The Eurozone Sovereign Debt Crisis

(Mr. Ben Mah, author of America and China, America and the World, America in the Age of Neoliberalism, Financial Tsunami and Economic Crisis – The End of American Hegemony, and the newly released China and the World, is a frequent contributor to this website.)

In 2009, amidst global recession and the Wall Street financial crisis, Greece’s newly elected social-democratic government delivered a bombshell when it revealed that the former government has deliberately understated its deficit, which exceeded EU guidelines. However, Greek’s deficit, as a percentage of GDP was not much greater than Spain or Britain, both with far bigger economies than Greece. “Nonetheless, Greece became the poster child for fiscal irresponsibility. And a ferocious attack was launched on Greece from many quarters.”^1.

These ferocious attacks were carried out with the use of speculative instruments including credit default swaps, which are bearish bets against the Greek sovereign bonds. Not surprisingly, speculators bid up the value of these derivatives more than seven fold in a little more than 6 months. Investors rushed to sell their Greek government bonds, leading to a speculative collapse in price. It has become a vicious circle, as the collapse in bond prices further increased the value of the credit default swaps and, most importantly, the recorded high interest rates at which the Greek government has to service its debt.^1.

Astonishingly, the Greek government seemed defenseless in the face of the speculative onslaught. Speaking at the Brookings Institution in Washington a few months in the aftermath of the debt crisis, Greek Prime Minister Mr. Papandreou bitterly complained that his government “is being undermined by concentrated powers in unregulated markets, powers which go beyond those of any individual government.”^2. As a result of speculation and ill-regulated financial markets, traders and speculators are pushing interest rates on Greek government bonds to unprecedented level, Mr. Papandreou said, and this is “a threat that imperils not only Greece but the entire global economy.”^2.

Speculators have made it extremely difficult for Greece to implement its fiscal policy, according to Mr. Papandreou, as hard won gains from the painful austerity program are “simply swallowed up by prohibitive interest rates.”^2. In the financial market, “there have been malicious rumors endlessly repeated and tactically amplified” for the purpose of price manipulation. “The same financial institutions that were bailed out with taxpayers’ money are now making a fortune from Greece’s misfortunate while those same taxpayers are paying the price in deep cuts to their salaries and social services. So unprincipled speculators are making billions every day by betting on a Greek default,” the Greek Prime Minister said.^2.

Not surprisingly, these unprincipled speculators who made big bets on Greek’s credit default swaps include Goldman Sachs, Barclays of Britain and France’s Crédit Agricole S.A.^1. The speculators are voracious predators whose appetite is insatiable: nothing seems to satisfy them.

Ironically, it was the same Goldman Sachs who used the tactic of deceit and accounting trickery that helped the Greek government to hide billions in debt from the budget overseers in Brussels in exchange for a transaction fee of $300 million. As a result, the Greek government was able to borrow billions of dollars with the use of derivatives. This scheme enabled the politicians in Greece, Italy and other countries in the Eurozone to spend billions beyond their means and eventually led to the sovereign debt crisis and potential defaults in Eurozone countries.

Unfortunately, “A Greek (or Irish or Spanish or Italian or Portuguese) default would have roughly the same effect on our financial system as the implosion of Lehman Brothers in 2008,” according to Robert Reich, the former Labor Secretary in the Clinton administration.^4.

Although Wall Street only lent $7 billion to Greece, the default by that country “could easily pummel German and French banks, which have lent Greece (and the other wobbly European countries) far more.”^4. Wall Street’s total exposure to the Eurozone is about $2.7 trillion, as American banks have lent considerable sums to French and Germany banks.

Most ominously, “Wall Street has also insured or bet on all sorts of derivatives emanating from Europe – on energy, currency, interest rates and foreign exchange swaps. If a German or French bank goes down, the ripple effects are incalculable.”^4.

Consequently, shares in the U.S. banking sector have dropped like a stone, to the lowest level since December 2008 and the cost of insuring Morgan’s debt has skyrocketed. While maintaining that it has no exposure to the French banks as its loans are fully insured, “Morgan could lose as much as $30 billion if some French and German banks fail.”^4. The reason for this is that the credit default swap is highly unreliable as an insurance instrument; this was fully demonstrated during the 2008 crisis, as financial giant AIG could not even pay its gambling debt and was pushed to the verge of bankruptcy. The mere fact that Morgan, the premier Wall Street bank, is a subject for the rumor mill shows the fragility of the U.S. financial system which is under stress with its massive exposure to derivatives.

In fact, Wall Street has become a casino since financial deregulation, as traditional commercial banking has been a marginal operation in term of profitability. For this reason, Wall Street has resisted financial reform despite the catastrophic 2008 subprime mortgage crisis. “For now, the financial powers that be are trying to keep the casino rolling, but it is inevitable that at some point this entire mess is going to come crashing down. When it does, we are going to be facing a derivatives crisis that really could destroy the entire global financial system.”^5.

