Trichet’s Fake Stress Tests Bring European Banking System to Edge of Abyss

Webster G. Tarpley
July 11, 2010

Seventy-nine years ago this month, the German banking system disintegrated. The Danat Bank closed its doors, and only a government-declared bank holiday saved the Deutsche Bank from liquidation. This July, it may well be that the entire European banking system is poised on the brink of a similar cataclysmic event. The $31 trillion European banking system, three times bigger than the US banks, may be about to dissolve.

The first weeks of summer 2010 have brought with them a series of ominous events, quite possibly harbingers of a new wave of panic at the door. In one 5-minute period, the stock of Citigroup, one of the leading US zombie banking institutions, collapsed 17% within a few minutes, and the stock had to be halted. A vigorous intervention by the ubiquitous Plunge Protection Team clawed back much of the loss, but Citigroup still closed down 7% on the day — a rout. What used to be called the New York stock market is now the plaything of the frenzied geeks who run the leading high frequency trading firms, and the hapless small investor is at their mercy.

At the end of June, the bucket shop known as the credit default swaps market was showing the second highest levels of fear registered thus far concerning an imminent default by Greece and other members of the Southern tier of the euro. A bet against Greek debt was quoted at 1,001 basis points, down just slightly from the all time record registered in the first week of June. In general, the credit default swaps-jobbers were showing a 40% likelihood of Greek default in the 25% chance of Spain going broke. We must naturally always stress that Greece and Spain are far more solvent and viable than the zombie banks, hedge fund hyenas, and ratings agency pirates who are attacking them.

On July 1, European banks were supposed to repay some €440 billion which they had received in the form of emergency bailouts sometime earlier. In the event, the banks proved unable to come up with the required sums, so the ECB had to extend them emergency financing of as little as one week in order to permit them to roll over these loans. Not a good sign.

On June 29, the European Central Bank held an auction in which they tried to market €55 billion worth of securities. This auction was a failure, and the ECB only succeeded in unloading €35 billion worth of the paper in question, with the rest remaining unsold. In addition, the interest rates the ECB had to pay were two or three times higher than what they had expected. The failed auction is one of the recurring nightmares of governments around the world, and here was a clear instance.

The institutions of the European Union appear paralyzed in the face of the looming new phase of the crisis. The European Parliament voted by a lopsided 625 to 28 vote to limit the short-term bonuses for bankers, with a cap of 30% of such bonuses payable in cash in the first year. To get the remaining 70% of their bonuses, bankers would have to wait for three years, and the banks would have to set aside some capital reserves for this purpose. The goal is the reasonable one of preventing these zombie executives from concocting new and more dangerous synthetic CDOs (collateralized debt obligations) in the form of kited masses of toxic securities wrapped up in additional derivatives and perhaps further enveloped in a structured investment vehicle (SIV). Such poisonous paper sometimes yields large profits in the first year, but goes bankrupt soon after, so the new measure aims at delaying the payoff beyond the immediate speculative time horizon. Salaries by contrast are not limited, but anything over €1 million must be reported. However, this proposal is already full of loopholes. Governments will decide whether it applies to top executives only, or to traitors as well. In addition, it may not survive the EU finance ministers’ meeting this week.

Generally, the European Parliament as a miserable track record of getting its recommendations implemented. Back in March, this assembly passed a resolution instructing Barroso, the Portuguese head of the European Commission, to push hard at the G-20 meeting in Toronto in favor of a Tobin tax on speculative financial transactions. All indications are that the Bilderberg stalwarts Barroso and his finance sidekick Olli Rehn simply ignored these instructions, and punted. The methods of Barroso, who grew up under the fascism of Salazar, are well-known: when confronting a group of European trade unionists who demanded financial reform, Barroso’s answer was to threaten a return of dictatorship to Greece, Spain, and Portugal – countries which were oppressed by paleofascist dictatorships well into the 1970s. In any case, the bonus restrictions are a classic case of too little too late. They would have been a great thing five or ten years ago, but today Europe is already being crushed by about half a quadrillion dollars’ worth or more of toxic derivatives. And we are still waiting for the European Commission to come up with a proposal on bridling a hedge funds.

