By Andrew Barber
On March 10 French President Nicolas Sarkozy, Luxembourg’s Prime Minister Jean-Claude Juncker, German Chancellor Angela Merkel and Greek Prime Minister George Papandreou signed a letter addressed to the European Commission demanding an investigation into the use of credit default swaps in sovereign debt and the role they have played in raising yields for bonds issued by more vulnerable Union members such as Greece and Spain. “We must prevent speculative actions from causing so much uncertainty on the market that prices no longer provide accurate information and state financing reaches a fundamentally unjustifiable high level,” they wrote.
This rush to blame bank and hedge fund traders for rising yields on sovereign debt is one-half scapegoating, one-half wishful thinking. EU politicians have found a convenient narrative that lets them gloss over both the lax reporting oversight on the national level that allowed the festering Greek situation go unacknowledged by policymakers for so long, as well as the profound economic challenges that finally pushed them into the spotlight.
Prime Minister Papandreou has repeatedly attacked the “naked” use of CDS as a major cause of the disparity between the cost of borrowing that his nation faces and that of Germany, currently a spread of nearly 100%. But with official figures showing that the Greek budget deficit now exceeds 12% of GDP, and total debt exceeding 113% of GDP with unemployment reaching 20% of the working population, just how unjustifiable is this premium demanded by Greece’s creditors? Should divergence between the perceived value of debt issued by EU members be reined in on the economic principle that the strength of the primary economies will implicitly balance any weakness in smaller individual states—that recovery in Germany and France will carry Greece, Spain, Portugal and Ireland along for the ride?
Europe, as with the rest of the developed world, suffers as older taxpayers become pensioners. Greece faces a staggering shortfall in pension obligations with (charitable) EU estimates that total obligations for retirees will approach 40% of GDP within the next 30 years. Prime Minister Papandreou triumphed in last year’s election in part due to his pledge to address his country’s pension shortfalls through greater efficiencies without scaling back benefits, a pledge that looks increasingly naive.
Greece is not alone; all of the EU states have adopted a policy of acquiring massive future pension liabilities while avoiding any proactive plan to pay for them. As the all-consuming cost of income and health care for the retiring baby boomer generation starts to weigh on the government budget, the impact of these off-balance-sheet obligations will come into sharp focus.
Official euro zone figures list local government debt at less than 5.5% of GDP in aggregate (in Greece, the estimate is that municipal borrowing is less than 1% of consolidated government debt). Although the extent of local government borrowing varies widely among nations, these figures appear low to anyone who has been active in the market.
The pervasive culture of graft and corruption that many member states hoped membership in the Union would eradicate has instead flourished over the past decade in some weaker economies—a fact not lost on ratings agencies, which remain worried about the impact on declining personal and corporate tax compliance.
Greece, for instance, has declined from 36th place to 57th in the Transparency International rankings since joining the EU: a 2008 survey found that 18% of Greek households reported paying a bribe to an official in the prior 12 months and Spain, Portugal and Italy each face their own problems in this arena.
Do unregulated derivatives markets create the potential for abuse and manipulation? Perhaps, but singling out the swaps market as the cause of rising yields on bonds issued by the weaker European economies is both disingenuous and absurd. The amount of work to be done in tackling the root structural causes of the EU’s present crisis dwarf any need for capital market reforms, and only resolving those issues can ensure permanent stability for its sovereign debt markets.
Andrew Barber is the founder of Waverly Advisors, an independent investment research and asset management company in Corning, New York.
