If this sounds like I’m talking about 2008, CDO syndication of sub-prime debt, and AIG and others offering Credit Default Swaps, or CDSs, as derivates used to hedge against CDO losses¹, you have a good memory, but I’m not.  I’m actually talking about the new European Bailout Fund which was much-hyped towards the end of last week. ²  Maybe the EU finance ministers missed the whole 2008 crisis, but even if they did, it’s hard to believe they expect the rest of us to buy their bonds based on the exact same false premises.  Fool me once, shame on you; fool me twice—oh, never mind.  Here’s the problem:

The Irish government needs a bailout.  They can’t borrow at anything but a junk bond rate.  So the EU announces to much fanfare that the big Trillion Dollar Bailout fund will come to the rescue.  But wait, it’s not a fund.  It’s a “facility,” and it doesn’t currently have a single cent in it. ³   Instead, it’s a facility that will issue bonds itself to other investors.  So the Irish debt has a lousy rating, but magically the bonds the Bailout facility issues turn into AAA securities.  How?  Because the remaining EU member states (those not recipient of bailout funds) put their “full faith and credit” behind the facility and guarantee it.  Heard that one before?  Yes, that’s the phrase everyone thought applied to the US government’s support Fanny and Freddie, but didn’t (and that worked out well, didn’t it?), but it’s also directly analogous to the commitment AIG made in the form of its CDSs before the meltdown.  AIG provided derivatives worth trillions of dollars of CDOs without much regard to whether, if those bundles of CDOs eventually defaulted at higher rates than projected, they would have the capital to post as the collateral required to support those CDS policies. ⁴

Here’s why this European facility looks just like the CDS crisis:  the guaranteeing countries guarantee the debts of the bailed out countries.  But some of those guaranteeing countries (Spain, Portugal, Italy, etc.) are already teetering on the brink.  Which means they may default.  And need bailouts themselves, guaranteed by the remaining countries.  The collateral requirement balloons far bigger than the original Irish crisis:  now it includes failures in Spain and Italy and Portugual as derivate problems of the core crisis.  Just as AIG’s derivatives policies forced AIG to post collateral far greater than the underlying CDOs.  So who ends up holding the bag?  AIG—I mean Germany.  For exactly how long do you think the Germans will guarantee the debts of the mismanaged Mediterranean (and Irish) economies?  This isn’t just counterparty risk, it’s political risk.  The future of the EU itself hangs in the balance.  If the Germans pull out, precisely who would guarantee these debts?

Like any other native New Yorker, the theater-going part of me used to dread the announcement that was occasionally heard just as the house lights went down:  “In this evening’s performance, the role of King Lear, normally played by Sir Anthony Hopkins, will be played by Justin Bieber.”  Everybody in the audience groans.  A few leave.  I’m having that same reaction to today’s performance of the European Bailout Fund.  “In today’s performance, the role of the Guarantor usually played by AIG will be played by Germany.”  We all groan.  You can see the bond fund managers leaving for the doors already.  Oh, look, there goes Alliance Bernstein.  And there goes CALPERS.  I wonder whether PIMCO will stay for the second act….

1. There was also straight out insurance against CDO losses, offered by such firms as FSA;  for more details, read Michael Lewis’s excellent The Big Short: Inside the Doomsday Machine
2. The facility has actually existed since May of this year; last week’s announcement marks the first deployment of the facility.  It becomes a permanent feature of the EU in 2013—if the EU makes it that long!
3. For a some great background information on the European Bailout facility, listen to Friday’s NPR Planet Money podcast.  I can’t recommend Planet Money enough.
4. The problem for AIG was not paying out on these insurance policies, since that was the job of FSA and MBIA.  Instead, it was the hugely inflated requirements of AIG to post collateral as a requirement of the CDS agreements which itself was too much for AIG to handle.

