THE BRITISH STEEL TYCOON
In June of 2019, UK based Liberty Steel bought Johnstown Wire Technologies, a former Bethlehem Steel mill in Western Pennsylvania opened in 1911. Sanjeev Gupta, the founder of GFG Alliance, the British conglomerate that owns Liberty Steel, has been praised as the “savior of steel” for his aggressive approach to purchasing failing and fallen steel mills, promising to reinvigorate US steel manufacturing (Thomas, 2021). Since beginning his foray into dilapidated steel mills, Gupta garnered global recognition for his visionary greener, 21st century reinvention of an iconic, classic American industry. Liberty Steel’s purchase of Johnstown Wire Technologies was the final piece in Gupta’s made-in-the-USA supply chain acquisitions which included; Georgetown, South Carolina; Peoria, Illinois and Tampa, Florida, all of which, he says, “will firmly embed the business along the full value chain in the U.S. steel market.” (PRN Newswire, 2019)
But in March of 2021, a significant component of his salvage-to-start-up empire, Greensill Capital, began experiencing what the New York Times called a “dazzlingly fast failure” and “one of the most spectacular collapses of a global finance firm in over a decade” (Nelson et.al., 2021). As details of Greensill’s collapse unfold, the NYT characterization becomes less literary hyperbole and more a realistic depiction of a new, post-2008, Wall Street security scheme. The depth and breadth of its damage, remains to be determined.
THE AUSTRALIAN FARMER
Enter farmer-turned-financier Lex Greensill. (Yes, that is really the name of this story’s money-hungry villian.) Greensill is an Australian ex-farmer who presented himself to the global banking industry as a small, business-minded simpleton just trying to ease the barriers to entry of modern finance for the little people. Put simply, small businesses like his family farm have limited capital to purchase supplies, and all too often, suppliers expect to be paid immediately. To overcome this finance gap, Greensill starts a supply chain finance business. He receives investment which he uses to pay the bills of small businesses, reinforcing the integrity of their supply chain. Then he charges interest to finance the payment and the suppliers receives their payment immediately, minus a small convenience fee. It’s a fairly common, respectable business transaction that is widely used in manufacturing and other industries with capital intense supply chains. As you’ve probably guessed, this isn’t the bad part.
Greensill went far beyond just financing the supply chains of small businesses. He added an extra dimension to his business process in order to increase his profits (Nelson et. al., 2021). This is the part where he starts to look less like Warren Buffet and more like Bernie Madoff. Greensill, takes the debt that he is financing and securitizes it as bonds, bundled into investment funds. At this point, not only is he making money on the interest fees paid by the buyer and the transaction fee paid by the vendor, he is also earning money on the securitized debt sold exclusively through Credit Suisse and GAM, a Swiss asset management firm. Then, in order to completely mitigate his risk, Greensill insures the debt through Tokio Marine Management. So if the buyers fail to pay their bill, he can just file a claim and be reimbursed. “What could possibly go wrong?” any reasonable person is inclined to ask.
Enter flashbacks of 2008’s mortgage-backed securities and collateralized-debt obligations. Greensill starts selling his funds to banks and investment firms with an “everybody wins/nobody can lose” pitch that, of course, smart bankers actually buy because they still haven’t learned to conceptualize “moral hazard.” As Greensill receives investment, $1.5 billion of which came from Softbank’s Vision Fund and plenty more from Credit Suisse, he uses the capital to pay companies’ bills, finance their debt, collect a fee and sell the debt as a security. And he manages to do this all over the world.
Eventually, UK Prime Minister David Cameron, who will eventually serve as an employee to Greensill Capital as well as an advisor expecting $60 million in stock from his participation, gave Lex Greensill a cabinet office in his administration so he could peddle his service across all branches of the British government. Greensill claims to have set up supply chain support for President Barack Obama and Australia’s former Foreign Minister would become an advisor. It seems the whole world was sold.
