It started on Sunday in the Wall Street Journal. The venerable paper reported what everyone already knew, the European stress tests were a fraud.
An examination of the banks’ disclosures indicates that some banks didn’t provide as comprehensive a picture of their government-debt holdings as regulators claimed. Some banks excluded certain bonds, and many reduced the sums to account for “short” positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July.
Because of the limited nature of most banks’ disclosures, it is impossible to gauge the number of banks that excluded portions of their sovereign portfolios from their disclosures, or the overall effect of that practice.
But the exposure to government debt of at least some banks, such as Barclays PLC and Crédit Agricole SA, was reduced by a significant amount, according to industry officials and financial filings made by the banks. Adding to the haziness, the stress tests’ reported sovereign-debt levels differed, sometimes widely, from other international tallies and from some banks’ own financial statements.
The findings undermine a primary goal of the stress tests—namely, to reassure investors and bankers world-wide the soundness of Europe’s financial system. “That would certainly be unhelpful to people’s perceptions” of the tests’ credibility, said UBS banking analyst Alastair Ryan. Reducing banks’ reported holdings of government debt “was clearly helpful for the thing [regulators] were trying to achieve: convincing you that there’s not a problem.”
The results were swift and brutal. PIIGS bond yields exploded alongside CDS contracts. Greek and Irish CDS are now above their May panic peaks. The bad news didn’t stop there though. Bloomberg piled on yesterday with this gem:
Four months after the 110 billion-euro ($140 billion) bailout for Greece, the nation still hasn’t disclosed the full details of secret financial transactions it used to conceal debt.
“We have not seen the real documents,” Walter Radermacher, head of the European Union’s statistics agency Eurostat, said in a Sept. 2 interview in his Luxembourg office. Eurostat first requested the contracts in February.
Radermacher vows new toughness when officials from his staff head to Greece this month to come up with a “solid estimate” of the total value of debt hidden by the opaque contracts. “This is a new era,” he said.
Greece is the only euro country that lied about using these complex swap contracts after Eurostat told countries to report them in 2008, Radermacher, 58, said.
Greek bonds rose again today even as Europe moved into positive territory in afternoon trading. Greek bank stocks are down as much as 8% in trading today after losses yesterday. As the head of Eurostat is openly referring to the Greek administration as liars, it is clear that the heat is being turned up. The politicians in Europe are now positioning themselves to create scapegoats when the inevitable default happens. It appears that Papandreou is being set to take the fall. I don’t expect Papandreou to allow this to happen without desperate accusations.
The question now becomes: who does Greece blame for their debt woes? How about the investment bank that crafted the “secret financial instruments”?
We saw early this summer how inept the company is at defending itself when the SEC went after Goldman for its Abicus CDOs (conveniently during the debate over fin-reg reform). The precedent has been laid. Goldman is persona non grata among the public, viewed to be at the heart of the financial collapse in ’08 and resented by taxpayers for receiving 100 cents on the dollar in the AIG (NYSE:AIG) bailout.
Goldman is the “vampire squid,” everything wrong with crony capitalism. It makes for an easy target. As massive strikes by public sector unions now encompass the core of Europe, politicians will need to solidify their base to be reelected. The entitled demand what has been promised, no matter that the governments promising it are broke. A smart politician would move to redirect this anger away from the political class to the banking class.
Disclosure: Small put position in GS