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The Greek Tragedy and its lessons

By: Dr.Dipak Basu
Aug-04-2010
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(The author is a Professor in International Economics in Nagasaki University, Japan)
 


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Greek government of Prime Minister Giorgios Papandreou announced massive social cuts worked out in negotiations with European and International Monetary Fund (IMF) officials to pay off the Greek debt to its international creditors. In exchange for these austerity measures, the European financial ministers decided to implement a ?110 billion bailout package for Greece so that Greece will not default, which would ruin the European monetary system and its currency Euro.

In the short term IMF involvement would give Greece the following.
1. Cash of up to 10 billion Euros at much cheaper than market rates. So she saves some money.
2. Following an IMF plan other countries may make bilateral loans to Greece on better terms than she can currently get from the markets.

Greek crisis, resulting into Greece"s submission to the IMF and the forthcoming social unrest is related to the Global crisis of finance. Globalization has massively increased the vulnerability of the world"s financial and economic system. Every day trillions of dollars is transacted at the speed of light, much of it unregulated. The derivative products or gambling of various kinds on every financial future market have accrued to the level of hundreds of trillions of dollars, unmonitored by any governmental authority. In essence, a vast global financial superstructure has been erected on a fragile foundation, which is just as worst as the sub-prime securities or loans to poor American to buy houses knowing their inability to repay but then selling these loans as assets to the rest of the world.

According Charles Kindleberger a stable international monetary is possible only where there is a world power able and willing to bear the burdens of responsibility for the preservation of the prevailing system. Such a leader must also be prepared to act as a lender of last resort. Britain played this role in the nineteenth century. USA was to play this role for much of the twentieth century until 1972 when Nixon in order to finance the Vietnam War started having the same irresponsible policy as used by George Bush to finance his invasion of Iraq. The decline of a "hegemon" is now reflected in a series of international financial crisis one after another; first was the stagflation of 1970s, followed by the debt crisis of 1980s, stock market crash of 1987, recessions in early 1990, stock market crash of and Asian financial crisis of 1998 and the worldwide financial crisis.

European governments decided to fund a bailout largely out of fear that a Greek default might lead to a new financial crisis and the bankruptcy of other countries, such as Portugal and Spain. Credit rating agencies recently downgraded both countries" debt.


How Greece fell into the Debt Trap:

Greeks are some of the world"s richest people. The National Bank of Greece, Eurobank, Alphabank and Piraeus bank, have 164 billion Euros in deposits alone. The estimated loans taken from the foreigners are about 216 Billion Euros. Greece has extremely low household debt / GDP ratio; low corporate debt/ GDP ratio; low bank debt/ GDP ratio; a manageable total debt / GDP ratio, but a very poor Government debt / GDP ratio, above 100% of GDP.

In 1980, when Greece has joined the European Union, Government Debt/GDP ratio was 30% and it would have been much lower were it not for the high costs of defense. When Greece joined the EU in 1980, it became a party time. A small oligarchy then was the only source of capital and had the acumen, education and experience to deploy it as the country developed. Old families controlled the steel, cement, foodstuffs and construction companies that rebuilt Greece after the war.

Money that was sent from the European Commission to build the Greek infrastructure, about 6% of Greek GDP for the last 30 years, was funneled directly into the pockets of the oligarchy due to high level of corruption in Greece. Most part of that money could be used in socially desirable projects, but instead the bulk ended up in the pockets of the twenty families who run Greek business and own all the banks. Low rate of interest from the European banks, have allowed the government of Greece to be borrow more and more but the people on the street never saw the benefit of the 300 billion the government has borrowed. Even then, Greece should not have any difficulty given the deposits and assets of the Greek banks.

Greece then fell into the trap of debt due mainly to a financial derivative called Credit-Default Swap. The contract, known as credit-default swaps, means if a company or, in this case Greece, an entire country, fails to pay its debts, Banks and financial institutions who own these swaps stand to profit. It"s like buying fire insurance on your neighbour"s house - you will be motivated to burn down the house of your neighbour so that you can receive a huge insurance payment subsequently. Similar conditions were created for Greece by a number of Banks, some of which are Greek. Greece was encouraged to borrow heavily by these banks to finance its budget deficit. At the same time, Goldman Sachs, JP Morgan Chase and about a dozen other banks had created an index that enabled market players to bet on whether Greece and other European nations would go bust.


As banks and others rush into these swaps, the cost of insuring Greece"s debt rises. Alarmed by that signal, bond investors then started rejecting shun Greek bonds, making it harder for the Greece to borrow. That, in turn, adds to the anxiety - and the crisis starts that Greece cannot repay its existing debts by borrowing more. Anxiety now covers other troubled economies like Portugal and Spain. European banks including the Swiss giants Credit Suisse and UBS, France"s Société Générale and BNP Paribas and Deutsche Bank of Germany have been among the heaviest buyers of swaps insurance, because those banks are the major lender to Greece along with the four major Greek banks (National Bank of Greece, Eurobank, Alpha Bank, and Piraeus Bank) . French banks hold $75.4 billion worth of Greek debt, followed by Swiss institutions, at $64 billion, according to the Bank for International Settlements. German banks" exposure stands at $43.2 billion.

