28 April 2010

The Greek Situation: My Prophecy

There's a lot of consternation about what's going down in Greece: on the one side of the Atlantic, we are concerned that it "threatens the recovery" that appears to be underway in the wake of the Great American Recession; on the other side, they rightly fear the same moral hazard about which America has done nothing will infect Europe, and that Spain, Ireland, or Portugal will take their place in the bail-out queue behind Greece. 

Fortunately I've been to Greece, where I acquired the curse of prophecy, so for the benefit of my readers I will explain how this pans out.

Greece is in trouble, and a big chunk of that trouble came from fudging its books, an ages-old government past-time and not one unique to Greece by any means. These days that general kind of deception is a much more sophisticated program that requires the assistance of foreign bankers as consultants and advisers, either before a problem arises in the form of people like Goldman, or after in the form of the IMF, but either way with the advice of people trained at Harvard or the Chicago or London Schools. But again, governments sexing up their dossiers is nothing new, so let's not blame Wall Street just yet.

One of Greece's problems is that they have taken on a lot of debt. Another problem is that they will need more if they are going to bail themselves out of this mess. Those two things are necessarily true no matter what you believe about their lazy workers or bloated public service - claims that are largely false, but either way also largely irrelevant. Greece has a whack of debt, and they are going to need a whack more.

Enter the rating agencies. Rightly concerned with Greece's creditworthiness, they downgrade their rating. This means that existing Greek debt trades at a substantial discount. People who have it on their books need to downgrade its value; speculators can pick them up at a bargain, accepting the credit risk of default. Of course, the panic in this market means Greece must offer very high yields on potential bond issues just at the time they are cash-strapped, and therefore makes it more likely that Greece will fail. 

Now the ratings agencies are private Wall Street institutions run by many of the same faces and all the same philosophies as the banks that give them their data and report their 'advice'.  But then we realize that these same banks, in addition to providing the initial advice and much of the ongoing 'disclosure' of evidence as to the quality of the economy and debt, are directly interested in that advice in what seems two obvious conflicts:

1) They have created derivatives to bet on Greece failing, and therefore the market-makers benefit from any bets placed (the house) and also from their own bets if Greece collapses or is bailed out (betting on their own market). 
2) They are also the same speculators who pick up the downgraded bonds at a substantial discount (high yield). 

So, it turns out that their advice and their rating and their derivatives market combine to create a self-fulfilling prophecy: Banks give bad advice for which they are paid; they set up a derivative to bet against their client for which they are also paid; they place bets against their client that they hope will be paid; they downgrade the debt to make it more likely the client will fail and the bets will pay; the downgrade also enables them to pick up the debt at bargain basement prices; the inability of Greece to obtain credit they helped cause forces Germany and other EU partners to step in with a bail-out; the bargain basement bonds that they picked up pay out dollar for dollar as if they were AAA.  'Buy Greece, Sell Germany' - that's what they say!

Now, it is certainly true that they will lose at least one bet, since they have skin both for and against Greece, so it's unlikely (but not impossible) that they win both their own derivative bets (against) and get the payout on their cheap bonds (for). But, like every house, they have ensured that the betting favors them, and they are getting paid on at least 3 out of 4.

And when a few years from now someone is called to answer, he will say that they lost money (true, in a sense) and that they are savvy (also true, in a sense) and that they did nothing wrong (almost certainly not true in any human sense), and that the market requires geniuses like him to be paid huge bonuses for creating a system where the bank wins 3 of 4 bets, even if they destroy their client and the world economy in the process. 

Now all that is just common sense. Here's the prophecyPeople will accept his story.


Blogger Porcupinetaxi said...


May 09, 2010  
Blogger Bigvic said...

Thank you for one of the best synthesis on this topic that I have read so far. I love the cynicism at the end.

June 23, 2010  

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