Banking on the illogical

The EU’s policies to overcome the Europe wide banking crisis seem beyond the understanding of all but the self-appointed economic elite. That is because, as Conor McCabe explains, they actually do not make sense.

It is often said that a definition of insanity is to do the same action over and over again, each time expecting a different result. In that case, the European Financial Stability Facility (EFSF), Ireland’s single-largest creditor, is a 21st century Bedlam.
Originally set up as a temporary measure, the EFSF was created in June 2010 in order to preserve the financial stability of the euro area by providing financial assistance to member states who found themselves in difficulty. It does this by selling bonds, and from the money raised it provides funds (with interest) to the financially-distressed states.
The EFSF takes bad loans, and by putting them together, turns them into good loans. It uses a financial
instrument similar to that used by institutions in the run-up to the 2008 financial meltdown – whereby
subprime mortgages were bundled together with other loans and sold as one good loan. These instruments
are known as collateralised debt obligations.
In February 2011 the Financial Times explained that, technically, the EFSF is not a collateralised debt obligation ‘but a special purpose vehicle that essentially pools guarantees and loans from stronger euro members to give it a top triple
A credit rating.’ The difference, however, is in definition, not in usage.
The economist Nouriel Roubini wrote in January 2011 that the EFSF was an instrument whereby ‘you take a bunch of dodgy less than AAA sovereigns (& some semi-insolvent) and try to package a vehicle that gets [an] AAA rating.’
And it is this process of bundling bad debt into bonds which are guaranteed by good lenders which makes it akin to the ‘financial weapons of mass destruction’ which almost brought down the US and European banking systems.
The loans are still bad, the sovereign states are still distressed – it is only the guarantee that has changed. The bonds are valued not so much on the loans themselves, but on the guarantee which comes with them. The risk has not gone
away. It has merely shifted from one place to another, from bad lenders onto good.
The reasons why the sovereign states find themselves distressed in the first place are not addressed in any shape or form. In Ireland’s case, the transfer of private banking debt into sovereign debt, alongside three years of deflationary budgets, has left the economy in statis, while debt obligations are transformed into triple-A bonds via the EFSF – making the EFSF a profit in the meantime.
The Greek economist, Yanis Varoufakis, explained the procedure in a blog post in February 2011.With Ireland and Greece frozen out of the money markets, ‘the EFSF loans for Ireland were raised from the money markets by the EFSF on the strength of guarantees issued by the remaining 15 eurozone states, in proportion to their GDP.’
The total raised was then ‘cut up in small packets, each containing a slice that was guaranteed by Germany, another by France, another by Portugal’ and so on. Given that each country had different degrees of creditworthiness, each was charged a different interest rate, before the packets were sold off as bonds, ‘mostly to Asian investors and to Europe’s own quasi-bankrupted banks’.
This means that Portugal, already on the verge of bankruptcy, had to borrow, at high interest rates, on Ireland’s behalf, thus adding to that country’s already strained debt obligations.” Were another Eurozone state to be forced to leave the
money markets, as has happened to Greece, Ireland and Portugal the EFSF would then have to issue new debt on behalf of the remaining eurozone countries, to help it.
In other words, 13 countries rasing money for four, until another defaults, then it’s 12 countries raising for five, and so on ‘until the bank of nations within the EFSF is so small that they cannot bear the burden of total debt on their shoulders.’
The complete lack of engagement with the problems facing the Irish economy – deflationary policies, falling tax returns, unemployment and emigration – in lieu of a credit solution for its bankrupt banking system, reveals a certain truth about the EFSF. The purpose of the bailout is not to help the Irish economy to recover – these are not investment loans, after all – but to ensure that European financial institutions are guaranteed a return on their loans to Irish banks: those private loans which are now part of Irish sovereign debt and which the present government is determined to protect, to the detriment of us all.
However, because new debt is being created for the sole purpose of servicing old debt, it is only a matter of time before another financial crash befalls Europe. It is not possible to repeat the same action and arrive at a different outcome.

[For those interested in the issues surrounding the EU debt crisis, Varoufakis’ blog is essential reading. The address is:]

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