maximum price at which the buyer or seller is willing to trade. This is what the HFT program figures out, and it is what gives the high-frequency trader the same sort of inside information available to the traditional market maker: he now gets to peek at the other player’s cards. That means high-frequency traders can do more than just skim hefty profits from other investors. They can actually manipulate markets.
How this is done was explained by Karl Denninger in an insightful post on Seeking Alpha in July 2009:
“Let’s say that there is a buyer willing to buy 100,000 shares of BRCM with a limit price of $26.40. That is, the buyer will accept any price up to $26.40. But the market at this particular moment in time is at $26.10, or thirty cents lower.
“So the computers, having detected via their ‘flash orders’ (which ought to be illegal) that there is a desire for Broadcom shares, start to issue tiny (typically 100 share lots) ‘immediate or cancel’ orders - IOCs - to sell at $26.20. If that order is ‘eaten’ the computer then issues an order at $26.25, then $26.30, then $26.35, then $26.40. When it tries $26.45 it gets no bite and the order is immediately canceled.
“Now the flush of supply comes at, big coincidence, $26.39, and the claim is made that the market has become ‘more efficient.’
“Nonsense; there was no ‘real seller’ at any of these prices! This pattern of offering was intended to do one and only one thing -- manipulate the market by discovering what is supposed to be a hidden piece of information -- the other side’s limit price!
“With normal order queues and flows the person with the limit order would see the offer at $26.20 and might drop his limit. But the computers are so fast that unless you own one of the same speed you have no chance to do this -- your order is immediately ‘raped’ at the full limit price! . . . [Y]ou got screwed for 29 cents per share which was quite literally stolen by the HFT firms that probed your book before you could detect the activity, determined your maximum price, and then sold to you as close to your maximum price as was possible.”
The ostensible justification for high-frequency programs is that they “improve liquidity,” but Denninger says, “Hogwash. They have turned the market into a rigged game where institutional orders (that’s you, Mr. and Mrs. Joe Public, when you buy or sell mutual funds!) are routinely screwed for the benefit of a few major international banks.”
In fact, high-frequency traders may be removing liquidity from the market.
So argues John Daly in the U.K. Globe and Mail, citing Thomas Caldwell, CEO of Caldwell Securities Ltd.:
“Large institutional investors know that if they start trying to push through a large block of shares at a certain price – even if the block is broken into many small trades on several ATSs and markets -- they can trigger a flood of high-frequency orders that immediately move market prices to the institution’s disadvantage. . . . That’s why institutions have flocked to so-called dark pools operated by ATSs such as Instinet, and individual dealers like Goldman Sachs. The pools allow traders to offer prices without publicly revealing their identities and tipping their hand.”
Because these large, dark pools are opaque to other investors and to regulators, they inhibit the free and fair trade that depends on open and transparent auction markets to work.
The Notorious Market-Rigging Ringleader, Goldman Sachs
Tyler Durden, writing on Zero Hedge, notes that the HFT game is dominated by Goldman Sachs, which he calls “a hedge fund in all but FDIC backing.” Goldman was an investment bank until the fall of 2008, when it became a commercial bank overnight in order to capitalize on federal bailout benefits, including virtually interest-free money from the Fed that it can use to speculate on the opaque ATS exchanges where markets are manipulated and controlled.
Unlike the NYSE, which is open only from 10 am to 4 pm EST daily, ATSs trade around the clock; and they are particularly busy when the NYSE is closed, when stocks are thinly traded and easily manipulated. Tyler Durden writes:
“[A]s the market keeps going up day in and day out, regardless of the deteriorating economic conditions, it is just these HFT’s that determine the overall market direction, usually without fundamental or technical reason. And based on a few lines of code, retail investors get suckered into a rising market that has nothing to do with green shoots or some Chinese firms buying a few hundred extra Intel servers: HFTs are merely perpetuating the same ponzi market mythology last seen in the Madoff case, but on a massively larger scale.”
HFT rigging helps explain how Goldman Sachs earned at least $100 million per day from its trading division, day after day, on 116 out of 194 trading days through the end of September 2009. It’s like taking candy from a baby, when you can see the other players’ cards.
Reviving the Free Market
So what can be done to restore free and fair markets? A step in the right direction would be to prohibit flash trades. The SEC is proposing such rules, but they haven’t been effected yet.
Another proposed check on HFT is a Tobin tax – a very small tax on every financial trade. Proposals for the tax range from .005% to 1%, so small that it would hardly be felt by legitimate “buy and hold” investors, but high enough to kill HFT, which skims a very tiny profit from a huge number of trades.
That is what proponents contend, but a tiny tax might not actually be enough to kill HFT. Consider Denninger’s example, in which the high-frequency trader was making not just a few pennies but a full 29 cents per trade and had an opportunity to make this sum on 99,500 shares (100,000 shares less 5 100-lot trades at lesser sums). That’s a $28,855 profit on a $2.63 million trade, not bad for a few milliseconds of work. Imposing a .1% Tobin tax on the $2.63 million would reduce the profit to $26,225, but that’s still a nice return for a trade that takes less time than blinking.
The ideal solution would fix the problem at its source -- the price-setting mechanism itself. Keiser says this could be done by banning HFT and installing his VST computer program in its original design in all the exchanges. The true market price would then be established automatically, foreclosing both human and electronic manipulation. He notes that the shareholders of his former firm have a good claim for voiding out the sale to Cantor Fitzgerald and retrieving the program, since the deal was never consummated and the investors in HSX Holdings have never received a penny for the sale.
There is just one problem with their legal claim: the paperwork proving it was shipped to Cantor Fitzgerald’s offices in the World Trade Center several months before September 2001. Like free market capitalism itself, it seems, the evidence has gone up in smoke.
Ellen Brown is the author of Web of Debt: the Shocking Truth About Our Money System and How We Can Break Free. She can be reached through her website.
The May 6 Stock Crash Revisited
"Over My 21 Years on Wall Street, I Never Saw Anything Remotely So Suspicious"
May 12, 2010
By PAM MARTENS
Procter & Gamble may have to put the second half of its name in bold in the future or maybe add an exclamation point. Cowboy capitalism threw a lasso around the staid 173 year old household products company on black Thursday, shaving some $62 billion off its market cap at the low point in trading.
Procter & Gamble started its day on May 6, 2010 talking about babies’ bottoms. It went downhill from there. Jodi Allen, Vice President for Procter & Gamble’s Pampers line of baby diapers issued a press release stating: "For a number of weeks, Pampers has been a subject of growing but completely false rumors fueled by social media that its new Dry Max diaper causes rashes and other skin irritations.”
