Betting on bankruptcy?

As speculation swirls as to whether the European Union (EU) or the International Monetary Fund will bail out Greece - a deal that in either case would stipulate crippling austerity measures on Greek workers--questions are emerging about the role that large banks played in making the crisis worse, and then profiting off it. Specifically, the question is whether the banksters hushed up the scale of Greece's debt situation, and then used that inside information to speculate on a potential default. Goldman Sachs is at the center of the scrutiny. Recent reports show that the firm consulted Greece as far back as 2000 on ways to take on more debt--and then hide it by packaging the liabilities into complex securities that were then counted as assets. It's the same kind of financial trickery that contributed to the massive housing boom and bust in the U.S. By hiding its new debts, Greece could circumvent stringent conditions on government budgets that the European Union imposes on member countries. And if that's not bad enough, it seems that Goldman used its insider knowledge of Greece's precarious financial situation to bet on a potential default by Greece. Thanks to its complicated financial maneuvers, the super-bank stands to make a killing in the event Greece defaults or needs to be bailed out. The culprit here is a familiar one. Goldman and other speculators are using credit default swaps as a way of gambling on the possibility that Greece will default--that is, it won't be able to repay its debts on time.

Credit default swaps are a kind of insurance policy that pays off if a particular bond or security defaults. The ostensible purpose of these credit default swaps--a form of the financial instruments that Wall Street calls "derivatives"--is for big investors to obtain financial protection against the possibility that a number of their investments could go bad. The idea is that the firms issuing credit default swaps agree to pay off what the original debtor owed. These swaps were popular during the sub-prime mortgage boom--they were supposed to be insurance for investors who bought securities that were based on large numbers of mortgage loans being paid off on time. It sounds fine in theory. But there are huge problems with credit default swaps. For one thing, the market for swaps is completely unregulated, and they aren't traded on public exchanges. That means a lot of backroom dealing can occur. Moreover, there's no limit on how many credit default swaps can be created and issued. So the market can swell to many times the size of the original assets or investments being "insured." Thus, the possibility that credit default swaps can turn from financial insurance to a gamble by speculators on whether homeowners or companies or whole countries will default on their debts. The lack of regulation allowed the market for credit default swaps to swell to such an enormous size, so that movements in the prices of derivatives can have knock-on effects on the real economy. Since 2000, the market for such swaps has ballooned from $900 billion to more than $36 trillion.

Credit default swaps helped drive the insurer AIG into insolvency. AIG had issued so many swaps backing up securities based on mortgage loans that when the U.S. housing market collapsed, the federal government nationalized AIG and pumped billions of dollars into the company so it could pay off its swaps. Because of all this, complex derivatives can have a massively destabilizing effect on the economy; which prompted super-rich investor Warren Buffet to call them "financial weapons of mass destruction." Importantly, investors don't actually have to own the asset that they are arranging a swap to cover. Thus, swaps can become a tool for gambling on defaults occurring--and can even contribute to defaults taking place. This is the equivalent of everyone else on a street buying fire insurance on one person's house--and then collecting when the house burns down. There's a reason that's illegal in the insurance business--the incentive is for all kinds of people to load up on insurance and then commit arson to collect. But on Wall Street, the same sort of activity applied to financial investments--called naked credit default swaps--is perfectly legal. In the case of Greece, it seems that the speculators have pushed the country closer to default.The growing demand for credit default swaps covering Greece have made it increasingly difficult for the country to raise money with newly issued bonds unless it pays a steep price--if it can find buyers at all. That increases demand for swaps still further, and so on, as the vicious cycle plays out. These practices forced even Federal Reserve Chair Ben Bernanke--hardly a critic of Wall Street--to admit last week, "Using these instruments in a way that intentionally destabilized a company or a country is--is counterproductive."

