By Alex Chambers
One of the reasons I was so keen to become Euromoney’s fixed income editor was to have the scope to explore in depth the credit market bubble that was building when I joined in the spring of 2005. Indeed, many of the stories I commissioned or wrote myself boiled down to the mispricing of risk.
It was during those early days of my time there – and of Clive Horwood’s editorship – that we found ourselves discussing the crazy world of European sovereign finances.
Given the depths to which the financial markets were to plunge just a couple of years later, it is easy to forget now that those were, relatively, tumultuous days in the summer of 2005.
Investors were extremely nervous after Ford and General Motors had been junked, causing a correlation crisis in the credit derivatives market. This crisis should have been a warning for the burgeoning world of structured credit in general, but we will return to that topic shortly.
What struck Clive and me was the complete disconnect between investor concerns about corporate credit – this was only a few years after fraudulent accounting at Enron and Parmalat saw them blow up – while they would happily ignore the blatant lies being told in the public sector.
Peter Lee joined the conversation and very quickly we had come up with a great angle for the bumper IMF edition of the magazine – the Enronization of European government debt.
From the very birth of the euro, bankers found ways to use derivatives and securitization to shift countries’ liabilities off balance sheet or into the future. It was quite remarkable how easily sovereigns such as Portugal were able to hide the true nature of their indebtedness without there being any repercussions on debt prices. We were not looking at small numbers, but no one was talking about it.
This was all the more surprising given that, rather than coming to an end, the practice of cooking the books was picking up.
There was plenty of material for us.
The year before, Greece’s debt-to-GDP ratio had jumped several percentage points, from 103% to 110%, because of dodgy statistics. In 2003, Belgium assumed Belgacom’s pension liabilities – estimated at €5 billion or 1.9% of GDP – but, because the assets were liquidated and the cash paid to the government, the country’s budget deficit that year disappeared.
It was a similar story for France, Italy and even Germany: one-off measures and creative (and off-balance sheet) financing vehicles were used to ensure that the debt on the official books was kept down.
While obtaining fiscal flexibility in the short run, sovereigns ultimately lost flexibility in the long run – something that eventually caught up with many when the eurozone crisis brought matters to a head.
The cover was a thing of beauty, drawn by Gerald Scarfe. If likening Europe’s sovereigns to the C-suite at Enron wouldn’t persuade readers to pick up that month’s hefty tome, the magazine’s elaborate gatefold cover certainly would.
It was a very different conversation that led to my jumping on a plane to New York in the autumn of 2006 to get to the bottom of what was inspiring brokerages such as Merrill Lynch to buy sub-prime mortgage originators like First Franklin.
These were the bull days of the credit bubble; the banks performing best were those that had vertical credit businesses. Those without such platforms were forced to bid competitively for loan portfolios – buying originators seemed to make sense.
But the story I returned with was very different to the one that I had envisaged when I set out. Rather than focusing on investment banks’ fixed income business strategy, it explored how deeply collateralized debt obligations of asset-backed securities had penetrated originators’ activities.
It did not piece together all of the components, such as the structured investment vehicles and money market funds that fell over so spectacularly. But it was a clear warning that the market had probably turned, a lot of poor loans had been written and serious pain was likely to be felt by participants unless the economy enjoyed a soft landing.
We all know now how that particular story ended.