From Volume 4, Issue Number 23 of EIR Online, Published June 7, 2005

World Economic News

A 'Plan B' for the Euro?

While the euro plunged to its lowest level against the U.S. dollar in eight months June 1, the German Finance Ministry, the Bundesbank, and the European Commission all delivered public statements describing as "ridiculous" and "absurd" the story by Stern magazine on euro failure discussions. Nevertheless, it could not be denied that there actually had been a closed-door meeting in Berlin the previous week on the implications of the euro for the European economies, sponsored by the German Finance Ministry and the Bundesbank. Several international economic experts were invited. One of the issues raised was that, apart from the overall neo-liberal framework and the blocking of public investments, already the establishment of a common interest-rate level throughout the euro-zone had a devastating effect, in particular on the German economy. This point was elaborated at the meeting by Morgan Stanley economist Joachim Fels, who, according to Stern, told the audience, "In a few years this could lead to the worst possible catastrophe: a collapse of the euro."

New Regulations Threatened Against Credit Derivatives

The British Financial Services Authority has threatened to impose new regulations on credit derivatives, unless banks and hedge funds improve their management of such derivatives deals, the Financial Times reported June. 1. The head of the FSA, Gay Huey-Evans, stated in an interview with the Times: "If we do not see an improvement over the summer, the FSA will take appropriate supervisory action." By a credit derivatives contract, two counterparties are transferring the risk of yet another company defaulting on its bonds. However, as the volume of such contracts has exploded in recent years, it now appears that counterparties often fail to sign the contract on time, "which could create a nasty legal quandary—and potentially cause a market seize-up—if any player collapsed or stopped trading. What further complicates the issue is that many financial players are selling on their contracts to third parties without telling the original parties," the FT summarizes the FSA warning. According to bank estimates, notes the FT, the trading volume of European credit default swaps was "four to seven times higher in recent weeks than the levels of the first quarter of the year," due to the downgrading of General Motors and Ford.

Derivatives Traders Anticipate More Regulation

According to a report in London's Financial Times June 2, an international gathering on derivatives regulations took place May 28 in New York. Participants included the International Swaps and Derivatives Association (ISDA); five other international groups representing the top derivatives trading banks such as Citigroup, JP Morgan, UBS, and Deutsche Bank; as well as 40 global regulators. As the FT notes, leading banking industry representatives at this meeting will "voice their deep concern about new rules on the trading of derivatives. Bankers say that the rules—which were created as part of the Basel II package of reforms—will dramatically raise the cost of many trading activities, particularly in complex financial instruments and private equity." The ISDA warns that the Basel II regulatory framework, which has been in negotiation for many years, and is supposed to finally go into effect by 2007, would have a huge impact on derivatives traders by requiring "a very significant increase in regulatory capital."

The Basel II requirements cover only the ordinary banking sector, but not hedge funds nor securities houses such as Goldman Sachs or Morgan Stanley. All of this is happening at a moment when the volume of derivatives trading is exploding, while at the same time, many banks have seen burning up significant parts of their core capital during recent speculative disasters.

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