For the moment, the euro as a currency appears to have stabilized, and is quoted this weekend at $1.264. Part of the credit is no doubt due to the aggressive actions carried out by Germany on May 20 in the form of a ban on naked credit default swaps against euro-denominated government bonds, supplemented with bans on naked shorting of all German stocks. Even more credit must go to the growing perception in London and New York that Berlin is ready to fight to defend itself and the euro against the onslaught of the hedge fund wolf pack which has come together on such occasions as the February 8 “idea dinner” at Moness, Crespi, and Hart with representatives of Soros, Paulson, Einhorn, Brigade Capital, and other predators in attendance.

The German actions against derivatives would be even more effective if France were to join in imposing them. President Sarkozy talked a great game of punishing the speculators, but when the time for action arrived, he was found to be a saboteur. Given the fact that Sarkozy grew up in a household profoundly influenced by the CIA Wisner family and the CIA’s dirty deals with Corsican and Marseilles mobsters, this treachery by the tenant of the Elysée Palace is not entirely a surprise. The current scandal unfolding around illegal financing from the Bettencourt-L’Oréal interests suggests that French traditionalist institutional forces are seeking to remedy or at least contain the problem posed by the widely hated Sarkozy.

London: “What’s wrong with our bloody derivatives today?”

Despite hysterical stories planted in the London Financial Times alleging that now China, now Iran was ready to dump the euro, the common currency has held up so well under attack that a number of British commentators have been publicly scratching their heads and wondering why their bear attacks against the continent have not been more effective. One is reminded of Admiral Beatty, the commander of the Royal Navy’s battle cruiser squadron at the Battle of Jutland in May of 1916. As three of his most modern battle cruisers were blowing up in the first half-hour, Beatty famously complained, “What’s wrong with our bloody ships today?” Today, there are doubtless some city of London hedge fund operators who are whining, “What’s wrong with our bloody derivatives today?”

Some commentators have concluded that China, instead of dumping euros, may actually be buying them, among other things to increase their investments and take advantage of the depressed prices now prevailing in places like Greece.1

German Restrukturierungsgesetz for banks

The German government has drawn up a new Bank Reform Law to govern the bankruptcy proceedings of insolvent banks. Under this measure, if a bank of systemic importance fails, the viable commercial banking business is separated out, and the rest of the bank, including proprietary speculation and derivatives, is to be liquidated under something like the US chapter seven procedure. No taxpayer money is to be used for bailouts. Instead, the banks themselves will be taxed to create a special fund, the Sonderfonds für Finanzstabilität or SoFFin, which will be used to pay the funeral expenses of these institutions. It is possible to see in this new law a kind of Glass-Steagal beyond the grave for such banks. With this measure, Germany keeps forward momentum against the speculators.

In the midst of this chaotic situation, European Central Bank boss Trichet has made the foolhardy decision to attempt stress tests on the top hundred or so European banks. What Trichet is planning is an obvious piece of public-relations fakery, similar to the fraudulent stress tests that were supposedly implemented by Tiny Tim Geithner more than a year ago. Geithner’s stress tests were notoriously meaningless because they excluded from consideration precisely those off-balance-sheet derivatives which were the main cause of the banking panic in the first place. We must remember that it was CDOs which brought down Bear Stearns, Lehman Brothers, Merrill Lynch, and Citibank. Credit default swaps made things worse for all of these institutions, and played the leading role in destroying the AIG insurance empire. In spite of this massive evidence, Geithner simply avoided any consideration of derivatives, in conformity with the official party line of both the Bush and the Obama administrations that the ongoing financial panic was a “subprime event,” rather than the world derivatives panic which it actually represented.

