Ann Pettifor

Why EU Summit futile: this is a global banking crisis


With thanks to Nomura International Securities and Bloomberg

I have been banging on about how this is a global banking crisis, not a eurozone crisis, for some time now. So I find it poignant to watch European politicians and their advisers in Brussels, piling the pressure on their own shoulders and frantically sweating over a solution to “the eurozone crisis”.

The fact is the eurozone is a side show. This is a global financial crisis, and Graph 1 proves it. It shows the Credit Default Swap (CDS) Spreads on EU and US banks (hat tip to Uldis Zelmenis).

CDS’s are an unregulated form of insurance against default by a borrower. Unregulated because speculators can take out this insurance against assets (e.g. loans) they do not own. That is akin to taking insurance out on your neighbour’s house.

The incentive to burn it down and collect is a powerful one – which is why regulators bar you from doing so. But hey, in the City of London’s shadow banking system, anything goes. The rise in these CDSs, and the ‘spread’ or gap between the price of European and American bank CDSs, tells the whole terrifying story.

Namely, while naive European politicians are focusing the attention of their citizens on an issue that is largely marginal to the crisis – eurozone budget deficits – speculators are betting on something far more calamitous: a collapse of the global financial system.

And American banks are deemed more risky than European banks.

Given this context, it is deeply ironic the British prime minister is in Brussels today to defend the interests of the City of London. Ironic because it is the City’s “loose, lax and unregulated system” – not the US or Europe’s – that has got American banks into trouble, and is likely to precipitate a second, more destructive and prolonged systemic failure of the global financial system.

This failure – which daily grows more imminent – will quickly engulf the eurozone, and eclipse the more trivial issue of budget deficits that has so consumed EU leaders, Labour party politicians, and their flawed, and orthodox economic advisers.

The burning fuse that is likely to ignite this conflagration? A failed global financial derivatives broker, MF Global, run by Jon Corzine, formerly chairman of Goldman Sachs. According to Christopher Elias of Thomson Reuters, MF Global slipped the noose of US regulators to shelter within the ‘loose and lax’ systems run by London’s more obliging Financial Services Authority (FSA).

Now each day brings more evidence of how this lax regulation enabled MF Global to use its own clients’ funds:

“…to finance an enormous $6.2 billion eurozone repo bet… a position more than five times the firm’s book value, or net worth.”

The euphemism for this form of gambling with other peoples’ money is “hyper-hypothecation” – a device by which banks create billions of “liquidity” for their own purposes, much of which has no real asset backing. (I strongly recommend that interested readers study both Elias’s report from Thomson Reuters, and this piece by Tyler Durden for brilliant, if eye-watering analyses of the scam.)

Hypothecation is just another way of ripping off foolish investors to leverage Big Monies – or, to quote Damon Runyon, “Big Potatoes” – for the broker.

As Christopher Elias argues, the really scary bit is this: hypothecation by the shadow banking system may have enabled bankers and brokers to increase:

“…the financial footprint of Eurozone bonds by at least four fold. (If so) then a eurozone sovereign default could be apocalyptic.”

That is why yesterday, in a badly-timed action signifying deep alarm, the ECB cut its benchmark interest rate by a quarter – for the second month in a row – to 1%. But it was the ECB’s second action that betrayed the sense of panic that has engulfed Frankfurt.

Europe’s central bank ‘loosened collateral standards’ for all those shadowy banks borrowing for – amongst other forms of speculation – hypothecation. The ECB is acknowledging that most bank collateral is not real. It is phantom.

Touchingly, the banks supported by the ECB are not European banks. They are global banks and/or financial institutions with branches/subsidiaries in Europe, most of which shelter under the regulatory umbrella of the City of London. Their practices are not unlike those of MF Global; but the bulk of their losses, when they come, will almost certainly be transferred to the taxpayers of Europe.

The tragedy is this: when the global financial system implodes in an ‘apocalyptic’ collapse, both our politicians, central bankers and regulators will once again be guilty of wilful and gross neglect. Corrupted by financial interests; ideologically bound to the ‘light-touch regulation’ of monetarists and other quack-economists, they have (deliberately?) been distracted by a far less serious matter: the debts of sovereigns.

These, compared to the debts of the shadow private banking system, can be considered trivial. Furthermore, the rise in public debts is nothing but the consequence of the debts of the private financial system. Without fixing the broken global banking system, there can be little hope of even the European Court of Justice imposing and enforcing ‘budgetary discipline’.

Which is why today’s EU summitry is so futile.



5 thoughts on “Why EU Summit futile: this is a global banking crisis”

    1. Brady, as Kartik Sharma of Seeking Alpha explains ( “The spread of a CDS is the annual amount that the protection buyer must pay the protection seller over the length of the contract, expressed as a percentage of the notional amount. For example, if the CDS spread of Citi (C) is 60 basis points or 0.6% (1 basis point = 0.01%), then an investor buying $10 million worth of protection from JPMorgan (JPM) must pay the bank $60,000 per year.”

      The spread therefore is effectively the price of the insurance against default. Where the risk of default is higher (as in the example of US banks in the chart above) the spread is higher……

  1. Hello Ann,
    may I also ask a question? Can you expand on what the “shadow banking system” is? My understanding is they are players who trade in “dark pools” rather than through the main exchanges, so no-one can see what is being bought or sold?

  2. This is a really interesting piece of information,but it confirms all that I picked up from reading Joseph Stiglitz’s book Freefall. What can we do about it?

  3. Brady: I would like to point out the following: the language of finance is deliberately MISLEADING to obscure the systematically FRAUDULENT practices … e.g.

    If a “CDS” is a form on insurance (against default) then why call it a “swap”? Precisely because it is NOT AN INSURANCE but pure speculation (a business which is much stricter regulated for obvious reasons):
    1) Buying insurance must be reserved for the party who is actually carrying the risk
    2) the risk premiums are extremely low (because AIG and others were convinced – that’s what their mathematical “models” and the rating agencies’ complicity told them – that the likelihood of default was practically zero!)
    3) they (the banks etc.) sell CDS to each other and because anybody can buy this fake “insurance” the amounts to be paid out in case of default are astronomical …

    So Please Ann (and addressed to the media)DO NOT USE THE WORD INSURANCE when writing / speaking about CDS …
    IT IS PURE FRAUD plain and simple (another Ponzi finance scheme) and why our “regulators” are still allowing this scam is beyond me ..

    Ann – you are great! Thanks a lot for this important piece of information, though it has confirmed my worst fears … these guys are insane, the whole neoliberal deregulation frenzy is madness … as Steve Keen has said “their goal was to limit the realm in which political action is seen as legitimate” .. and although the “market” cult has taken over in so many ways with catastrophical results – they still blame the governments for all problems!

    Here, the media has swallowed the bait, nagging every day about why the “debt brakes” have not yet been enshrined in the constitution and writing calmly about hospitals having to cut expenses, social safety systems to be dismantled (slowly but steadily) in order to fulfil the demands of the “Troika” … and guarantee the “tribute” to be paid to the financial parasites … it makes you sick …

    I wish we could get out of the EU and take back our democracy (by taking back the sovereign right to create our own money .. with zero interest for the state to invest for the people …

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