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Tuesday, January 31, 2012

Which way to the future, please?

The article "At bursting point?" from The Economist is definitely worth reading! Nevermind that it explains the reaons for today's misery of the Southern Periphery in terms which the Southern Periphery may not like, it also shows that there are still ways to "restore the lustre of the European Economic Model" (this in reference to a World Bank report which can be found here). One of the best paragraphs of the article is below: (quotes from the World Bank report in italics)

"All is not lost. Northern European states, especially Nordic countries, show it is possible to innovate, raise productivity and maintain generous social welfare at the same time. This is the World Bank's explanation for their success:
What has the north done to encourage enterprise and innovation? Much of its success has come from creating a good climate for doing business. All the northern economies are in the top 15 countries of 183 in the World Bank’s Doing Business rankings; at 14th, Sweden is the lowest ranked among them. They have given their enterprises considerable economic freedom. Their governments are doing a lot more. They have speeded up innovation by downloading the “killer applications” that have made the United States the global leader in technology: better incentives for enterprise-sponsored research and development (R&D), public funding mechanisms and intellectual property regimes to foster profitable relations between universities and firms, and a steady supply of workers with tertiary education. Tellingly, Europe’s innovation leaders perform especially well in areas where Europe as a whole lags the United States the most. These features make them global leaders; combining them with generous government spending on R&D and public education systems makes their innovation systems distinctively European".
Who would have thought that the message is as simple as suggested here in this blog a few months ago, namely that all Greece needs to do to have a good future is to become "a good place to do business in"?

In the World Bank's "Doing Business 2012 Report", Greece ranks #100 out of 183, by far the lowest rank of an EU-country.

In the "Corruption Perception Index 2010" of Transparency International, Greece ranks #30 out of 30 EU and other Western European countries.

Any long-term economic plan that Greece might come up with must have as two of its objectives that Greece moves dramatically up the scale in those two reports!

How does Mr. Papademos spend his time?

A Greek friend, 30 years old and about to receive a PhD, wrote to me the following over the weekend:

"I'm not a political analyst or an economist to be in a position to say who is exactly to blame. Probably all of us are responsible, even the Martyrs that tolerated this situation and did nothing to change it. Surely, we need someone descent in charge and maybe only one is not enough because the others will soon knock him out. I had hoped (and probably a lot of Greeks as well) that Lukas Papademos was our hope, but I see no change. A true will to reform Greece from its base; to reform and change the system; to really deal with tax evasion for example. There is a TV "show" in SKAI presented by Alexis Papahelas and two others called "i nei fakeli" that dealt with tax evasion and what I saw was absolutely hopeless".

That has caused me to ponder how Mr. Papademos might have been spending his time so far. Put differently: what has he done and what is he doing? How does he spend his time?

Well, if he has given a rousing blood-sweat-and-tears speech about the long dark tunnel ahead but with a light at the end of the tunnel, I must have missed it. Oh, one has to be a charismatic political leader to be such a rousing speaker? A technocrat can't do that? Well, anyone who has seen the movie where George VI gave the King' Speech will know that even a man with a speech impediment can rouse people.

If Mr. Papademos has done anything about developing a long-term economic plan for Greece, I have missed that, too. I am not saying that he, as Prime Minister, should do that personally. He shouldn't, despite all his technocratic expertise. But he could have commissioned a task force of "the best and brightest intellectual, economic and business talent" which Greece has to offer – and Greece offers a lot of that! – to develop such a plan.

Instead, everything I have heard from Mr. Papademos, via newspapers and/or social media, related in one way or another to troika issues, debt issues, austerity issues and other things like that.

So I can see why my young Greek friend is disappointed. I am, too! Particularly since it would be so easy to take some of the right steps. Just think what a regular, middle-market entrepreneur (possibly without academic education) might do when his company got into trouble.

Well, he probably would call all his employees together to talk to them about the problems. He would explain where the company has been; where it is now;  where he hopes to have it in the foreseeable future; and what everyone can contribute to achieve that. He would explain that they all have to work together, to pull on the same string in order to get there. He would explain to his employees that if they didn’t want to do that, he might as well close doors right away. On the other hand, if they did do that, they would all have a good time again in the future.

