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Wednesday, December 28, 2011

The race to lend Greece

Prof. Yanis Varoufakis published in his blog my recent tale about how Greece might have built up so much foreign debt. There were many comments to it and below is my response to them.

After reviewing the comments to my tale (thanks to Yanis for distribution), I would like to comment on comments.

My tale was about BEHAVIOR of banks and bankers and not about technicalities of banking. Having spent some of my banking years as “overpaid wine-taster” and some others as “narrow-minded domestic banker”, I can assure everyone that my description reflects quite accurately the behavior of large banks with international activities.

I did not want to attribute blame to anyone. While I took Greece as an example, the tale applies universally and I would guess that it is timeless.

One reaction was that I didn’t talk about the betting among banks against, say, Greece. That is correct. I could have easily concocted a couple of very biting paragraphs about that but, then, there are other aspects which I didn’t cover either. The tale had become longer than intended already.

Regarding the mean bankers/speculators who are allegedly out to “kill” countries and economies, I have never met any person fitting that description. However, there are many bankers/speculators out there who are chasing high financial returns, preferably short-term gains, and they can definitely destroy real values. Theoretically, if economies/markets were in complete balance (not possible in practice), these people would be out of a job. They thrive on imbalances and they have an amazing ability to detect imbalances. Oftentimes they can even create them. But they are out to (profitably) transact business and they are not out to (unprofitably) wage geopolitical campaigns.

The word “parasites” was mentioned and I find that very interesting. In the Middle Ages, that term was used against people who were deemed to take advantage of real economies without contributing to them. What we have today are entire industries who take advantage of real economies without contributing to them (other than recycling the financial wealth which they generate for themselves).

Even today, most banks (the medium-sized and smaller ones) understand that banks are not an end per se but a means towards an end. That their end is to support customers in the real economy so that there can be real wealth generation. Despite their quantitative majority, these banks really cannot influence large international capital markets. Instead, they are influenced by them. The much fewer large players have developed a mindset where the bank is an end per se and where it is the customers who become the means towards that end. They think less of “customers” and more of “counterparties”. Instead of visiting customers, their top executives visit institutional investors, attend analysts’ meetings, talk to consultants, etc. “Real” customers often, and rightfully, criticize them for speaking a language which no “real” customer understands. However, without a real economy somewhere out there, they could not transact any business. From that standpoint, to use the word “parasites” to describe them is mean but not false.

For individual banks/bankers caught up in the midst of the herd behavior, it is next to impossible to break out. Horst would have been fired if he had fallen too far behind Jean-Pierre and Charlotte (and replaced by someone who could successfully compete with them). Even a CEO like Josef Ackermann would have gotten into serious personal trouble if Deutsche Bank had fallen far below the 25% ROE which he had promised his investors. And he promised that return to investors to safeguard his job in the first place. A notable exception would be Warren Buffett who has built such a myth around himself that he does not really need to report to anyone (and, so far, no one has dared to question him); they all trust him blindly. When Warren Buffett decided not to take part in the IT-bonanza/bubble because he didn’t understand it, he could do so. Most everyone else would have lost his job for “not understanding” such (perceived) enormous profit opportunities.

Goldman Sachs was cited as the villain. Actually, G+S is the epitome of perfection in this game. Not only do they often profit the most from being in the herd. As “leading steers”, they push the herd onwards but they are smart enough to leave the herd before it goes over the cliff (and sometimes they even save themselves by driving others over the cliff). It is the nature of the game which needs to be criticized. If one justifies the nature of the game, one should not criticize its most successful (albeit reckless) performer.

G+S was criticized for advising Greece how to “cheat” with the level of her debt and for collecting high fees for that. The reality is that every major player in international finance employs entire divisions of supremely intelligent people who spend their time developing new products/ideas for making money. Regulations are a great opportunity for them because for every regulation there are possible ways around it. Maastricht is a case in point. The fee income earned so far by bankers, lawyers, accountants, etc. through advising governments how they can legally circumvent these regulations is probably beyond imagination. Some of the better known circumventions are: cross-border leasings; private-public partnerships; outplacing debt into SPVs; or – as in the case of Greece – cross-currency swaps. I cannot imagine that G+S got the mandate for Greece’s cross-currency swaps because they conspired with the Greek government how to cheat the EU. Instead, I would suspect that every major player had pitched for that mandate and G+S got it because they were the best. As far as I know, there was nothing illegal about the structure of the cross-currency swaps and Greece is definitely not the only country which is “optimizing” its sovereign debt for the purpose of reporting it (Austria’s reported sovereign debt would be about 20% higher without “optimization”).

These are some of the behavioral aspects which I tried to bring across and I appreciate the feedback from those who understood this. I attach a video below which came out almost 4 years ago. Not all of you may know it yet. It is priceless for its humor, and --- quite reflective of reality!

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