Hell, Handbaskets and Hellenic Default

Regardless of what the IIF and the Greek government may announce, Greece is heading inevitably for a destabilising default to some or all of its bond creditors. The most articulate and comprehensive account of the reasons why this must be so are documented in the ZeroHedge masterclass on Subordination 101: A walk thru sovereign bond markets in a post-Greek default world. Roubini concurs.

I've written before about what this implies for the financial system:

If any OECD state were to default there would be very serious implications:
- The Basel Accord zero risk weight of government debt would be proved fanciful;
- The assumption of government debt as a liquid asset suitable for bank Tier 1 reserves to meet unanticipated and sudden cash demands will become unsustainable;
- Banks would be forced to recapitalise at much higher levels, forcing even sharper deleveraging and contraction of lending;
- Governments would lose the captive, uncritical investor base they have relied on to finance excess public expenditure for the past 30 years;
- Central banks could be forced to suddenly monetise even more government debt if required to meet the cash demands of a run on their undercapitalised banks.

Worrying, but not unexpected. A few of us predicted back in 2008 that the implosion of RMBS and bank capital, leading to central bank and sovereign bailouts, would fuel a central bank balance sheet and sovereign debt bubble. The central bank balance sheets have since balooned to 20 percent of GDP for the Fed and Bank of England, and 30 percent of eurozone GDP for the ECB. Deficits have spiraled everywhere, despite promises of austerity. Now the sovereign bubble too may burst.

From Deflation Has Become Inevitable in December 2008:

In Lombard Street, Bagehot’s seminal tome on fractional reserve central banking, Bagehot advises any central bank facing a simultaneous credit crisis and currency crisis to raise interest rates. By raising rates they will ensure that foreign creditors remain incentivised to maintain the general level of credit available while the central bank resolves the local liquidity crisis through liquidation of failed banks and temporary liquidity support of stressed banks.

The very opposite policies have been pursued by central banks in the US, Europe and UK since the beginning of the sub-prime crisis in August 2007. They have cut policy rates drastically, and as the crisis escalated and spread, the yield on government debt has dropped to negative territory. Meanwhile they have shielded those responsible for the creation of record levels of bad debt from any regulatory accountability, relaxed transparency of accounts, and provided massive taxpayer-funded financial infusions to prevent failure and liquidation.

While in the short term these policies have expediency and the maintenance of market “confidence” on their side, in the longer term these policies must undermine any confidence a rational and objective saver or investor might have that savings or investment in the US, EU or UK will be fairly remunerated at an above-inflation rate, or that savings and investments will be protected by effective oversight and regulation from the sorts of executive debasement and outright misappropriation and fraud that are beginning to colour our perceptions of the past decade.

Anyone sitting on a pile of cash now is unlikely to want to either (a) place it in a bank, or (b) invest it in the stock market. As a result, the implosion of the financial and real economy must continue no matter how big the central bank’s aspirations for its balance sheet or the treasury’s aspirations for its deficit.

I'm sorry I was right. (sigh)

Survivor Bias and TBTF Tyranny

It's time to write again about insolvency, as the MF Global failure and the Greek debacle raise new troubling concerns.

As I wrote in Ring Fences and Rustlers before Lehman failed in 2008:

The key to having a happy insolvency, if such a thing exists, lies in ensuring that when a globalised bank goes bust, all the best assets are inside your borders and subject to seizure by [your banks or] your liquidators on behalf of your creditors.

If one were cynical, and one believed that Lehman was going to be allowed to fail pour encouragement les autres one might wonder if Lehman was quietly bidden – or even explicitly ordered – to sell off its foreign holdings and repatriate the proceeds to asset classes within the US ring fence. This would ensure that US creditors of Lehman received a satisfactory recovery at the expense of foreign creditors. It would also contribute to a nice pre-election illusion of a “flight to quality” as US dollar and assets strengthened on the direction of flow.

If one were really cynical, one might even think that a wily bank supervisor might arrange to ensure 100 percent recovery for its creditors with a bit of creative misappropriation thrown in the mix. Broker dealers normally hold securities and other assets in nominee name on behalf of their investor clients. Under modern market regulation, these nominee assets are supposed to be held separately from a firm’s own assets so that they can be protected in an insolvency and restored to the clients with minimal loss and inconvenience. Liberalisations and financial innovations have undermined the segregation principle by promoting much more intensive use of client assets for leverage (prime brokerage and margin lending) and alternative income streams (securities lending). As a result, it is often very difficult to discern in a failed broker who has the better claim to assets which were held to a client account but reused for finance and/or trading purposes. The main source of evidence is the books of the failed broker.