What are you waiting for, Mr. Papademos?

Monday, January 30, 2012

More thoughts on Petros Markaris' article

I have now read Petros Markaris' article several times. A foreigner who tries to understand Greece and Greeks cannot read it often enough (still: Greeks will never cease to surprise foreigners...).

One can tell that Markaris has spent formative years in the German-speaking culture (Vienna). There isn't a round-about description of Greek society or the very special Greek psyche. No! He neatly segregates Greek society into 4 groups with subsections in each group. That makes it easy for the reader eager to understand the subject matter: one only has to remember the 4 groups and the few subsections within each group and - by golly - one understands how Greece ticks! For those who did not take the time to read the very long article, these are the 4 groups:

The Profiteers - the name alone says it all! They are the ones who have profited enormously from Greece's joining the EU and, particularly, from Greece's joining the Eurozone. Three subsections are identified here: (a) the businesses that benefited from the patronage system of the last thirty years, in particular construction firms; (b) the businesses that supplied state agencies with goods (for example, firms that provided medical equipment and pharmaceutical supplies to public hospitals); and (c) the "poor Greek farmers” who deserved a better life and who have long secured for themselves this better life thanks to the agricultural subsidies of the European Union (and who today drive around the villages in their Cherokee Jeeps...).

The Righteous - here the name doesn't say it all because the name would suggest something positive whereas Markaris means by them the "martyrs" or the "fools". They are all those Greeks who devote themselves to hard work and clean living and who cannot escape the payment of taxes (which is why they are "fools"). They disprove the image many Europeans have of easygoing Greeks who shy away from work. Markaris says that they are the largest of the 4 groups but politically the weakest, which is why they are exploited from all sides (and which is why they are "martyrs"). The Righteous have been the hardest hit by the crisis.

The Molochs - they populate Greek bureaucracy and state enterprises. One subsection is made up of civil servants and officials who work in public agencies and state enterprises, and the other subsection are the trade unionists. The Molochs are the extra-parliamentary arm of every ruling party and the guarantor of the clientele system, because the great majority of its members are party members and party officials.

The Hopeless - the (mostly young) Greeks who sit at their computers all day, desperately searching the Internet for a job - somewhere in the world. They’re not guest-workers like their grandparents, who left Macedonia and Thrace in the 60s and moved to Germany in search of a job. These young people have a college degree, some even a Ph.D. But they head straight from the studies into the ranks of the unemployed.

So, here it is, Greek society. Very simple and easy to understand: 4 groups, a few subsections and that's about it. Now, let me take you on a bit of a journey. Let's say we had some political ambitions in Greece. How might we go about fulfilling our political agenda?

First, we need to start a movement; we need enthusiastic and passionate followers. Where do we start? With the Hopeless, of course! Anyone who has ever been on an enduring job search where hope that there would ever be a job offer had almost disappeared, any such person knows that within seconds of the surprise phone call with the job offer the entire world had changed from despair to near ecstasy. What do the Hopeless need? Very simple - hope! So, we will give them hope. We don't have any hard facts (yet) to justify that hope but we will work with soft facts. We will involve artists and other possible heroes to mobilize the spiritual powers of the Hopeless.

Once we've got that on track, we will go after the Righteous with a master plan. Here we will have to be a bit manipulative because the Righteous have already seen so much disappointment and disillusion that they no longer trust any new messiah. Sometimes the easiest way to become one's friend is to go after his enemies. So we will very skillfully and carefully ("float like a butterfly; sting like a bee") go after selected Profiteers and Molochs. We won't need to sting many of them but they will have to be the "right" ones. Those who, once they are stung by us, will give us credibility and trust with the Righteous.

And once we have the Hopeless and the Righteous on our side, we have the majority behind us. And then we can really start going about making changes to Greek society!

A word of caution. I haven't yet said who "we" is. Well, "we" could be a right-wing fascist or a left-wing radical. Either way, the changes which they would make to Greek society would probably not be very positive changes.

However, "we" does not need to be on either side of the wing. The strongest and most promising "we" would be one which comes out of the center of Greek society. There are no qualified candidates? Well, come on! There are as many qualified candidates in Greek society as there are in any other society. The only question is whether they have the courage "to stand up and be counted" for the benefit of their country.