It’s highly doubtful that this statement could have set off a precipitous plunge in its stock price. The company has been around since 1837. It owns some of the most well known brands in the world: Gillette, Ivory soap, Crest toothpaste, Camay, CoverGirl, Max Factor, Pantene, Oral-B, Scope, Pepto Bismol, Cascade, Vicks, Charmin and dozens of other top brands.
What Procter & Gamble is also, however, is one of the 30 stocks that make up the Dow Jones Industrial Average, the index most frequently quoted as a measure of the stock market. Someone wanting to knock out a strut holding up the stock market structure might see entering a large sell order on Procter & Gamble as one of a number of pivotal steps. Here’s why.
Procter & Gamble is in a lot of hands. Because of its historic strong performance and stability, it’s owned by a lot of conservative mutual funds. It would be beneficial to someone wanting to conduct a bear raid on the market on May 6 to knock out all those trailing stop loss orders on Procter & Gamble and pick up a tidy quick profit. (A stop loss order is when one wishes to place a limit on how far down one wants a stock price to go before it is automatically sold. That order stays in place for weeks or months or even years until the stock reaches that price and then is executed on the next tick. Unfortunately, on May 6, the next tick could have been many points below the last tick.) Stop loss orders also serve to slow down plunging stock prices because they cause trades to be printed at each of these various price levels, offering a chance for new buyers to come in at these prices. Once these are knocked off, there’s a big air pocket in a plunging market.
According to reports of time and sales, around 2:45 p.m. when the massive market disruption got underway, Procter & Gamble traded at $59.66. It had opened the day at $61.91. About a minute later, it was trading at $57.36, then $53.51, then it hit a liquidity air pocket and plunged to print a trade at $39.37. This created panic in the market. If one of the most conservative stocks can hit a 36 percent downdraft, some traders thought a major news event was happening outside. Liquidity hit a wall. In an eight minute span, the Dow lost $700 billion and saw a cumulative decline of 998.5 points or 9.2 percent before turning on a dime and moving in the opposite direction. It closed the day down 3.2 percent.
Aggravating the liquidity crunch on May 6 was the fact that the New York Stock Exchange, where Procter & Gamble is listed, paused trading momentarily to let humans on the floor of the exchange attempt to find buying support. That pause sent trades off to the world of electronic exchanges which now make up the bulk of all trading in the U.S. The New York Stock Exchange has only a 25 percent market share in its own listed stocks. The cowboys of capitalism command the rest.
To underscore how dramatic and unprecedented the trading in Procter & Gamble was on May 6, I reflected back to the day I sat behind a Wall Street terminal and watched the market lose 22.6 percent in one day. That day was October 19, 1987. That was more than twice the percentage drop at the worst market point on May 6. And yet, Procter & Gamble lost only 28 percent at its worst point in 1987 versus 36 percent on May 6 when the overall market was down less than 10 percent.
When a bear raid knocks out these stop loss speed bumps on Dow components like Procter & Gamble and 3M (it lost 21 percent at its worst point), the New York Stock Exchange pauses trading momentarily and trades are left to the feckless electronic exchanges, proprietary trading desks of the bailout boys (big Wall Street firms) and high frequency traders. This is like hitting an air pocket at 30,000 feet, then opening the cockpit door to find out no one is inside and the plane is on autopilot as the plane goes into a nose dive.
But sell orders in individual Dow component stocks were not the only problem on May 6. There was extensive selling in the Standard and Poor’s 500 futures contract known as the E-Mini. Futures can be purchased on much greater margin giving bear raiders a bigger bang for their buck. According to testimony from Gary Gensler, Chairman of the Commodity Futures Trading Commission before the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises yesterday, one trader “entered the market at around 2:32 and finished trading by around 2:51. The trader had a short futures position that represented on average nine percent of the volume traded during that period. The trader sold on the way down and continued to do so even as the price level recovered. This trader and others have executed hedging strategies of similar size previously.” That last sentence may be ignoring the reality that this was no ordinary day: the gauge of fear in the market, the VIX, had spiked over the past two days; there was intense fear of Greece defaulting on its debt and stresses in the credit markets were being reflected in rising yields on junk bonds.
Cumulatively, mom and pop investors lost many millions of dollars on their stop loss orders from this free fall on May 6. Only those trades occurring between 2:40 and 3 pm that were 60 percent or more away from the market are being cancelled. That means the losses in Procter & Gamble and dozens of other stocks are real losses for those who got stopped out and real profits for those on the other side of the trade.
Over my 21 years on Wall Street, I never saw anything as remotely so suspicious as the trading activity on May 6 or as nonresponsive as the SEC’s investigation to date.
To be continued…
Pam Martens worked on Wall Street for 21 years; she has no security position, long or short, in any financial company. She and family members own less than 500 shares in Procter & Gamble. She writes on public interest issues from New Hampshire. She can be reached at pamk741@aol.com
Volatility is Back With a Vengeance
Capitalism Without Capital
May 13, 2010
By MIKE WHITNEY
Volatility is back and stocks have started zigzagging wildly again. This time the catalyst is Greece, but tomorrow it could be something else. The problem is there's too much leverage in the system, and that's generating uncertainty about the true condition of the economy. For a long time, leverage wasn't an issue, because there was enough liquidity to keep things bobbing along smoothly. But that changed when Lehman Bros. filed for bankruptcy and non-bank funding began to shut down. When the so-called "shadow banking" system crashed, liquidity dried up and the markets went into a nosedive. That's why Fed Chair Ben Bernanke stepped in and provided short-term loans to under-capitalized financial institutions. Bernanke's rescue operation revived the system, but it also transferred $1.7 trillion of illiquid assets and non-performing loans onto the Fed's balance sheet. So the problem really hasn't been fixed after all; the debts have just been moved from one balance sheet to another.
Last Thursday, troubles in Greece triggered a selloff on all the main indexes. At one point, shares on the Dow plunged 998 points before regaining 600 points by the end of the session. Some of losses were due to High-Frequency Trading (HFT), which is computer-driven program-trading that executes millions of buy and sell orders in the blink of an eye. HFT now accounts for more than 60 percent of all trading activity on the NYSE. Paul Kedrosky explains what happened in greater detail in his article, "The Run on the Shadow Liquidity System". Here's an excerpt:
"As most will know, liquidity is, like so many things in financial life, something you can choke on as long as you don't want any....Liquidity is a function of various things working fairly smoothly together, including other investors, market-makers, and, yes, technical algorithms scraping fractions of pennies as things change hands. Together, all these actors create that liquidity that everyone wants, and, for the most part, that everyone takes for granted.....