At the end of Geithner’s phony stress tests, most of the bankrupt US zombie banks were given a clean bill of health, and this exercise is regarded on Wall Street as one of the indispensable preconditions for the relaunching of the New York stock bubble in March of 2009. A few banks were told to add to their capital reserves, and after that the speculators were off with a bang.

Trichet now imagines that he can carry out a similar crude parlor trick. He may even think that he can extort 100 billion more euros from the capitals of the continent to bolster the reserves of banks that are found wanting — in effect, an expansion of the existing EU bailout of European banks. But Trichet is deluded. Geithner had the luxury of carrying out his fake stress tests at a time when there was no concerted speculative attack on the US banking system, the dollar, and U.S. Treasury securities. Trichet today does not have this advantage. He is trying to conduct his stress tests while the euro, the European banks, and the ECB itself are under sustained speculative attack by the Anglo-American wolf packs. The Financial Times, the London Economist, Forbes, the Wall Street Journal, Bloomberg, CNBC, and other propaganda organs will do everything possible to sabotage the maneuver Trichet is seeking to carry out. US and British hedge funds will be eager to mount new bear raids against European bank shares.

Cavete XXIIII Julii

The date announced for the publication of the results of these stress tests on something like a hundred banks is July 23. Already, the rumors are beginning to fly. What banks are included in the stress tests? What are the criteria of the stress tests? Above all, do the stress tests include the eventuality of a national bankruptcy or sovereign default? And so on.

Battle of the lists among the zombie banks

A battle of the lists is developing, with each zombie bank publishing or leaking the names of the rival zombie institutions which it wants the public to think are more bankrupt than it is. The list reportedly issued by Citibank, certainly one of the most bankrupt of all institutions, directs attention to the possible insolvency of Commerzbank, the French Dexia group, and the National Bank of Greece. Not to be outdone, the rival zombies over at Credit Suisse have, according to Business Insider, come up with a more extensive list, including the German Postbank, followed by ATE Bank, the National Bank of Greece, the Hellenic Postbank, and Piraeus Bank, all of Greece, with the Italian Monte dei Paschi di Siena also making the list. The German Postbank, a big target, appears to figure on several lists, with the implication that if the Postbank is in trouble, the associated Deutsche Bank may also be, which takes us straight back to July 1931 once again. Needless to say, this German postal savings institution never should have been privatized and should be immediately re-nationalized and its shares taken off the market.

In short, conducting stress tests under Anglo-American financial bombardment is a gesture of folly, and Trichet may soon rue it.

At the same time, awareness that the current financial and economic difficulties represent in fact a world economic depression – as long maintained by the present writer — is rapidly growing. In June, the US economy lost some 625,000 jobs, dissipating many of the hysterical illusions of recovery. Paul Krugman of the New York Times is finally facing up to the fact of the world depression, which he counts as the third after the breakdowns of the 1870s and the 1930s. For Ambrose Evans Pritchard of the London Daily Telegraph, United States is now in 1932; he concludes from this that it is time for a combination of super austerity in government budgets plus an “ultra-loose” monetary policy to keep the financial barons well supplied with plenty of hot money. This proves that Pritchard has understood none of the lessons of the real 1932.

Needed: Mississippi Valley Authority, Danube Valley Authority, Baltic Basin Authority

More serious is James Galbraith writing in the New Republic, who calls for a new Reconstruction Finance Corporation and a Gulf Coast Reconstruction Authority. The latter of these sounds like a more limited version of the Mississippi Valley Authority which I have been advocating on my radio programs for the past month. Europe could use a Danube Valley Authority, a Baltic Basin Authority, and a Vistula Valley Authority, all on the FDR model.