In essence, derivatives are highly leveraged side bets, but an incredible amount of money is being wagered on these side bets, and Wall Street clearing banks are solely depending on their existence. American author Webster Tarpley duly noted: “Far from being some arcane or marginal activity, financial derivatives have come to represent the principal business of the financier oligarch in Wall Street, the City of London, Frankfurt, and other money centers. A concerted effort has been made by politicians and the news media to hide and camouflage the central role played by derivative speculation in the economic disaster of recent years.”^5. In fact, derivatives were responsible for the downfall of Bear Stearns, the bankruptcy of Lehman Brothers and the near collapse of AIG. Derivatives are also an important factor in the Eurozone sovereign debt crisis.

Among the derivatives, the most toxic are credit default swaps (CDS). As a matter of fact, “credit default swaps have cost the U.S. taxpayer almost $200 billion in the case of AIG alone, because of the bankruptcy of the AIG London-based hedge fund which had issued more than $3 trillion of derivatives – a total greater than the gross domestic product of France.”^7.

Notwithstanding the disastrous derivative experiences and amidst deepening European financial crisis, Wall Street banks increased its bets on Greek, Portuguese, Irish, Spanish, and Italian debt. The sales of credit default swaps by Wall Street banks have increased from $80 billion to $518 billion during the first half of 2011.^8. While the banks claim that their risks are “small because banks purchase swaps to offset ones that they’re selling, the big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who is ultimately going to pay for the losses?”^8.

For this reason, counterparty risk has become an important issue as the Eurozone debt crisis worsened. It was revealed that Bank of America, under pressure from its derivatives counterparties, moved its derivatives portfolio with $75 trillion of notional value from its Merrill Lynch investment bank unit to its depository banking division, which is federally insured. “This is a direct transfer of risk to the taxpayer done by the bank without approval by regulators and without public input.”^5. This also illustrates the threat of contagion from the Eurozone sovereign debt crisis.

The first major U.S casualty of the European contagion was MF Global, which declared bankruptcy after “disclosing a $191.6 million quarterly loss and $6.3 billion exposure to the debt of several European countries including Spain and Italy.”^6. MF Global, led by former U.S. Senator, Governor and Goldman Sachs CEO Jon Corzine, became the largest Wall Street failure since the collapse of Lehman Brothers three years ago. The disaster of MF Global showed that Wall Street has not learned a thing from the 2008 financial crisis when the entire American financial edifice was facing imminent collapse, only to be rescued by last-ditch efforts from the American government. The use of maximum leverage in making big bets by waging “the entire firm on a single trade” — the debt of Spain and Italy — is carrying out risk-taking to new heights.

Indeed, risk-taking has often been mentioned as part of Wall Street bankers’ DNA. As a result of reckless business behavior, the American financial system has been pushed over the precipice of total collapse. Similarly, after having embraced deregulation and the American model of financial capitalism, Europe is in crisis. The burning question is whither Europe after the crisis? To be sure, Germany, as the undisputed leader in Europe, “has been preparing the next steps for expanding its unabashed hegemony over Europe. An option, permitting direct intervention into the national budgets of indebted countries, is to be inscribed as soon as possible in EU Treaties.”^9. This will open the door to the creation of a future “core Europe” in which non-Euro countries such as Great Britain will be excluded.

Consequently, small and indebted countries in Europe such as Greece will lose their sovereignty, despite the fact that the Greek government has already surrendered to the EU and IMF demands for deep cuts in public sector salaries, pension benefits and social spending. Once again, the working class will bear the brunt of austerity.

As a result, it is estimated that Greek unemployment will reach 15% next year. Similarly, the cut in welfare benefits in Ireland will be nearly $1 billion and child-benefit payments will be eliminated, while public service employment has declined by 5-15%. In fact, budget cuts have been the order of the day for most European countries from Portugal to France and Great Britain.^1.

Unfortunately, deep budget cuts, public service retrenchment and reduced social spending will only lead to a downward spiral in the economy. This will create more deficits and debt, which coupled with the relentless financial assaults by the speculators, will put the life of the majority of working people in jeopardy over an extended period of time. As a result, millions of helpless and innocent people will lose their jobs, income and homes.

The Eurozone sovereign debt crisis has been blamed on the massive accumulation of debt as a result of profligate governments. If a high level of debt is what causes this fiasco, Japan should be the first country to have a debt crisis, as its government has the highest level of debt as a percentage of her GDP. When it comes to debt accumulation, the United States is not insignificant, as she has “public and private debt [totaling] ten times the debt of all Third World countries combined.”^10.

Aside from embracing deregulation and the American model of financial capitalism, the inability to issue sovereign credits for their funding needs, and the resulting dependence on foreign borrowing have been the root causes of the Eurozone debt crisis. In the final analysis, countries such as Greece, Ireland and Portugal only have themselves to blame, as they should realize that so-called international lending is no more than the credit generated from the computer keyboard, as a piece of paper in itself has no intrinsic value. Obviously, this is a scam, the Ponzi scheme of international finance.

7. Tarpley, Webster G.: “Fight the Derivative Cancer with Wall Street Sales Tax, Plus Bans Hedge Funds, Credit Default Swaps and Synthetic CDOs”, April 24, 2010 Tarpley.net