Do they need a new party program? At some later point, yes. Upfront, they only need to have value structures and communicate them. What kind of value structures? Well, the Judeo-Christian heritage provides a lot of them. Religious people could take the 10 commandments. More philosophical people could follow the thinking of Plato, Socrates or Immanuel Kant. And practically-minded people could follow the Rotarian 4-way-test, i. e. testing each action against the following questions: Is it the TRUTH? Is it FAIR to all concerned? Will it bring GOODWILL and BETTER FRIENDSHIPS? Will it be BENEFICIAL to all concerned?

First, it sounds very easy. Secondly, it will happen for sure. Thirdly, the only question is who the "we" will be!

Sunday, January 29, 2012

What ever happened to the McKinsey report?

Several months ago, the Athens office of McKinsey published the "Greece 10 years ahead report". When I posted on it, one Greek observer commented to me that "it got about 2 minutes' worth of fame". I suggest that it definitely deserves more than 2 minutes' worth of attention!

In a nutshell, the report shows how 500.000 new jobs could be created in Greece over the next 10 years adding 50 BN EUR to the GDP. Around 100 projects are listed. I would suggest to the Greek government that this deserves some attention. Perhaps there are even other reports which have similarly interesting ideas!

My recommendations to the Greek government:

1. Read the report.
2. Take the first 10 projects which appear most interesting.
3. Implement them immediately and create 50.000 new jobs during 2012.

That would seem to make a lot more sense than seemingly endless debt negotiations which will not lead to any new economic activity in Greece.

Saturday, January 28, 2012

Petros Markaris: "The Lights are going out in Athens"

This is a very powerful article by Petros Markaris. I judge from the comments to the article that some people violently disagree with his views. I cannot determine to what extent Markaris is objective but I can certainly recommend taking the time to read the long article!

More on EURECA

Perhaps Greece should take another look at the EURECA-project which was proposed by a consulting firm several months ago.

In a nutshell: Greece would put state assets into a fund, sell that fund to the EU for 125 BN EUR and the EU would commit to spend 20 BN EUR to bring those assets into good shape. Then these assets would be privatized (time frame about 10 years) and privatization gains of 40-60 BN EUR would be expected. These gains would go back to Greece.

Greece would use the 125 BN EUR to buy back her own debt. Such debt currently trades around 30% of nominal. If Greece could buy back her debt at that discount, the 125 BN EUR would be enough to make Greece debt-free (this is a bit of an exaggeration; in practice Greece will have to pay far more than 30% of nominal but, at the same time, far less than 100%).

The 20 BN EUR upgrading investment by the EU would in and by itself already be an enormous stimulus for the economy. Add to that the new momentum which the economy would experience by being able to focus on future potential instead of worrying about past debt all the time and you can expect a steep recovery.

Is there a catch to this? Not really. Well, there is one minor catch.

That minor catch is that the government will no longer have control over a rather large sector of the Greek economy. It will no longer be able to use the resources of those companies for political purposes. That is, of course, very sad for the government. On the other hand, the government will no longer have to pay for the deficits of those companies and that, in turn, is very happy news for Greek tax payers.

Friday, January 27, 2012

A turning point in sovereign debt handling?

This recent posting in the blog called The Slog concluded with the following statement:

“None of this will save Greece – or indeed the Eurozone. But my water tells me this could be a turning point in relations between sovereign states and their creditors”.

My response to this is below.

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If this becomes such a turning point, then it will not be a turn towards a new era of relations between sovereign states and their creditors but, instead, it will be a return to the way things have always been handled between sovereign states and their creditors. It is only thanks to the incompetence of EU-elites that what we have seen evolve in the last 2 years has turned into a perversion of banking. The only thing one can say in defense of those EU-elites is that they had no experience with external payment problems of sovereign states before, but they could have asked those who had. As the Senior Economist of Citibank said recently: “The Europeans didn’t know that outside of Europe reschedulings have come a dime a dozen in recent decades”.

