Barely a year after having saved the banks by devoting colossal sums to their rescue on both sides of the Atlantic – 25 percent of GDP, according to the European Central Bank – now indebted countries are under attack by those same financial establishments. That’s one of the – bitter – lessons of the Greek crisis, the most significant the euro has known since its creation.
There can be no doubt that Greece is living beyond its means. Nonetheless, the probability that it will not pay back its debts is virtually nil. Still, that doesn’t prevent the financial markets from creating CDS (“credit default swaps”) that are insurance against the risk of payment default. Why not, after all? Where the situation becomes complicated is that these CDS are themselves the object of speculation and their price has a direct influence on the yield of securities issued by countries.
Conclusion: speculating on a country’s problems in repaying its debts increases, even provokes, that country’s problems. The situation is all the less acceptable in that these CDS are in the hands of a few actors: three banks, JP Morgan, Goldman Sachs and Deutsche Bank, hold over 75 percent of the market. One actor’s speculation may be enough to make prices fluctuate significantly.
The banks’ role in the euro crisis does not stop there. Not only do they hold a large share of Greek debt, but they also lend money to speculative hedge funds, those funds the purpose of which is – in the most complete opacity – to speculate by minimizing the risks. As Michel Aglietta, Sabrina Khanniche and Sandra Rigot explain in their book, “Les Hedge Funds. Entrepreneurs ou requins de la finance?” ["The Hedge Funds: Entrepreneurs or Finance Sharks?”](Perrin, janvier 2010), “hedge funds may act in a concerted way and with a maximum of publicity to drag the market in the direction that suits them.”
So, the Greek crisis poses two questions: that of the solidarity of euro zone countries and that of financial regulation. On both sides of the Atlantic, the path has been laid out: obliging the banks to maintain more capital (to limit the leveraged operations that constitute hedge funds’ oxygen), to prohibit them from speculating for their own account … But for the moment, nothing has been implemented, and, in the greatest secrecy, the financial lobby is doing its utmost to nip these initiatives in the bud. May the euro crisis provoke the political wake-up call necessary to carry through this salutary undertaking.
Translation: Truthout French Language Editor Leslie Thatcher.
The economic crisis we’re going through has several facets. Historians will be hard-put to establish the correct version of the facts and assign responsibilities. The great macroeconomic disequilibria and American current account deficits surely played a role, as did the United States’ Federal Reserve’s monetary policy. The regulators were asleep at the wheel or were too indulgent in the face of the big American banks’ charm offensives. Rating agencies profited from Wall Street manna and didn’t do their work. Some economists warned against the real estate bubble, but others tried to justify the colossal increases in home prices by rational factors. The structure of compensation within banks encouraged risk taking.
And when the crisis really got started, the authorities’ bungling was also harmful. The failure of investment bank Lehman Brothers, for example, abandoned by the American Treasury, contributed in decisive fashion to the financial markets’ destabilization. The American treasury secretary at that time, Hank Paulson, attempts in his memoirs to throw responsibility for that failure onto the British Treasury, which blocked Barclays’ purchase of Lehman Brothers at the last minute because of (surely justified!) fears about the impact of such an acquisition on the stability of the British financial system. Historians will decide. Many questions are now being raised about the cost of rescuing insurance company AIG with billions of dollars of public money. The principal beneficiaries of that operation were the big investment banks, some considered close to the American administration.
Scholars are beginning to seriously study the lobbying of financial institutions in the United States. A recent research article [1a> poses an important question: why was regulation of the real estate loan market so faulty before the crisis? The authors’ response is simple and rich in information: the financial institutions primarily involved in the excesses of the “subprime” market are also those that spent the most money lobbying American members of Congress. Between 2000 and 2006, American financial institutions invested 60 to 100 million dollars a year in their lobbying efforts. The main thrust of those actions was targeted on real estate loans and their securitization. Let us recall that the practice of securitization led to the dissemination of toxic assets onto many financial institutions’ balance sheets and contributed to the deterioration in loan quality, since the banks that securitize and sell financial products to other institutions have few incentives to be strict about the quality of loans the credit risk of which they rid themselves. Now, it was precisely those institutions that issued the riskiest loans, that resorted the most to securitization, and with the fastest-growing portfolios of real estate loans that most showered their gifts on American members of Congress.
It does not seem an exaggeration to think that these institutions influenced the quality of market regulation implemented. American financial institutions’ firing power in terms of lobbying is huge. In the last decade, the financial sector’s profits constituted roughly 40 percent of American industry’s total profits, while it had never exceeded 16 percent from 1973 to 1985. The financial sector is at present engaged in frenzied lobbying to limit regulation of derivative products and of “credit default swaps” in particular – which are at the heart of many speculative strategies. During the first nine months of 2009, financial institutions spent 126 million dollars to influence Congress. Given the economic stakes, it’s not surprising that financial institutions try to use all their weight to fashion regulation of the financial system that preserves their rents. Will Congress and the regulators be able to resist this time?
[1a> “A Fistful of Dollars: Lobbying and the Financial Crisis,” by Deniz Igan, Prachi Mishra and Thierry Tressel, Working Paper n∞ 287, FMI, 2009.
Hélène Rey is a professor at the London School of Economics.
Translation: Truthout French Language Editor Leslie Thatcher.