On the wholesale side, margin and collateralisation in connection with derivatives and securities finance arrangements mean that creditors under these arrangements should have good delivery and secure legal claims to assets provided under market standard agreements. As a result, preferred wholesale creditors could have been streamed the choicest assets under arrangements that will look above suspicion on review as being consistent with market best practice.

The official report of the court appointed examiner confirmed my worst suspicions. We now know that the Federal Reserve Bank of New York and the SEC co-located staff inside Lehman from March 2008 to oversee the global repatriation of assets and cash in the run up to the insolvency in September. The Fed kept Lehman on life support during this period with more than $20 billion of liquidity which it paid back to itself from Lehman cash on the day Lehman filed for liquidation. In the meanwhile, from March 2008, Lehman looted its affiliates and client accounts worldwide by using prime broker and securities lending mandates to lend assets to the US affiliate which were sold (hence the sharp fall in Eastern Europe and Asian markets and growing volatility eleswhere from March 2008) and the proceeds streamed to US creditors as margin payments on derivatives and other obligations. The official receiver elected not to challenge the cash transfer to the Federal Reserve or any of the transfers of cash or securities made to major Lehman counterparties and creditors.

Those following the MF Global failure have noted a strikingly similar pattern of conduct by JP Morgan in advance of failure as occurred with Lehman, although without obvious official mandate. Yves at Naked Capital has been covering the parallels admirably. Carrick Mollenkamp, Lauren Tara LaCapra and Matthew Goldstein at Reuters have provided a very substantive story of how JP Morgan used its superior knowledge of MF Global's trading and credit position to enrich itself at the expense of MF Global and its clients before precipitating the MF Global failure.

I am concerned that MF Global demonstrates that the too-big-to-bail banks have found a new and almost riskless way to make outsize profits. Because derivatives, repo and liquidity are so very highly concentrated now, and leverage is at pre-crisis levels again, these few players can rig the markets and liquidity to choose when and how their clients fail. Their top down view of clients' trading and custody portfolios and cash positions and flows puts them in a position to exercise tyranny. They can game their clients, taking advantage of superior information, credit and liquidity to ramp or crash targeted markets as needed to precipitate a crisis. They can demand the choicest assets as collateral, setting very high over-collateralisation thresholds, and then exercise during post-failure turmoil to retain everything they hold at rock-bottom prices.

In today's low volume markets, a crash or squeeze is even cheaper and less risky than ever before. Instead of working for their clients' success, an unscrupulous clearing bank - or several operating in collusion - can profit on engineering market instability or turmoil.

If one were a conspiracy theorist, one might suspect that such games were being played now in global markets. Perhaps gold is being used as collateral for margin and cash liquidity, sold by counterparties to bring the price lower, leading to margin calls for even more. A crisis arising from a major default (Greece, Portugal, a huge bank) would force the price lower still, when the collateral would be exercised on default. Following on, the price might rocket again to enable the conspirators to seize outsize profits. Just a scenario, mind you! (Although, I note that Lehman's counterparties reported record profits through much of 2009.)

What is left of the global markets becomes a game of engineered survivor bias. Only those operating outside the law and with unlimited regulatory forbearance can win while the rest of us lose. As I noted in 2008, after Lehman failed, in Financial Eugenics, "It's not your survival they're engineering."

I don't say absolutely that what I describe is actually happening. But it may be. Certainly market conditions are ripe for it, and MF Global reinforces the pattern.

Now over to Greece. I find the PSI (private sector involvement) negotiations for Greece's restructuring of its debts troubling because it shows the same determination to engineer survivor bias. One of the core principles of insolvency law is that all creditors of like standing should be treated equally in the resolution. The PSI approach is starkly contrary to this principle, despite the evidence that Greece is well and truly insolvent. First, the official bond holders (central banks, supranationals, governments and the ECB) are excluded from mark-downs of their debts, preferring to impose the burden of capital losses entirely on the private sector bond holders. Second, the private sector bond holders are divided between those with an interest in preventing a declaration of default (either unhedged or have written credit default swaps) and those who will profit from a default through claims on credit default swaps. Rather than being represented equally in the negotiations through a creditors' committee, the negotiations are being driven by the Institute of International Finance, a trade lobby of just the biggest banks. Why the IIF should have credence as representing hedge funds, pension funds and insurance companies holding Greek debt is beyond me.