The first thing which must happen when sovereign states see external payment problems around the corner is that their creditors are called upon to form a Steering Committee with which the state can negotiate. As of this date, there is no official Steering Committee representing all creditors of Greece. There is this entity called IIF which feels self-appointed to lead negotiations but they don’t seem to have a mandate from anyone. Certainly not from Deutsche Bank because Josef Ackermann, Deutsche’s CEO and the IIF’s Chairman, was called back from the negotiations by his board citing that he had no mandate from Deutsche to strike deals. Without a Steering Committee as a first step, there is no way that one can effectively keep private creditors “on the hook”.

Whenever the Steering Committee tries to pass the buck to governments, the latter return the buck and insist that negotiating results must first be achieved between borrower & creditors before the governments come in. Governments come in at the end of this process and not at its beginning (in the case of Greece, governments jumped the gun without any need to do so!). Governments will, of course, “monitor” the process behind the scenes (and exert pressure here and there when necessary).

Borrower & lenders will always reach some form of negotiating results because they know that the alternative would be disaster for both. The only question is how much of a hole they keep open to be filled by governments. In the case of Greece, the banks got away by saying from the start that the governments would have to fill 100% of the hole and that was never really contested by governments. In actual fact, governments rarely get involved with existing debt because that should be rescheduled with existing creditors. Governments typically take care of the Fresh Money.

Then there is the role of the borrower. The initiative must always be taken by the debtor country and never given out of its hand. The debtor country must make a restructuring proposal to its creditors. The politicians of the debtor country must show that what they propose is “their proposal” and not something imposed on them by foreigners. In the case of Greece, Mr. Papandreou turned, from the start, his problem into a problem of the EU and the EU was silly enough to accept that ball right away. From that moment on, Mr. Papandreou had no choice but to be perceived as the recipient of orders taken by others. No chance that the resulting deal will have domestic support.

I could go on and on. Instead, I enclose a couple of links showing how incompetent EU-elites turned what would/should have been the most natural problem in the world into the risk of a financial Armaggeddon!

http://klauskastner.blogspot.com/2011/06/how-not-to-manage-sovereign-debt.html
http://klauskastner.blogspot.com/2011/07/bill-rhodes-on-europeans.html
http://klauskastner.blogspot.com/2011/09/rescheduling-of-sovereign-debt-is-most.html
http://klauskastner.blogspot.com/2011/06/perverson-of-banking.html

EURECA - worth another look?

In October 2011, Roland Berger presented their EURECA-project. At first, I ruled it out as a solution for the following reasons:

(a) any Greek government which would recommend selling 125 BN EUR of state assets to foreigners might have to arrange foreign asylum before it does that. Particularly if that idea does not come from the Greek government but from - good grief! - a German firm!
(b) it is not clear to me who should receive the privatization gains in these assets (between 40-60 BN EUR according to Roland Berger). If they are for Greece, ok. If not, big problem.
(c) finally, are there really 125 BN EUR of state assets in Greece?

As regards the last point: if there are indeed 125 BN EUR of state assets in Greece, the Greek state - seemingly bankrupt - must be one of the wealthier states in the EU. But that's a moot point.

I have now looked at the Roland Berger paper again with one principal question in mind, namely: what - except the above - really speaks against pursuing this idea? I cannot come up with anything significant.

On the contrary, this sounds like a game where everyone could win. Overnight, Greece would increase direct foreign investment by 125 BN EUR and very quickly former state inefficiencies will be replaced by private sector efficiencies. This is not just about the mathematics of debt vs. equity Euros. It is about corporate and business culture and about the transfer to Greece of foreign know-how.

I have searched the internet for critiques of EURECA but have not found any. Has there been discussion about this in Greece? Is something being done about it?

This reminds my of another project where the Athens office of McKinsey proposed a "Greece 10 years ahead report" which would create 500.000 new jobs during the next 10 years and 50 BN EUR in new GDP. One competent observer of Greece commented to me that this report "got about 2 minutes worth of fame". Should one perhaps take another look at that report as well?

Not all bond holders can be found. Really?

One difference between a loan and a bond is that a loan is a private agreement between lender and borrower and the borrower knows who his lenders are, and a bond is a public debt instrument which is meant to be sold in the market and where the buyers/owners of the bond are not officially known.

