1. The origins and the essence of the current financial crisis
The recent debt crisis in the United States of America, as well as some new findings about the current economic problems in European countries, have revealed how the instrument of public debt is used for the benefit of banking and finance.
First of all, it is necessary to highlight the fact that public debt is in no way inherently bad. Actually, it should be an important instrument of financing state policies - on the basis of which the governments are allowed to contract debts, obviously under certain limits and conditions. The loans should provide access to funds that, in association with those raised through taxes, serve to enable the government to fulfill its role in satisfying basic needs of the citizens.
Yet many studies, audits and inquiries have already revealed that instead of contributing to the advancement of public policies, significant amounts registered as public debt do not correspond to money collected through loans. Besides that, the largest part of sovereign debt is being used to pay interest and amortizations of previous debts whose original counterpart is not publicly known.
The essential problem, as can easily be detected, is that the instrument of public indebtedness is being converted into a means for a kind of embezzlement of public resources. Because of the lack of transparency in these processes and an excessive number of privileges - in both legal and financial areas, with many ramifications –this scheme can be said to work like a debt system and to function for the benefit of a small sub-sector of the financial markets.
The “Debt-System” is a very profitable business. The private financial system is a complex web of agents with a series of privileges in legal, political, financial and economic areas. These agents are large corporations led by banks and powerful rating agencies.
In the United States of America, this system operated recently to rescue banks from the imminent risk of bankruptcy. The dimension of this rescue plan was unveiled on July 21st, by Senator Bernie Sander |1|, who presented the findings of the audit carried out by the Government Accountability Office |2|. This report proved that the Federal Reserve Bank (FED) spent about US$ 16 trillion in the bail-out, which was directly transferred to banks and large corporations with interest rates close to zero, between December 2007 and June 2010.
The revelation of this governmental audit report must surely be one of the most relevant examples of the privilege of the financial sector: the crisis of this sector was the first step towards the current “sovereign” debt crisis, not only in the United States, but also in many European countries. The sum disbursed by the FED to bail out institutions is higher than the overall total of public debt in the USA (currently estimated at US$ 14.5 trillion) and than the Gross National Product (US$ 14.3 trillion in 2010).
The audit of this operation must keep up, as it clearly testifies to the conversion of huge private debts into public debt. The main recipients of the money given by the FED as specified in the report are summarized below:
Citigroup: $2.5 trillion ($2,500,000,000,000)
Morgan Stanley: $2.04 trillion ($2,040,000,000,000)
Merrill Lynch: $1.949 trillion ($1,949,000,000,000)
Bank of America: $1.344 trillion ($1,344,000,000,000)
Barclays PLC (United Kingdom): $868 billion ($868,000,000,000)
Bear Sterns: $853 billion ($853,000,000,000)
Goldman Sachs: $814 billion ($814,000,000,000)
Royal Bank of Scotland (UK): $541 billion ($541,000,000,000)
JP Morgan Chase: $391 billion ($391,000,000,000)
Deutsche Bank (Germany): $354 billion ($354,000,000,000)
UBS (Switzerland): $287 billion ($287,000,000,000)
Credit Suisse (Switzerland): $262 billion ($262,000,000,000)
Lehman Brothers: $183 billion ($183,000,000,000)
Bank of Scotland (United Kingdom): $181 billion ($181,000,000,000)
BNP Paribas (France): $175 billion ($175,000,000,000)
These amounts show the privilege of the financial sector which, aside from the huge FED loan funds, has also received other significant amounts from the National Treasury, either directly or by other bail-out plans that have consumed a great part of the resources collected from tax payers. Meanwhile, the same tax payers are suffering from growing unemployment, restrictions in health programs and cuts in other sectors of social welfare, that altogether reshape the social structure and lead the society to worsening social conditions; inequalities are now greater than just a few decades ago. This paradox explains the reason why manifestations like “Occupy Wall Street” are gaining momentum.
The same situation can be attested for Europe, where many countries are facing serious “debt” crises and social demonstrations of millions of citizens in the streets. It is important to recall that back in 2008, there was no such “debt” crisis, but instead, a crisis affecting the largest banks. At that time, the authorities decided to bail out those institutions, even though they knew the serious risks this choice represented for the budget and the “over-indebtedness” of all countries, as shown by a news-item in February 2009:
Despite their awareness of the risk of economic ruin, transcribed in some secret documents, and an atmosphere of fear and emergency summits, the European Union took their countries through a series of bank bail-out operations, in order to rescue financial institutions. Since the countries did not have the funds to carry out this operation, huge amounts of sovereign bonds were issued.
