In recent years, the German government has been very keen on attacking hedge funds. It all started in 2005 with Müntefering’s “locusts” diatribe, and the current Finance Minister Wolfgang Schaeuble has kept up the act, most recently by demanding that funds be placed “under surveillance” by intelligence agencies. Yet, observing German government behaviour over the last year, I cannot help but wonder whether, in their hedge fund obsession, maybe they have learnt some tricks of the trade.
Where to start? First, among the activities of hedge funds that attract them so much public ire is accelerating a bond panic, say by short-selling sovereign debt, and then surreptitiously buying it back at vastly reduced prices, once the panic has run its course. As data from the Chicago Mercantile Exchange shows, speculators went massively short the euro in January, and Greek debt in particular: yet by the end of summer, just as ordinary investors had sold out their positions in terror of an impending eurozone ‘collapse’, institutional investors had piled quietly back in.
Whether by accident or design, Berlin has got a similar deal with its own eurozone crisis lending. In late 2009, as it became clear that Greece had falsified its accounts and would be in need of a bailout, the new government announced emergency cuts and canvassed support from potential lenders. After a slow-motion crash which saw bond yields spike 7 months later at 12 per cent, EU member states finally agreed a lending package that would allow Greece to borrow from other members at a reduced rate of 5 per cent.
Yet many forget that in late 2009 , the yield on Greek 2-year bonds was still 4 per cent, and that the real loss of confidence only occurred in February when Germany blocked other eurozone states from finalising an EU ‘bailout’ mechanism and France blocked Greece from turning to the IMF. Had Greece been allowed to go straight to the Fund, the country could have borrowed at a 3 per cent SDR rate. EU member states, led by Germany and France, precipitated a crisis that has allowed them to force out of Greece a rate of return a good margin greater than what the country might have received elsewhere. This is the kind of trickery that would earn any hedge fund manager a very healthy end-of-year bonus.
Likewise, there is also a strange parallel to be found in the financing of major investment banks, and Germany’s involvement in the new European Financial Stability Facility (EFSF). Perhaps one of the most subtle and odious practices since the financial crisis has been the way that banks have recapitalised by borrowing unlimited amounts from the ECB and the Federal Reserve, at interest rates you or I cannot access, and built back their balance sheets (as well as maintain their salary structure) by lending out at higher rates to companies and to governments (though in the eurozone, primarily to distressed governments). Strangely, via the EFSF Germany, along with its other contributors, looks set to profit from a similar kind of debt arbitrage. In order to pay for its contribution, the ESFS is expected to issue bonds at 3.5 per cent, and then lend the money to countries like Ireland at a final rate of 6 per cent; if Germany receives compensation equivalent to its €120bn guaranty, debt arbitrage will pocket Berlin an additional €4.4bn a year – a cumulative 400 euro windfall for every man, woman and child in Germany over the next ten years! And this the policy for which German voters are apparently outraged. Many of course remain under the sad delusion that Germany has actually given money to Ireland, rather than simply written insurance on a loan.
I know the German government response would be that these loans will be very risky, and in the event that Ireland or Greece has to default, the German taxpayer that will foot this cost (though I calculate a huge haircut of around 25 per cent would be required for this ‘Bund-EFSF arbitrage’ to turn a loss). They also might say that issuing guarantees to Greece, Ireland and so on forces up the cost of their own debt refinancing, though the evidence is mixed so far. And I know that finally they might reply that if Germany and other eurozone governments did not step in, these countries would not find institutional investors for their loans, and could face a paralysing default. Even here I am not so certain, as in addition to the IMF, China’s two main sovereign wealth funds have about $700bn in total assets under management, the Russians have at least $150bn, the Abu Dhabi Investment Authority about $600bn, Saudi’s AMA has $431bn, and Libya has another $70bn lying spare. Some assortment of these countries might be prepared to bail out Europe’s little sovereign defaulters, if they agreed to rent out their foreign policy for a few years.
So in exacerbating crises from which they subsequently profit, are Germany and France behaving like ‘hedge funds’? I, myself, am not cynical enough to believe that they would collude to extract a tough deal simply for their own benefit. But I am realist enough to know that, unless concessions are offered further down the line, many voters in Dublin and Athens will start to see it that way.
#1 by dcm on December 3, 2010 - 7:56 am
Don’t forget the competitive devaluation that Germany achieved by letting the euro crisis drag on for so long. At some point you wonder whether they have deliberately let it run in order to bring this about.
#2 by Klaus Pedersen on December 3, 2010 - 2:07 pm
You make some interesting observations, but the argument doesn’t hold water when you ask: who is “Germany”?
I see no conflict in German politicians calling for international regulations of alternative funds, but not restraining the managers of pension funds which happen to be held in Germany. In fact, this dilemma illustrates the very need for international regulations of hedgefunds
#3 by George on December 3, 2010 - 3:11 pm
This is a very clever piece. Very insightful. In Sweden it has not escaped the notice of the press that Sweden has made a tidy profit bailing out Iceland. I’m sure that the German government did not deliberately precipitate Ireland and Greece’s problems in order to profit from them, but profit from them they likely will and then one must ask the question whether this is fair and whether perhaps some share of those profits should go toward writing down the loans. Just a thought.
#4 by Christian on December 3, 2010 - 7:52 pm
Just wondering, in case of default, who would be the big losers? And I don’t mean primarily Greece or Ireland, because here it’s kind of clear that it’s going to be the German, French or British taxpayers, but let’s say Portugal will default instead of getting bailed out. Does this mean Portugal is for some years of the map, or does it just mean some banks will lose their money (after taking a certain risk into account when lending that money, or at least you would say that).
