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Tuesday, August 14, 2012

Lessons from the lull of August

August seems to be a quiet month for Greece (and for the Eurozone, for that matter). It is being described as the lull before the storm, with the next hurricane being expected to come around in September.

Why is August a quiet month? Undoubtedly, it being a vacation month is part of the reason. But the more important reason is that there are no major decision points in August (except for the August 20 refinancing which has been taken care of). September, on the other hand, will be a month full of decision points.

Wouldn't one lesson from the above be to move decision points way into the future? Moving them into the future doesn't solve any problems, of course, but it provides time which, if used well, can make the solving of problems a lot easier. Problems are best solved during a lull. They are rarely solved during a storm.

Suppose we were still back in January of this year and suppose Greece would have suggested to private creditors that they should take 100 BEUR of their Greek debt and put a moratorium on it for 10 years (i. e. no principal/interest payments for 10 years). I can see how everyone would have screamed "no way!"; "one can't do that!"

Well, what was done instead at the time? Enormous effort was invested and a lot of china was broken by getting private creditors to agree to a 100 BEUR haircut. That hundred billion is gone as far as the private creditors are concerned. No more chance to negotiate all or part of it in, say, 10 years from now. It is gone forever.

Wouldn't it be smart to be practical about the debt problem? The fact is that principal and interest can only be paid if someone lends Greece the money to pay them in the first place. Why go through all those painful motions when there is absolutely no financial gain from them for anyone involved?

Why not take a large amount of Greece's remaining sovereign debt, perhaps 150 BEUR or so, and say: "We put principal and interest on follow-up in 10 years from now. Until then, that debt will just stand there as a 10-year loan with interest capitalized and due at the end of the 10 years. At the end of the 10 years, we will negotiate a new principal/interest structure of the debt outstanding then".

Creditors might scream that, if they agreed to this, they would lose all leverage on Greece to make reforms. That is a fallacy because there is still enough of sovereign debt to play with for leverage purposes. And, actually, one only needs interest payment dates to exercise leverage. The respective clause in the loan agreement would simply state: "Non-payment of interest makes all outstanding debt immediately payable in full".

The trick is to gain time. The even greater trick is to make sure that this time is used well. The carrot at the end of the stick for creditors is that they don't give up anything yet. In 10 years, they have the right to negotiate ALL the debt which is outstanding then.

To make a long story short: when in financial trouble, the idea of repaying debt is a fairy tale. To spend all one's resources on debt repayment possibilities is a waste of time.

The most important thing is to "regularize" debt in whatever form or fashion so that one can enjoy the lull for as long as possible (to make reforms) before the next storm hits.

Look at any sovereign debt restructuring in history. The debt was never lower once the restructuring was completed (unless it was forgiven). It was only "regularized".

I am not familiar with the current debt situation of the State of California but I am sure it would be a good example. I remember that, not too long ago, the specter of bankruptcy circled around California. During quite some time, the state had to pay some of its bills with IOU's. Now, everything seems to be fine. Is California's debt lower today than it was then? I doubt it! So why does everything seem to be fine in California today? Because the state's debt could be "regularized". Its maturities could be restructured in such a way that decision points were moved way into the future.

Knowing how Californians run their state, I doubt that they have solved many problems since the last "regularization". Undoubtedly, we will see a storm again in California at some point in the future. But until then, California enjoys the lull during which it could correct some of its problems.

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