Now, as I am sure you are imagining, there is a point where this whole thing starts to go awry. It’s the same part where everything on Wall Street typically starts to turn to shit: TRANSPARENCY. The bills that the purchasing company financed, appeared on their balance sheet as an account payable, instead of as debt. That meant companies could underrepresent how leveraged they were and misrepresent their financial health. That misrepresentation allowed them to take on more debt than a traditional lender would permit. The unorthodox method of financing the debt through a supply-chain financier instead of a bank also presented another level of balance sheet opacity in that, because it didn’t involve traditional evaluations of risk, Greensill was able to finance company debts beyond normally accepted limits of credit exposure. Suddenly, this entire thing is really starting to look like Lehman brothers 2.0. But Lex had a solution to set himself above the paltry snake-oil securities machinated by the architects of the 2008 collapse. To do so, he touted his revolutionary “tech” as an astounding automated algorithm of ingenuity that could mathematically alchemize investments into private jets and Mercedes Maybachs. (De Paoli, 2021). Because that is precisely the formula you use to get smart people with Ivy League educations to believe and invest in ridiculous shit. I’m exaggerating of course. But you get the point.
As I’m sure you’ve surmised by now, it’s about to get real for overleveraged Lex. And that reality comes to Lex in the form of an insurance auditor. Now, I don’t have the actual inside scoop about what went down to cause Tokio Marine to refuse extension of Greensill Capital’s insurance. So I choose to imagine a stodgy, middle-aged European man, working as a simple insurance auditor for Tokio Marine, eating a bagged lunch at his desk while reading in some obscure trade periodical or financial magazine about how Lex Greensill is assuaging the economic obstacles of the world’s simple farmers by double billing small business purchasers and vendors on the same transaction, then selling the debt like dice on a craps table so Wall Street can take a bite. And I imagine that, while he reads this plutocratic puff-piece he thinks to himself, “oh hell no.”
Upon the moment that Greensill receives notice that their policy is up for renewal, our auditor begins to examine the health of Greensill’s books as well as those of his customers. One of the most disturbing findings yielded in review of Greensill’s financials is, a significant number of assets, purchased through GFG Alliance Group (the conglomerate owned by the aforementioned “Savior of Steel” Sanjeev Gupta) simply did not exist. Yes, they were not real, fabricated or more bluntly put, fraudulent. And it is with that revelation as well as many others, the spectacular collapse of this massive ponzi scheme ensues at the speed of light.
This supply chain scam, as with the 2008 mortgage-backed securities collapse, only stays afloat as long as the debt is insured to mitigate the risk. Once the risk gets beyond what insurance providers can or are willing to take on, a system based entirely on trust is no longer trustworthy. Call to attention the epic slide to the brink of AIG in 2008, all because AIG insured the credit-default swaps and mortgage-backed securities that were tanking the economy. The most crucial bailout of that crisis was not for the banks, but stabilizing the massive financial responsibility with which AIG was charged. This burden went far beyond just mortgages, spreading to public-sector pension funds, life insurance, corporate insurance and much more.
Unlike AIG, Tokio Marine saw the writing on the wall and refused to extend Greensill’s 2 policies leaving the company to shoulder the sole burden of their own leverage. Upon that action, Credit Suisse froze $10 billion in Greensill’s assets essentially paralyzing the firm. The aftermath of this collapse takes us around the world to Spain, France, Germany, Australia and back to Sanjeev Gupta, our steel tycoon and the a coal magnate who also serves at the Governor of West Virginia.
Greensill expanded far beyond small business supply chains into corporate lending. This included financing the bargain-basement purchases of down-and-out steel mills by Liberty Steel, who employs 35,000 employees world-wide. According to Gupta, the purchase of these mills for renovation was too risky a venture for traditional business financiers. So Gupta relied on Greensill’s securitized debt program to fund many of the plant purchases (though the Johnstown Wire plant does not appear to be one of them). In a number of recent interviews, Gupta states that Liberty Steel owes Greensill “hundreds of millions of dollars.” Worse yet, Bloomberg reports GFG has never published a consolidated set of accounts, making a money trail nearly impossible to establish (Spence, 2021). Liberty Steel requested a bailout from the British government of 170 million euros. The government declined.
