Die Presse in Austria has an interesting case of a 45 year (named Monika. R) old law graduate that has lost 1/3 bio EUR of local government money. There is no indication that personal enrichment has been the motive.
In 2001, the community of Salzburg decided to step on the slippery financial market. The community wanted to ”invest” and hired a ”brilliant, trustworthy, and capable” Monika R. for the job. Of course she was checked – by one of her employees.
Everything was splendid until 2006, when she bought Icelandic sovereign bonds, which yielded nicely until Iceland collapsed. First, she had forced her employee to sign – later simply forged the signature. The reports to the control committee under the Finanzlandesrat (approx. finance minister local government) were always in order – they were pure fiction.
Then CDS (among other things) was tried to recoup the losses. Then one spilled the beans.
As late as 2012 the local government denied there was a problem. But then, Monika R. was forced to take a vacation, though she vehemently opposed. Then information from Deutsche Bank AG (ETR:DBK) (FRA:DBK) (NYSE:DB) in Frankfurt came that didn’t quite match the reports to the politicians.......
Now let’s leave the rather pathetic case of a “brilliant” financial expert trying to fix a local government problem. Nobody will get any merit badges from this one – and there is a hefty bill for the local taxpayers.
But it is a more general problem:
Die Presse mentions similar cases in Linz, St. Pölten, etc. The CB-governor Ewald Nowotny will not exclude other cases. A consultant estimates a potential figure of 8 bio. EUR in local government losses due to speculation in structured financial products gone wrong – in Austria alone.
The consultant, Edlinger, estimates from German figures that in a letter from the Central Credit Committee to the parliament Creditcommitte in 2010, estimates ”bets” between banks and local governments of 63.7 bio. EUR (trust a German official to give a rough estimate with three figure precision). The real risk is estimated to be a two figured billion EUR amount. The instrument has been used even more intensively in Austria.
There have been some communities in Denmark that have suffered from playing in the banks bingo-parlor as well. Figures have not been that high – but that might still surface. In the Austrian example it took ten years before the horror was discovered.
To compare the amounts to something: The Spanish bank rescue stands at the moment to about 44 bio. EUR. Spain and Italy also have the problem in spades.
There are two issues of principal interest here:
1) Even people who are supposed to be skilled professionals have let themselves be lured into credit instruments and transactions they could not evaluate. It is surfacing ever so often that the banks and bankers themselves habitually are ignorant of their own business. I.e. a banker might not even be aware he is lying!
The serious aspect is that sort of “banking” brings nothing but grief to society, but hearkens back to a fundamental lack of ability to evaluate risk in the financial world. If banks can’t make the simplest risk estimate – if you don’t understand, say NO – then what use are they.
2) The problem is one of official bodies being particularly vulnerable, as they are able to raise credit on favorable terms, due to their ultimate recourse of the tax-payers money. Germany particularly so, where the local government bonds only have slightly higher interest rates than sovereigns – and are as prevalent as sovereign bonds.
Again, it is the fundamental lack of understanding of the nature of risk and risk premiums. A business loan carries a higher interest than a sovereign bond for a simple reason: The yield on business loans is higher, because they sometimes result in losses. But everybody seems contend just to pocket the difference.
Now as a banker you can make provisions, reservations, and impairments for that – indeed all countries' legislation says that – but no banker in his right mind will follow sanity.