“Largely unnoticed, however, at least among non-professional investors, the provision of liquidity has changed immensely in recent years. It is more fickle, less predictable, and more prone to disappearing suddenly, like snow sublimating straight to vapor during a spring heat wave. Why? Because traditional providers of liquidity, market-makers and other participants, are not standing so ready to make the other side of the market. There are fewer traders prepared to make a market for the sake of market health.....
“For the first time we have large providers of this shadow liquidity, algorithms and high-frequency sorts, that individually account for large percentages of daily trading activity, and, at the same time, that can be turned off with a switch, or at an algorithmic w him. As a result, in market crises, when liquidity was always hardest to find, it now doesn't just become hard to find, it disappears altogether, like water rushing out sight via a trapdoor to hell. Old-style market-makers are standing aside as panicky orders pour in, and they look straight at shadow liquidity providers and say, "No thanks." (Paul Kedrosky, "The Run on the Shadow Liquidity System" Infectious Greed)
The fact that the SEC can't figure out what happened, has been a bigger blow to investor confidence than the erratic behavior of the markets themselves. It shows that regulators really don't have a handle on the technology that's driving the markets. That just reinforces the perception that trading is a crap-shoot and the market is a casino.
Deregulation has also eroded confidence in the markets. Since Glass Steagall was repealed in 1999, the financial markets have been completely overhauled. Unfortunately, the new architecture is riddled with flaws. The main levers of credit creation are now in the hands of privately-owned shadow banks instead of highly-regulated "depository" institutions. That's a problem, because the hedge funds, insurers, brokerage houses, SIVs and off-balance sheet operations are mostly unsupervised, so they can ignore capitalization requirements and traditional lending standards. Even worse, they can crank out as much credit as they want via the repo market or by using financial instruments (like MBS, CDS, CDO) Here's how economist James Hamilton explains it in a recent post titled "Follow The Money". Here's an excerpt:
"If you buy a mortgage-backed security (or collateralized debt obligation constructed from assorted MBS), you could then issue commercial paper against it to get most of your money back, essentially making the purchase self-financing. This was the idea behind the notorious off-balance sheet structured investment vehicles or conduits, which basically used money borrowed on the commercial paper market to buy various pieces of the mortgage securities created by the loan aggregators. The dollar value of outstanding asset-backed commercial paper nearly doubled between 2004 and 2007.
“Yale Professor Gary Gorton has also emphasized the importance of repo operations involving mortgage-related securities. If I buy a security, I can then pledge it as collateral to obtain a repo loan, again getting most of my money back and allowing the purchase to be mostly self-financing as long as I keep rolling over repos. Although I have not been able to find numbers on the volume of such transactions, it appears to have been quite substantial.
“The question of how the house price run-up was funded thus has a pretty clear answer: Other People's Money. Because of so much money pouring into house purchases, the price was driven up." ("Follow The Money", James Hamilton, Econbrowser)
This is how Wall Street pumped up leverage to ungodly levels and steered the financial system off the cliff. The debt-instruments and repo market were used to create a ginormous debt pyramid balanced precariously atop a few crumbs of capital. The system was bound to crash.
Naturally, the people who benefit from credit default swaps (CDS) and other derivatives, continue to sing their praises, but their numbers grow smaller and smaller all the time. Many people now understand the role that derivatives played in crashing the system and are demanding change. But Wall Street doesn't care about public opinion. The big banks have already deployed their army of lobbyists to Capital Hill to make sure that the new reform legislation doesn't restrict their use of hybrid derivatives which have become their biggest profit-makers. Considering the amount of money they've spread around, it would be a miracle if they didn't get their way.
Low interest rates didn’t cause the crisis
Last week, economists Edward L. Glaeser, Joshua Gottlieb and Joseph Gyourko published a research paper and presented their findings to the Federal Reserve Bank of Boston. Here's what they said:
"It isn't that low interest rates don't boost housing prices. They do. It isn't that higher mortgage approval rates aren't associated with rising home values. They are. But the impact of these variables, as predicted by economic theory and as estimated empirically over many years, is too small to explain much of the housing market event that we have just experienced."
Glaeser, Gottlieb and Gyourko say those factors can explain only about a 10 per cent increase in home prices between 2000 and 2006. That's only one-third of the 30 percent increase in prices (adjusted for inflation) during that period, as measured by the Federal Housing Finance Agency, or the 74 per cent increase measured by the Case-Shiller/Standard and Poor's index of prices in 20 large metro areas.
So what is to blame for the bubble? Well, they're not sure. "Using the standard toolkit of the empirical economist, we are unable to offer much of an explanation for what happened," they write." ("Low interest rates didn't cause the bubble economists say", Elizabeth Razzi, Washington Post)
The crisis was not sparked by interest rates or lax lending standards, but by leverage. In fact, the repo market, securitization and the vast array of debt-instruments are all designed with one purpose in mind; to conceal the amount of leverage in the system. It's capitalism without capital.
The $1.5 trillion in subprime mortgages wasn't nearly enough to bring down the entire financial system. But the losses on trillions of dollars of derivatives that were balanced on top of these mortgages, certainly were. So, what really happened? Here's a summary of the meltdown by economist Henry Liu:
"...the current financial crisis that began in mid-2007 was caused not by bank runs from depositors, but by a melt down of the wholesale credit market when risk-averse sophisticated institutional investors of short-term debt instruments shied away en mass.
“The wholesale credit market failure left banks in a precarious state of being unable to roll over their short-term debt to support their long-term loans. Even though the market meltdown had a liquidity dimension, the real cause of system-wide counterparty default was imminent insolvency resulting from banks holding collateral whose values fell below liability levels in a matter of days. For many large, public-listed banks, proprietary trading losses also reduced their capital to insolvency levels, causing sharp falls in their share prices." ("Two Different Banking Crisis--1929 and 2007" Henry Liu)
The banks don't fund themselves by taking deposits and then using them to lend out money at higher rates. What they do is buy long-term illiquid assets (mortgage-backed securities, asset-backed securities) and exchange them in the repo market for short-term loans. It's like going to a pawn shop and borrowing money by posting collateral, except --in this case--a financial institution (counterparty) takes the other side of the deal.