However, the lending by Swiss Banks are in fact lending by Greek shipping magnets like the Latsis Family who owns some of this banks along with a major part of the German airlines Lufthansa. Greek banks over the years moved their assets to Switzerland and then to London. Actual debt of Greece is about $300 billion. The assets of the Greek banks are more than $400Billion according to some estimates, but the truth is unknown. Greece government gave money to these Greek banks out of the European fund for development of Greece, as Greece was a poor country when it has joined the European Economic Community. Since 1960, Germany alone has paid around 33 billion deutsche marks (or 66 Billion Euro) in aid to Greece both bilaterally and in the context of the European banks. Greek banks then invested this money in various activities in various countries to multiply the initial assets. Confiscation of these assets can solve the problem of Greece overnight, but that is not the way capitalism works.

In a liquidity crisis Central Banks often step in and use their ability to create fiat money and make loans. For example the UK"s banks have been supported by the Special Liquidity Scheme of the Bank of England to the tune of around £170 billion. Greece does not have her own central bank and so this option does not exist on a national level as her central banking is now controlled by the European Central Bank in Frankfurt since 2001, when Greece joined the European monetary system. European Central Bank(ECB) gave Greece was the ability to use its bonds as collateral for loans at the ECB. Greece gave a large part of these bonds to the Greek Banks, who in turn borrowed more and more to finance their various activities. Apart from the liquidity it provides, estimates of the profits Greek banks made from this in the year 2009 alone were in the region of 3/4 billion Euros.

Role of the US Financial Institutions and the Financial Derivatives:

Greece has come under pressure recently to explain allegations that it used complex financial products, provided by US investment banks, to conceal the true state of its debt pile over the last decade. Greece is also accused of manipulating its figures to gain entry into the European Monetary union in 2001.

Goldman Sachs and other banks set up a new index or derivative, in plain English a bet, in September of this year that investors could use to bet on the likelihood that Western European countries like Greece would default on their debt. The very same company that created this index set up a similar index in early 2006 that allowed investors to bet on the likelihood of defaults in the subprime bond market in USA. That index was a collaboration between two companies Markit and CDS IndexCo, a consortium of 16 banks, including Goldman Sachs. The acting chairman of CDS IndexCo was Goldman Sachs managing director Bradford S Levy. Goldman Sachs and a hedge fund manager John Paulson, who made billions betting against the subprime sector, were the major buyers of these Index or derivative .

Goldman is, in fact, using swaps to bet heavily on the likelihood of a Greek default, At the same time that it is helping Greece to hide its debts. The game plan is fairly simple: create government bonds to hide true levels of debt, then make profitable bets that the government will fail to pay off . This would create a financial crisis. The country would expect other governments and the International Monetary Fund would take the responsibility for its debt. The bets will earn enormous profits for these investment banks.

Goldman Sachs and John Paulson did this with AIG before to create the financial crisis in USA and subsequently for the world, devising complex securities known as "synthetic CDOs" which were composed entirely of bets on a set of mortgage loans given to poor Americans who can not afford these. Paulson has collected the contracts for these mortgage loans, selecting the ones that were most likely to have default. Goldman then created the securities combing these mortgage loan contracts and sold them as investments to investors like AIG ( American Insurance Group). The bets were essentially designed to fail, with Paulson (and Goldman) on the winning end. The hidden cost of default was massive enough to make AIG bankrupt, threaten the world financial system, and necessitate a help from all G-20 countries.

These bailout funds were then passed on to Goldman Sachs. Due to the activities of Goldman Sachs and Paulson, according to the Securities and Exchange Commission of USA, Royal Bank of Scotland and Germany"s IKB Deutsche lost about $1 billion on the deal, which was later financed by the respective governments of Britain and Germany. Similarly, Greek government now has to borrow money from the International Monetary Fund for the game Goldman Sachs and Paulson played. John Paulson"s investment firm earned more than $15 billion in 2007 and Goldman Sachs earned $4.79 billion in the last quarter of 2009 alone. The Greek crisis is created using the similar technique, when Greek banks have enough assets to walk over the crisis.

However, when Greece is dealing with the prospect of financial ruin, Goldman Sachs and Paulson have been speculating heavily in Greek debt markets with a team of 20-30 traders focused on the country. As New York Times reported, that on Jan. 28 and 29 this year, analysts from Goldman Sachs Group Inc. took a group of investors on a field trip to meet with Deputy Finance Minister of Greece and head of other private banks in Greece. Greece appears to have been negotiating for its economic future with Goldman Sachs and its network of hedge fund colluders, many of whom have taken large speculative positions on Greek debt. The Wall Street Journal reported on a Manhattan dinner party where a group of hedge fund managers discussed their bets against the Euro, which is now seriously affected by the crisis in Greece and possible crisis of Spain, Portugal, Ireland, and Italy.

