Thursday, September 30, 2010


Back in 2004 Wall Street investment giants Bear Stearns, Lehman Bros., Merrill Lynch, Goldman Sachs, and Morgan Stanley were in trouble. Major losses and big debt was on the horizon, as they were on the hook for trillions of dollars in toxic mortgages and securities.

So Wall Street's biggest banks sent then Goldman Sach's CEO Hank Paulson to the Securities and Exchange Commission (SEC) to work out a deal (it wouldn't be his last).

Paulson wanted to get the SEC to allow the biggest investment banks to borrow more money.

Specifically, he wanted to more than double the amount of debt Wall Street's biggest investment banks could carry on the books. Wall Street's strategy was to borrow and bet invest more in the market, so they could grow their way out of trouble.

After their special exemption was granted, the investment industry's debt limit (net capital rule) was lifted from 12:1 and reached more than 30:1 for several firms by 2008 (and more than 40:1 for Merrill Lynch). We all know what happened in 2008. Wall Street's "let's borrow more to get out of debt" plan was a bust because they were borrowing big so they could bet invest big on market garbage.

Fast forward to the present ...

Remember the 110 billion (Euro) package for Greece, and the 750 billion (Euro) “safety net” for all Euro zone members? The amounts were so large because the European Union (EU) wanted to "shock & awe" market players. They wanted to show the world that the EU knew how to deal with Europe's financial problems ... by borrowing more money.

The EU's financial rescue plan is starting to be exposed for what it really is ... a real mess.

Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives has much to say about how Europe plans to fund it's bailout program. Here are some of the highlights (lowlights?):

* In order to finance EU member countries as needed the EU - through the European Financial Stability Facility (EFSF) - needs to issue debt, which will be backed by EU member states. The major rating agencies have already awarded the fund the highest possible credit rating AAA [didn't this happen before? you know, on Wall Street.].

* The measures are not designed to assist Greece or the other troubled countries. In reality, they are designed to support banks that have lent heavily to them [in plain speak this means the plan is more political than economic].

* If an individual nation-state fails to supply its share of funds it's share will be covered by a surplus “cushion” which requires participating EU countries to guarantee an extra 20% beyond their shares.

* A cash reserve will provide additional support (Greece is not included in the EFSF program because no one believes they can cover their commitment).

Got that? Europe is going to cover it's member countries' debt by issuing more debt.

With the amounts we're talking about, isn't this Wall Street deja vu all over again? Seriously. It doesn't matter that the real goal of propping up the banks (instead of individual countries) is to make sure every one's got some skin in the game. The end result is that Europe is borrowing more to prop up a weak system.

And the system is slowly crumbling because no one really wants to confront the world's financial markets - like we failed to do with Wall Street in 2004 - and  make them pay for their greed and stupidity.

Sigh ...

- Mark

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