Governments are now world’s financial engineers
By Antony Currie and Agnes T. Crane
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.
The last financial crisis was supposed to have killed off financial engineering. It certainly seems to have for the most part turned excess leverage and overly complex borrowing structures into a pariah. But Western authorities have embraced them with gusto.
Recent responses to the mess in Europe provide the latest examples. The European Financial Stability Facility, or EFSF, plans to employ a design that mimics credit derivatives, something European leaders have publicly skewered the private sector for using, to help the fund get a bigger bang for its buck. But with the future of the euro zone up in the air, engineering can’t make up for investor skepticism. The fund may raise just 700 billion euros, barely a third of the most optimistic earlier estimates.
Greece’s bailout, meanwhile, offers a sleight of hand to make investment bankers proud. The current package secures a manageable interest rate for the country, but only by forcing it to invest a chunk in safer bonds than its own.
In fact, many policy responses since the bust have been built with tools used during the heady bull-market days. In 2007, U.S. Treasury Secretary Hank Paulson wanted to relieve banks of problems caused by structured investment vehicles by creating a Super-SIV to mop them up. It never got off the ground.
Later efforts to help banks offload dodgy assets or fund new deals – PPIP and TALF, for example – required elaborate architecture and large doses of debt. They ended up being much smaller than initially touted.
The U.S. government has even adopted the worst of private-market practices in subprime mortgages. Not only does the Federal Housing Administration require minimal down payments, it has piled on leverage. Its capital reserves are just 0.24 percent, a staggering 417-to-one ratio that makes Bear Stearns and Lehman Brothers look ultra-conservative.
Granted, borrowing has a role in solving this financial crisis. But such complicated and risky games are far easier to play in boom times. Having been singed by Wall Street’s CDO-squareds and the like, investors aren’t so easy to talk round these days.