In Greece's case, the firestorm began last October when the government revealed it had a budget deficit that amounted to 12.7 percent of its gross domestic product. Overall, Greece's debt stands at $300 billion. As a percentage of GDP, that's three times the limit for member nations of the European Union. Concerns about Greece--along with Portugal, Italy and Ireland--have shaken confidence in the EU's currency, the euro, and prompted the EU to pressure Greece to get its books in order. The Greek government promised to cut the gap to 3 percent of GDP by 2012 by freezing public-sector salaries and raising taxes. It raised taxes on fuel earlier this month and has announced a series of further measures, including making Greeks collect receipts for goods and services, like taxi rides, in an effort to fight tax evasion. But more painful cuts are in store.

Greece has until March 16 to convince EU finance ministers and the executive European Commission that the steps it has already announced are enough. It also needs to borrow or refinance $72 billion--with nearly half of that amount due in April and May. The interest rate that Greece would have to pay on bonds that can raise this money is currently being valued at 7 percent--nearly double what Germany has to pay to borrow and 3 percentage points higher than Greece's borrowing costs before this crisis. This is the result of investors betting in various ways against Greek bonds. The problem has become so vexing that the German government is trying to identify speculators in Greek debt to prevent them from profiting from any bailout. Here is where Goldman Sachs' damaging influence comes into play. In 2001, Goldman advised Greece to turn some of its debts into derivatives that could then be counted as assets rather than liabilities, thus hiding the real level of debt. As the New York Times described: "As in the American sub-prime crisis and the implosion of [AIG], financial derivatives played a role in the run-up of Greek debt. Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere...Critics say that such deals, because they are not recorded as loans, mislead investors and regulators about the depth of a country's liabilities."
 
A report in the German newspaper FAZ indicates that AIG sold the credit default swaps on Greece. Ultimately, these transactions enabled Greece to borrow 1 billion euros without adding to its official debt--and according to Bloomberg, Goldman was paid $300 million for arranging the deal. And that was just one deal. According to the New York Times, a legal entity called Aeolos, created in 2001, gave Greece cash upfront in return for pledging future landing fees at the country's airports. A similar deal in 2000, called Ariadne, did something similar with revenue from Greece's national lottery. Similar deals were structured by Goldman and other banks, including from Europe. In late 2009, Goldman came calling again. A team, led by Goldman President Gary Cohn, proposed that Greece push debt from its health care system into the future by creating another set of derivatives. The proposal was rejected. But Goldman wasn't done. It had loaded up on credit default swaps covering a default by Greece. "Wall Street, led here by Goldman and AIG, helped to create the debt, then helped to create the hysteria about possible defaults," Marshall Auerback, a professor of economics at the University of Missouri-Kansas City, wrote. "As [credit default swap] prices rise and Greece's credit rating collapses, the interest rate it must pay on bonds rises--fueling a death spiral because it cannot cut spending or raise taxes sufficiently to reduce its deficit." The overall amount of swaps on Greek debt hit $85 billion in February, up from $38 billion a year ago, according to the Depository Trust and Clearing Corporation, which tracks swaps trading.


As a result of these activities, the Securities and Exchange Commission and Federal Reserve Bank are investigating the role that Goldman played. But given the kid-gloves treatment that Goldman has received--not to mention the extent that it's already been bailed out by the government--it seems highly unlikely that anything will come of these inquiries. As Gretchen Morgenson wrote in the New York Times: "If the past is prologue, we might see a case or two emerge from that inquiry five years from now. The fact is that credit default swaps and other complex derivatives that have proved to be instruments of mass destruction still remain entrenched in our financial system three years after our economy was almost brought to its knees." Worse, it's now clear that the U.S. government will do whatever it takes to bail out financial firms out and keep them solvent, even when their gambling blows up in their faces. This implicit guarantee is only encouraging more reckless behavior. Whilst Goldman cashes in and likely gets off scot-free for helping to cause the crisis, the working class stands to be punished brutally. Over the past month, the Greek government has already announced wage freezes, bonus cuts, tax crackdowns and pension reforms meant to save about $6.7 billion. New measures that could be part of a bailout plan engineered by the EU could include a 2 percent increase in the country's value-added tax--already at 19 percent--higher fuel prices and the possible abolition of one of two additional months of pay received by public-sector workers and employees at many private firms. In other words, the costs of Greece's default are being passed on to workers.