When a debt restructuring becomes necessary, it is very easy to get all bank lenders to the negotiation table because one knows who they are. The bondholders can legally claim anonymity. And they will do that as long as they can because as long as they are not agreeing to any renogotiation, the original terms of the bond will continue to apply. Collective action clauses (CAC) alleviate that problem a bit.

A recent article stated that about 80 BN EUR of Greece's sovereign bonds are held by owners who cannot be identified and who, therefore, cannot be involved in any renegotiation.

Of course one can identify all owners of all bonds! Prima facie it may not be legal (because of violation of banking secrecy) but smart lawyers can find ways around that. The agent of a bond must distribute the interest to all bondholders, so the agent does know the names of the accounts to which interest is to be transferred. Just follow the cash.

Now in all likelihood, many of the account holders are companies, trusts, foundations, etc. However, every bank is required to know the name(s) of the natural person(s) who are the ultimate beneficial owners of those accounts. They are not allowed to pass this information on but, again, there are smart lawyers.

And, finally, there is the instrument of making public announcements in major financial newspapers addressed to all holders of a certain bond. Again, smart lawyers know how to do that.

All in all, it may be not be easy to get a hold on all bondholders but one has to try it because one can only renegotiate with one's creditors if one knows who they are.

Learn from private equity investors!

In a nutshell, 4 out of 5 private equity investors operate as follows (assume that the purchase price of the target company is 100 units): (1) form a NewCo (a new company which will be the purchaser); (2) capitalize NewCo with, say, 30 units; (3) take up debt in the NewCo of 70 units; (4) have NewCo pay 100 units to the seller as purchase price for the target; (5) merge NewCo with target so that the resulting combined company has 70 units of more debt than before and a lot of goodwill on the asset side.

Two major skills are required of the private equity investor in order to be successful: he must know how to assess the value of a company so that he doesn't overpay; and he must know how to structure debt in such a way that it can be serviced in a manner acceptable to lenders. This is where intelligence and, above all, creativity are required ("financial engineering").

Typically, the new merged company is in no position to service the new level of debt in the traditional form (i. e. paying interest on the entire debt from the start and making linear annual instalment payments of principal from the start). Thus, financial engineers need to become creative. The classic tools are:

(a) make as much of the principal as possible due at the maturity of the loan and move that maturity as far into the future as possible. In the case of sovereign debt, this is accomplished through the instrument of public bonds which, normally, are due in one payment on maturity.
(b) determine how much cash will be available for interest payments and translate that amount into the "cash interest rate". Since the company is unlikely to have enough cash for the entire interest, the rest of interest must be capitalized.
(c) implement an excess cash-flow covenant which means that should more cash become available than projected, that extra cash will be used to reduce capitalized interest.

Will the company be able to repay all its debt by maturity? No way! Why do banks still make those loans? Because the expectation (and practice!) is that the company will be sold again and that the new buyer will pay out all existing creditors. Is that a Ponzi scheme? Sometimes yes, but not always. If the new buyer is a strategic investor who incorporates the company into his overall business, the Ponzi scheme has been brought to a successful conclusion.

The Greek debt problem has so far been characterized by the complete absence of financial creativity! All that has been done so far was to repay maturing loans with new loans and replace old interest rates with new interest rates. Period! Sorry, some creativity was applied to the PSI but that's the wrong thing to apply it to. And a lot of creativity was applied by third parties outside Greece between themselves by buying below-par assets and insuring them at par. If it were not so sickening, one would almost have to respect the hedge funds for their creativity in dealing with the March bond maturity.

One should learn a bit from the financial creativity of private equity investors. The most important variable is the amount of cash interest which flows through the budget (interest which is accrued and/or capitalized does not flow through the budget until it is paid in cash).

A fixed interest to be paid in cash generally doesn't work in restructurings. One has to work with variable interest rates and with the instrument of accruing/capitalizing interest.

One could, for example, say that 5% of government expenditures will be allocated to interest (today, interest amounts to about 15% of Greece's government expenditures). Depending on how government expenditures develop, this might translate into a cash yield for creditors of, say, only 1% whereas the creditors require 4%. The difference of 3% would be capitalized during the period of restructuring of, say, 10 years.

