How nations go bankrupt, one sliver at a time

July 7, 2011

Governments in Greece, Portugal, the United States and elsewhere are borrowing, and often wasting, money at a reckless pace. Why do banks and financial markets cooperate? Because there’s something in it for them.

They keep a little slice of the public money being borrowed or wasted. Only a sliver. But the more that is borrowed, the larger the sliver becomes.

This is the Sliver Strategy, and it underlies the ways many of the Western world’s wealthy institutions relate to government.

Here’s how the Sliver Strategy works. If government spends a moderate sum and an interest group gets a large share, this will be noticed and denounced. If government spends a gigantic amount  and the interest group gets a sliver, this won’t be noticed. But a sliver of a gigantic amount may be more than a large share of a moderate sum.

Many sovereign bonds and similar securities, for instance, are accompanied by credit-default swaps, which may amount to around half a percent of the amount borrowed. That’s just a sliver. But the more borrowed, the larger the sliver.

Half a percent of the low-end estimate on default swaps for bad Greek debt is $35 million.  Half a percent on the high-end estimate of the roughly $600 billion that Greece, Ireland, Portugal, Spain and Italy are — let’s just say in arrears on —  is $6 billion. Quite a sliver!

In the case of default swap fees, these proceeds go directly to the bottom line of financial companies, boosting short-term profits and pumping up executive bonuses. The more that is borrowed — by governments directly, or by quasi-government entities such as Fannie Mae — the bigger the sliver, and the bigger the executive bonuses.

In the case of many kinds of swaps, the fees are pure profit since if the loan defaults or otherwise goes south, the swap issuer will just shrug and claim penury. This is what happened in 2008 when AIG, the world’s largest issuer of default swaps, simply refused to cover the debts it had claimed to insure, handing a $182 billion bailout tab to U.S. taxpayers. Amusingly, AIG called its products “collateralized” default swaps, though it turned out there was little or no collateral. What a sense of humor those AIG crooks had! The swaps were pure profit — AIG took rich fees for providing nothing at all, other than a blessing that securities firms could use to pretend their issuances were backstopped against default.

How many AIG-like or Lehman-like slivers are out there right now in bad European debt? Nobody really knows. If it’s any consolation, the professional organization of derivatives and similar all-but-unregulated financial instruments promises “safe, efficient markets.”

Other kinds of Sliver Strategies have corrupting impacts on finance and government.

Why did big banks underwrite the liars’ loans that caused the housing bubble? Because they took origination fees and other payments, then passed the toxic debt along to taxpayers. The greater the loan volume the larger the sliver — and most of the slivers ended up in the pockets of the banks’ top management.

Why do defense contractors and  companies that build roads, rail and bridges love cost overruns? The more bloated the final bill, the larger their sliver. If the Godzilla attack helicopter program cost $10 billion and the contractor kept a third as profit, the public would be outraged. If exactly the same program cost $50 billion and the contractor got a tenth as profit, the public will be quiet — though the former is a far more cost-effective buy than the latter.

Why does the U.S. Congress support obvious boondoggles, such as $6 billion a year in  subsidies for corn ethanol production? A reverse Sliver Strategy is at play. The more money Congress wastes on corn ethanol, the more the ethanol lobby donates to members of Congress. The donations are but a sliver of the total subsidy — meaning the total subsidy must be large for the sliver to matter.

This incentive to hand out very large sums, in order to get back small sums as donations, is a hidden factor in many congressional decisions about agriculture policy, Social Security benefits and other issues. If members of Congress simply awarded themselves a couple hundred thousand dollars each for campaign expenses, the public would be furious. But if Congress gives away hundreds of billions of dollars, in order to ensure a couple hundred thousand dollars per member comes back as donations, the Sliver Strategy goes unnoticed.

The experience of Greece and Portugal — and perhaps the United States — shows that undisciplined borrow-and-spend depresses economic performance. So you’d think institutions with a major stake in national economic success, such as banks and industrial sectors, would resist government’s impulse to borrow.

Instead they are enablers, because the Sliver Strategy puts a cut directly into their pockets. It is one of the insidious reasons many nations’ balance sheets look steadily worse.

12 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Exactly why we should prevent an increase in our debt limit and why taxes should not be raised. Doing either will just encourage more spending for more slivers and more handouts to ensure more terms in office.

Posted by zotdoc | Report as abusive

It would seem the fatcats are present everywhere you look, fat contracts = fat paycheque. As I was reading this article I thought: finally a journalist who can speak what I have been saying for so long……

Goverments do not care about people, they just want to ensure that society keeps the money rolling in.

Well written article overall and yet it will fall on deaf ears due to general complacency. People at the end of the day do not care, even though we all have the power to stand up to this corruption we won’t for fear of reprisal and loss of our western idylic lifesyle.

If only people would stand together we could make this egrigious waste of OUR money come to a swift end.

Theres always communisim I guess…….

Posted by zerocool81 | Report as abusive

Excellent article. Any government system needs a negative feed back mechanism to prevent a system from getting too out of whack.
Look at our politicians and ask yourself can these people actually do anything for a common good of the country?

Posted by 74LS08 | Report as abusive

[...] go bankrupt By Sean Lee  || July 7, 2011 at 22:49 GMT || 0 comments || Add comment Nice opinion piece from Reuters. The GFC happened because lenders were falling over themselves to issue debt, because every time a [...]

Or as someone said (Twain?): At first slowly, and then suddenly!

Posted by XRayD | Report as abusive

Jimmy Carter had suggested Zero Based Budgeting to tackle problems before they get out of hand. It’s time to use it now.

Posted by XRayD | Report as abusive

Wow, you remember ZBB. That was in the dim mists of prehistory, like, 1977. As I recall, the problem with zero based budgeting (requiring agencies to justify every expense from scratch) is that every federal agency classified everything it did as essential, and thus exempt from the process.

Posted by Gregg Easterbrook | Report as abusive

Alas! We are doomed! We are condemned to repeat boom and bust until we are busted.

Posted by breezinthru | Report as abusive

The biggest slivers come from spending on war. Thus the Afghan and Iraqi wars , which supposedly have cost $11 trillion. And people think it is all about oil and/or national security. To appreciate the criminality of the scheme, think of all those who died fighting for their country.

Posted by Biscayne | Report as abusive

isn’t it about taking short positions on some black swans that probably won’t happen? managers can take benefits from such decisions for a couple (even a lot) of periods. I’m not an expert but I wonder who is responsible for such decision when such a person leaves company. Great article!!!

Posted by GrzegorzK | Report as abusive

I look forward to your writing because it is some of the most ideology-neutral, and therefore credible, that I have found. However, I think that 1/2% of $600BN would be $3BN not $6BN.

Posted by BigBlue80 | Report as abusive

It’s not possible to pay off the debt to the Federal Reserve… We have to borrow the money to pay them.

We need to end the Fed before we can accomplish anything ever again

Posted by OuttaLuck | Report as abusive

Do some homework. Our debt to GDP ratio is very similar to all 1st world countries. No need to panic.

Posted by Chris_colorado | Report as abusive