Hedge funds probe exposes heart of Greek crisis

Saturday, March 6, 2010

THE JUSTICE DEPARTMENT has ordered several U.S. hedge funds to retain records relating to trading in the euro, perhaps for a probe of speculators' role in the Greek debt crisis that has hammered the European currency. Justice's action lends a measure of validation to the many European officials who blame the "hedgies" for colluding against the euro beyond what economic fundamentals warrant. Indeed, European Union regulators are discussing measures to limit betting on government bonds that the speculators don't actually hold -- so-called "naked" credit default swaps.

The European authorities and Justice -- as well as the Federal Reserve and the Securities and Exchange Commission -- must pursue any credible accusations of wrongdoing. We certainly wouldn't put it past the hedgies to pull a fast one on Greece or anyone else. But we doubt hedge fund misbehavior, if any, will be shown to account for most or even much of Greece's woes, let alone Europe's.

The fundamental problem here is that, in the decade since it joined the euro area, Athens has consistently run massive budget deficits, in violation of European Union rules, and then disguised them with less-than-honest bookkeeping. The responsible E.U. and member state officials essentially did nothing about it. Perhaps Goldman Sachs enabled Greece's chicanery with cleverly designed currency swaps in 2001, as has been reported. But, as the Wall Street Journal has reported, this maneuver might have masked a tenth of a percent of gross domestic product in deficits -- not much compared with the current total of 12.7 percent of GDP.

To be sure, much Greek red ink reflects the cyclical impact of the recession. But an awful lot of it is structural, the consequence of subsidies, rampant tax evasion and lush pensions for Greek civil servants. Germany, where the retirement age is 67, is rightly wondering why it should help refinance a country where the retirement age, until now, has been 61.

To its credit, the new Greek government of Prime Minister George Papandreou has responded with reforms designed to cut the deficit to 3 percent of Greece's GDP by 2012. To their credit, German and French officials are demanding even more -- and it remains to be seen whether Mr. Papandreou can withstand the political backlash against austerity. Greece successfully floated a bond issue this week, albeit at high interest.

No doubt politicians from Berlin to Athens would have preferred to keep pretending that 16 countries could employ a single currency without an enforceable common fiscal policy. But the hedge funds called this massive bluff. Before retaliating, government authorities should factor in the possibility that the hedgies merely precipitated a crisis that Europe was going to have to face sooner or later. Now at least Europe has a chance to fix its economic architecture before things got even worse. Speculators have made a killing off Greece's short-term misfortune. But maybe they did Europe a long-term favor.

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