Once again we see centuries of jurisprudence and decades of statutory law and market practice cast aside for the convenience of a handful of big banks. They argue that abandoning our principles is desirable to prevent destabilisation of the financial system - again. I am wondering if a system that requires constant sacrifice of all the principles of market price discovery, rule of law and equitable treatment of like behaviours is worth stabilising.

If the Greece negotiations fall apart, and Greece defaults, is it likely that the banks will embrace the rule of law and let their contracts stand? Or will they try to "reinterpret" their obligations or once again seek taxpayer reimbursement for their losses?

Tyranny takes many forms, but the essence is arbitrary exercise of power or despotic use of authority. Given their willingness to throw principles out the window whenever profits are threatened, it seems we are confronting a tyranny by a handful of bankers. Perhaps we should embrace some sacrifice of stability to forestall a more stable and much more dangerous tyranny.

UPDATE: Excellent, thorough analysis of the Greek debt situation is up on ZeroHedge: Subordination 101: A Walk Thru For Sovereign Bond Markets in a Post-Greek Default World. Well worth your time to read the whole thing as a primer on the potential pitfalls of all outcomes of the Greek debacle for global sovereign bond markets. Conclusion about the high stakes of the current standoff reads:

Finally, while we have no prediction of whether or not any of the above happens, one thing we are sure of: if the runaway central planners of the world believe they can legislate their way into an upper hand over the bond market, in ever more desperate attempts to avoid the day of reckoning, they will fail without any shadow of a doubt. Because demand for risk comes first and foremost from a sense of stability, of fair and efficient markets, and equitability: something which has long been missing in the stock market, and which may very soon be taken away, by force, from the bond market as well.

Banks are lawless dictators? Whose side are the police on?

First, hat tip to Barry Ritholtz for the articles linked here. I read two of the articles, written on opposite sides of the planet, one after another, and suddenly the dangers confronting us in political instability were much clearer.

Back in June I wrote:

It used to be that the role of the state in financial market regulation was to ensure efficient market operations, promote transparency of prices and liquidity, protect consumers from abusive practices, and to resolve failed companies according to principles of equitable distribution of assets among like classes of creditors. If the role of the state now is to shield HFT, dark pool and OTC markets from transparency, provide liquidity where the market fails, oversee the orderly fleecing of consumers, and to ensure that some creditors of failing firms always win while others always lose, then we no longer have a market economy. And as virtually all these regulatory policies have evolved in the absence of public debate and legislative scrutiny, we also no longer have democratic governance of markets.

The deficit that worries me most in terms of the future of our civilisation is the legal accountability deficit - or anomie as I use it here. This deficit is huge and still growing rapidly as decisions are taken behind closed doors to shield lawless bankers from taxes or criminal sanctions and dedicate more and more public funds and/or monetary expansion to the same lawless bankers with too little public accounting, scrutiny or recourse.

This morning a commentary by Robert Fisk crystalised this concern as a political crisis in the offing: Bankers are the dictators of the West.

Let's kick off with the "Arab Spring" – in itself a grotesque verbal distortion of the great Arab/Muslim awakening which is shaking the Middle East – and the trashy parallels with the social protests in Western capitals. We've been deluged with reports of how the poor or the disadvantaged in the West have "taken a leaf" out of the "Arab spring" book, how demonstrators in America, Canada, Britain, Spain and Greece have been "inspired" by the huge demonstrations that brought down the regimes in Egypt, Tunisia and – up to a point – Libya. But this is nonsense.