It is worth noting that the fundaments for this decision were the “secret 17-page paper”, which must be brought out into the open by a complete audit of this process.
The origin of the financial crisis is related to the lack of regulation in this sector. Some existing controls under the SEC |3| - that since the 1929 crisis was assigned to control the “quality and authenticity” of bond-trading
Actividades de mercado
Trading ACTIVIDADES DE MERCADO / TRADING: Operación de compra y venta de productos financieros* (acciones*, futuros*, productos derivados*, opciones, warrants*, etc.) realizada con la esperanza de obtener un beneficio a corto plazo. in the financial market – were revoked or simply disrespected and bypassed by the main financial institutions.
The lack of regulation opened space for the creation of an immeasurable amount of assets – such as derivatives and other kinds of financial products that can be considered simply as bets – without any real value or support. These so-called “toxic assets” loaded the financial market with “garbage”.
The amount of these “toxic” papers was so substantial that some financial institutions specially designed to receive such assets - the “bad banks” - were created to relieve the banks of part of this “garbage”, as reported by the Financial Times:
Crucially, the institutions which issued the “toxic” papers are the most prominent ones in the financial sector: they are the ones who have the “credibility” to have their papers accepted and traded in the financial market. They were at risk of default, but only very few of these important institutions went bankrupt - Lehman Brothers, for example. Many measures were rapidly taken to bail them out and save them from bankruptcy.
Nations have had different destinies. Predictably, the bail-out plan has led the euro zone into deep crisis: an economic depression of a scale that had not been seen since World War II.
Despite all the information about the European crisis in the media, insisting on the public debt problem, very little is published about its origins. These lie especially in the bank crisis, and not in massive public spending, as is commonly heard.
For a deeper analysis, it is also necessary to understand the mechanisms used by the financial system, the “creativity” of the financial markets and products like the derivatives and other unbacked assets that allow investors “to profit from changes in the prices of stocks, indices, commodities Commodities COMMODITIES : Las commodities agrupan el mercado de materias primas (productos agrícolas, minerales, metales y metales preciosos, petróleo, gas…). and other underlying assets” |4|.
Derivatives have spread within financial markets and have been transferred to mutual funds, pension funds, sovereign funds, and all kinds of investments throughout the world. As prices did not follow expectations, the great volume of insurance policies started being used, leading banks to serious financial crises. It is worth knowing that, at that time, “the average securities firm was leveraged 27 to 1, i.e. they had borrowed 27 times their capital” |5|.
Several solutions are being constructed as a workaround for this situation, such as the afore-mentioned bad banks. In Ireland, the National Asset Management Agency (NAMA) was created in 2009 as an attempt to bail out the financial system, by nationalizing private debts in exchange for public bonds (on which the banks themselves base all kinds of speculation). Such procedures come down to the “socialization” of bank losses with brutal effects on taxpayers’ lives |6|.
Regardless of all the consequences for the economies and the immense social costs of the measures adopted by governments to rescue the financial sector, these same institutions do not accept any legal restriction, so that financial transactions continue to go unregulated. Differently from other assets, which are subject to many legal constraints, derivatives have almost no control and no transaction costs. Banks and other corporations are still allowed to recklessly issue new assets and speculate on them.
2. The misuse of public debt
In order to help banks to substitute part of the big bubble of “toxic assets”, the nations either issued currency (as did the USA, as revealed by the audit realized by the Government Accountability Office which proved that US$ 16 trillion had been given by the FED to the banks), or created public debt by issuing public bonds, among other instruments.
A significant part of the “sovereign bonds” of these countries did not represent real “public debt”, i.e. bonds issued to obtain resources for the country, but simply the misuse of the debt mechanism to guarantee funds for financial institutions.
Furthermore, the de-regulation of the financial market allows sovereign debt bonds to be used as though they were cards or chips being gambled in a casino. One of the main privileges of the financial sector is the freedom to move anywhere, especially to tax havens, under bank secrecy, and negotiate sovereign bonds in any secondary market, globally, often without even the knowledge of the country that had issued those bonds in the first instance. And this is not new; it has been a great difficulty for the Latin American countries since the 70´s, when the international banks used to sell parts of the debt-contracts on the secondary markets.
For how long will the society be held responsible for the losses of such irresponsible and immoral operations, which are taking money from essential services like Health, Education, Social Security etc., resulting in thousands of job-losses while at the same time, securing large profits for the financial sector?