THE WEST VIRGINIA COAL MAGNATE
Liberty Steel isn’t the only well-intentioned business to fall into insolvency as a result of Greensill’s scam. West Virginia Governor Jim Justice, who’s coal company Bluestone Resources received an $850 million loan from Greensill and signed a deal ensuring future financing, is now suing the collapsing firm for misrepresenting their financial standing and bailing on their obligations. Greensill’s collapse has left Bluestone in a perilous situation (Von Voris et al, 2021).
The failure of Carillion, a UK contractor with 43,000 employees, many of whom are union, caused shockwaves in a number countries and a political uproar in the UK. The ultimate story of overleverage and greed-run-amuck is told through two hospital projects Carillion ultimately tanked due to hoarding equity, over-reliance on invoice-backed financing and significant underbidding that severely sacrificed engineering and construction quality. According to a review by Arup Group, the structural issues were considered serious and required 70 “structural interventions” including demolition (Reina, 2020). Because the Carillion hospital deals were funded through a debt-backed private initiative and government subsidies, the impact of the failure was ultimately absorbed by the insurance companies and the bank, not the contractor (Reina, 2020).
As the Carillion collapse unfolded in epic fashion across the globe, back in the UK, Labour Party leaders aggressively questioned the propriety of using private contractors for government services. The GMB Trade Union, representing more than a half million workers stated, “There is no place for private companies who answer to shareholders, not patients, parents or service-users in our public services.” (Douglas, J. 2018)
In France, Greensill failed to deliver on an $18 million dollar state-backed loan to Alvance Aluminum Poitou. As a result, the Confederation Generale Du Travail labor union, representing 600 workers, states that company told workers there may not be enough capital to cover the upcoming payroll (Jack, 2021).
Abengoa, a Spanish infrastructure company, brushed with bankruptcy in 2015 due to Greensill’s shady investment strategies and the ability to obscure its level of debt. The company, which was founded in 1941 and built a sound reputation in the energy industry, managed to survive six more years, helped by government-back US grants and loan guarantees supporting its electric power plants in California and Arizona. (Proud & Unmack, 2021). After creditors lost confidence in the company’s ability to achieve solvency in a third attempt to restructure debt, Abengoa filed for bankruptcy this February (Witt, 2021).
IMPLICATIONS FOR POLICY-MAKERS
Thankfully, at least one insurance company learned something from the 2008 collapse, preventing this new security swindle from gaining global credit default swap, great recession proportions. And the resulting collapse was just big enough to get global exposure without causing too-big-to-fail economic market mayhem.
The learning to be extracted from this post-2008 lesson in market self-correction is one that should be absorbed and applied for policy-makers, politicians, progressives and plutocrats across the globe.
1. Contrary to the magical thinking that Ayn Rand, Allen Greenspan and Adam Smith would have you believe, markets don’t self-correct. Hedge fund managers, investment bankers and corporate raiders have never and will never wake up and say “You know, we’re making tons of money but we should slow down because we’re getting out of control and things could backfire.” The only party with a demonstrated interest in curbing greed-is-good overleverage schemes and an obvious capacity to act in their own self-interest which run counter to risk, is those who bear the risk – insurance companies. And unlike almost everyone else after 2008, the insurance companies realized what the ultimate root cause of that collapse was
Glass-Steagall (The Banking Act of 1933) effected an economic barrier between commercial banks viewed as monetary safehouses for the American middle class and investment banks viewed as corporatized casinos. When Glass-Steagall was essentially dissolved in 1999, it allowed assets to cross that barrier without any regulation or best-practices to establish accountability for the use or transparency of those assets. In essence, when mortgages closed by commercial banks were sold, bundled and traded by investment banks, the evaluation of risk for each mortgage was assumed without being physically evaluated, since the mortgage wasn’t attached to the security. That caused the rating agencies to mistakenly rate severely sub-prime mortgage-backed securities as AAA, which eventually went into massive default across the system. In the end, the derivative of every mortgage, in every security, in every fund that fell victim to the mortgage crisis, was not visible to the rating agency. So the entire market was flying blind with their heads buried in the sands of deniability. And they were loving every minute of it.
