Greece Debt, Who is Accountable?

By: Submissions

Raymond Matison writes: There are millions of individual and institutional investors worldwide who purchase equities and fixed income instruments.  When they make a decision to purchase an investment, they hope to make a profit, but they also take on a risk of losing their money.  If the stock or bond purchased loses value, it is solely the investor or lender who takes the loss.

When a family purchases a home and seeks a mortgage loan, the bank making the loan used to be at risk.  That is, they made an evaluation of the borrower’s ability to repay, and used the property as collateral to secure the loan.  If the loan went bad, the bank was at risk of losing money.  Over the last decades, banks sell off their mortgage loans to be packaged into a security which is sold to investors, thus passing the loss risk to individual and institutional investors.  It is the ultimate investor or lender who accepts the risk of loss.

A small business owner seeking financing for expanding a business will seek a loan from a local bank.  This bank evaluates the business prospects of the borrower, and secures the loan the best way that it can in order to protect itself from a loss.  However, if the loan fails, and the security for the loan turns out to be inadequate, the bank will take a loss on the loan.  Having used collateral to recoup its loss, it cannot go further to collect funds from principals or business employees.

Large businesses seeking major expansions or plant additions will require funds that are too large for one bank to finance, and accordingly, such financing is syndicated through a lead investment bank which utilizes the marketing and sales departments of many investment banks and brokers to raise the needed funds via a sale of securities to both institutional and individual investors.  The lead underwriter purchases the securities and resells them to the syndicate to be further sold to the ultimate investors.  In this process the lead underwriter maintains a position in the securities in order to stabilize their market value.  Eventually, as the market value is established this inventory will be mostly liquidated, and the ultimate investors are the ones bearing the risk of loss.  Should the business underlying the financing fail in a short period of time, investors may try to recoup their losses from the underwriter, if investors can show that the underwriter did not exercise a proper level of due diligence – that is, properly evaluating the company’s ability to repay a loan or make proper use of the funds raised.

For the largest amounts of financing, such as that required for governments, central banks and investment banks are involved in distributing the securities.  If markets are operating freely without constraints or manipulation, the interest rate on the security determines the level of anticipated risk.  That is, bonds of most secure countries are sold yielding the lowest interest rate, while bonds of the riskiest countries are sold yielding the highest rates.  Of course, at some high level of interest a government may choose not to float an issue recognizing that a too high rate of interest may itself be the catalyst that causes the bonds to fail, thereby becoming a regulating mechanism limiting debt.
With each of these lender/borrower or investor instances the process is quite clear.  Banking or financial institutions make decisions to approve loans, and unless they can offload the risk of the loan to other investor/lenders, it is the institution making the lending decision that is at risk of losing money if the loan goes bad.  When lending institutions can offload the risk to investors, the latter are the one’s bearing the risk of loss.  In no instance does the lender or investor have a chance of being reimbursed for that loss unless provable fraud is involved.

The army of economists and financial experts at major money center and central banks are well prepared to access the ability of a sovereign borrower to repay a proposed loan.  And with respect to Greece, these due diligence teams were acutely aware of Greece’s history of loan defaults over the last two centuries.  In the book “This Time is Different” by Carmen Reinhart and Kenneth Rogoff published in 2009, they document the frequent sovereign defaults of Greece – a history that was not hidden to central banks. These authors note: “Greece, lived in a perpetual state of default for over a century… which gained its independence only in 1829, made up for lost time by defaulting four times.”

During the second half of the 20th century a new kind of lending developed.  This was described by John Perkins in his book “Confessions of an Economic Hit Man” published in 2004.  As a member of a consulting group he called on countries with natural resources lacking infrastructure and proposed large projects for roads and electrification that would be financed by loans through large lenders including the World Bank.  The idea for the loans were sold to leaders of the target country to be repaid by development of mining, drilling or other projects which would provide the borrowing country in question with enough revenues to discharge the loan.  Except for the unspoken truth, the loans were structured to fail over time so as to provide negotiating leverage greatly favoring the lender when the loans were to be restructured.  More simply stated - they were predatory loans.  Mr. Perkins states: “the loans are so large that the debtor is forced to default on its payments after a few years.  When this happens, … we demand our pound of flesh. This often includes one or more of the following: control over United Nations votes, the installation of military bases, or access to precious resources such as oil or the Panama Canal.  Of course the debtor still owes us money – and another country is added to our global empire.”

