This what the titans of Wall Street have wrought through the use of nifty derivatives like Credit Default Swaps. I’ll explain one interesting, catastrophic feature of those items below the fold. Meanwhile the government of Greece is falling apart:
The Greek government was plunged into chaos on Tuesday and faced an imminent collapse, as lawmakers rebelled against Prime Minister George Papandreou’s surprise call for a popular referendum on a new debt deal with Greece’s foreign lenders.
The Greek story is complicated, but it started in part with those derivatives called Credit Default Swaps. These started out as mortgage insurance vehicles for lenders. There are two sides to them, we’ll call them party A and party B. Party A lends money to a homeowner, and sends a portion of the interest payments they collect from the homeowner to the party B in exchange for default protection. In the event of default by the homeowner, Party B makes good on the interest and principle. That’s the basics of a Credit Default Swap. All well and good, so far the swap is a great product that facilitates home loans by transferring risk from party A who doesn’t want risk, to party B who does.
Then party B had an epiphany. Why not duplicate the exact same swap, sell it to anyone who will buy it, anyone willing to place a bet the note will default someday? And why not create a shadowy secondary market free from pesky regulations requiring party B to have enough capital reserves to actually pay their end of the deal if and when the underlying homeowner defaults? Then party B will be getting even more fees every month on the same swap! And that’s exactly what party B did, they cloned that swap, in some cases thousands of times, it was like printing money!
Until the homeowner defaulted. Then party B owed the interest and principle times however many hundreds or thousands of time they cloned that swap and placed the other side of it with other parties. during the real estate bubble bust this happened over and over again.
Oops! It is estimated that over 60 trillion dollars in liability was created this way. The party that up to then had collected the fees couldn’t even come close to paying the parties they owed, and the parties they owed were going to go bankrupt if they didn’t get paid. The largest banks in the world were about to close their doors unable to meet payroll or deposit demands, the banking system would freeze, revolving credit would stop, and your checking account would be deader than fried chicken.
What happened here in the US was the government stepped in and bought those horrible swaps, made good on them, and saved the system. Which is hilarious, because now those same guys and companies that created the most toxic debt of all time are lecturing the government and the people who bailed them out on deficits and debt.
It would be nice to see these lectures limited to fellow inmates. We just cannot afford that kind of justice in this wonderful system.
Greece is in a hole for largely separate reasons than the financial crisis caused by CDS’s here. Unlike the US, they genuinely do have a debt problem, one that can’t be resolved just by going back to the tax rates of a few years ago, which is caused by not having collected any taxes for the last 40 years. Much of the economy is underground and even the aboveground economy often isn’t taxed. The bigger problem is that Ireland, Spain, and Italy are close to the same point, and with the euro, the collapse of any one country will lead to implosion of the currency.
Don’t be confusing us with facts Midnight.
The fun bit is that the banks have happily resumed their trading in derivatives and are making even more profit now than when they were too big to fail.
@Midnight: Greece indeed had a debt problem before, it’s just that nobody cared that much until the bottom dropped out of the world financial market.
Note that Goldman Sachs – and their dubious investment deals – were hands-in-pants with the (previous) Greek government and had a great deal to do with the disappearance of the public treasury there.
I agree with Midnight. Greece’s problem has been building for decades. They simply have been borrowing beyond their ability to service the debt, and far faster than their economy has grown. Add to that a rampant inability to do anything about tax avoidance (the legal counterpart to tax evasion) nor about out-and-out tax evasion, and you have a recipe for disaster in epic proportions.
It didn’t need the swap issue to come to a head. The ripples from that economic disaster didn’t help, of course, but sooner or later everyone was going to have to recognize that Greece was, for all practical intents and purposes, facing a very self-imposed bankruptcy.