Saturday, October 23, 2010

The quintessential Greek (financial) tragedy

For the last 6 month, the travails of highly indebted countries in the European Union and Greece in particular has been the source of considerable turmoil in the financial system. In addition to increasing the cost of borrowing for Greece and other countries in a similar situation like Spain, Portugal, Ireland and Italy, the other impact has been to increase the overall systemic risk and push the world economy back into the 2008 depths.

The Greece story is particularly fascinating. Unlike other countries where banks made ruinous bets and had their capital wiped out, impacting lending and slowing down economic activity, the banks had no role to play in Greece. Instead it was the systemic lack of fiscal discipline, lack of enforcement of basic property and taxation principles and a proliferation of special interest driven that causes Greece to be on a slippery slope to sovereign bankruptcy and default. The inimitable Michael Lewis has written a highly entertaining but also illuminating piece on why this came to happen. Link is here.

Now what is very interesting and scary is that many of the ills mentioned here is present in many countries around the world. Talk about the aversion towards taxes, the large scale tax evasion, the rampant bribery and corruption in government circles. Seems scarily familiar to people from India and other developing countries. What do you think causes Greece to fail in such spectacular fashion (well, if it hasn't already failed, this article should convince you to "short" Greek debt).

Tuesday, October 19, 2010

Sensational ... but true

Photograph by Terry McCombs
My writings in this space are usually somewhat academic and what I think is an objective view point, whenever I stray from highly academic topics. A recent article from the Rolling Stone magazine, though, caught my eye. The writer talks about the systematic way in which Wall Street banks touting their financial engineering expertise have expanded their influence into small governments in America. The banks have peddled products that have invariably resulted in huge amount of financial distress for these agencies. See link here.

The phenomenon of bankers behaving badly with small governments or for that matter even with larger ones (state pension funds) is nothing new. The 1994 bankrupting of Orange County by Robert Citron (Citron? for Orange Country?), the county treasurer, is a well-known story. See a really good article about this failure here. Another notable example from the same period is Proctor & Gamble's dalliance with derivatives that resulted in a lot of grief for themselves as well as for Banker's Trust, their investment banking advisers. The human psyche seems particularly frail and susceptible to smooth talking operators, talking interesting numbers and displaying other forms of spreadsheet gadgetry, and promising the moon in return for money. In addition to the banks' rapacity, the people at the customer end - that sought to invest in little understood financial instruments, where the risk of the counterparty is bounded but your own downside is infinite - are as much to blame. Not for the lack of financial savvy, but for getting into a situation where such financial gimmickry needed to be resorted to in the first place.

The primary problem here is the particular weakness of small government bodies to be reckless about spending during good times. In an attempt to do something big and important for their constituents (ascribing the best motives), governmental bodies take on big projects when the economic cycle is positive and tax revenues are abundant. They take on big loans which need servicing even when things go bad - when tax revenues decline or interest rates rise or whatever. And then these agencies find themselves strapped for money and start to resort to financial gimmickry. And fall into the arms of the Wall Street firms.

Reminds me of the famous Roald Dahl story about the old man who has a priceless painting tattooed on his back. And who goes away with a smooth talking stranger who promises to keep him happy for the rest of his life, only if the old man displayed his painting to the stranger's guests at his hotel. Needless to say, but in a few weeks, the painting appears sans the old man in a famous art gallery.