I think the podcast at the following link addresses a question I have been thinking about for some time about what exactly caused the MFGlobal bankruptcy.
I have been concerned that the top 5 US banks are involved in insuring European soveriegn debt by selling 97% of all credit default swaps. Credit Default Swaps are like insurance for bonds. European countries who have joined the EU can no longer print their own money. So, if these countries spend more than they bring in in taxes, they have to borrow that money by selling bonds. EU countries can't simply print money and inflate away their debt like the US. Despite the higher interest rates, bond holders fear they may never be paid back. Consequently, US banks have been selling insurance to pay bond holders in the event of a default. I have no idea the person who thought US banks selling EU sovereign debt insurance was a good idea.
Long story short, if countries like Greece were to "default" on the repayment of their bonds, US banks and the US taxpayer would be on the hook to pay the derivative/insurance/bond holders. I say US taxpayers will be on the hook because even the US banks know they don't have even close to the money needed to pay off a national default.
I have heard many say Greece is already in default. However, the podcast explains that the International Swaps and Derivatives Association makes the determination of when a default has occurred and when the CDO insurance issuers (like AIG or the US Banks) will have to pay up. Turns out because Greece renegotiated their debt to repay only 50% of what they owe, the renegotiation is "not a default."
According to the podcast, MFGlobal went bust because they were invested in Greek Bonds and also CDO insurance. However, when Greece negotiated a 50% repayment plan, and the ISDA ruled this "not a default", then MFGlobal took a loss on bonds and a loss on insurance. Its like purchasing flood insurance only to find it doesn't cover flooding from a broken pipe.
Goldman Sachs had insider information and knew what was up and supposedly cashed out before the the ruling. MFGlobal is a bank and according to fractional reserve principles, only is required to keep 10% of its money on-hand. Goldman Sachs was a major investor with MFGlobal and knowing of the Greek settlement before it happened cashed out including taking all the money in MFGlobal private segregated accounts.
What do you think of the US Banking exposure to Euopean Bonds via CDOs and when the ISDA will officially declare a default? According to the podcast, even the newest 30% Greek repayment settlement is not yet deemed a default.
If countries like Greece, Portugal, Spain and Italy do default, the US Banks will not have near the capital necessary to cover the insurance policies they have been selling. Thus, the US Government will be forced to bailout the US banks by printing huge amounts of money further devaluing the dollar.
Goldman Sachs is the bank that began selling European Banks the toxic housing derivatives from the beginning. Then, when those derivatives went bust, European banks were bailed out with US taxpayer money. During TARP and QE2, the US printed several trillion dollars and lent this money out for free to the banks.
Now, many EU countries are in trouble because of their huge budget deficits required to maintain their welfare programs. In response, the banks are using their TARP money to bail out EU nations.
The banks who purchased the bonds keep the interest and the US who gave away free money gets nothing in return. In some cases many banks have used free TARP money to buy US TBills which are repaid with interest. With this in mind, we realize the US taxpayer is currently paying a few people to take our own money.
In addition, for whatever reason, US Banks are responsible for selling 97% of these Credit Default Swaps that insure European bonds. So, long-story-short, the US taxpayer gifted Greek bonds to the bankers, and at the same time the US is insuring those Greek bonds against default.
Lastly, the bankers themselves are in charge of the ISDA. So the bankers will decide when they will accept a renegotiated debt, and when they determine when they can collect on their insurance policy. We should also remember that with these debt negotiations, the EU banks are requiring collateral like Greek islands and certain conditionalities like austerity.