As for the Reconstruction Finance Corporation, I pointed out 18 months ago that the Paulson-Bernanke Wall Street bailout, alias the TARP, was in fact a modern version of the Herbert Hoover version of the Reconstruction Finance Corporation, which was unfortunately used in ill-advised attempts to save and bailout collapsing banks in various areas. Galbraith should specify that what we need is a return to the post-1933 Reconstruction Finance Corporation of Franklin D. Roosevelt and Jesse Jones, which invested some 50 billion 1940s dollars in industrial plant and equipment through the War Plants Corporation and related vehicles, in the process providing this country with one of the greatest infusions of capital investment into industrial plant and equipment in our entire history, and laying the basis for the rapid postwar growth of places like Texas and California. The profound difference between the Hoover RFC and the New Deal RFC was noted in real time by the great German economist Wilhelm Lautenbach, although it is often still not perceived by modern Keynesians.

To get out of this crisis, Europe needs to implement the German bans of naked credit default swaps and short sales. This should be expanded to a blanket ban on all credit default swaps and collateralized debt obligations. It is high time for a 1% Tobin tax on all financial transactions, with the resulting revenue being used for national budgets to maintain the social safety net. Hedge funds should be regulated and thus banned.

Orderly debt moratoria needed immediately in the spirit of the Hoover Moratorium

More broadly, the national debts of the southern tier cannot be paid, so it is time to halt the insane austerity programs being enacted in countries like Spain, which already has 20% unemployment. Seventy-nine years ago even Herbert Hoover could see that when there is a depression, debt relief is order of the day. The Hoover Moratorium of June 20, 1931 was a payments freeze on most international government debts of Germany, Britain, France, and the United States – the main countries of the day. Since Obama is so inferior even to Herbert Hoover, places like Greece, Spain, Portugal, Iceland, Latvia and many others must end the macabre self-immolation of fiscal austerity and permanently freeze their international financial debts. After that, they will be able to dictate terms to the zombie bankers, who would no longer exist without state subsidies; these nations can do as well as Argentina did and perhaps better than Argentina did in reducing their debt. Nugatory tricks like trying to switch euro or dollar debt into local currencies, followed by devaluation, would procure these countries as much hostility of the zombie bankers as an outright debt freeze would, while sacrificing critical advantages. Purveyors of these recipes are the new Hilferdings, recalling the pedantic and doctrinaire German Social Democratic economics spokesman who in 1931-32 willfully sabotaged the Woitinsky-Tarnow-Baade program of the German trade unions to shrink unemployment and thus deprive the Nazis of their base. The WTB Plan aimed at forcing the German central bank to create 3 billion Reichsmarks in cheap credit to build autobahns, railroads, telephone systems, and rural electrification, generating several million productive jobs in the process. This program was also what Wilhelm Lautenbach of the German Economics Ministry was demanding.

The most effective policy bullet: nationalize the central banks

If the zombie banks cease to exist, so much the better. Every central bank can be seized and nationalized into a Hamiltonian national bank offering abundant 0% credit for infrastructure and tangible physical production. This is the way out of the deflationary dilemma of either tax increases or budget cuts which haunts economists who have not understood that every government has the inherent sovereign ability to function as its own bank, using national credit creation for national job creation in vast projects of infrastructure and capital goods production. This is the “policy bullet” which has yet to be tried, and the one which superficial and a-historical commentators like Nouriel Roubini have never understood. It is time in short to de-emphasize government borrowing as a means to counteracting the depression, and shift into the far more effective mode of dirigistic government lending for production. The US Fed and the ECB have been routinely dishing out credit at very near 0% rates to zombie banks. Dump that failed policy, and start issuing recovery tranches of long-term, 0% loans for energy, transportation, health, and education infrastructure to restore full employment and produce an economic recovery.

Once it is admitted that there is a depression, the consequences of this situation must be faced. In a depression, it should be obvious to most people that a recovery program must be implemented. So the economists who have finally figured out that the world is in an economic depression need to go much further, and tell us what new emergency measures they propose to permit economic recovery. This is all the more urgent since the European crisis is approaching a new crescendo.

1 “Is euro’s recent stability a Chinese basket case?”, Market Watch, June 28, 2010, at http://www.marketwatch.com/story/is-euros-recent-stability-a-chinese-basket-case-2010-06-28

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