What's more, Germany's involvement in the bailout is creating a race to the bottom across national borders in Europe. "Germany has, in the last 10 years, been through very painful social reform, which means curtailing rights and social benefits, and pushing back the retirement age," Thomas Klau of the European Council on Foreign Relations told the New York Times. "The argument in Germany is 'Why should our workers work to the age of 67 to enable Greeks to retire earlier?'" The harsh measures in Greece will ultimately make things worse. As economists Simon Johnson and Peter Boone wrote, austerity programs in Greece and other countries with high debt loads could "massively curtail demand, lower wages and reduce the public-sector workforce. The last time we saw this kind of precipitate fiscal austerity--when nations were tied to the gold standard--it contributed to the onset of the Great Depression in the 1930s." In addition, privatizations--also done at the behest of financial firms like Goldman--mean that former sources of government revenue, such as toll roads, are no longer in the state's hands--leaving it even less able to pay its public debt. Thus, the pay cuts and austerity programs could end up exacerbating defaults and necessitating another round of reductions--exactly when governments should be running up deficits to hire unemployed workers, pay out benefits and stimulate economic activity. That's the cost of the vicious cycle that the banksters set in motion.

The trillion dollar crash

“History books will document that the global economy experienced a sudden stop after 15 September. The manner in which Lehman Brothers failed disrupted the trust that underpins the smooth functioning of market economies. As a result, virtually every indicator of economic and financial relationships exhibits characteristics of cardiac arrest”. These words, from one of the Financial Times’s guest columnists, could have come from virtually any of the mainstream economic commentators witnessing the chaos afflicting their system. Things that seemed an outside possibility three months ago, when we sent the previous issue of this journal to press, had become a reality by the time it came back. The credit crunch had turned into possibly the biggest crisis the global financial system had ever seen, leading governments to pour in more than a trillion dollars and partially nationalise banks across Europe and the US to prevent their collapse. But even that failed to halt the crisis, as was shown dramatically when the Bush administration “all but nationalised Citibank, the world’s largest bank” in the last week in November. By that stage the crisis had spread to what mainstream commentators call the “real economy”. There was “a week of living perilously” as “panic seized the markets”. The plague of insolvency sweeping the City had now spread to the High Street, with the demise of Woolworths and MFI, and to the historic core of US manufacturing as car sales slumped. Chrysler lost millions by the day, General Motors said it needed $4 billion immediately to avoid bankruptcy and Ford joined them in asking for a $34 billion government handout. The toll of sackings in every sector began to compare with the haemorrhaging of jobs in the crisis of the early 1980s. And the pain was felt not merely on both sides of the Atlantic, but on both sides of the Pacific too, with thousands of factory closures in south east China and the spread of recession to Japan.

The crisis has produced something else previously unimaginable to most commentators—a phase change in the approach of those who try to manage the system. Until August their approach was still that often described as “neoliberalism”—meaning a revamped version of the laissez faire market “liberalism” that preceded the turn to state intervention three quarters of a century ago. It was always somewhat misleading as a description of capitalist practice, as opposed to capitalist theory. States have intervened to help capitalists deal with economic crises or foreign competition throughout the past three decades. For instance, the US state bailed out Chrysler in 1979-80, the saving and loan (S&L) associations in the mid-1980s and the Long Term Capital Management hedge fund in 1998. But these were treated as exceptions. Now not only have multibillion bailouts become the norm but so too has partial nationalisation. The theory has been abandoned—for the time being at least. The collapse of Lehman Brothers was decisive. Allowing it to fail was meant to signal that market discipline could restore the health of the system by purging financial institutions holding “toxic assets”. Instead it spread the problems of one part of the system to others thousands of miles away, causing huge dents in the balance sheets of banks in Britain, Germany, Belgium, Iceland and the Netherlands as well as the US, and bringing the whole financial system close to collapse. The only way for states to keep the system going was to return to the methods of wholesale state intervention—state capitalism—supposedly jettisoned in the aftermath of the recession of the mid-1970s. “Friedmanism” and “Hayekism” got their marching orders as Keynesianism came back with a vengeance. Such a phase change will have political repercussions. Even more than a theory of economic management, neoliberalism has been an ideological prop for the system, translated into common sense aphorisms such as “No one owes you a living”, “You have to stand on your own feet” or “State intervention never works”. It served to absolve those who ran the state from responsibility for the harm done to people’s lives by capitalism. Now they have very visibly intervened to save the bankers and will find it hard to avoid demands to intervene to do something about the devastation of jobs and homes caused by the crisis.