When the financial crisis of 2008 almost melted down the global banking system, several systemic problems were identified.  First, it was acknowledged that the immense increase in housing loan defaults was the immediate cause of the crisis.  However, it was also acknowledged that the amount of credit extended to the public by  banking institutions was at such a high level that income levels of the population, even considering historically low interest rates, were not sufficient to service or pay down the debt. 

We need to remember that politicians, our government agencies and bureaucracy promoted unsound lending over the last several decades (starting with the Community Investment Act of the 1973) by eliminating “red lining”, a crude method of loan underwriting, and threatening banks with reprisals which did not participate in lending to the riskiest low income sector.  When mortgage loans ultimately defaulted causing a crisis that would bankrupt our major banking institutions, the Fed provided capital and liquidity.  Yet several years after the crisis, these banks and mortgage loan companies eventually had to pay huge fines for making predatory loans.

According to Richard Duncan, in his book “The New Depression” published in 2012, the amount of credit in the U.S. grew from $1 trillion in 1964 to $53 trillion in 2008. He notes: “The inability of the private sector to bear any additional debt suggests it can’t generate growth through further credit expansion… If none of the major sectors is capable of taking on more debt, the economy cannot grow… Now that the debtors can bear no more debt, the global growth paradigm no longer works.”  Since inception of the European Union their credit has grown also to unsustainable levels, far in excess of their Maastricht Treaty agreed upon limits.

The logic that would allow for making low quality loans, such as those for Greece, would include the fact that sovereign loans are backed by that government’s taxing power of its people.  With that operating principle it would seem that all sovereign loans are fundable. However, when tax rates become too high to be raised further, or there are too many tax avoiders, a ludicrously early retirement age allowing full pension benefits, or there are too simply many social benefit programs provided that cannot be properly funded, there simply is not enough money to service or pay off its sovereign debt.  Greece certainly has not been financially prudently managed, but they are not the exception, but merely one of the first to emerge.

The European Union leaders and central banks have been eager promoters and participants in this mega credit expansion for the countries within its union. The Chinese, in trying to protect their trade accumulated UST’s, and to promote internal growth have exploded credit growth in their economy.  U.S. government debt has exploded by $8 trillion in a period of six years. Basically, the whole world has too much credit outstanding relative to its good assets and productive capacity.  Thus, the quality of assets backing many loans, such a Greek sovereign debt, is weak and failing. 

Banks were too eager to make loans to many of its participant countries, which with proper financial due diligence and discipline should never have been made.  In other words, either the banks were foolish in providing these loans, or a possible alternative motive for making the loans was the guiding principle.  Could it have been intentional predatory financing?  If so, it will backfire because the whole world is overleveraged with debt – it simply cannot be repaid. 

The citizens of Greece had not voted to take on this debt, even as their former leaders were willing foolishly to take on more debt to solve what was already an excessive debt problem.  The lenders chose not to turn the credit spigot off. They made the decision to lend – so the lenders, not the borrower should accept the risk of loss.  More recently, their citizens have decidedly voted to elect new leaders and not to be responsible for debt approved by a previous government.  These loans also were eagerly provided by bankers who can create funds to be loaned with the click of a computer button, but the actual proceeds rather than going to be used for economic stimulation quickly mostly disappears to service previous debt. Certainly this could be viewed by citizens living under a severe austerity program as predatory. 

Since there is too much debt in both socialist and capitalist countries, this issue is not about the political right or left.  It is squarely related to the accountability that sophisticated lenders bear when permitting or promoting the world to be overloaded with debt.

We should learn from their outstanding empirical study and book “This Time is Different” that “What one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does.  When countries become too deeply indebted, they are headed for trouble.  When debt-fueled asset price explosions seem too good to be true, they probably are.  But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.” In Greece and the European Union it now appears that the crisis has been ignited requiring a solution to overbearing debt.

Unfortunately, we are not immune from this overseas crisis because of our global interdependence, and our own debt levels.  In the words of Richard Duncan, author of “The New Depression”: “The end of growth has collapsed tax revenues but driven government spending higher and produced  sovereign debt crisis around the periphery of Europe that not only threatens to spread to the core but also portends what awaits most of the rest of the world over the next decade.”

Raymond Matison

Mr. Matison is a U.S. patriot who immigrated to this country in 1949. With a B.S. in engineering physics, an M.S. in Actuarial Science, work in the actuarial field, and as a financial analyst at Legg, Mason Inc., Lehman Brothers, and investment banking at Kidder Peabody, and Merrill Lynch provides a diverse background for experience.  First-hand exposure to fascism, socialism, and communism as well as the completion of a U.S. Army military intelligence course in the 1960’s have inspired a continuing interest in selected topics in science, military, and economics.
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