Moreover, can the result of these operations be considered as “public debt”? Economics textbooks explain that public debt is an instrument that can be used to finance state needs and complement the funds required by State services for the benefit of society. The bonds issued to bail out banks without any criteria should not be considered as “public” debt, but should be treated as a separate loan to be paid by banks, not by the entire society.
The financial institutions that were bailed out after the 2008 crisis bought Treasury bonds with the money borrowed from governments, transferred liquidity – because of the low interest rates asked by governments – to speculative branches (through hedge funds Hedge funds Les hedge funds, contrairement à leur nom qui signifie couverture, sont des fonds d’investissement non cotés à vocation spéculative, qui recherchent des rentabilités élevées et utilisent abondamment les produits dérivés, en particulier les options, et recourent fréquemment à l’effet de levier (voir supra). Les principaux hedge funds sont indépendants des banques, quoique fréquemment les banques se dotent elles-mêmes de hedge funds. Ceux-ci font partie du shadow banking à côté des SPV et des Money market funds. , unregulated forms of investment) that intend to earn more money by “investing” in public debt by issuing more and more derivatives, with the problems mentioned above.
In spite of all this, governments still help financial institutions, and implement the social reforms demanded by neoliberal policies. The obvious perception is that countries are exchanging democracy for bank profits, as a result of a political system in which decision-making is not based on public deliberation, but takes place at negotiation tables among “technocrats” who claim not to be doing politics.
3. The need for an audit – methods, transparency, citizen monitoring and the role of international institutions
The instrument of “public debt” is being used now in Europe as it has been used in Latin America since the 70’s. The experiences of debt audits – official auditing in Ecuador |7| and citizens’ initiatives in Brazil |8| – have proved that in the last 40 years the only beneficiaries of the commercial external debt were the large international banks. Instead of being an instrument to finance state activities, this kind of debt in bonds was a mechanism to transfer public resources to the private financial sector.
The debt audits also proved that the financial crisis that we went through in 1982 in Latin America was caused by the same international private creditors, who unilaterally raised the interest rates, from 5 to 20.5% a year. That crisis gave the IMF an opportunity to interfere in our economies with fiscal adjustment plans – just like what is now happening in Europe – that cost at least 2 decades’ worth of heavy social sacrifice (that we call lost decades) in order to guarantee profits for the financial sector.
It is very important that European countries – which are not under dictatorships as we were in the 80’s in Latin America – organize official audit commissions, like Ecuador did in 2007. It is also essential that civil society starts citizen debt audits, like our organization in Brazil – to research documents, encourage popular investigations, studies, social mobilization and elucidation about this debt process as soon as possible.
A debt audit is an opportunity to obtain documents and evidence of the real nature of the so-called “public” debt. The results of the audit can encourage concrete actions in all fields: popular, parliamentarian, legal and any other policies.
3.1 The case of Greece and the audit experiences in Ecuador and Brazil
The misuse of the instrument of public debt must be unmasked. In Greece, for instance, the manipulation of country risk by rating agencies – downgrading the country’s classification just a few days before certain obligations fell due – forced the government to sign agreements with the IMF and the European Union. This gives an insight into how the mechanism works. Once the framework is set, international institutions and major corporations may invade the country, imposing their interests – which includes the dismantling of social rights, the protection of financial institutions and the sale of state apparatuses, mainly by privatizing the profitable public companies.
This pressure mechanism of the “Troika Troika Troika: IMF, European Commission and European Central Bank, which together impose austerity measures through the conditions tied to loans to countries in difficulty. ” (the “markets", the IMF and the European Central Bank) against countries - that have to "negotiate" alone - leads to great inequality between the parties, a clear indication of illegitimacy. The IMF is a specialized agency of the UN, as are the ILO and FAO, and thus “should act in close collaboration with UN agencies and other specialized institutions, to achieve the objectives of the UN Charter and the Universal Declaration of Human Rights”. |9| However, over time, the IMF moved away from its initial goals, and now evidently defends the financial market. Therefore, it is to be expected that the UN, through UNCTAD, will repudiate this behavior of the IMF.
But more crucial is the way the sale-of-state process happens. Public bonds are utilized to capitalize private businesses, pushing national economies even further down. On account of the deregulation of the financial sector, the bonds can be sold on secondary markets, wherever it works.