The real comparison, needless to say, has been dodged by Western reporters, so keen to extol the anti-dictator rebellions of the Arabs, so anxious to ignore protests against "democratic" Western governments, so desperate to disparage these demonstrations, to suggest that they are merely picking up on the latest fad in the Arab world. The truth is somewhat different. What drove the Arabs in their tens of thousands and then their millions on to the streets of Middle East capitals was a demand for dignity and a refusal to accept that the local family-ruled dictators actually owned their countries. The Mubaraks and the Ben Alis and the Gaddafis and the kings and emirs of the Gulf (and Jordan) and the Assads all believed that they had property rights to their entire nations. Egypt belonged to Mubarak Inc, Tunisia to Ben Ali Inc (and the Traboulsi family), Libya to Gaddafi Inc. And so on. The Arab martyrs against dictatorship died to prove that their countries belonged to their own people.

And that is the true parallel in the West. The protest movements are indeed against Big Business – a perfectly justified cause – and against "governments". What they have really divined, however, albeit a bit late in the day, is that they have for decades bought into a fraudulent democracy: they dutifully vote for political parties – which then hand their democratic mandate and people's power to the banks and the derivative traders and the rating agencies, all three backed up by the slovenly and dishonest coterie of "experts" from America's top universities and "think tanks", who maintain the fiction that this is a crisis of globalisation rather than a massive financial con trick foisted on the voters.

The banks and the rating agencies have become the dictators of the West.

The banks as dictators makes sense to me. In thinking about my dissatisfaction with financial regulation for much of the past decade, I see that a great deal of it is attributable to who the regulators see as their polity. Their idea of consultation on regulations is to ask the bankers, traders and rating agencies whether they approve. The idea of making public policy in the public interest if the bankers disapprove is unimaginable to them. And so the banks get the regulations they prefer - or at least did so until the crisis.

And my queasiness about David Cameron's behaviour in Brussels on Friday stems from the same concern. He threw his toys out of the pram and turned his back on the EU because they wouldn't guarantee to preserve the City from further taxation, regulation and scrutiny. It's very clear that the polity he was serving was not the United Kingdom's 62,300,000 people - but the one per cent that make their living in the City of London.

Immediately after reading the Fisk piece, I read the moving statement of Patrick Meighan, My Occupy LA Arrest.

My name is Patrick Meighan, and I’m a husband, a father, a writer on the Fox animated sitcom “Family Guy”, and a member of the Unitarian Universalist Community Church of Santa Monica.

I was arrested at about 1 a.m. Wednesday morning with 291 other people at Occupy LA. I was sitting in City Hall Park with a pillow, a blanket, and a copy of Thich Nhat Hanh’s “Being Peace” when 1,400 heavily-armed LAPD officers in paramilitary SWAT gear streamed in. I was in a group of about 50 peaceful protestors who sat Indian-style, arms interlocked, around a tent (the symbolic image of the Occupy movement). The LAPD officers encircled us, weapons drawn, while we chanted “We Are Peaceful” and “We Are Nonviolent” and “Join Us.”

As we sat there, encircled, a separate team of LAPD officers used knives to slice open every personal tent in the park. They forcibly removed anyone sleeping inside, and then yanked out and destroyed any personal property inside those tents, scattering the contents across the park. They then did the same with the communal property of the Occupy LA movement. For example, I watched as the LAPD destroyed a pop-up canopy tent that, until that moment, had been serving as Occupy LA’s First Aid and Wellness tent, in which volunteer health professionals gave free medical care to absolutely anyone who requested it. As it happens, my family had personally contributed that exact canopy tent to Occupy LA, at a cost of several hundred of my family’s dollars. As I watched, the LAPD sliced that canopy tent to shreds, broke the telescoping poles into pieces and scattered the detritus across the park. Note that these were the objects described in subsequent mainstream press reports as “30 tons of garbage” that was “abandoned” by Occupy LA: personal property forcibly stolen from us, destroyed in front of our eyes and then left for maintenance workers to dispose of while we were sent to prison.

When the LAPD finally began arresting those of us interlocked around the symbolic tent, we were all ordered by the LAPD to unlink from each other (in order to facilitate the arrests). Each seated, nonviolent protester beside me who refused to cooperate by unlinking his arms had the following done to him: an LAPD officer would forcibly extend the protestor’s legs, grab his left foot, twist it all the way around and then stomp his boot on the insole, pinning the protestor’s left foot to the pavement, twisted backwards. Then the LAPD officer would grab the protestor’s right foot and twist it all the way the other direction until the non-violent protestor, in incredible agony, would shriek in pain and unlink from his neighbor.

