Time for the EU to shut down the casino

22 July 2011

Until the European Commission shows it has learnt the lessons of the 2008 financial crisis and demonstrates the political will to re-regulate the financial sector, it will be unable to resolve the crises in Greece, Ireland and Portugal

There is widespread agreement on left and right that the EU has failed in its response to the Euro-crisis, that is now taking a heavy toll on the economy, democracy and society of Greece, Ireland and Portugal. However the failure of the European Union to respond either effectively or justly to the Euro crisis is not a recent phenomenon. It reflects their failure to learn the lessons of the global financial crisis in 2008 and its unwillingness to use the wake-up call then to rein in the financial sector.

The most clear example of this failure is that the same speculative financial instruments – in particular Credit Default Swaps (CDS) and naked short selling - that caused the global financial crisis have played a key role in the Greek crisis.

Credit default swaps are insurance contracts investors buy to try to protect themselves from default. When investment banks like Goldman & Sachs or Deutsche Bank as well as hedge funds started to purchase these in higher numbers for Greek bonds, their increased demand raised the prices of CDS and was perceived as a confirmation that the situation of Greece was worsening.

The same speculative financial instruments that caused the global financial crisis have played a key role in the Greek crisis

The over-powerful Credit Rating Agencies, such as Moody's interpreted rising CDS prices by downgrading the rating of the country, which pushed up the price of the CDS even more and increased interest rates for Greece and therefore its debt burden.  Meanwhile the price of Greek bonds started falling, fuelling naked short selling (which involves financial traders speculating on the difference between the prices for CDS and bonds); pushing bond prices down even further.

As a result Greece could only issue new bonds or reschedule old ones at a very high interest rate, 20%, which is unsustainable and hugely increased the debt burden. Speculators became the core drivers behind Europe's economic crises; turning speculation of default into self-fulfilling prophesy.

The warning bells were clear in 2008 and well before that. Yet despite bold statements, almost no action has taken place to stop these speculative attacks, which end up creating serious social crises affecting much of Europe. It has taken until July this year, 2011, for European Parliament to even draft legislation which would regulate – rather than ban - short selling and CDS. There are already signs that this could be further weakened by the Council of Finance Ministers due to fierce lobbying by the financial sector.

Attempts to regulate over-the-counter (OTC) Derivatives – unregistered and non-transparent derivative trading accounting for 85% of derivative transactions - have suffered a similar fate. Early proposals have been watered down considerably with no limits imposed on levels of trading, no special measures agreed for speculation on food prices, exemptions made for key players such as pension firms and important implementation issues left for consultation with the financial industry.  Even the "stress test" of the largest 90 banks in the EU by the new European Banking Authority is not completely credible. The stress test showed that some banks were still not strong enough to withstand worsening crisis scenarios while other banks were stronger than the financial speculators assumed.

Commissioner Barnier, responsible for regulating the financial market, announced "stiff measures" in November 2010 “to reduce the power of the [Credit Rating Agencies], such as forcing them to justify their decisions by revealing the details of their analyses and criteria, and scrutinising whether they are properly registered in Europe”. However it is not clear if these measures will be on time or too late, if they will be sufficient or not, and will provide more credible and independent ratings. The evidence based on other attempts to re-regulate the financial industry does not hold much hope.

Perversely more progress has been made in attempts by the EU in its attempts to impose a stricter neoliberal fiscal regime on member countries, including sanctions for those in the Euro zone. On 18 June 2011, the heads of state meeting at the European Council adopted a programme for new Economic Governance at EU level, known as the ‘six pack’ as it consists of six legislative proposals. The core of the ‘six pack’ is surveillance of national budgets, aiming at converging all European economies to a public debt limit of less than 60% of GDP, which  was fixed in the Maastricht treaty.

By setting fiscal discipline as its top priority, all other parameters such as growth, employment, social welfare are subordinated to what they consider to be ‘sound fiscal policies.’  The European Trade Union Confederation (ETUC) commented that: "this is likely to paralyse the scope for recovery and to exacerbate unemployment and insecurity." The ETUC called for the clauses which safeguard wages and collective bargaining, that had been introduced by the European Parliament, to be maintained and strengthened.

What the Euro crisis has revealed clearly is that the financial markets are still able to determine the fate of Europe and the global financial system and economy.

The lack of reform of the financial sector can also be seen at G20 level. The US is afraid to introduce stricter regulation of derivatives than the EU, while the EU complains that the US regulates less in other areas such as banking and remuneration reforms. The G20 Agricultural Ministers, who met for the first time on 22-23 June 2011 after arduous preparations, did not even decide on how financial markets could be prevented from excessive speculation on food and other commodity prices.

What the Euro crisis has revealed clearly is that the financial markets are still able to determine the fate of Europe and the global financial system and economy. It has shown once again, that the globalisation of finance has led to a system where politics, even of big countries and the entire EU, are helpless vis à vis the financial markets. All attempts since 2008 to reform the sector have been weakened or severely delayed. Instead, solutions are being sought in old models, such as the EU Economic Governance package and austerity measures, which implement redundant neoliberal economic policies and budgetary restrictions and lack credibility.

Yet the continuing and escalating crises in Europe is clear evidence that it is time for decision makers and the financial sector to change their old ways of acting and thinking before the crisis gets completely out of hand. The only solution is imposing strict control over the financial markets and financial speculation, and the banning of speculative instruments such as short selling and CDS on sovereign bonds. As UNCTAD has put it: “Nothing short of closing down the big casino will bring a lasting solution.”