Robbed of housing by business bandits

A quarter of all households - in owned or rented accommodation - say that worry over housing costs is causing them stress or depression, says a survey by housing charity Shelter. Working class people are being asked to pay the bill for bailing out the banks. But the banks still behave the same way. Last year they repossessed 46,000 homes of people in financial difficulty - a 14 year high - and that figure is projected to reach 53,000 this year. The banks claimed that they would obey 'new protocols' but subprime lenders still charge exorbitant fees to borrowers who fall into arrears, flouting Financial Services Agency guidelines. Shelter's magazine 'Roof' reports that one borrower was taken to court by Southern Pacific, her lender, for arrears of almost £2,000. Three quarters of that arrears was charges that a judge ruled to be unfairly levied. Fees, including over £1,000 for 'litigation management' and £250 for 'arrears management', were imposed even though the borrower was never more than two months behind on her payments. The banks should be fully nationalised and run democratically to support a housing plan based on need. They should stop paying massive bonuses and offer cheap loans to support a programme of building good quality homes, upgrading existing stock and a massive expansion of council housing. At the last count, the government's mortgage rescue scheme had helped just six people! It should be massively expanded to stop banks creating more homelessness. If you can no longer pay the mortgage you should be able to stay put as a tenant.

All three main capitalist parties advocate market solutions in housing even though this is what led to the financial crisis. Housebuilding is now at the lowest peacetime level since 1922. Shelter says that 98% of councils are failing to deliver enough homes to meet need. They comment: ""With 1.8 million households on housing waiting lists and more than one million children living in overcrowded homes it is unacceptable that only eight councils have produced enough homes to meet social need." The main parties still see home ownership and the market as the way forward. But the average age of a first time buyer is now 37. Young people are priced out - the image of home ownership starting a smooth escalator of increasing wealth and better housing is a mirage. Given the lack of new social housing (and the need to improve existing social housing) and the problems of the private rented sector, this causes massive discontent. Between 1997 and 2007, house prices rose 200% although earnings went up just 52% - that was part of the property bubble that led to the credit crunch. House price rises create no new real wealth, but redistribute wealth to people who own property from those that don't. Some people exploit this even further by owning property they can trade (ie not just your own home). The more you own, the more you make. Some blog sites reflect the problems of millions whose aspirations are frustrated by the housing market. The 'Renter girl' blog describes life surviving in insecure and often badly managed private rented accommodation. None of the big parties can respond to this.

The 'Priced out' website campaigns for the 1.2 million first time buyers "denied their own home because government policy gives billions in tax breaks to property speculators" and talks of improving tenants' rights for the "87% of renters who are, predominantly, priced out first time buyers, to improve their security of housing." Socialists call for improved tenants' rights and proper regulation of the private rented sector as well as a clampdown on tax perks that drive up house prices. We oppose cuts in legal aid that make it harder for tenants to defend themselves against bad landlords. We also support calls for tighter regulation of the banks, but the real answer is to fully nationalise them and run them for people not profit. Trade unions need to take up this issue which will hit their younger members. It is only possible to do so by opposing New Labour. In this election, that means supporting Trade Unionist and Socialist Coalition candidates where they are standing. It will mean building a mass movement against the profit-making banks, against public sector cuts and for a housing policy based on need not profit or speculation. Barking and Dagenham borough has London's lowest house prices. But you still need a £60,000 annual household income and a deposit of around £20,000 to buy a family home, putting buying far out of reach of most people locally. Since 1980 the council has sold off 17,523 council houses and its housing stock is now half what it was 30 years ago. A local Labour MP, Jon Cruddas, identifies a need for more housing in Inside Housing magazine (5 March). But Cruddas offers as his basis for hope Barking Riverside, part of the Thames Gateway development which will create 11,000 homes at a cost of £3.1 billion.

