28 Nov 2011

The Goldman Sachs reality distortion field

If you've been following the "European debt crisis," then you've heard more than once about "voluntary" debt reductions that would lower payments to creditors WITHOUT triggering credit default swaps (insurance policies against default).

Why has it been so important to claim that the emperors are wearing clothes?* Perhaps this:
The grave danger is that, if Italy stops paying its debts, creditor banks could be made insolvent. Goldman Sachs, which has written over $2trn of insurance, including an undisclosed amount on eurozone countries' debt, would not escape unharmed, especially if some of the $2trn of insurance it has purchased on that insurance turns out to be with a bank that has gone under. No bank – and especially not the Vampire Squid – can easily untangle its tentacles from the tentacles of its peers. This is the rationale for the bailouts and the austerity, the reason we are getting more Goldman, not less.
Default, in other words, would require GS to pay $2 trillion of claims (or pay something against losses on $2 trillion of policies; not clear) at the same time as GS may not be able to lay off those claims on other companies banks that sold CDS re-insurance to GS.

That's why Goldman Sachs -- as the article makes clear -- has got its people working overtime to make sure that European politicians and bureaucrats (many of them Friends of GS) do not formally announce default -- something I recommend as the first step in recognizing reality.

Bottom Line: Goldman's attempts to protect its terrible decisions are dragging EU countries and citizens into a lifetime of debt -- all to make sure that traders keep bonuses awarded when times were "bubbly" (while still taking home a bonus when the company loses money!)

* When a creditor says he will repay 50% of the money he owes you, he's defaulting on that debt, whether or not you "voluntarily" accept that fact!
Addendum: A semi-relevant discussion of CDSs on Marginal Revolution.
Addendum 2: Paulson (ex-GS) gave insider information on FannieMae/FreddieMac.


Andrew said...

So you advocate that Greece and other heavily indebted EU countries should simply default rather than attempt to save the currency union. Do you not worry about the potential future ramifications of this path, i.e., difficulty securing credit, loss of competitiveness, and austerity measures that come along with decreases in and restrictions on government spending? Do you think if the ECB took a more active role in this whole fiasco that default wouldn't necessarily be the only solution? Also, I find it a little bit far-fetched to imply that Goldman Sachs is the reason Greece and other EU MS have such terrible public finances today.

David Zetland said...

@Andrew -- yes, but not with your implication of "euro destruction". Default doesn't mean the end of the Euro. GS is ONE player with big stakes (and political pull); French banks, et al. are also trying to avoid paying for their mistakes.

Andrew said...

Ok I see your point. I think they should obviously pay their liabilities as well, but even if Greece were to default, some level of austerity would have to result due to the government being excluded from cheaper credit markets and lower government expenditures as a result of lower tax receipts (as compared to before the crisis). My point is that default or not some sort of serious austerity compared to pre-debt-crisis levels is to be expected and I think not necessarily the fault of GS or other Euro banks, no?

David Zetland said...

@Andrew -- While it's true that gov'ts HAD to borrow the money to get into this mess, I'd say that there were elements of sell-side on the primary market (GS, et al. saying "cheap money, take it") but -- more important -- a lot of manipulations on the derivative markets that are really screwing things up.

As a "survivor" of several financial crashes, I'd say the best way fwd is to default, live modestly and grow at an organic (non geared) pace.

GS et al. may not make all their fat commissions, but their income is based on hot air.

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