There is a scene in The Big Short, the film about the global financial crisis, in which Selena Gomez explains the subprime scam through a Blackjack game in a casino. On a winning streak, she bets $10 million on her hand. Someone watching is impressed and places a side bet on her winning the next game. And then someone places a bet on that bet. In this way, an initial bet of a few million dollars turned into a sequence of bets of hundreds of millions. It’s an attempt to explain the domino effect of a CDO — the collateralised debt obligation, which collapsed the subprime houtilizing market. Inevitably, she busts. Cue a cascade of losses.
In real life, though, it was so much worse. The highly leveraged bets placed were in the billions, not millions, and the banks turned them into products which they would then sell on to naive investors. From the outside, these products viewed just like a safe government bond. But, in reality, they were toxic — just like the three-day-old seafood stew metaphor that Anthony Bourdain cooks up in another scene from the movie.
If there is one thing that everybody should remember about the global financial crisis, it is this: complex financial products, especially the three-letter acronym ones, serve one purpose — to defraud. The only financial advice I ever dished out during my previous career as a financial journalist was that when you meet a three-letter acronym, run quick.
You might have believed that the calamity of that relatively recent crisis would have put an finish to these scams. And in one respect it did: banks no longer apply them. The problem is, governments do. And the three-letter acronyms are back. We saw this only last week, in Brussels, where EU leaders were on the brink of agreeing on a €150bn loan to Ukraine. That the plan fell through was becaapply Bart De Wever, the Belgian Prime Minister, viewed at the tiny print of the agreement. When he discovered that his countest would be most exposed by the loan, he inquireed the others to share the risk. They stated “No”. So he stated “No”.
I am sure the EU will find a way to modify De Wever’s mind. And if it is good at one thing, it is at receiveting people to agree to something they don’t want to agree to. Certain readers might consider this would be a good outcome: Ukraine requireds the money to deffinish itself against an evil aggressor. But let’s first take a closer view at the tiny print of this special purpose vehicle — also known by the three-letter acronym SPV — or “reparations loan”.
After Russia’s invasion of Ukraine, the EU froze some €200bn worth of its assets. Most of that money is sitting in Belgium, with a financial company called Euroclear. This is not an ordinary bank, but a depository, where governments and central banks around the world hold their assets.
Originally, some member states wanted the EU to sequester the Russian money outright — to literary take the money and give it to Ukraine. But this would have been a huge legal and financial risk. Foreign courts would have declared the confiscation illegal and forced Euroclear, which has offices around the world, to compensate Russia. And since Euroclear is headquartered in Belgium, the Belgian government would have been the ultimate guarantor. So the EU devised a scheme very similar to the subprime scam 20 years ago — a scheme with the sole purpose of hiding the risk, to create it impossible for foreign law courts to receive their fingers on the money. No wonder De Weever was antsy.
Here’s the tiny print. Step one, the EU creates an SPV — a special purpose vehicle — essentially a reparations loan to Ukraine based on the Russian assets. This means that the frozen Russian money is not physically relocated; it stays in the frozen bank account at Euroclear. But the SPV holds a claim on those funds. In step two, the European Commission would issue the debt, which would be guaranteed by the member states. This money is then put into the SPV. In step three, the SPV then gives out a loan with this European money to Ukraine.
Ukraine receives the money. But can’t afford to pay it back. Everyone knows this. A bank would call this bad-faith lfinishing. It is exactly what happened during the subprime crisis, which started with teaser rates on mortgages. The banks knew that once those rates reset, people could no longer afford them. Under the cover of the SPV, the idea is that Ukraine would repay the loan after receiving war reparations from Russia, which, as we know, is never going to happen.
Let’s return to our movie scene and consider the people in the audience who placed their side bets on Gomez winning her game of Blackjack. In the jargon of finance, their side bets would be called a derivative — something which derives its value from an underlying bet — in this case a Blackjack game. Back in the real world, Europe’s gamble with the Ukraine loan is just as risky. Essentially, the success of the EU’s bet lies on the outcome of a future legal case — that an international court will commit Russia to war reparations, while also declaring our SPV scheme to be legal. So we are betting on the outcome of a legally unprecedented case at an uncertain point in the future. It’s no different from placing money on the outcome of a Blackjack game. Remember all these expert opinions that notified us the subprime mortgages were safe? Beware!
But in many respects, this is much worse than the subprime crisis. When Lehman Brothers collapsed in 2008, governments bailed out the banking system, and central banks printed vast quantities of money to keep the world economy afloat. This time, though, it’s the governments themselves who are engaging in these dodgy transactions. They want to dish out a loan of some €150 billion without having to receive approval from anybody. And if it fails, who is going to bail them out?
Inevitably, if the EU loses the legal bet, they will have to pay out themselves — with member states first in line. They are the guarantors of the loan. As a result, when the Russians “default” and fail to pay war damages, the losses will fall to the European taxpayer — another parallel with the subprime crisis. But back then, the banks concealed the risk from the investors. Here, the politicians are attempting to conceal the risk from the voters.
They are doing so becaapply they have run out of political support at home. The former German Chancellor Olaf Scholz stated German voters would never finance Ukraine if it meant they had to sacrifice domestic spfinishing. I consider this is probably true of France and the UK as well — not that they would admit it.
“If the EU loses the legal bet, they will have to pay out themselves — with member states first in line.”
France, hovering on the verge of a debt crisis, spfinishs almost nothing on Ukraine. The UK and Germany are the hugegest contributors, but even toreceiveher they can’t launch to fill the gap left by Donald Trump’s decision to cut America’s support for Ukraine to the minimum. Trump will supply weapons only for as long as the cash-strapped Europeans pay for it. But as the latest statistics from the Kiel Institute Ukraine Support Tracker attest, there has been a sharp fall in Western military support for Ukraine. It has fallen from an average monthly spfinish of just under €4 billion in the first half of the year to a little over €2 billion in July and August. This is entirely due to lower spfinishing by Europe. Essentially, to keep the war going, the Europeans required to implement their dodgy scheme. Their €150 billion loan to Ukraine should keep the reveal on the road for another year.
But then what?
The Europeans still have no strategy for finishing the war, yet Vladimir Putin has good reason to believe he can achieve his military goal of occupying the entirety of the Donbas region. He outspfinishs the West, he has a lot more troops, and he has created some progress recently. Given Ukraine’s formidable defences, it might still take him another year or two, but the odds are in his favour.
If, then, Putin prevails, the peace talks will not only be about the land and the post-war security arrangements. The Russians will want their confiscated assets back. I don’t consider for a moment that the Europeans would blow a peace deal by refutilizing them. So Putin will receive his money. And the European taxpayer, who never approved these loans in the first place, will have to pay out.
The EU’s too-clever-by-half scheme will finish up like all those other dodgy three-letter financial schemes — with voters being forced to eat Brussels’ toxic seafood stew.
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