The “Euro Drama” and a Bust on Wall Street
by Michael Liebig
The first week of November 2011 was an eerie one. The mood in many media outlets, the financial markets and political sphere was almost hysterical. There was the tentative climax of the “Greek tragedy” and the beginning of the “Italian drama”. But there was a third drama which, however, received comparatively little attention: the bankruptcy of a big Wall Street hedge fund – MF Global – headed by Jon Corzine, the former boss of Goldman Sachs. These events are interconnected. The bankruptcy of Corzine’s hedge fund is a pointer to the hidden “underside” of the socalled “euro crisis”: massive derivatives speculation against European sovereign debt.
Trying to understand what had happened during this week is somewhat difficult because events have been shrouded in hysteria. Not ordinary hysteria, but political hysteria. Therefore, it’s not the psychoanalyst Sigmund Freud we should turn to, but the sociologist Max Weber, who coined the term “sterile excitement” (sterile Aufgeregtheit). Ordinary hysteria is an involuntary condition, the hysteric is gripped and overwhelmed by emotions. Sterile excitement – the post-modern phrase would be “hype” – means intentional, calculated emotionalizing for political purposes.
The Greek Roller-Coaster
Let’s first turn to the “Greek drama”. Four days after the 17 member countries of the Eurozone, including Greece, had agreed on a comprehensive package of debt reduction, bailout and tough austerity measures for Greece, the Greek prime minister suddenly announced to hold a plebiscite on this package. Three days later, the referendum was canceled. And by the end of the week, Papandreou announced his resignation to make way for a “national unity” government.
What’s behind this political roller-coaster? The first answer is power politics: Chancellor Merkel and President Sarkozy told Papandrou that sticking to his referendum idea would mean that Greece would be immediately cut off from any further EU funds. In other words: before the end of the year Greece would face state bankruptcy and be expelled from the eurozone. Issuing this ultimatum, Merkel and Sarkozy of course knew that, except Papandreou himself, practically no one in Greece wanted a plebiscite to be held.
The second level is about political psychology: It would seem, Papandreou’s referendum project was simply a desperate attempt to gain some sort “psychological relief” for himself: passing the buck back to voters who had put him in power to make decisions – including unpopular decisions. The Greek people were visibly unenthusiastic over the prospect of referendum – and that is quite understandable. The root cause of the Greek crisis are decades of client politics in the political class. But client politics takes two. The Greek people – not just the wealthy upper class – had willingly accepted and colluded with client politics, while (psychologically) blocking out the inevitable consequences.
I would assume the Greeks have feared all along – at least subconsciously – that reality would eventually catch up with them. And that did happen in early 2010. Since, the Greek people have gone through a intense process of self-disillusionment and its seems most Greeks now know three things quite well: First, they have to pay an ugly price – austerity and loss of sovereignty – for the mess created by the accumulated mistakes of the past. Secondly, the Oct. 27 EU package is probably the best deal under the circumstances. Thirdly, Greece without the euro and outside the EU, would face a truly existential social-economic crisis – comparable to what we have seen in the debt crises of Third World countries during the 1980s.
In spite of massive protests by trade unions and leftist groups, is seems most Greeks want a concerted national effort for terminating client politics and a fair sharing of the inevitable austerity among all layers of society. They want a national unity government which would concentrate on building a sound and sustainable industrial base for the economy. So, Papandreou’s referendum plan was really a kind of “flight forward” which we know from soldiers in war.
But what about the “sterile excitement” outside Greece – in Continental Europe and especially so in Britain and the United States? Why did so many political leaders and media outlets not simply state the obvious: Papandreou had lost his nerves, but his own party, the parliamentary opposition, the business community and the Greek public were against a referendum. Instead, it appeared that Papandreou’s lone “flight forward” was a existential threat for Europe and world!
Barrages of political statements and media commentaries were released claiming the planned referendum would wreck the euro currency along the whole European banking system, bring prolonged depression for the European economy and beyond, and lead to the political dismemberment of the European Union.
An eerie indicator for the level of hype were reports in the British Daily Telegraph and the American business magazine Forbes about a “joke” circulating in senior political and financial circles: In order to “solve” the Greek crisis after the referendum announcement, Greece “needed a military coup”. A military junta would eliminate democracy and force through the necessary austerity measures by suppressing police state-style all opposition to it. On top of this, ran the “joke”, a military junta ruling in Athens would automatically mean Greece’s expulsion from the EU and thus end the whole affair. Even without consulting to Sigmund Freud, we all know that jokes, including bad jokes, do echo what people do think in real-life.
When it comes to sterile excitement over Greece as the embodiment of the alleged downfall of the EU as a whole, a quartet of American “experts” has taken the avant-garde position: the economists is Paul Krugman, Barry Eichgreen and Kenneth Rogoff plus the historian Niall Ferguson. Every other day, they release commentaries or give interviews which contain a simple message: Europe is financially, economically and politically on the way down. Cash-strapped Europeans are begging China for money. And worse, Europe’s utter failure is a threat to world economy; Europe’s disease is contagious and might infect the United States.