It is important to remember that the lower the price, the greater the yield, which is an interesting attraction for speculators. In Greece, for example, it was calculated that the bonds were being sold in secondary markets for 60% of their face value. Applying an interest rate of 7%, the effective remuneration would be 11.67%, as explained in the table below:
|-||Face Value||Market price||Interest rate||Interest||Rate|
|Example||€1.000||60% = €600||7%||€70||11.67%|
When a bond-holder sells their bonds with the so-called “haircut”, the one who buys these bonds makes a lot of money. As the market price goes down, the yield rises accordingly, which is the ultimate attraction for speculation. So, if someone “suffers” a haircut by selling below the nominal value, the one who is buying will have an extra gain due to the higher yield of the bonds, which characterizes a market manipulation and an abuse against Greece.
This situation leads to the urgency of an integral audit, which means that it must not only look at the data and accountability of each bond issue, but also at all the aspects of the country’s circumstances which have brought it into deep indebtedness, for example:
1. How much sovereign debt has been issued to bail out failed banks?
2. What is the responsibility of the European Central Bank and the European Commission in the countries’ indebtedness process?
3. What is the responsibility of the rating agencies for downgrading sovereign bonds, causing the elevation of interest rates?
4. What is the responsibility of the IMF and the EU for forcing some governments to implement reforms against the interests of their people and for the benefit of the banks?
5. What is the responsibility of the Banks for:
a. thrusting more and more loans onto the markets
b. Speculating on sovereign bonds, in order to make the interest rates go up continuously to force an intervention of the IMF?
c. playing with derivatives, “Credit Default Swaps” and other “toxic” papers?
6. What is the origin of the registered sovereign debt? Did the country receive the full amount of money? Where did it go? Who benefited from these loans? For what purpose?
7. Which private debts were transformed into public debts? What is the impact of these private debts on the budget?
When we have a clear view of all this information, we can tell what part of the sovereign debt is illegal, supported by many legal facets, for example:
Co-responsibility of creditors and international financial institutions
Asymmetry between parts
Violation of general principles: Reasonability, Rebus sic Stantibus
Right to Development
Right to Sovereignty
Violation of Human Rights
Other legal studies are necessary to bring to light, within the country’s legal framework, the prohibition of procedures like “market manipulation” and “abuse”, because it is evident that some countries – like Greece - are paying abusive interest rates, as shown in the examples above.
Every legal system includes the notion of the Abuse of Rights. In general, the main characteristics that define an abusive act are related to cases when the act produces damage, harm or injury; when there is excessive prejudice to a party; when there is evidence of the intention to produce prejudice or to obtain excessive benefits; when the act goes against the social and economic rights, when the act does not comply with the “reasonability” cast in terms of social interests, among others.
During the Ecuadorian Debt Audit, besides applying the country legislation, the audit commission – CAIC - also searched for principles of International Public Law, International Pacts, like the International Covenant on Civil and Political Rights and the International Covenant of Economic, Social and Cultural Rights. We found out that most of the negotiations of Ecuadorian external debt had violated those treaties.
The CAIC also utilized some General Principles of Law that could be useful for Greece too, like:
Enrichment without cause
Principle “contractus qui habent tractum successivium et dependientium de futuro rebus sic stantibus”, which determines that an obligation can be revised and no longer be binding if the circumstances have substantially changed (interest rates, for example);
Usury, known as the illegal practice of charging excessive, unreasonably high, and often illegal interest rates on loans.
Vicious in origin
Good Faith (as in the United Nations Convention)
Equity (the laws do not deal with other forms of abuse such as financial abuse)
Solidarity and Cooperation (also part of UN Convention)
Furthermore, the CAIC studied closely the doctrines of Odious Debt and Illegitimate Debt that can also be applied to other countries, because there are many subjects to be investigated, which Eric Toussaint |10| summarized thus:
The Greek public debt made the headlines when the country’s leaders accepted the austerity measures demanded by the IMF and the European Union, sparking very significant social struggles throughout 2010. But where does this Greek debt come from? As regards the debt incurred by the private sector, the increase has been recent: the first surge came about with the integration of Greece into the eurozone in 2001. A second debt explosion was triggered in 2007 when financial aid granted to banks by the US Federal Reserve, European governments and the European Central Bank was recycled by bankers towards Greece and other countries like Spain and Portugal. As regards public debt, the increase stretches over a longer period. In addition to the debt inherited from the dictatorship of the colonels, borrowing since the 1990s has served to fill the void created in public finances by lower taxation on companies and high incomes. Furthermore, for decades, many loans have financed the purchasing of military equipment, mainly from France, Germany and the United States. And one must not forget the colossal debt incurred by the public authorities for the organization of the Olympic Games in 2004. The spiraling of public debt was further fueled by bribes from major transnationals to obtain contracts, Siemens being an emblematic example.
