Holding Hostage the World Economy

Standard and Poor, one of the rating agencies that gleefully rubber stamped toxic assets as AAA grade investment vehicles for years, has declared that if the investors do not get fully all the benefits they were entitled to expect when they bought Greek securities, they will declare all solutions as technical defaults.

Standard & Poor’s said Monday that it “views certain types of debt exchanges and similar restructurings as equivalent to a payment default”: when a transaction is seen as “distressed rather than purely opportunistic” and when it results “in investors receiving less value than the promise of the original securities.”

Translation: Not only will we not accept any "haircut" deal for our buddies the banksters, we will bring the whole system down unless they are paid in full what they are owed.

It essentially means that there is no risk left in capitalism for these players.

If they gamble, as they did with the housing bubble, they need to be bailed out because they are too big to fail. If they invest in risky ventures (priced accordingly by the way) they are entitled to their money if the ventures go south.

How can they do that?

Well by now everyone has heard about the credit default swaps, the largely unregulated arrangements that enable large financial institutions to make high risk and high return investments and be insured for them. The most famous example was AIG that went down during the height of the 2008 crisis and needed a $200 billion bailout.

Depending on how many such contracts were written on the European debt, a technical default could have enormous implications for not just the EU banks but a lot of other financial institutions as well. As the NY Times put it:

More worryingly, Western banks, including the giants of Wall Street, have built a tower of credit default swaps — essentially insurance — on the debts of those countries, and the cost of paying up in a default would be huge. While the French and German banks have the biggest direct exposure to Greek's debt, it is American banks and insurance companies that would have the largest obligations to cover payments to those holding the swaps. 

A finding by the credit ratings agencies of default would also require the E.C.B. to impose discounts, known as haircuts, on the Greek debt it has accepted as collateral. That would inflict more financial pain on banks holding that debt.        

In other words, even the restructuring of debt not by a haircut but by spreading returns over time was not acceptable to these agencies: they want their buddies' money and they want it now.

The question everyone should be asking why were the financial institutions given such an unregulated casino tool and why is no one is doing anything about it?

I understand that it is impossible to get any reforms passed in the US as "they own the place" but what about Europe?

On a somewhat related note, Le Monde reports today that Christine Lagarde will follow a policy line very similar to DSK's.

Le bilan de DSK au FMI est le suivant. Profitant du tremplin de la crise, il a rendu au Fonds un rôle de sauveteur financier, une légitimité en donnant plus de place aux pays émergents dans ses préoccupations et dans son fonctionnement. De facto, le FMI est devenu le secrétariat du G20, l'inventeur de formules que les chefs d'Etat et de gouvernements ont reprises.
Enfin, il a rendu au personnel du FMI le moral qu'il avait perdu. M^me Lagarde a présenté au Conseil d'administration du FMI un programme qui ressemble furieusement à celui qu'appliquait DSK, y compris dans son souci nouveau des conséquences sociales de la crise et des remèdes à mettre en place par le FMI.

I hope so but I am not so sure.

What Dominique Strauss-Kahn did was to use the crisis to inject a heavy dose of Keynesianism into the strict monetarist perspective of IMF. Those were the confused days of "too big to fail" and to avoid a meltdown they did not object. But by now, these forces have regrouped and they will not allow any such heresy anymore.

If we learn in the next weeks that the rating agencies changed their mind about "technical default" we will know that the financial sector was given a major concession on something very important to them. Otherwise they will play the game of chicken to the end and not even IMF can do anything about it.

I gather rioting Greek people think that their politicians are turncoats who sold them out but I have a feeling that Papandreou and his allies acted the way they did because they were told of the consequences of a default by their European counterparts. And they all must be scared beyond words.

Remember, Hank Paulson coming in on a weekend in September 2008, with a two and a half page proposal asking $700 billion and telling everyone if it is not approved right away the whole world would collapse?

And everybody caving in?

We are looking at a different version of the same play.

Welcome to the world of Galtian Overlords.