And here we can clearly see that sterile excitement in politics is – opposite to ordinary hysteria – intentional and calculated. Have Krugman et. al. merely forgotten the astronomic $14 trillion public debt of the United States of which at least $1.2 trillion are held by the Chinese government? Have they forgotten that the attempts to introduce fiscal discipline in America are “grid-locked” in Congress? Believing that would grossly misjudge the cognitive capabilities of Krugman et al. However, the hysterical talk about a “failed Europe” provides a good deflection from the mess back home.
In line with the “message” of Krugman et. al. was the widespread media equalization of the (planned) Greek plebiscite with the bankruptcy of Lehman Brothers which ignited the 2008-09 international financial and economic crisis. The “Lehman moment” had come to Europe, proclaimed numerous “experts” and political commentators. Well, the alleged “Lehman moment” in Europe leads us to true causes of the hype in particularly the Anglo-American media.
The MF Global Bankruptcy
On very same day that Papandreou announced his referendum plan, the Wall Street firm MF Global went bankrupt – the 8th largest bankruptcy in US history. The media coverage of the bankruptcy was rather modest however, even though the chairman of MF Global was Jon Corzine, the former boss of Goldman Sachs and ex-U.S. Senator for New Jersey. If there was a “Lehman moment” in the first week of November, it was the MF Global bankruptcy.
MF Global was essentially a hedge fund doing derivatives speculation. Its high-risk financial “bets” were mostly debt-financed; the ratio of core capital to debt incurred was 1:34. The derivatives speculation involved commodities, financial instruments and state bonds. MF Global was particularly focused on “bets” on European state bonds. Whether MF Global’s “European” derivatives speculation or some other financial “bets” misfired, is not known yet. In any case, the bankruptcy of Corzine’s hedge fund demonstrates the deep involvement of Anglo-American financial institutions in the “euro crisis” – via derivatives speculation.
Anglo-American Banks, hedge funds and rating agencies have been big players in the “Greek crisis” all along. Corzine’s former bank, Goldman Sachs, helped the Greek government to “cook the books” prior to its Greece’s entry into the Eurozone. The three American rating agencies gave Greece good ratings – until 2009. Then, beginning early 2010, the rating agencies downgraded Greek state in rapid succession to “junk” status. In parallel, massive speculation against Greece set in – primarily by Anglo-American financial institutions.
As a consequence, banks across the globe began to “insure” their Greek loans with derivatives – so called “credit default swaps.” Through these CDS and other – more or less exotic – forms of speculation on Greek debt, a vast nexus of derivatives contracts has been created in between banks and hedge funds internationally – and at its center have been Anglo-American financial institutions. Not that they were holding Greek debt or state bonds of other Southern European countries. They engaged in derivatives speculation on these state bonds – without owning them.
The exact volume of these derivatives contracts is not known, but it is much bigger than the outstanding European sovereign debt. Anything that happens in Greece or in respect to Greece affects these derivatives contracts directly. Any new development triggers a myriad of new “bets”: On the Greek state bonds themselves, on the banks in and outside Greece holding these states bonds, on the bonds and other financial instruments (with no connection to Greece) issued by these banks – and so on and so on. But derivatives speculation does not only react to what is happening in the real world, speculation equally reacts to rumors about what is supposedly happening.
Derivatives speculation is “leveraged” – only a percentage of the contract is paid in as cash, the rest is credit-financed – as we have seen in the case of Corzine’s MF Global. Leverage develops a logic of its own. When there are indications or mere rumors that derivatives bets have misfired, suspicion begins to spread on the interbank market where banks lend money to each other and to hedge funds. The mistrust first affects one or a few banks or hedge funds – but because of the enormous interwovenness of derivatives speculation it can turn into a snowball effect. Banks withhold credits to each other and demand that their credits be repaid – the whole interbank market can dry out. Exactly that happened in Autumn 2008 after the Lehman Brothers bankruptcy.
I would guess that during that eerie first week of November, frantic efforts were underway behind the scenes to prevent the MF Global bankruptcy triggering a chain-reaction. And this operation was much aided by the fact that world attention was fixated on Greece and Europe – not on Wall Street.
So, the sterile excitement over Greece and European “failures” in the Anglo-American media and its echos in Europe’s political class and media apparently served a purpose. Merkel and Sarkozy acted swiftly and in a determined fashion to “settle” the Greek question with their ultimatum. But they haven’t settled the question of derivatives speculation. Occasionally, European leaders tell the public about the enormous dangers of derivatives speculation, albeit in a piecemeal fashion. They have repeatedly stated that they intend to regulate and to tax derivatives – but they haven’t done so.
In between the MF Global bankruptcy, the “Greek tragedy” and the “Italian drama”drama”, the G20 Summit was held in Cannes, France. There was agreement on implementing some new regulatory measures on financial markets. But there was no agreement on an effective regulation of derivatives speculation. And there was no agreement on a financial transaction tax. The veto came from the United States and Britain.
What else can we learn from that eerie week in November: When things turn hysterical, don’t gaze in the direction everyone else does; wait a moment and try to get the “overview”. You may find something really interesting – in the corner no one is looking at.