This is why the legitimacy and legality of Greece’s debts should be the subject of rigorous scrutiny, following the example of Ecuador’s comprehensive audit commission of public debts in 2007-2008. Debts defined as illegitimate, odious or illegal would be declared null and void and Greece could refuse to repay, while demanding that those who contracted these debts be brought to justice. Some encouraging signs from Greece indicate that the re-challenging of debt has become a central issue and the demand for an audit commission is gaining ground.
When we start to investigate the public debt of any country, the first step to take is to know the origin of this debt. In the Ecuadorian debt audit (CAIC) and also during the parliamentary investigations in Brazil |11|(CPI), with a thorough analysis of documents and data we were able to prove, for example, the explicit practice of anatocism (compound interest), finding evidence on the transformation of interest into capital. That happened during the Brady Plan – the same plan was adopted for many countries in Latin America. The plan transformed the previous debt into new sovereign bonds. The previous debt had a part of capital and a large part of interest that had been accumulated because they went so high that our countries could not pay them. Some of the new bonds issued under the Brady Plan were the unequivocal transformation of the accumulated interests into capital and were called Interest-bonds.
The Brady Plan took place in the early 90´s and all kinds of media and even some academics believed that it was a good step, because it was widely presented as a plan that would bring our countries back from insolvency to market operations. Moreover, it was said that the transformation was “giving” our countries a discount. In fact, one category of the new bonds issued under the Brady Plan was called “Discount Bond”. Only when we did the audit in Ecuador and the investigations in the Brazilian parliament and had access to the contracts were we able to see that the reality was totally different from the propaganda.
The documents proved that there was a “Debt System” under the continuous refinancing of previous debt; a mechanism of creating new debt to pay previous debt in such a way that the new debt was always much bigger than the previous one, besides the huge payments of capital, interest, commissions, fees, taxes, costs, and all kind of extra charges. The audit also proved that the negotiations had been carried out abroad and on many occasions – as with the Brady Plan - the money registered as debt on the contracts and bond issues never arrived in our countries, because the transformation of the previous debt into new bonds had been made by the creditors themselves, in the Luxemburg stock market, with no registration in the SEC - Securities and Exchange Commission in United States of America – even though the law and jurisdiction were North American. The interest rates, costs and clauses of the contracts were completely illegal and abusive. To sum up, the audit proved a complete misinformation about the real significance of the Brady Plan for our countries. And this was made possible by obtaining the documents of the negotiations: contracts, records of meetings, writings, proceedings and all registers of each operation, as well as the statistics and data available.
This is only one of the examples of how we proved the anatocism and the illegality of the process. The main conclusion arising from the 30 years audited in Ecuador and 39 years investigated in Brazil is that the “Debt System” benefited only the large international banks, and did not serve as a mechanism to finance our countries, as economic theory defines public debt. The instrument of public debt has been usurped by the “market”. Our job is to reveal the truth, by obtaining the documents and evidence that can unmask the many lies that have been told about our countries’ public debt. We cannot keep paying illegal debt with our jobs and our lives. We must be encouraged to organize commissions to carry out debt audits urgently, everywhere, and unmask this “debt system”.
The current financial crisis has revealed the usurpation of the instrument of public debt, used as a mechanism for transferring public resources to cover a problem of the private financial system, mired in doubtful operations of unbacked derivatives. The social cost of this crisis is getting huge, especially in Greece. The experience of debt auditing in Ecuador showed the value of this tool to expose the truth about the indebtedness process, and proved it can help to achieve effective results. The initiative of a citizen debt audit in Brazil also shows the importance of this work for a historical approach to the debt process, a wider understanding of recent developments related to the debt crisis, keeping the matter of public debt on the agenda of national and international debates. It is essential to achieve a complete debt audit in countries affected by the recent crisis, provoked by a problem located in the financial market, in order to guarantee decision-making in favor of justice and dignity for society as a whole.
Maria Lucia Fattorelli is Coordinator of Citizen Debt Audit-Brazil since 2001; Member of the Commission of Debt Audit of Ecuador (2007-2008), and Technical Assessor of Brazilian Parliamentarian Investigation of Public Debt (2009-2010) www.divida-auditoriacidada.org.br Citizen Debt Audit-Brazil. I thank Rodrigo Ávila, João Gabriel Pimentel Lopes and Laura Carneiro de Mello Senra for their collaboration with this article.
Edited by Vicki Briaut and Stéphanie Jacquemont.