An "excess cash flow covenant" could be structured in a variety of ways: should the budget be balanced more quickly than anticipated, one could increase the interest allocation from 5% to, say, 8%. Or one could tie the interest rate/expense to the development of the economy. There are no limits to creativity when it comes to structuring finance.

One could, of course, call Goldman Sachs for help. Or one could ask Greek students of economy to come up with some creative proposals. Who knows? The Greek students might be so creative that they not only come up with workable solutions but also get job offers from Goldman Sachs afterwards...

This ain't no time to play hard ball!

There have been commentaries of late that Greece might consider playing hard ball with foreign creditors. One case in point would be the alleged consideration by the Greek government to pass a law which would - retroactively! - require holdouts in the PSI negotiation to take losses. Another case in point would be that with Lazard as financial advisers and Cleary Gottlieb as legal advisers, Greece has proven "big boys" in her court who have outmanouvered bondholders before.

Two years ago that might have been smart maneuvering; not today!

One of my major cricitisms of the government of Mr. Papandreou was that Greece, from the start, handed the management of her debt problem over to the EU. Instead, Greece should have taken the initiative from the start; making her own rescheduling proposals to existing creditors; making her own restructuring proposals of the public and private sectors; making her own budget consolidation proposals; etc.

Greece should have made it clear from the start that she expected the contribution of her existing creditors to come in the form of rescheduling the maturities of interest and principal way into the future. No more than that; and certainly no haircut!

Whether or not it was smart of Mr. Papandreou to play the referendum card, once he played it he should have used it as the great negotiating tool which it could have been. Not to threaten default but rather to obtain substantial new financing for investments in the economy.

Today, a certain fatigue on the part of the self-appointed EU-rescuers is quite noticeable. Officials/politicians between Paris, Brussels, Frankfurt and Berlin are making statements today which they wouldn't have dared to make a year ago. When one side has accepted the fate of losing the game, it becomes virtually impossible for the other side to make them nervous again. The degree of nervousness about a possible Greek default has certainly declined dramatically between Paris, Brussels, Frankfurt and Berlin.

This is why now is the worst time for Greece to show muscle. It is unlikely to have any effect on the other side and it would certainly lead to dramatic long-term damages for Greece.

To force creditors by law to take losses is more or less equivalent to repudiating part of one's debt. The repudiation of sovereign debt is probably the silliest thing a first-world country could do. There is no upside to it and unlimited downside. Furthermore, to accomplish this by making a new law with retroactive application is even sillier than repudiating debt outright. Legislation with retroactive application is more or less the equivalent of disavowing the State of Law. How would a foreign investor ever trust Greek legislation again?

At this point, the Greek government should rely more on advisors with "peace-negotiating skills" rather than on financial and legal sharks. There is absolutely no need to threaten with an event (default) which is going to happen automatically anyway unless others step up to avoid it. Greece alone can't avoid it.

Should default occur, Greece will need to have friends at those institutions which can provide bridge-financing so that state and economy don't collapse entirely. These friendships must be built up now!

It appears likely that March is going to be a month of truth because that 14 BN EUR bond which matures will either get paid or not. Everything Greece does between now and then should follow the principle of being able to say later: "We have done everything we possibly could to avoid this problem".

Wednesday, January 25, 2012

Run on Greek banks

Deposits in Greek banks (not counting deposits from the central government) declined from 181 BN EUR to 178 BN EUR in November. At the beginning of the year, deposits had still amounted to 214 BN EUR. 

This translates into a decline of 36 BN EUR during the first 11 months of 2011!

Some of that money was transferred to offshore accounts; the rest was withdrawn in cash. Either way, that is a gigantic number! To put this number into perspective: the aggregate capital & reserves of Greek banks is around 45 BN EUR. Incidentally, the amount of deposits withdrawn since January 2010 is 64 BN EUR!

Normally, a banking system would have to close doors when confronted with that kind of a run. Not so in Greece because the ECB, as lender of last resort, replenishes with loans what depositors withdraw. In the theoretical long run, this would mean that the entire Greek banking system will at some point be funded by the ECB.

The bottom line is: any economy from which that amount of liquidity is withdrawn (mind you that the current account deficit withdrew another at least 20 BN EUR in 2011) has no chance of survival. If the free movement of capital and goods leads to those results, then those 2 freedoms must be constrained at least on a temporary basis.