If, throughout the subprime frenzy of the 2000’s, AIG had begun doing insurance audits on the derivatives of those securities (examining the actual mortgages), it might have occurred to some medium-level risk manager that things were getting out of control and could backfire. But that didn’t happen and the banking industry cannibalized itself to the point of global catastrophe.
In the case of over-leveraged Lex Greensill, the insurance company did what never occurred to any regulator or government office, they did the deep-dive into the numbers, saw the actual risk and pulled the plug immediately.
2. The banking industry operates with the same physics as any other system. In those systems, people, businesses, politicians and government entities have proven they are systemically incentivized to push risk as far as their mitigators will allow in the interest of accumulating profit or power. The only valid systemic remedies to this problem are: absolute systemic transparency and a reliance on the scientific method for process improvement. When it is systemic change we seek, we must first expose all actions of the entire system and then evaluate its problems using the scientific method. Without both, the customers, constituents and taxpayers of the aforementioned actors are always at greater risk than they perceive. Any other solution is just a band-aid.
CITATIONS
De Paoli, L. (2021). Greensill collapse exposes gap at the heart of its technology claims. Bloomberg Quint. March 20, 2021. https://www.bloombergquint.com/business/greensill-s-collapse-shows-company-had-a-big-technology-gap
Douglas, J. (2018). Carillion collapses, forcing government to step in. Wall Street Journal. January 16, 2018 https://www.wsj.com/articles/carillion-collapses-forcing-government-to-step-in-1516031587?mod=article_inline
Jack, S. (2021). Unions fear huge job losses as “Savior of Steel” hits crisis. BBC. March 2, 2021. https://www.bbc.com/news/business-56250732
Liberty Steel Press Release (2019). Liberty Steel consolidates US wire market leadership with Johnstown acquisition. PR Newswire. June 10, 2019. https://www.prnewswire.com/news-releases/liberty-steel-consolidates-us-wire-market-leadership-with-johnstown-acquisition-300864472.html
Nelson, E., Ewing J., & Alderman, L. (2021). The swift collapse of a company built on debt. The New York Times. March 28, 2021. https://www.nytimes.com/2021/03/28/business/greensill-capital-collapse.html
Proud, L., Unmack, N. (2021). Breakingviews – Scandal and sunlight will end trade finance party. Reuters. March 5, 2021. https://www.reuters.com/article/us-greensill-capital-bankruptcy-breaking/breakingviews-scandal-and-sunlight-will-end-trade-finance-party-idUSKCN2AX14J
Reina, P. (2020). UK Auditor’s Report: Carillion collapse landed on banks and insurers. Engineering News-Record. January 22, 2020. https://www.enr.com/articles/48542-uk-auditors-report-carillion-collapse-landed-on-banks-andinsurers#:~:text=The%20failure%20of%20Carillion%20plc,the%20U.K.%20National%2
Serenelli, L. (2021). Greensill Credit Suisse case unlikely to harm swiss pension funds. IPE. March 29, 2021. https://www.ipe.com/news/greensill-credit-suisse-case-unlikely-to-harm-swiss-pension-funds/10051930.article
Spence, E. (2021). Greensill pressure ambitious “Savior of Steel” Gupta. Bloomberg. March 3, 2021. https://www.bloomberg.com/news/articles/2021-03-03/greensill-woes-put-pressure-on-ambitious-savior-of-steel-gupta
Thomas, P.M. (2021). Explained: Is Sanjeev Gupta’s “steel savior” story over? Money Control. March 16, 2021. https://www.moneycontrol.com/news/business/explained-is-sanjeev-guptas-steel-saviour-story-over-6632711.html
Von Voris, B., De Paoli, L., & Griffin, D. (2021). Greensill sued by West Virginia Governor over mining loans. Bloomberg. March 16, 2021. https://www.bloomberg.com/news/articles/2021-03-16/greensill-capital-is-sued-for-fraud-by-bluestone-resources
Witt, I. (2021). Abengoa files for bankruptcy in Spain. S&P Global. February 24, 2021. https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/abengoa-files-for-bankruptcy-in-spain-62836456