There are plenty of reasons to be freaked out by the banking and sovereign debt crisis now reaching a crescendo in Europe. But one factor that’s gotten little attention could turn this Very Bad Situation into a True Calamity.
It’s this: Regulators here and in Europe have no idea — repeat, no idea — of the full extent of the derivatives exposure that could be triggered by an “official” Greek default, or by the failure of a major French bank. And if the people in charge have no clue as to the fallout from what may be trillions of dollars in side bets waiting to be triggered in a catastrophic cascade, they’re basically flying blind.
Matt Miller
A senior fellow at the Center for American Progress and co-host of public radio’s “Left, Right & Center,” Miller writes a weekly column for The Post.
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If it strikes you as insane that officials don’t know the exposure of these derivatives, given the havoc these “financial weapons of mass destruction” wreaked last time, you’re thinking clearly. The idea that we could be back on the edge of a Lehman/AIG-style implosion, just three years after the near-death experience of 2008, defies all presumptions about the human species’ capacity for learning. But then, Darwinian optimism leaves little room for the greed and myopia driving the global banking lobby today — or for the industry’s destructive power to kill or defer common-sense reform.
Remember, it was always odd that problems in the relatively small market for subprime mortgages could have brought the global economy low. The reason they did was because these subprime woes were massively amplified by trillions in side bets placed on these mortgages via exotic derivatives. “Naked credit default swaps” allowed parties with no interest in the underlying mortgages to place huge bets on whether borrowers would or would not perform. Fear of the explosive power of this casino — and its hidden concentration in a reckless, “too-interconnected-to-fail” giant like AIG — led U.S. officials to cough up no less than $180 billion in taxpayer money to pay off these bets in full. These officials, fearing a meltdown, treated sophisticated derivatives traders exactly as they would treat innocent consumer depositors in a failing bank, as people to be protected at 100 cents on the dollar.
It was, and is, grotesque.
Today, Greece’s economy is roughly the size of the economy of Massachusetts. The notion that its debt problems could bring down the global financial system seems absurd.
Except for two things. First, many European banks holding Greek debt are so thinly capitalized (another way of saying “so imprudently managed”) that even tiny Greece’s default could wipe them out. Yet Europe’s emerging plan to cover this capital shortfall is tragically inadequate.
As Douglas Elliott, a former investment banker now at the Brookings Institution, points out, the plan to add 100 billion euros in capital represents a 10 percent capital boost for the top 90 banks, which have about a trillion euros in capital today. But since they also have around 27 trillion euros in assets, this new capital would protect them against a further decline of less than half a percentage point in the value of their assets.
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