When the subprimes started blowing up, the institutions that had been taking the other side of the deals, (the counterparties) got nervous, because they thought the subprime-backed collateral might be worth less than the money they were providing in loans. So they demanded more collateral from the banks which forced the banks to sell more assets to raise money to cover their losses. This pushed prices down, sparked a flurry of firesales, and drove the weaker institutions into bankruptcy.
The amount of leverage built up in these derivatives was simply staggering. Take a look at this article from the Wall Street Journal:
"Documents released by Senate investigators last week provide clues as to why the losses were so severe. The documents show how Wall Street banks packaged and repackaged the same risky bonds into securities that ultimately helped magnify the impact of defaulting subprime mortgages on the financial system.
“In one case, a $38 million subprime-mortgage bond created in June 2006 ended up in more than 30 debt pools and ultimately caused roughly $280 million in losses to investors by the time the bond's principal was wiped out in 2008, according to data reviewed by The Wall Street Journal.....("Senate's Goldman Probe Shows Toxic Magnification", Carrick Mollenkamp and Serena Ng, Wall Street Journal)
So it wasn't the subprime mortgages that caused most of the damage, but the amount of leverage bundled into the derivatives and the repo market. Congress needs to focus their attention on the particular instruments and processes (derivatives, repo and securitization) that are used to maximize leverage and inflate bubbles. That's where the problem lies.
Nomi Prins explains it a bit differently in this month's The American Prospect. Here's an excerpt from her article "Shadow Banking":
"Between 2002 and early 2008, roughly $1.4 trillion worth of sub-prime loans were originated by now-fallen lenders like New Century Financial. If such loans were our only problem, the theoretical solution would have involved the government subsidizing these mortgages for the maximum cost of $1.4 trillion. However, according to Thomson Reuters, nearly $14 trillion worth of complex-securitized products were created, predominantly on top of them, precisely because leveraged funds abetted every step of their production and dispersion. Thus, at the height of federal payouts in July 2009, the government had put up $17.5 trillion to support Wall Street's pyramid Ponzi system, not $1.4 trillion. The destruction in the commercial lending market could spur the next implosion." ("Shadow Banking", Nomi Prins, The American Prospect)
This is a point that bears repeating: "...nearly $14 trillion worth of complex-securitized products were created" on top of just "$1.4 trillion" of subprime loans." No doubt, the investment bankers and hedge fund managers who inflated these monster balloons, knew that they were doomed from the get-go, but then, they must have also known that "I.B.G.-Y.B.G.", which in Wall Street parlance means, "I'll Be Gone and You'll Be Gone."
For a long time, Wall Street concealed its bubblemaking and racketeering behind theories that glorify the wisdom and flexibility of unregulated markets. Government intervention was disparaged as an unnecessary intrusion into a divinely-harmonized system. Now the curtain has been lifted and the sham exposed. The state has a clear interest in making sure that credit-generating institutions are adequately capitalized, that lending standards are strictly upheld, and that reasonable limits are put on the amount of leverage that financial institutions are allowed to use. That's the only way the public can be protected.
Mike Whtney lives in Washington state. He can be reached at fergiewhitney@msn.com
seemslikeadream in another thread quoted Reuters wrote:Exclusive: Waddell is mystery trader in market plunge
Herbert Lash and Jonathan Spicer
NEW YORK
Fri May 14, 2010 12:26pm EDT
(Reuters) - A big mystery seller of futures contracts during the market meltdown last week was not a hedge fund or a high frequency trader as many have suspected, but money manager Waddell & Reed Financial Inc, according to a document obtained by Reuters.
Waddell sold on May 6 a large order of e-mini contracts during a 20-minute span in which U.S. equity markets plunged, briefly wiping out nearly $1 trillion in market capital, the internal document from CME Group Inc said.
The e-minis are one of the most liquid futures contracts in the world, providing holders exposure to the benchmark Standard & Poors 500 Index. The contracts can act as a directional indicator for the underlying stock index.
Regulators and exchange officials quickly focused on Waddell's sale of 75,000 e-mini contracts, which the document said "superficially appeared to be anomalous activity."
Gary Gensler, chairman of the Commodity Futures Trading Commission, said in congressional testimony on Tuesday that it had found one sale was responsible for about 9 percent of the volume in e-minis during the sell-off in the U.S. markets.
Gensler said there was no suggestion that the trader, who he did not identify, did anything wrong in only entering orders to sell. Gensler said data shows that the trades appeared to be a bona fide hedging strategy.
The CME document shows that during the sell-off and subsequent rally, other active traders in e-minis included Jump Trading, Goldman Sachs, Interactive Brokers, JPMorgan Chase and Citadel Group.
During the 20-minute period, 842,514 contracts in e-minis were traded while Waddell from 2 p.m. to 3 p.m. traded its contracts, CME said. The CME document did not provide a break-out of Waddell's trading during the crucial 20 minutes.
Overland Park, Kansas-based Waddell did not comment. CFTC also declined to comment.
A CME spokesman, who declined to comment on the document, said the Chicago-based futures exchange operator never discusses customer activity.
"We found no evidence of improper trading activity or erroneous trades by CME Globex customers," said CME spokesman Allan Schoenberg.
Waddell's contracts were executed at Barclays Capital and later given up to Morgan Stanley, according to the document.
CME said it spoke to representatives from both banks on May 6 and planned to speak to Waddell representatives the following day. The firm oversaw $74.2 billion in assets as of March 31.
Morgan Stanley told CME that it "did not have concerns regarding the activity," the document said, because Waddell "would typically use equity index futures to hedge macro market risk associated with the substantial long exposure of its clients."
'QUITE A SHOCK TO THE MARKET'
Gensler said the contracts were sold between 2:32 p.m. and 2:51 p.m., the height of the meltdown.
The market for e-minis on May 6 fell more than 5 percent in a little more than 5 minutes starting at 2:40 p.m. -- the height of the crash, the document said. The e-minis began to recover before stock prices turned higher.
An order the size of the Waddell contract would be a big trade to execute on a normal day, said a trader whose firm is active in S&P 500 futures market. About 50,000 contracts are typically traded in an hour, the trader said.
"To get rid of 75,000 contracts, that's a lot of trading even if the market is healthy," the trader said. "But when suddenly the market changes and there's not as many bids there to trade with, 75,000 is going to cause quite a shock to the market."