I’m a little confused why default is something that’s never considered since most states make new debts only to pay for old ones and in a market economy you would say it’s the most normal thing for creditors to also lose sometimes. The explanation that comes to my mind so far, is that banks are right now more powerful than the rest of society and therefore can make greater pressure on governments; but I feel (and hope) it’s to simple and to conspiratorial.
#5 by Roberto Foa on December 4, 2010 - 9:20 pm
DCM: True, but I’m not sure German politicians are that cynical. I think Merkel is uncomfortable with any kind of change or innovation, does not trust Sarkozy, and does not understand finance, and that explains why it has taken so long.
Christian: there are three reasons why default is not considered as an option:
First, governments cannot default, because they still need to borrow to finance their current spending. You can be a borrower or a defaulter, but not both at the same time. If Greece of Ireland were to default now, they would be frozen out of the capital markets, and have to immediately bring their budgets into balance. This would be exceptionally painful (indeed impossible, in the case of Ireland). The idea that ‘debt restructuring’ is a realistic alternative for Ireland or Greece at the present time – as frequently suggested in the press – is a total and utter fiction. They can do it in a couple of years once their primary balance is under control, but not now.
Second, many of the holders of Irish, Portuguese and Greek government debt are the European banks, for as a means of rebuilding their balance sheets they have spent much of the last two years borrowing from the ECB and purchased higher yielding sovereign debt. Thus a sovereign default could set off an immediate banking crisis. Allowing the banking sector to collapse is not an option, as it would send Europe into a depression. Hence, again, if there is to be a ‘haircut’ on sovereign debt it needs to happen in a couple of years time – once European banks have rebuilt their capital bases enough to write off the losses.
Third, as the consequence of a sovereign default would be to send contagion through the banking system, and the banking system in countries like Spain or Portugal cannot be allowed to collapse, it will be their governments who have to step in. Even if they nationalise the banks, wipe out the shareholders and bondholders, and cut bonuses, this will not be enough to save the banks themselves, which require substantial recapitalisation. And that will require even more contributions from the taxpayer, once they are nationalised.
#6 by Dimitrios on December 5, 2010 - 8:59 am
No. Absolutely no.
Germany’s political entity in Europe is governed by THE TREATY ON THE FINAL SETTLEMENT GERMANY, the known ‘Two Plus Four Agreement’. Germany knows that politically is nothing other than an “occupied” state and as Europe’s largest economy and second most populous nation (after Russia), Germany is a key member of the continent’s economic, and defense organizations. European power struggles immersed Germany in two devastating World Wars in the first half of the 20th century and left the country occupied by the victorious Allied powers of the US, UK, France, and the Soviet Union in 1945. With the advent of the Cold War, two German states were formed in 1949: the western Federal Republic of Germany (FRG) and the eastern German Democratic Republic (GDR). The democratic FRG embedded itself in key Western economic and security organizations, the EC, which became the EU, and NATO, while the Communist GDR was on the front line of the Soviet-led Warsaw Pact. The decline of the USSR and the end of the Cold War allowed for German unification in 1990. Since then, Germany has expended considerable funds to bring Eastern productivity and wages up to Western standards. In January 1999, Germany and 10 other EU countries introduced a common European exchange currency, the euro. Thus Germany cannot be a productive hedge fund manager due to the lack of the political controla that is exercised by others
#7 by Dimitrios on December 5, 2010 - 10:44 am
#8 by Betterworld Now on December 7, 2010 - 3:38 am
The German govt insisted the Irish taxpayer accept the debts of its private banks who had borrowed money from the German private banks who were happy to underwrite their risky investments … they wanted (and got) a piece of the Irish action. When the investments went wrong and the Irish banks went under, the German banks persuaded the German chancellor to insist that the Irish taxpayer bail out the private Irish banks so that they didn’t have to accept the losses on their risky investments.
I think hedge fund is too charitable. Think mafia organisation and you are closer to reality. The German banking mafia own the German government and have a controlling interest in the ECB. And the EU sees fit to criticise Bulgaria as corrupt!
The only problem is that he Irish debt is not only unpayable … it is uncollectable.
#9 by Marcel on December 11, 2010 - 1:50 pm
The EU is a massive threat to the wealth of Europe, and the Euro is its main instrument of destruction of said wealth. We must get rid of the EU and its banker friends or else they will drag us all into poverty if they can (and they will, unless we stop them).
#10 by dcm on December 14, 2010 - 7:43 am
They may be acting like a hedge fund – but they are not acting alone. The Netherlands, Austria and (as you mention) France were also complicit in these awful Ireland and Greece packages. Anyway, kudos to you for pointing out how much the core EU states stand to make from squeezing peripheral taxpayers. A sad outcome for Europe.
#11 by Betterworld Now on December 15, 2010 - 1:37 pm
There is a 1.3% “arrangement fee” for the European portion of the loan to Ireland. This amounts to over €1,500,000,000.
Who is pocketing that money, at the expense of the Irish tax payer.
And, more importantly, why?
#12 by Joe on June 1, 2011 - 6:12 pm
With or without an EU, “EMF”, IMF, of whatnot, European banks, and German, French, Dutch, etc. Governments would be lending to governments runing a risk of defaulting on bonds. The price would be high because they need to be.
So I just don’t see that there are many alternatives, because the governments at risk of having bonds default aren’t going to rein in spending adequately or dispose of assets. What’s sad is that this “piece of the action” as if it was good, is both falling into the lap of the taxpayer, and enlarging the size and power of gevernments that crowd out free markets that know better how to lend and allocatte assets.
It also INCREASES sovereign debt, and I don’t know how society, particularly the lowest earners and future workforce participants benefit from that.
Governments end up catering to the noisiest mob that demand resources from people other than themselves in society for reasons not directly related to what those assets are being asked for, or to do things that realistically enlarge the economy to employ more people.