PITTSBURGH — Greece’s financial peril is a reminder that unregulated, complex financial instruments can pose hefty risks for governments much as they can destroy the balance sheets of big banks and companies willing to make wagers that they don’t have the money to cover — whether they be swaps or sub-prime mortgages.
Though the effects of unregulated hedging are the same whether in the U.S. or Europe, there is no global consensus on how to use regulation to eliminate ploys that disguise the real financial condition of either a country like Greece or a company like the AIG Group, the collapsed American insurer that took a $180 billion federal bailout.
Greece’s near financial collapse and pleas for help from Washington and the EU countries have much in common with the financial meltdown in the U.S. 18 months ago. A combination of running up explosive debt and then disguising it with inscrutable financial instruments like credit default swaps, a form of insurance against bond defaults, has been contributing to the ongoing global financial crisis.
Greece’s predicament presents yet another opportunity to consider how governments worldwide might use regulation to avoid the near bankruptcy of countries, trillion-dollar bailouts of banks and corporations, exorbitant bonuses, hidden deficit spending and resultant recessions that cause unemployment and financial misery for everyone.
Peter Morici, former chief economist at the U.S. International Trade Commission and now a professor at the University of Maryland business school, said credit default swaps and speculators did not cause Greece’s collapse, especially since not many swaps were written against Greece’s $400 billion in outstanding debt. They may have covered up the problem by “putting off the day of reckoning,” but the real problem is “a big deficit and a squirrely government,” he said.
Greece has insisted that speculative trading in the instruments boosted the cost of the country’s borrowing power as speculative trading in swaps intensified, the bet being the country’s debt would worsen.
That was the message that Greek Prime Minister George Papandreou brought to the U.S. in a White House visit with President Barack Obama early this month. His plea was that countries should regulate speculative trading in swaps.
Papandreou said he got a sympathetic ear from Obama. He might also take comfort in knowing that the head of the Commodity Futures Trading Commission in the U.S., Gary Gensler, has become a believer in bringing regulation to the derivatives market, where deals are unregulated and privately arranged.
“We must now bring comprehensive reform to the over-the-counter derivatives market. Effective reform cannot be accomplished by any nation alone. It will require a comprehensive, international response. With the significant majority of the worldwide OTC derivatives market being conducted in the U.S. and Europe, the effectiveness of reform depends on our ability to cooperate and find general consensus on this much needed regulation,” said Gensler in a speech March 18 at a Chatham House conference on financial regulation in London.
However, 18 months after near collapse of the U.S. economy and ongoing debt crises in Europe, the U.S. Congress has not settled on the terms of broad financial reform. Current discussion centers on legislation introduced by Sen. Chris Dodd (D-Conn.), which is being picked apart by lobbyists.
The crisis in Greece, and the revelation that Goldman Sachs Group Inc., beginning in 2000, sold Athens on cross-currency swaps that made its debt appear smaller, has focused European countries on how to shore up Greece’s economy.
European finance ministers meetings in Brussels recently decided on a standby lending arrangement for Greece, but there is much criticism and unhappiness over Greece’s profligate spending. The European Union also is actively working on the banning of speculative trading in credit-default swaps where only legitimate investors could hedge against defaults by borrowing nations.
Gensler, noting that is it is unclear how such a ban would technically work, is pushing for forcing sellers of derivatives, like banks, to trade on public exchanges and have enough capital to cover a “credit event.”
Greece, meanwhile, is concentrating on spending cuts, tax increases, and selling more bonds since it is not likely to get an AIG-style bailout from its eurozone counterparts no matter how tragic its future looks. The only thing certain about the future is this: No country is alone, and no regulatory prescription in one country is enough.