It was horrible to watch, and apparently designed to terrorize the rest of us. At least I was sufficiently terrorized. I unlinked my arms voluntarily and informed the LAPD officers that I would go peacefully and cooperatively. I stood as instructed, and then I had my arms wrenched behind my back, and an officer hyperextended my wrists into my inner arms. It was super violent, it hurt really really bad, and he was doing it on purpose. When I involuntarily recoiled from the pain, the LAPD officer threw me face-first to the pavement. He had my hands behind my back, so I landed right on my face. The officer dropped with his knee on my back and ground my face into the pavement. It really, really hurt and my face started bleeding and I was very scared. I begged for mercy and I promised that I was honestly not resisting and would not resist.

My hands were then zipcuffed very tightly behind my back, where they turned blue. I am now suffering nerve damage in my right thumb and palm.

I was put on a paddywagon with other nonviolent protestors and taken to a parking garage in Parker Center. They forced us to kneel (and sit--SEE UPDATE) on the hard pavement of that parking garage for seven straight hours with our hands still tightly zipcuffed behind our backs. Some began to pass out. One man rolled to the ground and vomited for a long, long time before falling unconscious. The LAPD officers watched and did nothing.

This account turned my stomach, as it demonstrates all too clearly that the sympathies of the state are with lawbreaking bankers and not the victimised masses bailing them out.

So that’s what happened to the 292 women and men were arrested last Wednesday. Now let’s talk about a man who was not arrested last Wednesday. He is former Citigroup CEO Charles Prince. Under Charles Prince, Citigroup was guilty of massive, coordinated securities fraud.

Citigroup spent years intentionally buying up every bad mortgage loan it could find, creating bad securities out of those bad loans and then selling shares in those bad securities to duped investors. And then they sometimes secretly bet *against* their *own* bad securities to make even more money. For one such bad Citigroup security, Citigroup executives were internally calling it, quote, “a collection of dogshit”. To investors, however, they called it, quote, “an attractive investment rigorously selected by an independent investment adviser”.

This is fraud, and it’s a felony, and the Charles Princes of the world spent several years doing it again and again: knowingly writing bad mortgages, and then packaging them into fraudulent securities which they then sold to suckers and then repeating the process. This is a big part of why your property values went up so fast. But then the bubble burst, and that’s why our economy is now shattered for a generation, and it’s also why your home is now underwater. Or at least mine is.

Anyway, if your retirement fund lost a decade’s-worth of gains overnight, this is why.

If your son’s middle school has added furlough days because the school district can’t afford to keep its doors open for a full school year, this is why.

If your daughter has come out of college with a degree only to discover that there are no jobs for her, this is why.

But back to Charles Prince. For his four years of in charge of massive, repeated fraud at Citigroup, he received fifty-three million dollars in salary and also received another ninety-four million dollars in stock holdings. What Charles Prince has *not* received is a pair of zipcuffs. The nerves in his thumb are fine. No cop has thrown Charles Prince into the pavement, face-first. Each and every peaceful, nonviolent Occupy LA protester arrested last week has has spent more time sleeping on a jail floor than every single Charles Prince on Wall Street, combined.

A deflationary collapse will lead to political instability. It always does, because deflation destroys the value of paper assets which are mostly held by the most wealthy - the 1 per cent. And when deflation destroys their assets, it destroys their power and creates a vacuum. We need to be very clear in such a case that the enemy of the people is not the state, because if the state uses its police powers to protect the guilty and punish the innocent, then popular resistance and revolt become all too probable.

In Europe, the politicians know this. Even the police know this. No matter what I think of any British government, the conduct of the LA Police would be inconceivable here. The police killing just one career criminal this summer sparked nationwide riots. Brutalising non-violent protestors would have all of us on the streets.

There are values which are independent of financial assets. Those of us concerned to retain those values as a legacy for our children need to be vigilant as the bankers are only concerned with the values they can cash short term.

Thomas Jefferson wrote, "When the people fear their government, there is tyranny; when the government fears the people, there is liberty."

Fisk and Meighan remind us that the people are sovereign. The protests are because our sovereignty is undermined when it is disrespected by bankers buying lawlessness or by the police or financial regulators using state powers against the public interest. We have a right as a free people to self-governance under the rule of law. We as a free people have a right to regulate financial services to ensure that it serves a socially constructive function in the economy. Applying the rule of law to bankers reinforces the principles of justice essential to capitalism and the preservation of private property. The banks are not sovereign, and do not have a right to laws, regulators and police that protect them and them alone. There's some work to do here, of course, but having the issue crystallised helps a lot.