There was something surreal about watching President Obama take the oath of office from a hotel room in Karachi, Pakistan. Several times, I wondered whether there were more suicide bomb barriers surrounding his dais or my hotel. Suicide bombers had nearly destroyed the hotel a year or two earlier, and the predictable reaction—to erect sufficient vehicle barriers to stop more than one simultaneous attack—had of course been implemented. And so I watched, from 13,000 miles away, as America took what I profoundly hope will be the first of many steps towards reestablishing its international reputation as a symbol of freedom, all the while knowing that I was under strict orders from our hosts not to leave the building.

All around me were little security instruction sheets, thoughtfully Xeroxed by the hotel staff and placed in every room. From the typical (“this water is unsafe for drinking; kindly enjoy the complimentary bottle of mineral water provided”) to the stern (“do not stand on balcony; snipers may be active”), the warnings combined to deliver the message that, thanks to the efforts of less than 1% of the population, Westerners are simply not welcome in Pakistan. 99% of Pakistanis we met were hopeful, interesting people, happy to talk to an American (and to ask us about our new president—more about that in a different post). But all I had to do was look out my hotel room window to realize that it is the 1% who rule the country.

View from my Karachi Hotelroom

As they so often do, this picture tells the story better than I can. The balcony is enclosed in a net, lest grenades be thrown up onto the landing. The wires above the pool are for god-knows-what security technique. (My guess: since they are either grounded or energized, probably an anti-eavesdropping measure which doubles as a mechanism for defeating radio frequency bomb triggers, although my mobile phone worked just fine underneath them, so perhaps not.) There were magnetometers, x-ray machines in the lobby, and nearly every entrance to every building was peopled by thoroughly un-reasuring armed guards. There were small trucks parked in the parking lots of both “Western” hotels, each filled with four chain-smoking Pakistani infantrymen, on top of which was mounted what looked like an M60 (.50 caliber machine gun). Two bomb-sniffing Labrador retrievers worked the parking lot. ID checks were performed endlessly.

I doubt that any experience since 9/11 has reminded me that this really is a war. Not a war which gives our government the right to abrogate our Constitution, but a war nonetheless. And until it ends, Americans traveling abroad had better remember that the actions of our own government (and in particular the recently-departed administration) catalyze reactions abroad which pose as grave a threat to our well-being as any other. (Until 2002, there had been no attacks against Western targets in Karachi. That all started after we reacted to 9/11.) In the end, no matter how hopeful I am that the inauguration of President Obama will set us off to righting our standing worldwide, we will remain “the enemy” for a long time to come.

As its title suggests, Shashi’s newest book focuses on the ongoing transformation of his homeland. (In an interesting aside, Shashi points out that the cover of his book in its US edition, shown below, bears an almost cliched illustration of a Hindu God—which I take to be Ganesh—holding a tiger in one hand and a cell phone in the other, but the Indian edition shows a real photograph of a Hindu Sanyashi—a monk—sitting on his bicycle, making a cell phone call.) In particular, Shashi related a couple of anecdotes which gave me some idea of just how profound the impact of modernity has been on India. One is worth re-telling: as recently as 1984, when the population of the country was approximately 650 million (it is now in excess of 1.1 billion), there were a mere 8 million telephone land lines. In 2007, India set the world record by adding 8.4 million mobile phone lines in a single month. In other words, India is adding more mobile lines per month than the entire country had a mere quarter century later. Think that might change the dynamics of the society a bit?

Skilled diplomat that he is, Shashi deftly parried the inevitable “China versus India” question by answering that the felt China had won the conflict, such as it is, some thirty years prior. (He points out that China began its economic expansion long before India’s 1991 liberalization.) One observation I wasn’t expecting: Shashi relayed that India is perhaps the only country in the world with any significant Jewish population which does not have a single recorded episode of antisemitic violence. Religious tolerance and pluralism, although certainly not an absolute (think Hindu nationalism), certainly does seem more the rule than the exception in India. As Shashi points out, where else could a Roman Catholic, Italian born Indian (Sonia Ghandi) resign her mandate in favor of a preternaturally well-educated Sikh (Manmohan Singh) who would then work with a woman President (Pratibha Patil), in order that he lead a country which is 80% Hindu? We Americans, who in 225 years have not managed to elect anyone as our president who is not white, male and Christian, could perhaps learn a thing or two from the example.