Europe’s debt crisis and the danger we can’t see
There are plenty of reasons to be freaked out by the banking and sovereign debt crisis now reaching a crescendo in Europe. But one factor that’s gotten little attention could turn this Very Bad Situation into a True Calamity.
It’s this: Regulators here and in Europe have no idea — repeat, no idea — of the full extent of the derivatives exposure that could be triggered by an “official” Greek default, or by the failure of a major French bank. And if the people in charge have no clue as to the fallout from what may be trillions of dollars in side bets waiting to be triggered in a catastrophic cascade, they’re basically flying blind.
If it strikes you as insane that officials don’t know the exposure of these derivatives, given the havoc these “financial weapons of mass destruction” wreaked last time, you’re thinking clearly. The idea that we could be back on the edge of a Lehman/AIG-style implosion, just three years after the near-death experience of 2008, defies all presumptions about the human species’ capacity for learning. But then, Darwinian optimism leaves little room for the greed and myopia driving the global banking lobby today — or for the industry’s destructive power to kill or defer common-sense reform.
Remember, it was always odd that problems in the relatively small market for subprime mortgages could have brought the global economy low. The reason they did was because these subprime woes were massively amplified by trillions in side bets placed on these mortgages via exotic derivatives. “Naked credit default swaps” allowed parties with no interest in the underlying mortgages to place huge bets on whether borrowers would or would not perform. Fear of the explosive power of this casino — and its hidden concentration in a reckless, “too-interconnected-to-fail” giant like AIG — led U.S. officials to cough up no less than $180 billion in taxpayer money to pay off these bets in full. These officials, fearing a meltdown, treated sophisticated derivatives traders exactly as they would treat innocent consumer depositors in a failing bank, as people to be protected at 100 cents on the dollar.
It was, and is, grotesque. (more)
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