Tuesday, March 02, 2010

The Greece troubles

The Greece’s problem is emblematic in various ways. All though the base line story is heard numerous times in recent period. Especially so in the housing bubble. We have a party (a country in this case) borrowing beyond their means and bankers who helped them not only in borrowing but also masking the debt in such a way that the party could borrow more. The bankers reaped hefty fees (Goldman making $300 millions from Greece just in fees) and then started shorting the party, hoping that the party will default in near future. And Greece is indeed flirting with default. In both ways Banks makes a lot of money. I don’t think there is any better example of head you loose and tail I win!

Granted, that no policy maker from Greece were forced to borrow at such a gigantic scale. They did it on their own. But that doesn’t absolve these God’s bankers from cardinal sins. What makes this activity criminal is the fact that these Greek policy makers collateralized the country resources (like revenues from the ports or airports for certain number of years) effectively selling their country to the bankers! If it were 18th century then in the case of default, the bankers (in this case Goldman Sachs) would have owned the Greece till the debt is paid. I even coined a new term to explain the phenomena - Credit Colonization. Colonization is so 20th century! At least mere colonization was good for the conquering nation. But the stuff bankers are doing doesn’t seem to benefit anyone except for themselves. The traders at Goldman Sachs and the mangers who efficiently sold debt to Greece do not care about welfare of anybody except for themselves. The bonus is their redemption.

The general prescription of growth IMF and World Bank usually prescribe is heavy de-regulation and privatization. For this argument’s sake we need to talk concentrate only on de-regulation point. In US there has been trend to deregulate with no or minimal oversight in financial industry. The Feds, the SEC and bunch of other agencies are still active but minimally so. Thus when Banks were coming up with highly cryptic and complex financial instruments these oversight agencies were napping. And when Banks used these instruments to bring down not only other world economies but also US economy these oversight agencies, well, were caught napping. In absence of any oversight or stringent regulations the juggling these Banks did was perfectly legal. I mean legality, one can argue, is subjective. All the instruments used in masking debt were within the gamut of what’s allowed. These bankers were so ahead of the curve that world is still catching up with workings of Options and Swaps. To be honest, it’s not that hard to understand how these instruments work but what makes them deadly is that how they are used and how intertwined they are with each other. The net effect, if contrary to your expectations or calculations, is negative then they will bring down the house so quickly that you stand no chance of surviving.

Another aspect, something I don’t see getting discussed popular publications, is that unlike Stock Market where value actually evaporates, the way these instruments work is that the value or the cost gets transferred to other party. Thus if someone’s loosing money then someone else made the exact amount. The US stock market lost trillions of dollars of value but value lost through the usage of financial instruments was the value gained by the folks who used them correctly. I mean we are talking about folks making hundreds of millions in single year!

This transfer of wealth brings me to my second point.

In economics there is a theory called trickle-down effect. According to the theorem entrepreneurs should be allowed to make as much money as possible through various measures like tax-cuts because the money makes its way down. These rich people with their infinite money will buy infinite amount of services and products. That way the money will find its way to the service providers like restaurant or product sellers like shopping malls. As mentioned earlier in this column, this theory played instrumental role in deregulating US financial industry in 1990’s. (Along with Mr. Greenspan) So far so good! But the evidence is quite contrary. In last thirty years or so, in America, the rich are richer and poor are getting poorer. The middle class is completely stagnated. Interestingly, the same scenario is repeated on global scale where rich nations are getting richer while poor nations are loosing their resources fast and dignity at even faster pace. Fancy that!

The Greece fiasco succinctly explains this contradiction. The policy makers are bozos for sure. Politics of the region played important role too. They couldn’t manage the budget and the deficit but they were dead set about joining EU. Now EU has stringent rules for deficit handling. So instead of taking the hard path of fiscal austerity they decided to actually go full throttle on spending. They borrowed more and banks helped them to do that. And then banks through products like derivatives, Futures and Options helped policy makers to keep the debt concealed. The cost this jugglery was not only the fees incurred to the bankers but also the future installment payments at higher interest rates to the banks who sold the products to them at first place. If you’re logical compass isn’t going coo-koo yet then wait for the climax. The valuable country resources were sold to the bankers at cheap price. The services that government ought to provide are forgone and the hard earned money of citizens was handed over to the Bankers.

Thus it’s an inverse trickle down effect. It’s a trickle-up effect!

You can apply this case study, with minor changes to lot of cases. The average debt owed by a US citizen is rising constantly over the years. The average debt held by US government is rising constantly. The average debt held by African countries is rising constantly. In fact, the debt is increasing rapidly everywhere. And someone’s selling this debt. And that someone is making huge money.

In short the very small minority in rich nations is sucking off wealth from whole planet. This trend will have far reaching impact on social, environmental as well as economical well being of every nation. I am not sure if anyone can stop this juggernaut from rolling. I am just worried that Greece could be just a trailer and horror movie is to follow soon.

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