Why I oppose Financial Stability

Financial Stability became a topic in the late 1990s, at a time of peak laxity in international financial supervision. The same minds which promoted the Financial Stability Forum (now the Financial Stability Board) also crafted the deeply flawed and destructive Basel II.

I have never understood why Financial Stability should be an objective of public policy. Desirable, measurable outcomes of benefit to the public should be the objectives of public policy. Stability is a silly and impractical goal in a capitalist economy. Success and failure of competitive firms are the basis for economic progress, capital allocation and market pricing. Capitalism requires recognition of failure, and failure always causes economic loss and some instability as past assumptions are re-examined and re-assessed more objectively in light of current painful reality.

The management of failure can contribute to better future outcomes, but only if the costs of failure are born by those who caused the failure and not by those innocent of it. The 1990s policies promoted by regulators during the Great Moderation aimed to forestall failure by disguising it, delaying it, and subsidising it. Since the collapse of securitisation and inter-bank credit markets in 2008, governments have been too willing to socialise the costs of failure (by then magnified with leverage) to taxpayers through serial bailouts.

One strength of the US banking system from the 1930s to the 1980s was that failures were dealt with quickly and certainly. Foreclosed properties had to be sold by banks within two years of repossession, leading to a quick and certain reallocation of assets from failed borrowers to new owners. The FDIC swiftly and mercilessly shut down failed banks. New owners - often buying at distressed prices - were encouraged to invest in making the assets productive and profitable. It was this simple recycling from failed managers to better managers that was largely behind the short recessions and strong recoveries during this period of American economic history. With forbearance now institutionalised at all levels of the US economy, we are seeing Japanification instead of recovery. And it is even worse just about everywhere else where dominant banks are much more influential.

Financial Stability - like national security - can never be objectively confirmed as achieved. It is more often used to disguise the ulterior aims of its proponents, or to misdirect attention in aid of bad public policy that harms rather than promotes the public interest. For example, the Greenspan Put was a brilliant mechanism for ensuring financial stability by preventing any adjustment of the markets in response to the S&L crisis or dot-com bust. The Bernanke Put and Paulson Plan were financial stability solutions to the securitisation fraud crisis that revealed the undercapitalisation of global banks and over-leveraging of real estate. Bank bailouts and special liquidity facilities were financial stability innovations to prevent mark downs of mis-priced and illiquid capital assets.

Rather than review whether massive financial deregulation and promoting concentration in a few incumbents was in the public interest, the Greenspan Put, Bernanke Put, liquidity facility innovations and public bailouts have disguised misallocation of capital by pumping the markets with taxpayer funds and monetary laxity whenever they began to flag. Financial Stability initiatives have therefore taught incumbent bankers that any disruption is an excuse to double down on bad bets as the central banks and state treasuries would flood enough cash to make bad bets come good. MF Global made this bet, and although it (and its clients) won't be collecting, I expect the creditors/counterparties that seized all its collateral assets expect to come out way ahead.

I oppose Financial Stability because it is the most misleading banner for a set of bad, harmful and expensive public policies protecting bad executive management and preventing recognition of realistic market outcomes.

So what would I promote instead? Resiliency and resolution. Resiliency means the ability to withstand stresses and shocks which will unavoidably arise in global, competitive markets. Resolution means the dispersion of assets to creditors - and competitors - when banks fail, in hopes the assets and enterprises will be better managed by other managers than the same ones that led the bank to failure. Together these two principles - if made the basis for public policy - would do more to restore sanity to global banking than anything else I can think of. Resiliency will favour more and better capitalisation, with a focus on marketable assets with transparent price discovery (e.g., traded on transparent markets and recorded on balance sheet). Speedy and certain resolution of failed banks will make management and shareholders conscious of the risks of failure falling first on them, then on unsecured creditors and bondholders, and never on the taxpayer.

We are a long way from adopting principles of resiliency and resolution, as demonstrated by the EU's continued efforts to forestall defaults while protecting incumbent managements and bondholders. Our policy makers continue to chase the chimera of financial stability, and make bad policies worse along the way.