"That's an enormous position for anybody, whether it's a hedge or whether it's a trade. It's a big position, no doubt about it," the trader said.
seemslikeadream again from another thread quoting buzzflash wrote:Rep. Anthony Weiner Wants FTC and SEC Action for Goldline, Beck and the FOX Gold-Shilling Narrative
BUZZFLASH NEWS ANALYSIS
by Jeffrey Joseph
Critics have reprimanded Glenn Beck before for his advertising-turned-conservative-talking-point shilling for Goldline in the past, but never quite on the level that Rep. Anthony Weiner (D-NY) demands now.
Beck has long held a close relationship with the gold seller, including advertisements throughout his radio career with spots on his show and ads placed openly on his website. The conflict arises from the fact that Beck’s content, full of blatant fear mongering about the potential decline of society and of paper money, appears to fit too perfectly with Goldline’s advertising agenda. In effect, Beck’s content seems driven by his advertising, and since Beck’s rhetoric tends toward the extreme, it presents a noticeable danger to the public.
Weiner has served notice that he has had enough of Beck’s crass shilling for the gold industry. Weiner has taken note of the conservative strategy to promote gold as a safe bet in the current political and economic climate. Though consumers would need gold to exceed record highs to reach a return on their investment, while the hosts promoting the gold reap the benefits in simply selling to those consumers now. Consequently, commentators like Beck, who have invested in the gold they advertise and thus have a vested interest in its doing well, can push the narrative of the decaying U.S. to benefit themselves, regardless of its distance from reality.
“Commentators like Glenn Beck who are shilling for Goldline,” said Weiner, “are either the worst financial advisers around or knowingly lying to their loyal viewers.” Weiner sought action from the Federal Trade Commission (FTC) and the Securities and Exchange Commission (SEC) because “Goldline’s high-pressure sales tactics and fear mongering about big government as well as their ability to hire sales staff and spokespeople who misrepresent their roles are case studies in why entities like the SEC and FTC are necessary.”
Beck’s responded predictably — by claiming that it was Weiner who was “trying to use fear” to manipulate Beck and his sponsors. Inflating his position as the last standing, self-appointed paragon of truth, he tried to claim Weiner’s actions proved Beck’s incessant fear mongering about how the government will go after his fans. He claimed, “If you associate yourself at all with Glenn Beck, Congress will come after you.” To defend his standing, Beck claimed that sponsors called him, and not the other way around, to say they dropped him because they could not handle the White House coming after them. Of course, he ignored the reality of growing, grassroots movements to contact Beck’s sponsors to request dropping him that have met success simply because of Beck’s own inflammatory statements.
In addition, Beck openly admits his suspicious relationship to Goldline. He asked the Goldline president on the air, “May I ask… do the other hosts, do they invest in the product like I do?” The Goldline president responded that “many, if not close to all” do, and that he would be willing to buy ad time with liberals if they had the same “passion for gold.” Though, in so doing, he seemed to concede that liberals may buy into Goldline’s narrative as conservatives.
As further evidence of what that narrative entails, people need look no further than Beck’s FOX colleagues. In a book FOX contributor Newt Gingrich has recently begun promoting, for example, he boldly and baselessly states that the Obama Administration “represents as great a threat to America as Nazi Germany or the Soviet Union.” In the nation Gingrich portrays — apparently on the precipice of destruction because of actions like the Obama Administration refusing to be so simplistic as to write off terrorism as “radical Islam” — a product like gold makes plenty of sense. Then those pushing the gold, regardless of a lack of substance in promoting them, cash in on the profits.
Rep. Weiner deserves commendation for his call to keep the disingenuous disinformation from Beck and his FOX colleagues appropriately checked. An informed public should demand more of those types of investigation into the conflicting interests and manipulated information masquerading as “news” from FOX — and in the meantime, choose to Turn…
by JackRiddler » Wed May 26, 2010 3:49 am
Alan Greenspan finally tells the truth, but nobody believes him.
The Crisis
March 2010
http://www.brookings.edu/~/media/Files/ ... enspan.pdf
It was an unexpected medium for a theoretical explanation from he who had been the most powerful economist in the world. In a short, quasi-academic paper titled The Crisis and published by Brookings, Alan Greenspan finally commented on the events to which his name will forever be attached. Neither ringing defense nor melodramatic mea culpa, the paper is instead a brief survey of the "geopolitical" events which led to the "Great Recession", and a series of reform suggestions which are strangely at odds with its analytical premises.
Greenspan's paper was met by a brief firestorm of criticism, and then, instant, contemptuous, dismissal. Greenspan was the monster whose policy suggestions had brought these events into the world. Greenspan was a cynical liar who was merely trying to save what was left of his reputation. Greenspan was a fool, trying to lend an objective skeleton to what was so obviously the result of greed and corruption...
In reality, these responses were mistimed. For perhaps the only time in his career, Greenspan wrote something worth reading. Greenspan's famous instant postmortem before Congress on the banking collapse, "I was wrong", and his simultaneous embrace of Keynesian regulation have been well documented. In The Crisis, Greenspan goes much, much farther... beyond Keynes, beyond Say, beyond Ricardo, to become a full-fledged Marxist. The Great Recession was a crisis of overproduction, pure and simple. They are words that could not be heard from the enfants terrible of the neo-Keynesians... not from Stiglitz nor Krugman nor Rubin. But, Greenspan goes there and without even a hint that any other interpretation is possible.
Of course, Greenspan doesn't remain a Marxist for long. By the time that reform proposals are required, Greenspan easily reverts to his comfort zone. Regulation? Certainly, with an eye to the capital requirements of the banks, a few monetary twists, and... And what? And nothing. There is such a very wide gap between what Greenspan explains as the genesis of the Great Recession and what he now proposes, that nothing whatever is resolved. Had his reforms been in place, could these events have been avoided? The answer is too obviously, "No". And lest the reader miss his point, Greenspan is strangely ambivalent in the last half of The Crisis, one moment talking about the Great Recession as a "once in a century crisis", and the next, implying that it may lend its character to all crises in the foreseeable future. One moment it is bailouts which will never be necessary again, and the next it is bailouts which were the only thing that prevented a truly titanic collapse and may be routinely required as the economy goes forward. The entire premise of the paper is based in the geopolitical "events" that created the Great Recession, but there is not a single mention of how those events have now been solved, reconciled or tamed.
This thing is worth reading. That Greenspan is a major, MAJOR tool, is a foregone conclusion. The Crisis is a reminder that even tools have their day... before quietly, inevitably, fading away.
