How Greece Could Take Down Wall Street
By Ellen Brown
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Global Research, February 21, 2012
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In an article titled “Still No End to ‘Too Big to Fail,’” William Greider wrote in The Nation on February 15th:
Financial
market cynics have assumed all along that Dodd-Frank did not end "too
big to fail" but instead created a charmed circle of protected banks
labeled "systemically important" that will not be allowed to fail, no
matter how badly they behave.
CDS are a form of derivative taken out by investors as insurance against default. According
to the Comptroller of the Currency, nearly 95% of the banking
industry’s total exposure to derivatives contracts is held by the
nation’s five largest banks: JPMorgan Chase, Citigroup, Bank of America,
HSBC, and Goldman Sachs. The CDS market is unregulated, and there is no requirement that the “insurer” actually have the funds to pay up. CDS are more like bets, and a massive loss at the casino could bring the house down.
It could, at least, unless the casino is rigged. Whether a “credit event” is a “default” triggering a payout is determined by the
International Swaps and Derivatives Association (ISDA), and it seems
that the ISDA is owned by the world’s largest banks and hedge funds. That means the house determines whether the house has to pay.
The
Houses of Morgan, Goldman and the other Big Five are justifiably
worried right now, because an “event of default” declared on European
sovereign debt could jeopardize their $32 trillion derivatives scheme. According to Rudy Avizius in an article on The Market Oracle (UK) on February 15th, that explains what happened at MF Global, and why the 50% Greek bond write-down was not declared an event of default.
If you paid only 50% of your mortgage every month, these same banks would quickly declare you in default. But the rules are quite different when the banks are the insurers underwriting the deal.
MF Global: Canary in the Coal Mine?
MF Global
was a major global financial derivatives broker until it met its
unseemly demise on October 30, 2011, when it filed the eighth-largest
U.S. bankruptcy after reporting a “material shortfall” of hundreds of
millions of dollars in segregated customer funds. The
brokerage used a large number of complex and controversial repurchase
agreements, or "repos," for funding and for leveraging profit. Among
its losing bets was something described as a wrong-way $6.3 billion
trade the brokerage made on its own behalf on bonds of some of Europe’s
most indebted nations.
Avizius writes:
[A]n
agreement was reached in Europe that investors would have to take a
write-down of 50% on Greek Bond debt. Now MF Global was leveraged
anywhere from 40 to 1, to 80 to 1 depending on whose figures you
believe. Let’s assume that MF Global was leveraged 40 to 1, this means
that they could not even absorb a small 3% loss, so when the “haircut”
of 50% was agreed to, MF Global was finished. It tried to stem its
losses by criminally dipping into segregated client accounts, and we all
know how that ended with clients losing their money. . . .
However,
MF Global thought that they had risk-free speculation because they had
bought these CDS from these big banks to protect themselves in case
their bets on European Debt went bad. MF Global should have been
protected by its CDS, but since the ISDA would not declare the Greek
“credit event” to be a default, MF Global could not cover its losses,
causing its collapse.
The house won because it was able to define what “ winning” was. But what happens when Greece or another country simply walks away and refuses to pay? That is hardly a “haircut.” It is a decapitation. The asset is in rigor mortis. By no dictionary definition could it not qualify as a “default.”
That sort of definitive Greek default is thought by some analysts to be quite likely, and to be coming soon. Dr. Irwin Stelzer, a senior fellow and director of Hudson Institute’s economic policy studies group, was quoted in Saturday’s Yorkshire Post (UK) as saying:
It’s
only a matter of time before they go bankrupt. They are bankrupt now,
it’s only a question of how you recognise it and what you call it.
Certainly they will default . . . maybe as early as March. If I were them I’d get out [of the euro].
The Midas Touch Gone Bad
In an article in The Observer (UK) on February 11th titled “The Mathematical Equation That Caused the Banks to Crash,” Ian Stewart wrote of the Black-Scholes equation that opened up the world of derivatives:
The financial sector called it the Midas Formula and saw it as a recipe for making everything turn to gold. But the markets forgot how the story of King Midas ended.
As Aristotle told this ancient Greek tale, Midas died of hunger as a result of his vain prayer for the golden touch. Today, the Greek people are going hungry to protect a rigged $32 trillion Wall Street casino. Avizius writes:
The
money made by selling these derivatives is directly responsible for the
huge profits and bonuses we now see on Wall Street. The money masters
have reaped obscene profits from this scheme, but now they live in fear
that it will all unravel and the gravy train will end. What these banks
have done is to leverage the system to such an extreme, that the entire
house of cards is threatened by a small country of only 11 million
people. Greece could bring the entire world economy down. If a default
was declared, the resulting payouts would start a chain reaction that
would cause widespread worldwide bank failures, making the Lehman
collapse look small by comparison.
Some observers question whether a Greek default would be that bad. According to a comment on Forbes on October 10, 2011:
[T]he
gross notional value of Greek CDS contracts as of last week was €54.34
billion, according to the latest report from data repository Depository
Trust & Clearing Corporation (DTCC). DTCC is able to undertake
internal netting analysis due to having data on essentially all of the
CDS market. And it reported that the net losses would be an order of
magnitude lower, with the maximum amount of funds that would move from
one bank to another in connection with the settlement of CDS claims in a
default being just €2.68 billion, total. If
DTCC’s analysis is correct, the CDS market for Greek debt would not
much magnify the consequences of a Greek default—unless it stimulated
contagion that affected other European countries.
It is the “contagion,” however, that seems to be the concern. Players
who have hedged their bets by betting both ways cannot collect on their
winning bets; and that means they cannot afford to pay their losing
bets, causing other players to also default on their bets. The
dominos go down in a cascade of cross-defaults that infects the whole
banking industry and jeopardizes the global pyramid scheme. The
potential for this sort of nuclear reaction was what prompted
billionaire investor Warren Buffett to call derivatives “weapons of
financial mass destruction.” It is also why the banking system cannot
let a major derivatives player—such as Bear Stearns or Lehman
Brothers—go down. What is in jeopardy is the derivatives scheme itself. According to an article in The Wall Street Journal on January 20th:
Hanging
in the balance is the reputation of CDS as an instrument for hedgers
and speculators—a $32.4 trillion market as of June last year; the value
that may be assigned to sovereign debt, and $2.9 trillion of sovereign
CDS, if the protection isn't seen as reliable in eliciting payouts; as
well as the impact a messy Greek default could have on the global
banking system.
Players in the future may simply refuse to play. When the house is so obviously rigged, the legitimacy of the whole CDS scheme is called into question. As MF Global found out the hard way, there is no such thing as “risk-free speculation” protected with derivatives.
Ellen Brown is an attorney and president of the Public Banking Institute, http://PublicBankingInstitute.org. In Web of Debt,
her latest of eleven books, she shows how a private cartel has usurped
the power to create money from the people themselves, and how we the
people can get it back. Her websites are http://WebofDebt.com and http://EllenBrown.com.
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Monday, March 26, 2012
How Greece Could Take Down Wall Street
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