In the eye of the storm: the debt crisis in the European Union (5/7)
23 September 2011 by Eric Toussaint
In July-September 2011 the stock markets were again shaken at international level. The crisis has become deeper in the EU, particularly with respect to debts. The CADTM interviewed Eric Toussaint about various facets of this new stage in the crisis.
CADTM: You haven’t talked about Credit Default Swaps (CDSs) yet.
Eric Toussaint: CDSs are a derivative financial product which is not submitted to any form of public control. They were created in the first half of the 1990s in the middle of the era of deregulation. Credit Default Swap literally means permutation of unpaid debts. Normally, it should allow the holder of a loan to obtain compensation from the CDS seller in the case of default by the bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. -issuer, whether a government or a private company. I use the conditional for two main reasons. Firstly, a CDS can be bought as protection against the risk of non repayment of a bond that the buyer does not have. This is the same as taking out insurance for the house next door, hoping that it will catch fire so that one can get the money. Secondly, CDS sellers do not begin by banking enough funds to indemnify victims of defaults. If a whole lot of private companies having issued bonds should go bankrupt, or if a major lender State should default on payments, it is quite certain that CDS sellers would be incapable of indemnifying as promised. In 2008, the collapse of the North-American company AIG, the biggest international insurance company (which was actually nationalized by Bush to avoid the consequences of bankruptcy) and that of Lehman Brothers were directly linked to the CDS market. AIG and Lehman had both been very active in this sector.
The CDS enables all sorts of manipulations. I had the opportunity to observe closely an attempt at manipulation when I was a member of the audit commission for the internal and external debts set up by the government of Ecuador in 2007, which delivered its report in September 2008. While we were auditing the Ecuadorian debt and President Rafael Correa was threatening to stop paying the illegitimate part of the debt to the international money markets, a private North-American company contacted the Ecuadorian government with a most edifying proposal. The company suggested that President Correa should let it be known that he was going to suspend payments just before the next due-date three weeks later. This would enable the company to sell CDSs for a value they had calculated at USD 300 million. The final outcome was supposed to be as follows: in reality, Ecuador would pay what it owed as usual. This would mean that the company would not need to indemnify the CDS holders and it would give half the proceeds to the Ecuadorian government. The company claimed that this operation was completely free of any risk of prosecution as it would be an over-the-counter transaction outside US government control. It claimed to have already carried out similar transactions on several occasions. In the end, the Ecuadorian government refused the offer, opting for another strategy which produced good results. The point about this true-life story is that it illustrates that issuers and buyers of CDSs can carry out all sorts of manipulations. Let us not forget that right up until the AIG disaster and the collapse of Lehman Brothers, the IMF
IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.
When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.
As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).
The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
http://imf.org
, the US Federal Reserve
FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.
FED – decentralized central bank : http://www.federalreserve.gov/
and the ECB
ECB
European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.
https://www.ecb.europa.eu/ecb/html/index.en.html
repeatedly claimed that CDSs were a new product that offered excellent guarantees
Guarantees
Acts that provide a creditor with security in complement to the debtor’s commitment. A distinction is made between real guarantees (lien, pledge, mortgage, prior charge) and personal guarantees (surety, aval, letter of intent, independent guarantee).
against risks (see the box on CDSs). Since then, their discourse has changed, but nothing, absolutely nothing, has been done to regulate the CDS market. Meanwhile, in view of the size of the phenomenon, CDSs constitute a huge time-bomb hanging over the international finance system. The fact is that CDS should be outlawed.
CADTM: How much responsibility do rating agencies bear for the crisis?
Eric Toussaint: The North-American Standard & Poor’s and Moody’s and the Franco-American Fitch are the three private agencies which rule the roost regarding credit ratings and the credibility of bond issuers, whether they be State or corporate. [6] They have existed for almost a century but it was not until the 1970s-1980s, with the financialization of the economy, that their business took a sudden leap. However they are constantly in a situation of conflict of interests. Until the 1970s, it was the prospective buyers of bonds issued by the State and by companies who paid rating agencies for their advice on the quality of the issuers. Since then, the situation has been completely reversed: now it is the issuers of bonds who pay the agencies to rate them. What motivates the government and the companies is of course to get good ratings so that they can pay the lowest possible interest rates
Interest rates
When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…
The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
to those who buy their bonds. Let us recall that until the eve of the collapse of Enron in 2001, highly paid rating agencies attributed top marks to the power supplier. Again, in 2008, it was the same story with the investment banks, Merril Lynch and Lehman Brothers. And again with Greece in 2009-early 2010. These are ample demonstrations of the harm they do. They should be sued for the damage caused by the results of the ratings they hand out. Risk assessment is a task which should only be entrusted to public bodies.
End of the fifth part
Translated by Christine Pagnoulle and Vicki Briault in collaboration with Judith Harris
Éric Toussaint, doctor in political sciences (University of Liège and University of Paris 8), president of CADTM Belgium, member of the president’s commission for auditing the debt in Ecuador (CAIC), member of the scientific council of ATTAC France, coauthor of “La Dette ou la Vie”, Aden-CADTM, 2011, contributor to ATTAC’s book “Le piège de la dette publique. Comment s’en sortir”, published by Les liens qui libèrent, Paris, 2011.
[1] See the first part “Greece”, the second part “The great Greek bond bazaar” the third part “The ECB, ever loyal to private interests” and the fourth part “A European Brady deal: austerity for life”
[2] Alan Greenspan, The Age of Turbulence, Adventure in a New World, London, Penguin, 2007, pp. 371-2.
[3] See http://www.imf.org/external/pubs/ft/scr/2007/cr07265.pdf. For more on the IMF’s errors of judgement concerning the USA and Ireland, see: François Sana “Zéro de conduite pour le FMI”
[4] Financial Times, “Deutsche hedges Italian risk”, 27 July 2011, p. 13.
[5] Financial Times, “Greek rescue plan worries hedge funds”, supplement FTfm, 8 August 2011.
[6] There are others, such as the Chinese Dagong, but they have little influence.
is a historian and political scientist who completed his Ph.D. at the universities of Paris VIII and Liège, is the spokesperson of the CADTM International, and sits on the Scientific Council of ATTAC France.
He is the author of Greece 2015: there was an alternative. London: Resistance Books / IIRE / CADTM, 2020 , Debt System (Haymarket books, Chicago, 2019), Bankocracy (2015); The Life and Crimes of an Exemplary Man (2014); Glance in the Rear View Mirror. Neoliberal Ideology From its Origins to the Present, Haymarket books, Chicago, 2012, etc.
See his bibliography: https://en.wikipedia.org/wiki/%C3%89ric_Toussaint
He co-authored World debt figures 2015 with Pierre Gottiniaux, Daniel Munevar and Antonio Sanabria (2015); and with Damien Millet Debt, the IMF, and the World Bank: Sixty Questions, Sixty Answers, Monthly Review Books, New York, 2010. He was the scientific coordinator of the Greek Truth Commission on Public Debt from April 2015 to November 2015.
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When President Joe Biden says that the US never denounced any debt obligation it’s a lie to convince people that there is no alternative to a bad bi-partisan agreement
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