*******
In a terse, no nonsense style, Greenspan lays out the crisis in the following terms: The fall of the Soviet Union and the collapse of the Socialist Bloc (and the dismantling of the protected Socialist trading zone which partially buffered the Chinese and Indian economies, among others) added hundreds of millions of highly productive workers to the world economy. While this massive addition was as productive as the workers in the advanced capitalist countries, it did not consume nearly as much. The result was a discontinuim between between production and markets, particularly domestic markets. The increase in productive capacity without markets meant an increase in the production of commodities for export. A massive overproduction of commodities was the inevitable result. Greenspan does not use this exact terminology, but makes his case in a way which defies any other conclusion.
From the overproduction of commodities, the next stage in the escalation of "the crisis" was the overproduction of Capital. Greenspan plots this as an unprecedented fall in the general rate of interest, in all major economies, regardless of their specific policies. With the fall in interest rates, a general rise in the price of fixed assets, particularly real estate, follows. It is here that the advent of derivative securities and the rest play their part. Greenspan does not deny that these instruments, and the rampant speculation they produced, were the immediate cause of the "bubble" and the following crisis. He does imply, however, that the great mass of Capital trapped by falling interest rates would have created a similar crisis through some other medium if real-estate derivatives had not been available. Once again, he points to the onset of the very same crisis in economies which, for one reason or another, did not participate in the real-estate securities bubble.
What Greenspan is describing, to the consternation of his critics, is not a crisis of greed, speculation, policy, deregulation, politics or institutional inertia. What he is describing is a fundamental crisis of capitalism. Worse, while he is very specific as to the cause of the "Crisis", he is anything but clear as to how it has in any way been resolved... even partially.The bankruptcy of Lehman Brothers in September 2008 precipitated what, in retrospect, is likely to be judged the most virulent global financial crisis ever. To be sure, the contraction in economic activity that followed in its wake has fallen far short of the depression of the 1930s. But the virtual withdrawal, on so global a scale, of private short term credit, the leading edge of financial crisis, is not readily evident in our financial history.It was the global proliferation of securitized, toxic U.S. subprime mortgages that was the immediate trigger of the current crisis. But the roots of the crisis reach back, as best I can judge, to the aftermath of the Cold War. The fall of the Berlin Wall exposed the economic ruin produced by the Soviet bloc’s economic system. In response, competitive markets quietly, but rapidly, displaced much of the discredited central planning that was so prevalent in the Soviet bloc and the then Third World.
A large segment of the erstwhile Third World nations, especially China, replicated the successful economic export-oriented model of the so-called Asian Tigers: fairly well educated low-cost workforces joined with developed-world technology, protected by an increasing rule of law, unleashed explosive economic growth. The IMF estimated that in 2005 more than 800 million members of the world’s labor force were engaged in export-oriented and therefore competitive markets, an increase of 500 million since the fall of the Berlin Wall. Additional hundreds of millions of workers became subject to domestic competitive forces, especially in the former Soviet Union. As a consequence, between 2000 and 2007, the real GDP growth of the developing world was more than double that of the developed world.
The red-bashing is minimal by Greenspanian standards and largely ironic considering the near instant cataclysm following on the elimination of "discredited central planning" (the "erstwhile Third World nations" described by Greenspan are all socialist or formerly socialist economies). Much more important is the sheer magnitude of the number Greenspan quotes: the number of workers producing for export went to 300 million between 1750 and 1989. Between 1989 and 2005, that number nearly tripled, from 300 to over 800 million. A vast increase in the production of commodities for export was the result.
A secondary point worth noticing is that everywhere in the paper, the former Socialist world and the "Developing World" are one and the same for Greenspan - no doubt a disappointment for those who thought that globalization meant a vast new middle-class market for Nike and Starbucks developing in Paraguay.The consequence was a pronounced fall from 2000 to 2005 in both global real long-term interest rates and nominal long-term rates (exhibit 1) which indicated that global saving intentions, of necessity, had chronically exceeded global intentions to invest. In the developing world, consumption restrained by culture and inadequate consumer finance could not keep up with the surge of income and, as a consequence, the savings rate of the developing world soared from 24% of nominal GDP in 1999 to 34% by 2007, far outstripping its investment rate.
The capitalism-ation of the former-socialist world unleashed its productive capacity in the form of the production of commodities for export, but not in the markets to consume them. The result translated into an over-production of commodities which became an overproduction of Capital.Yet the ex post global saving – investment rate in 2007, overall, was only modestly higher than in 1999, suggesting that the uptrend in the saving intentions of developing economies tempered declining investment intentions in the developed world. That weakened global investment was the major determinant in the decline of global real long-term interest rates was also the conclusion of the March 2007 Bank of Canada study. Of course, whether it was a glut of excess intended saving or a shortfall of investment intentions, the conclusion is the same: lower real long-term interest rates.
The capital accumulated by this process added to a "glut" already evident in the capitalist countries, leading to a fall of worldwide interest rates - the best indication of a fall in the rate of profit and the overproduction of capital.
The reader should also note the phrase: "whether it was a glut of excess intended saving or a shortfall of investment intentions, the conclusion is the same: lower real long-term interest rates". In this short fragment, the Marxist Greenspan, dismisses the entire supply-side/demand-side "debate" of the Libertarian Greenspan and the complete host of Austrians and Randians and assorted ninnies.Inflation and long-term rates in all developed economies and major developing economies by 2006 had converged to single digits, I believe for the first time ever. The path of the convergence is evident in the unweighted variance of interest rates on ten-year sovereign debt of 15 countries that declined markedly from 2000 to 2005 (exhibit 2). Equity and real-estate capitalization rates were inevitably arbitraged lower by the fall in global long-term real interest rates. Asset prices, particularly house prices, accordingly moved dramatically higher.The Economist's surveys document the remarkable convergence of nearly 20 individual nations' house price rises during the past decade. Japan, Germany, and Switzerland (for differing reasons) being the only important exceptions. U.S. price gains, at their peak, were no more than the global peak average. In short, geo-political events ultimately led to a fall in long-term mortgage interest rates that in turn led, with a lag, to the unsustainable boom in house prices globally.
Various critics interpreted these passages as a defense by Greenspan of his own policies: "It happened everywhere, even where my policies were not in effect, so it couldn't have been me."