Most homes will be for sale, and 14% of these will be "affordable", which just means a little cheaper than the market rate. Many people will stretch themselves to get one because of the lack of alternatives, but many locals will find this out of reach. The remaining 'social housing' will not be council controlled and will have less security of tenure than council housing. Much of the 'for sale' housing could end up in private landlords' hands. No doubt banks, landlords and Bellway Homes (the major builder involved) are pleased. Working class people may be less hopeful! Another local Labour MP, Margaret Hodge, who faces an electoral challenge from the leader of the far-right racist BNP, acknowledges that more houses should have been built. The local council has commissioned just 63 new properties. But she says: "There won't be a return to the 1960s and 70s when we saw mass building of council houses." Jon Cruddas doesn't put a different position. Many people struggling to find a decent home, or make rent or mortgage payments, may drift into despair and groups such as the BNP feed on despair. The workers' movement must pose the alternative of fundamental socialist change that can meet people's clear need for affordable public-sector housing.

Breaking the bankers' hold

Gordon Brown is right to say that the last few days of the election campaign will be crucial, but Labour's tactics laid down by Peter Mandelson risk turning off already alienated working-class voters. Mandelson insisted that Brown would be lauded as tough and up for a fight and that party campaigners would put more emphasis on the tough decisions he has taken. The millions of working people who have edged away from Labour since 1997 are in no doubt that Brown is capable of showing how tough he can be against people like them. That's partly the reason why Labour Party membership has plummeted and why Labour's vote has continually declined in every election since those heady days 13 years ago. Billionaire media leader writers may well be impressed by the government's refusal to abolish anti-trade union legislation, its rejection of the case to jail bosses responsible for safety lapses that kill workers and its siding with employers in industrial disputes. But these people are not the bedrock of Labour's electorate. Its bedrock has always been the workforce in both private and public industry and the government has let the entire working class down. It has allowed 1.5 million jobs in manufacturing to haemorrhage since 1997 and it is now lining up civil servants and local authority staff, among other public-service workers, to bear the brunt of the crisis caused by the greed and adventurism of finance-sector fat cats.

Labour is being described by Tory-Liberal politicians and the City bankers as profligate for increasing public spending and running up a huge deficit, ignoring the fact that these were in direct response to a crisis of the bankers' making. Unfortunately, Labour remains in thrall to the finance industry, allowing it to rebuild its reserves and profit margins on the basis of readily available pump priming from the Treasury. Those parasites who gorge on the banking sector are never satisfied with the levels of their unearned wealth and have caused Barclays shares to dip by 6.4 per cent despite the bank announcing a 47 per cent rise in quarterly pre-tax profits of £1.82 billion. When Alistair Darling stepped in just over a year ago, he didn't simply bail out a number of banks. He rescued the entire finance system. The bankers took it as their due and are still dispensing not so much advice as orders, which the government is following rather than having taken the banking sector under public control. Such decisive action would have enthused much of the electorate and sent a message that bankers' gambling debts would not be met by low-paid workers and pensioners. Even now it is possible for Brown and Darling to mark a sharper distinction between the immediate and savage cuts proposed by the Tories' Bullingdon Club boys and Labour's approach. The resistance to the international bankers' agenda shown by workers in Greece, Portugal and Spain indicates that the current crisis will not be short-lived. If the Tories are returned to office, with or without the Liberal Democrats, they will not delay before laying waste public services and the welfare state. It is essential to prevent this happening and to then mobilise the entire labour movement to learn how Labour and the unions fell for the neoliberal line and how to chart another more progressive direction in future.