Anomie Watch: EFSF and bailout lawlessness

Anomie literally means lawlessness. Although banks are burdened with many, many rules, they are seldom obeyed and largely unenforceable against the most powerful. Central banks are even more likely to ignore their enabling statutes and applicable regulations in innovating "financial stability" solutions. It is this lawlessness that was brought to the fore this week by a vote to reject the EFSF in Slovakia.

My post earlier this week coincided with a furore in Slovakia over approval of the European Financial Stability Facility. The EFSF is yet another mechanism for ill-transparently transferring taxpayer funds via governments and central banks to bankers, bondholders and bank shareholders.

An obscure leader, Richard Sulik, of an obscure minority party, SaS, objected to impoverishing his already poor countrymen to enrich foreign bankers. Under the terms of EFSF financing, taxpayers in Slovakia - the second poorest nation in the EU - would bear a disproportionate share of the EFSF burden relative to the size of the economy.

When the prime minister made support for the EFSF a vote of confidence, Sulik and his party brought down the government. The EFSF is likely to pass following a reorganisation of the coalition government, but in the meanwhile we have a teaching moment of real value.

I respect any politician who acts out of principle rather than self interest. Since the occurence is relatively rare, I was prompted to take a closer look at Mr Richard Sulik and his views on the EFSF. Fortunately he has documented his objections fully in a paper available online:

European Financial Stability Facility: A Road to Socialism

Just like it is impossible to extinguish fire with a fan, it is equally impossible to solve the debt crisis with new debts. The only thing that will help is to face the truth. Greece must declare bankruptcy, Italy must start saving and the rules set up by the eurozone upon its establishment must finally start being observed. It will hurt, but it is the only solution. . .

I would like to point out that this is not the same eurozone we entered in 2009. There are rules that should have been observed but all of them have been violated. Temporary EFSF and permanent EFSF will cost us 1 to 1.5 the amount of our annual state budget! Moreover, there is no guarantee that the attempts for the EFSF increase are over. . . .

EFSF ratification by the National Council will be a decision that will harm the citizens of Slovakia in the long run and to a great extent.

SaS will simply not sign up for something like this.

Whether you are for or against the EU, for or against the Eurozone, for or against bailouts, this is an important document to read. It catalogues the lawlessness and lack of accountability that made a bad financial crisis into a bad banking crisis then worse sovereign debt crisis and an even worse currency crisis.

I wish Mr Sulik had a career ahead of him in central banking or EU public policy. I fear after this week, he may once again be relegated to obscurity. His fellow Slovakians should be grateful for his principled stance and his foresight, and perhaps return him and his party to government when the costs of the betrayal of other parties become all too clear.

UPDATE: This just in! Berlusconi must face a vote of confidence tomorrow in the Italian parliament after defeat in a routine vote on government budget and accounts yesterday. Perhaps the Slovakian teaching moment will last longer than one day?

UPDATE (2): The three outgoing coalition parties have agreed with the opposition SMER party to pass the EFSF in a further vote to be scheduled before the end of the week. An election will be held on 10 March 2012. I hope the Slovakian voters remember then that the party that did not betray them to Brussels and the banksters was SaS.

Dexia, Mafia and Revolution

I knew I had seen the script we're living somewhere:

What I am saying is, we have now what we have always needed, real partnership with the government.

And this is what follows: Revolution!

What does that tell you? It tells me that when predatory bankers and their complicit government cronies cannibalise the real economy to the tipping point, then regime change is just a matter of time. Politicians are acting like bankers are their only paymasters. In reality the bankers are just the noisiest and most demanding paymasters - until the people rise up in anger.

This morning the 11 million people of Belgium have woken to find themselves the 100 percent owners of a bankrupt and unprofitable retail bank at a cost of 4 billion euros, and guarantors of a further joint 122 billion euros in liabilities with France and Luxembourg. The shareholders and bondholders will be grateful, and the markets are accordingly delighted, but pity the poor Belgian taxpayer. The CEO and Chairman of Dexia have admitted that the bank operated as a hedge fund, and yet they are given serial bailouts at the taxpayers' expense. The Belgians have already thrown out their government, so now what do they do?