Effects of the Rescue Plan for Greece:

The IMF plan to have any chance of success will tighten Greece"s austerity plan further. Greek GDP is expected to shrink by 3/4% this year as it is and this will fall further if the IMF demands a further tightening. The Greek government is seeking to reduce the budget deficit from 14 percent to 4 percent of Greece"s gross domestic product (GDP), which stands at roughly ?245 billion. A proportionate reduction would amount to $1.4 trillion in government spending cuts in the US, or ?241 billion worth of state spending cuts in Germany. As it absorbs the impact of these cuts, the Greek economy is expected to contract by 4 percent this year-compared to previous estimates of a contraction of 0.3 percent.

Public sector workers face a 15 percent cut in their official wages with a reduced bonus capped at a maximum of ?1,000 per year, available only for workers with monthly salaries under ?3,000. Wages will then be frozen until 2014. Other bonuses-a large portion of public-sector workers" total pay-will be cut by 8 percent, on top of previous cuts of 12 percent.

Pensioners also face massive cuts. The retirement age-65 for men, 60 for women-will be increased and indexed in relation to life expectancy, while the pay-in period to receive a full pension will increase from 37 to 40 years. Pensions will be calculated from the average yearly salary a worker has earned over the course of his working life, and not the last yearly salary he received. In the private sector, a new minimum salary will be put in place for young workers, and the government plans to scrap legislation barring companies from firing more than 2 percent of their total work force in any given month, while loosening guidelines on severance packages.

Sales taxes-which fall most heavily on the working class-will be increased by 2 percent, to 23 percent, after a two-percent increase in March, with a further 10 percent increase on fuel, alcoholic beverages, and tobacco products. Property taxes will also increase, and Athens announced a one-time tax on "highly profitable" companies.

Greece also plans to privatize mass transit and utilities-moves that will doubtless dramatically increase user fees, just as workers face plunging wages and rising unemployment. There will also be large cuts in spending on hospital equipment and medical care.

Conclusion:

There were two reasons behind the financial crisis of 2008; both of them are the result of this liberalization of the economy started since 1980s. The first is the idea that people can take care of their housing needs without any help from the government. The second is to consider liability as asset by building some new financial schemes to turn speculative gambling bets on future market as respectable assets. Neither of these can happen if there is a public ownership of financial institutions and if the government takes the responsibility for the basic needs of the people. Greece is now a victim of both the speculative activities of the global investment banks and corruptions and greed of the private sector companies and banks of Greece.

The stream of virtual money or derivatives are nothing but some kind of gambling bets on the expected future prices of various commodities, gold, shares of companies, rate of interests and exchange rates of various countries and of course the price of these Mortgage Backed Securities. It has created gambling casinos in the futures market, where different financial institutions are betting for the future values of various financial instruments. These betting have resulted into more and more bankruptcies of famous institutions like Barring Bank or Equitable Life Insurance Company. The game went on describing what can be called dangerous financial risks as assets just by attaching values on them. The fundamental idea is that past bahaviours can predict the future. However, there is one very important lesson from the past is missing here: the experience of 1930"s crash of the US Stock market, that speculative bubble would burst sooner or later and no mathematics can predict when that would happen.

Another factor that has contributed to the crisis is the greed of the corporate managers of these financial institutions. Getting intoxicated by the creation of the virtual money using bets on the financial futures they have rewarded themselves astonishing salaries which sometime higher than national incomes of most countries.

Citigroup"s Sanford Weill was paid $44.6 million as his annual income for his work as chairman and CEO. Merrill Lynch"s president and CEO, E. Stanley O"Neal, received $28 million as his annual income. James Cayne, chairman and CEO of Bear Stearns, another big investment house that went bankrupt recently, earned more than $39 million per year recently. In simple words the senior executives of all private financial institutions in the Anglo-American countries looted the depositor"s money.

The combined wealth of these billionaires reached $1.9 trillion. The wealth of these few hundred people exceeds the gross domestic product of the world"s 170 poorest countries combined, and equals nearly 4 percent of the annual production of the entire world. The world"s top three billionaires alone possess more assets than the combined Gross National Product of all the least developed countries and their combined population of 600 million people. While 1.3 billion people struggle to live on less than $US1 a day, the world"s richest 200 people have their net worth more than $1 trillion.

However, their greed has no limit. After nearly destroying the financial system of both USA and UK, they are now trying to ruin country after country by offering them loans and creating derivative or bets that the country cannot pay back the loans. They know that richer countries like Germany and IMF would not allow a country like Greece to go bankrupt. However, ultimately the people of Greece will have to pay, for the corruption and short sightedness of its Government and the corruption and greed of the captains of its private sector, in terms of their much lower standard of living.

India has a lesson to learn from the Greek tragedy. Indian companies are borrowing heavily in the international market to acquire properties abroad. India also allows huge amount of short-term borrowings by its institutions from the international market. International private financial institutions are allowed to operate in the Indian stock market, real estate market and in the food and agricultural market, thus creating inflation. Thus, India is getting more and more exposed to the speculative games that these financial institutions play to ruin a country. In 1998, several East Asian countries became their victims, in the same way as Greece and several European countries are today.


Dr.Dipak Basu

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