In truth, Greenspan is saying something much more transcendent: that the crisis was fundamental, far exceeding the impacts of any "policy". A glut of capital plus a reduction of investment opportunities produces a fall in the rate of interest. The inevitable deflation/devaluation begins, expressed as an inflation in the prices of fixed assets, real-estate foremost among them. This is the virtual "bubble" looking for an outlet.Subprime mortgages in the United States for years had been a small appendage to the broader U.S. home mortgage market, comprising only 7% of total originations as recently as 2002. Most such loans were fixed-rate mortgages, and only a modest amount had been securitized. With the price of homes having risen at a quickening pace since 1997 (exhibit 3), such subprime lending was seen as increasingly profitable to investors.
Belatedly drawn to this market, financial firms, starting in late 2003, began to accelerate the pooling and packaging of subprime home mortgages into securities (exhibit 4). The firms clearly had found receptive buyers. Both domestic and foreign investors, largely European, were drawn to the above average yield on these securities and a foreclosure rate on the underlying mortgages that had been in decline for two years.
It is not greed, speculation and corruption which causes a crisis of capitalism but a fundamental crisis of capitalism which causes the inevitable increase in greed, speculation and corruption. The only unresolved issue is where it will all come to a head.
But, don't the participants see it coming? On the contrary...Clearly with such experiences in mind, financial firms were fearful that should they retrench too soon, they would almost surely lose market share, perhaps irretrievably. Their fears were formalized by Citigroup’s Charles Prince’s now famous remark in 2007, just prior to the onset of the crisis, that “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
From this clear-headed description of the crisis, Greenspan's paper becomes more and more muddled. It is now time to propose "reforms" and it is in this mode that the analysis becomes increasingly tentative and ambiguous. From Greenspan the monetarist, no obvious monetary prescriptions are forthcoming. From Greenspan, the libertarian, a change of heart is evident. Greater government requirements for increased capital reserves are proposed, while all testimonials to the "self-correcting" nature of "free capital markets" are entirely dispensed with. Still, what Greenspan proposes would have had little or no effect on the crisis he himself describes. Greenspan senses this in a series of standalone commentaries on the failures of economic forecasting, regulation, and the banking system as a whole.It is in such circumstances that we depend on our highly sophisticated global system of financial risk management to contain market breakdowns. How could it have failed on so broad a scale? The paradigm that spawned Nobel Prize winners in economics22 was so thoroughly embraced by academia, central banks, and regulators that by 2006 it became the core of global regulatory standards (Basel II). Many quantitative firms whose number crunching sought to expose profitable market trading principles were successful so long as risk aversion moved incrementally (which it did much of the time). But crunching data that covered only the last 2 or 3 decades prior to the current crisis did not yield a model that could anticipate a crisis.U.S. commercial and savings banks are extensively regulated, and even though for years our largest 10 to 15 banking institutions have had permanently assigned on-site examiners to oversee daily operations, many of these banks still were able to take on toxic assets that brought them to their knees. The heavily praised U.K. Financial Services Authority was unable to anticipate, and prevent, the bank run that threatened Northern Rock. The venerated credit rating agencies bestowed ratings that implied AAA smooth-sailing for many a highly toxic derivative product. The Basel Committee on Banking Supervision, representing regulatory authorities from the world’s major financial systems, promulgated a set of capital rules that failed to foresee the need that arose at the height of the crisis for much larger capital and liquidity buffers.The ultimate goal of financial structure and regulation in a market economy is to direct a nation’s saving, plus any saving borrowed from abroad (the current account deficit), towards investments in plant, equipment and human capital that offer the greatest increases in a nation’s output per hour. Nonfinancial output per hour, on average, rises when obsolescent facilities (with low output per hour) are replaced with facilities that embody cutting-edge technologies (with high output per hour). This process improves (average) overall standards of living for a nation as a whole. The evident success of finance for decades prior to the onset of this crisis in directing our scarce savings into real productive capital investments appears to explain the extent nonfinancial market participants had been compensating U.S. financial services.
The share of U.S. gross domestic income accruing to finance and insurance, according to the Bureau of Economic Analysis, had risen fairly steadily from 2.3% in 1947 to 7.9% in 2006 (exhibit. Only a small part of the rise was the result of an increase in net foreign demand for U.S. financial and insurance services. The decline in the share to 7.4% in 2008 reflects write-offs of previously presumed productively employed saving.
In the end, it is left entirely unclear as to whether Greenspan believes that the larger crisis is over. At one turn Greenspan calls his crisis, "a once in a hundred year" event while at the next he wonders whether each succeeding crisis will not be similar... a once in a hundred year crisis occurring every 10 to 15 years. So too with massive government intervention. While Greenspan clearly attributes the forestalling of another Great Depression to that immediate governmental bailout, he offers no hope that it won't be required each time that the crisis reasserts itself.
It is this last point that should concern Greenspan's critics. While there are debatable proposals for moderating the breakdown of credit in future crises, there is no proposal whatever for resolving the underlying dynamic that Greenspan himself lays out. What is it that prevents Greenspan's crisis from immediately reasserting itself once the immediate impacts of this recession pass?
by JackRiddler » Wed May 26, 2010 4:03 am
The Senate is currently debating legislation that would call for the farthest reaching overhaul of financial regulation since the Great Depression. The House, mainly along party lines, passed a similar overhaul bill in December. The New York Times has highlighted some of the bill's 434 amendments below.
The Misreporting of U.S. Government Borrowing Costs Leaves Open the Possibility of Manipulation
By George Hall and Thomas J. Sargent|Feb 17, 2010, 7:18 PM|Author's Website
Net interest payments on the federal debt are widely reported, yet this column argues that this misreports government borrowing costs and leaves open the possibility of manipulation. Computed correctly, the return on Treasury debt is lower on average and considerably more volatile than the official reported interest costs.
Net interest payments on the US federal debt play such a prominent role in the Congressional Budget Office’s (CBO) Budget and Economic Outlook: Fiscal Years 2010-2020 that a graph of the series illustrates the publication’s front cover. According to this report, last year the US federal government paid $187 billion in net interest on $7.544 trillion of Treasury debt, implying a positive interest rate of about 2.5%. Curiously however, 2009 was not a terrific year to be an investor of Treasury securities. Many Treasury Bond mutual funds lost money, with the benchmark Barclays US Treasury Bond Index falling 3.9% over the year. Long-term bond holders were hurt particularly hard, as rising rates imposed large capital losses.