UPDATE: Ironically, after putting up this post about how crony accommodation of the banksters can lead to revolution, the reality is unfolding even now in Slovakia. Slovakia was the last country required for unanimous consent to the extension of the powers of European Financial Stability Fund. The prime minister made the vote on the EFSF a vote of confidence in the government. Ooops. Looks like she loses her post and the government tonight, as one of the smaller parties took offense at the blackmail against the national interest.

My new hero is Richard Sulik, leader of the coalition's SaS party, who is willing to take down the government rather than betray his country's taxpayers. The vote, which has had the market on edge all day, has now been indefinitely postponed. Even if the EFSF vote passes this week, when the fecal matter hits the ventilator in the not distant future, the voters will remember that Mr Sulik tried to do the right thing.

FT.com:
“I'd rather be a paraiah in Brussels than have to feel ashamed before my children, who would be deeper in debt should I back raising the volume of funding in the EFSF bail-out mechanism,” Mr Sulik told parliament.

Mr Sulik resisted the entreaties of Ms Radicova and other officials, who stressed that Slovakia's credibility as a responsible member of the eurozone was on the line.

While the trials of countries such as Portugal and Ireland do find sympathy in Slovakia, which is the second-poorest member of the eurozone, there is very little feeling for Greece, which is seen by many Slovaks as having caused its own problems.

“Extending the EFSF is mainly for saving foreign banks, and it will be expensive for Slovakia,” said Mr Sulik.

Zerohedge is liveblogging the Slovakian Parliament for those who like their crony capitalism raw and in colour.

Transaction Taxes and Transparency

The City of London is in a stir over the EU proposal of a financial transactions tax. The great and the good are uniformly arrayed against such a tax. I am not so sure that it wouldn't be a good thing.

Here in Britain we now pay 20 per cent Value Added Tax on virtually everything we buy, except food, medicines and children's clothing. Yet the financial sector is exempt of any similar tax on transactions. This is patently unfair since approximately 5 pence of the 20 is required to finance the state bailouts of the financial sector. As a regressive and unfair tax, that is hard to beat.

In addition to raising revenues from an investment banking sector which has decimated public finances for a generation to come, a transaction tax might be a very good thing from an accountability and transparency perspective.

Those opposing say it would be anti-markets and drive trading offshore. Markets clearly do not work properly anymore at price discovery, liquidity aggregation or trade transparency. I rather think markets would work better if those participating had an economic stake in the transaction longer than a nanosecond, and a trading objective more durable than front-running real investors with HFT gaming.

More than that, a transaction tax would recognise that the state adds value to the market and deserves to be recompensed for that value. A huge part of the operational value of developed markets is derived from the rule of law. Taxing transactions would be recognising that each transaction benefits from the legal system which makes such a transaction valid and enforceable.

In my view, the way to make the transaction tax workable and cost-effective is to incentivise the reporting of transactions and the payment of tax. The way to do this is to legislate that transactions themselves will only be legally enforceable if there is a record that the tax has been paid. Anyone might choose not to pay the tax, but if they want to enforce a trade or debt obligation they are on their own. If they want recourse to the courts, rights to exercise on margin/collateral or a valid claim in insolvency, then they pay the tax as their ticket to rely on the legal system.

In the United States we see that the MERS scandal boils down to the wholesale attempt by US banks to avoid paying the transaction taxes on land mortgage registrations with local counties and states. As a result, the very enforceability of millions of mortgages is being thrown into doubt as a matter of law.

Had originators, banks, investment banks and investors been forced to register interests in mortgages in compliance with the law, some of the great abuses of securitisation would have become much more difficult to sustain for so long. In that sense, transparency would have promoted greater accountability and helped curb abuse.

The public has an interest in the integrity of markets. That integrity has been undermined horribly over the past 25 years by demutualisation of exchanges and clearing houses, fragmentation of markets to off-exchange systems and derivatives, leveraged shadow banking, and information assymetries between highly concentrated market insiders and everyone else. We now don't know who owns what and who owes what, and that means that economies are operating with dangerous blind spots. Relaxed accounting rules and forbearance on capital mean that mis-pricing and mis-allocation of capital are endemic and worsening, making any recovery even more doubtful.

A transaction tax on trades, as a pre-condition to legal enforceability, might restore some integrity to markets. That would help restore more efficient functioning to economies with much greater promise than further bailouts to banks.