Derivatives Can Wreak Havoc

I'm a little tired to spew further vacous babblings from abroad with any verve this evening. But, I do leave ye with with this article titled Too bad not to fail discussing derivatives in The American Scholar.

I liked this passage and will offer no thoughts in addition to it since, like I said, I'm weary.

"Greece, in 2001, sought to enter the euro zone but learned that it had too little revenue and too much debt to meet the European central bank’s standards. The Greek government turned to Goldman Sachs, paying the firm $300 million to fix the books. Goldman provided cash up front in return for mortgaging Greece’s airport fees and lottery proceeds until 2019; the loans were called sales, a classification that camouflaged the debt. Based on Goldman’s cooked books, Greece was admitted to the euro zone, and then Goldman began betting against its own client and the euro. “By enabling politicians to mask additional borrowing,” Michael Fallon, a member of the British Parliament, admonished the managing director of Goldman Sachs during hearings this year: “Banks like yours have, in fact, accentuated the sovereign risk of these countries which the markets are now focusing on.” Edward Gerald Corrigan of Goldman replied, “With the benefit of hindsight . . . the standards of transparency could have been and probably should have been higher.”


Based on Greece’s status as a euro-zone member presumed to be adhering to euro-zone standards, European banks bought lots of Greek debt. Now Europe can’t easily let Greece go, given the present global sovereign (meaning government-backed) debt crisis. “The fear that began in Athens, raced through Europe, and finally shook the stock market in the United States is now affecting the broader global economy,” the Times reported.


In May, the European Finance Ministers announced a $1 trillion rescue plan to set up a special-purpose facility, funded with taxpayer money from the International Monetary Fund and the European governments, to buy euro bonds from the banks. The result, much like America’s TARP, is to shift the loss from the banks to the taxpayers. German voters, unwilling to bail out Greece, took away Prime Minister Angela Merkel’s legislative majority. Once again, Goldman had designed something to fail and positioned itself to profit from the failure.


Like the irresponsible millionaires Tom and Daisy Buchanan in The Great Gatsby, Goldman left a mess in its wake. As Fitzgerald wrote, “They were careless people, Tom and Daisy—they smashed up things and creatures and then retreated back into their money or their vast carelessness, or whatever it was that kept them together, and let other people clean up the mess they had made.”


Greece was not American banks’ first foray into foreign-policy territory. The bankers also sold complex derivatives to Italian cities like Milan as well as to smaller municipalities such as the Umbrian hilltop town of Baschi, population 2,713. As detailed in the Financial Times, the Italian central bank reports that between 2001 and 2008, 525 local Italian authorities entered into 1,000 interest-rate swaps with an aggregate value of $50 billion—one-third of all local Italian debt. Baschi thought it could get a lower interest rate if it entered into a swap, and the bankers offered $40,000 in cash to entice the town into the deal. Baschi exchanged its fixed-rate lending on $4 million for a variable rate with the bankers. The small print of the contract was so unfavorable to the town that it lost both ways. Interest rates rose and the village lost; interest rates fell and the village still lost. The town’s treasurer, Antonietta Dominici, says derivatives should be banned. Meanwhile, Americans would do well to question whether American banks should be destabilizing Italian cities and hilltop villages.


Credit default swaps “grow like mushrooms in the dark,” Grigori Marchenko, governor of Kazakhstan’s central bank, told the Financial Times. He is concerned about CDSs because they are dragging down the country’s two major banks. Between 2004 and 2007, Western banks rushed to provide financing to Kazakh banks to fund Kazakhstan’s building boom. Some, including Morgan Stanley, purchased CDSs to protect themselves against potential losses on the outstanding Kazakh loans. And some, again including Morgan Stanley, may have bought more swaps than they had loans outstanding—meaning they would benefit if the Kazakh banks defaulted. Kazakh­stan is now trying desperately to restructure its banking system but suspects that the Western banks may be betting against them. “I don’t think anyone was prepared for what has happened here,” says Marchenko. “There is a new class of financial institutions now who are speculating that BTA [the largest Kazakh bank] will go into a default . . . rather than in keeping the bank as a going concern.” Goldman Sachs was an adviser to the Kazakhstan government but resigned for reasons the Financial Times calls unclear.


Americans, meanwhile, would do well to wonder if U.S.-chartered banks should be undermining the banks of a strategic U.S. ally. Dollar Diplomacy, as designed 100 years ago by Theodore Roosevelt and William Howard Taft, used American business to achieve national policy objectives, primarily to stabilize Latin America and discourage European meddling in our back yard—such as Vladimir Putin’s recent visit to Hugo Chávez’s Venezuela. The new Goldman Sachs version of Dollar Diplomacy is, of course, not intended to advance the national interest but to profit the company. Profit opportunities are advanced by volatility not stability."