A TRAGEDY WORTHY OF AESCHYLUS

6/8/11

Perhaps the biggest financial story of the last few weeks has been the maneuverings among the European Central Bank (“ECB”), the IMF, various European economic powers, and agencies created by those powers to avoid a default by Greece. Greece received about $160 billion in bailout money in May, 2010 but hasn’t been able access the private markets, as had been hoped (It does spring eternal, you know.) when the bailout was arranged, so a chunk of Greek debt coming due over the next few months can’t be refinanced without help from somewhere.

Why just not let Greece default, as Argentina did in 1992, and be done with it? If one believes in the free market’s disciplinary and recuperative powers, a default makes sense. However, eurocrats and the bankers they serve are afraid that a default by one eurozone country will affect the creditworthiness of other, perhaps all, eurozone countries, leading to what President Obama, not at all shy about sharing his manifest financial expertise with the likes of Angela Merkel, so financially doltish that she runs a country that is fiscally sound, called the “disastrous” results of an “uncontrolled spiral and (sic) default in Europe.”

The real reasons that the eurocrats feel they must once again hit up their taxpayers to allow the Greeks to live well beyond their means are two. First, if Greece defaults, the ECB will no longer accept Greek debt as collateral for loans. This would cause problems for European banks who have lent heavily to Greece knowing that they can use the Greek bonds as collateral for loans from the ECB and, doubtless, counting on the time tested strategy of privatizing gains and socializing losses. These banks would have to refinance such loans from the ECB elsewhere, and, wherever “elsewhere” is, it wouldn’t take defaulted Greek debt as collateral. This ECB problem, however, is far from insurmountable. In the event of a Greek default, the ECB could simply change what have become, over the last few years, its very flexible rules.

The biggest reasons that avoiding a Greek default (Language gets tricky here.) seems so imperative to the eurocrats and the banks they serve is because a “credit event,” which is not necessarily the same as a default, would trigger the credit default swaps (“CDS”s) written by an array of financial players, including, in large part, European banks. If whatever solution is concocted to bail out Greece short of more lending from European taxpayers under the fig leaf of the European Financial Stability Facility (“EFSF”), be it a “voluntary” exchange of maturing debt for debts with similar terms (Such an exchange would definitely be considered a default by the rating agencies; the agencies have already stated that an exchange of maturing debt for debt with terms more generous to the debtor than those available in the secondary market, in which Greek debt is trading, when it does, with yields in the 15% to 20% range, would constitute a default. But a default is not necessarily a “credit event” for CDS purposes.) or a technical payment at maturity matched instantaneously with an “encouraged” purchase of new debt, is considered a “credit event,” buyers of CDS could collect from those who wrote the CDS contracts. The supposition seems to be that the writers of the CDS contracts are largely European banks; thus, a Greek “credit event” could trigger a financial “crisis” in Europe and in our interconnected financial world. So the general consensus among the eurocrats seems to be that the possibility of a “credit event” must be avoided at all costs, and thus the only solution is for European (EFSF) and world (IMF) taxpayers to save Greece and its creditors by reaching further into their pockets.

But think about this for a minute. Eurocrats, along with the IMF, are striving mightily to avoid a Greek “credit event” in order to absolve supposedly sophisticated financial actors of the responsibility to make good on contracts they voluntarily entered into. If Greece does not experience a credit event, the writers of the CDS contract make money, in some cases, considerable money. The other side of that coin, in a free market, is that if Greece does default, the writers of those contracts lose money, in most cases, considerable money. Isn’t that the way a market is supposed to work? But, the way the eurocrats and the IMF see it, the writers of those contracts ought to be able to profit from those contracts if Greece is saved but should be able to pass their potential losses onto other parties, maybe onto Greece’s lenders, often the people on the other side of the CDS trade, who will be forced to “voluntarily” extend their debt but not collect on the CDS contracts they may have purchased, but more likely onto European taxpayers.

So again, what we are seeing is an example of “too big to fail,” socialization of losses and privatization of profits, and a perversion of capitalism, all in the interest, supposedly, of maintaining financial stability. This system stinks. Taxpayers in Germany, Finland, and other fiscally responsible countries see this. The politicians in such nations better open their eyes or there is bound to be trouble in Europe and beyond; restive populations are not a prescription for “stability.”