U.S. and foreign stock markets continue to zigzag wildly in response to expectations about whether the euro can survive, in the face of populations suffering under neoliberal austerity policies being imposed on Ireland, Greece, Spain, Italy, etc. Here’s the story that I’m being told by Europeans regarding the recent turmoil in Greece and other European debtor and budget-deficit economies. (The details are not out, as the negotiations have been handled in utter secrecy. So what follows is a reconstruction.)
In autumn 2012, it became apparent that Greece could not roll over its public debt. The EU concluded that debts had to be written down by 50 percent. The alternative was outright default on all debt. So basically, the solution for Greece reflected what had happened to Latin American debt in the 1980s, when governments replaced existing debts and bank loans with Brady bonds, named for Reagan Treasury Secretary Nicolas F. Brady. These bonds had a lower principal, but at least their payment was deemed secure. And indeed, their payments were made.
This write-down seemed radical, but European banks already had hedged their bets and taken out default insurance. U.S. banks were the counterparties to much of this insurance.
In December (?) 2011, a quarter century after Mr. Brady, Mr. Obama’s Secretary Geithner went to Europe met with EU leaders to demand that Greece make the write-downs voluntary on the part of banks and creditors. He explained that U.S. banks had bet that Greece would not default – and their net worth position was so shaky that if they had to pay on their bad gambles, they would go broke.
As German bankers have described the situation to me, Mr. Geithner said he would kill the European banks and economies if they did not agree to take it on the chin and suffer the losses themselves – so that U.S. banks would not have to pay off on the collateralized default swaps (CDOs) and other gambles for which they had collected billions of dollars.
Europeans were enraged. But Mr. Geithner made a deal. OK, he finally agreed: The White House would indeed permit Greece to default. But America needed time.
He agreed to open a credit line from the Federal Reserve Bank to the European Central Bank (ECB). The Fed would provide the money to lend to banks during the interim when European government finances faltered. The banks would be given time to unwind their default guarantees. In the end, the ECB would be the creditor. It – and presumably the Fed – would bear the losses, “at taxpayer expense.” The U.S. banks (and probably the European ones too) can avoid taking a loss that would wipe out their net worth.
What really are the details? What we do know is that U.S. banks are pulling bank their credit lines to European banks and other borrowers as the old ones expire. The ECB is stepping in to fill the gap. This is called ‘providing liquidity,’ but it seems more to be a case of providing solvency for a basically insolvent situation. A debt that can’t be paid, won’t be, after all.
Geithner’s idea is that what worked before will work again. When the Federal Reserve or Treasury picks up a bank loss, they simply print government debt or open a Federal Reserve bank deposit for the banks. The public doesn’t view this as being as blatant as simply handing out money. The government says it is “saving the financial system,” without spelling out the cost at “taxpayer expense” (not that of the banks!).
It’s a giveaway.
Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) and Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy. He can be reached via his website, firstname.lastname@example.org.