How can it be that the government reports positive interest payments while its creditors claim to have lost money? It turns out that net interest payments on the federal debt as reported by the Treasury, National Income and Product Accounts, and CBO is a flawed measure of government borrowing costs. As noted earlier by Robert Eisner (1986), Henning Bohn (1992), and others, the number the government reports as net interest does not correspond the interest payments economists put in the government budget constraint; instead it is the sum of all the coupon payments on the Treasury notes and bonds and the capital gains of the zero-coupon Treasury bills. This arithmetic mismeasures the government’s interest payments by failing to account properly for real capital gains and losses government creditors receive due to changes in inflation, interest rates, and the maturity structure of the debt. Coupon payments should not be viewed as pure interest payments – they are part principal repayments, part interest payments.
To measure the government’s interest payments accurately, we have built our own accounting scheme using market prices and quantities held by the public for every marketable Treasury security since 1941 (Hall and Sargent, 2010). Our calculations take into account inflation, fluctuations in the term structure, and changes in the maturity structure of the debt.
In Figure 1, we contrast the US federal government’s official interest payment series with our series using annual end of the year data from 1941 to 2008. We report both our measure of interest paid (the blue line) and the government’s reported interest payments (the red line) as percentages of the market value of debt. Thus, both series can be viewed as rates of return.
Figure 1. A comparison of the official interest payments and our estimates of interest payments
Note: The blue line is our computed interest payments on the debt. The red line is the officially reported interest payments. Both series are reported as percentages of the total market value of publicly-held Treasury debt. The black line is the red line minus the inflation rate.
Computed correctly, the return on US Treasury debt is lower on average and considerably more volatile than the official reported interest costs. The official interest payments average 5.8% of the debt while our measure of the real return on the debt averages 1.7%. If we subtract the inflation rate from the officially reported interest payments (the black line), the two series have roughly the same mean (2.0 versus 1.7).
In contrast to the officially reported net interest payment series, our measure of the return on government debt demonstrates some striking outcomes.
First, there were large negative returns immediately after World War II as inflation surged with the lifting of price controls.
Second, during the early 1980s, when, perhaps unexpectedly, Paul Volcker brought down inflation, bondholders – particularly long-term bond holders – received large positive returns. Many who point to the 1970s as a time during which the US was able to pay low returns to its creditors through inflation often fail to acknowledge the large returns many of those same creditors received when inflation fell in the early 1980s.
Third, annual real returns became considerably more volatile in the two and half decades after 1980 – a period of low volatility in GDP growth often described as the Great Moderation.
The misreporting of US government borrowing costs leaves open the possibility of manipulation. The government could drive its measure of net interest payments to zero every period by perpetually rolling over, let us say, zero-coupon 10 year bonds. Such bonds would never pay coupons and never mature – each period they would be repurchased as nine year zero-coupon bonds and reissued as fresh 10 year zero-coupon bonds. Though the government accounts would put interest payments at zero, in truth the government would still pay interest in the economically relevant sense determined by the government budget constraint.
References
•Bohn, Henning (1992), “Budget Deficits and Government Accounting”, Carnegie-Rochester Conference Series on Public Policy, Vol. 37:1-83.
•Eisner, Robert (1986), How Real is the Federal Deficit? The Free Press, New York.
•Hall, George and Thomas Sargent (2010), “Interest Rate Risk and Other Determinants of Post-WWII U.S. Government debt/GDP Dynamics”, NBER Working Paper 15702.
by JackRiddler » Wed May 26, 2010 4:11 am
35,000 People Protest Christie’s Budget Cuts At Trenton Statehouse, Outnumbering Earlier Tea Party Rally 87-to-1
As the poor economy continues to take a toll on the nation’s tax coffers, states across the country are facing serious budget crises. One such state is New Jersey, which has a projected $10.7 billion budget deficit. To deal with the budget deficit, progressive state legislators passed legislation creating a new tax bracket on residents making more than $1 million. The state’s nonpartisan Office of Legislative Services estimates that the new tax would lead a household making $1.2 million annually to pay only $11,598 more a year.
Yet New Jersey Gov. Chris Christie (R) vetoed the progressive legislators’ tax bill, despite the fact that the state has the “second-highest personal income in the country.” Instead, the governor has proposed massive cuts to public services, like an $820 million reduction in the state’s education budget and ending millions of dollars of aid to cash-strapped municipalities.
Saturday, New Jerseyans, outraged at Christie’s choice to protect the wealthiest citizens of his state rather than its schools and infrastructure, demonstrated outside the statehouse in Trenton, chanting, “We are not the problem.” Police estimated that 35,000 people took part in what quickly turned into “one of the largest protests ever in the state.”
While the protests took place, Christie was 54 miles away at a bill signing at Monmouth Park racetrack. When asked about the protesters, the governor simply dismissed them, saying, “I’m here. They’re there. Have a nice day.” “How ’bout some jobs, Governor Christie?” one woman reportedly yelled at Christie during his appearance at the track.
The massive rally is particularly significant when compared to the right-wing tea party protests, which the media have covered obessessively. At a tea party rally in Trenton last month where demonstrators gathered to protest “unchecked” government, police estimated that, at a maximum, only 400 people attended. Which means that at the very least, the protesters marching against Christie’s budget cuts and for decent investment in public infrastructure outnumbered the anti-government tea party protesters 87-to-1.
justdrew wrote:Here may be an answer to "what must be done"...Freigeld
In the theory of Freiwirtschaft, Freigeld ('free money', German pronunciation: [ˈfʁaɪɡɛlt]) is a monetary (or exchange) unit. It has several special properties:
* It is maintained by a monetary authority to be spending power stable (no inflation or deflation) by means of printing more money or withdrawing money from circulation
* It is cash flow safe (a scheme will be put in place to ensure that the money is returned into the cash flow - for example, by requiring stamps to be purchased and attached to the money to keep it valid)
* It is convertible into other currencies
* It is localized to a certain area (it is a local currency)
The name results from the idea that there is no incentive to store the money as it will automatically lose its value after some time. It is claimed that as a result, interest rates would drop to almost zero.
According to Silvio Gesell, all human-produced goods are subject to expensive storage, whereas money is not: Grain loses its weight, metal products rust, housing deteroriates. Therefore money has a supreme advantage over all other goods. John Maynard Keynes found another effect, which he deemed more important: liquidity preference. Being "liquid" with money is a great advantage to anybody, much more so than having comparable amounts (past utility) of any product. The result is that people will not even provide zero-risk, inflation corrected credits unless a certain interest rate is offered. Freigeld simply reduces this 'primordial' interest rate, which is estimated to be somewhere around 3% to 5%, by an absolute, in order to lower the average interest rate to a value around 0.
http://en.wikipedia.org/wiki/Freigeld
http://www.complementarycurrency.org
http://www.appropriate-economics.org/
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