To do: implement import taxes and capital controls!

Tuesday, January 24, 2012

Lessons to be learned from the Greek past

One caveat at the outset: I have not done primary research regarding the content below. And a suggestion: sometimes the past is a good teacher as regards the handling of the future!

A Greek sovereign debt default is about to happen? The financial world will never be the same again? Well, maybe yes, maybe no.

Let us remember the 1830s when part of today's Greece freed itself of the Ottoman rule. The European "powers that be" arranged that Greece should become a monarchy. About 170 years before Otto Rehagel literally deserved to be called King of Greek Soccer, the Bavarian Otto became King of Greece by appointment.

King Otto, of course, knew exactly what Greece needed --- namely, white/blue-efficiency (the colors of Bavaria) for a sunshine country. Those who today think that Greeks should become more like Germans should read up on Otto's experiences.

White/blue-efficiency encountered its limits in the regions of Greece where the "local powers that be" told the efficient emissionaries from Athens what they could do to themselves. By the early 1840s, the white/blue-efficiency was sent back to Bavaria.

Nevertheless, royal credibility made it possible that Greece obtained credit from abroad. Good news? Unfortunately not, because only little of that money found its way into the real economy of Greece. Does that by any chance sound familiar?

Much of that money was immediately booked as fees and commissions. Another big chunk went into the military. Infrastructure and education came at the end. There was little investment in roads, trains, harbors, schools, public administration, etc. Sounds familiar?

Now let me cite a report which I have read recently: "Without a stimulus to the economy, without tax receipts, Greece could not service her debts. New loans were not granted. By 1875, the Greek economy had collapsed. Imports exceeded exports by 60% (note: in 2011, this excess was 135%!). Half the Greeks worked in agriculture where tax revenues could not be obtained. Also, the property rights were uncertain". Sounds familiar?

By 1879, Greece managed to arrange a debt rescheduling. Fresh Money was also provided but that, of course, required Greece to recognize all the past debt which had not been serviced (a good proof that sovereign debt may be rescheduled but it can never disappear unless there is a consensual agreement between borrower & creditors to forgive it). In the late 19th century, Greece's debt service increased from less than 10% to well over 30% of total government expenditures. Economists have calculated later that at least 40% of the new loans landed in "non-productive areas". Sounds familiar?

"Dystichos eptochevsamen" (we are bankrupt) were the famous words of Prime Minister Trikoupis in 1893.

Did foreign creditors forgive any debt? Of course, not! Everyone knew that, sooner or later, the time comes when a sovereign state again needs something. That time came a few years later when Greeks had lost against Turks in the battle for Crete. Greece needed new money and the condition for that was that Greece would recognize all the debt which had been in default since 1893. Does anyone still doubt that sovereign debt never disappears?

Having said all this, I welcome feedback from historians that this, that or the other is not quite correct. It doesn't really matter. What matters is that sovereign debt is a very different "animal" from normal debt. The history of Greece is but one example. There are many, many other examples (one might even start with Germany).

UPDATE ON February 13, 2012
I have now found two articles which give more details on the financial history of Greece: one in the Blog Investopedia and the other one from LISwires.

Can sovereign states go bankrupt?

Bill Clinton would probably answer this question by saying "That depends on what you mean by bankrupt"; and he would be right!

Bankruptcy can be used as a description of economic reality or as a legal/technical term. If "bankruptcy" is used in a legal sense, it can only be meaningful where there are bankruptcy laws. Without bankruptcy laws, there cannot be a legal bankruptcy. This is why the economic reality of a bankruptcy of a sovereign state is quite different from the legal bankruptcy of a person or company (to my knowledge, there are no bankruptcy laws for sovereign states anywhere).

A sovereign borrower could best be compared to a private individual before bankruptcy laws for private individuals were implemented. The debt which a private individual incurred during his twenties remains with him until he dies (or until it is fully repaid, whichever came sooner). A sovereign state cannot really die (exceptions: revolutions where the new state repudiates the former state). Thus, the debt remains legally in place unless there is a consensual agreement between borrower & creditors to forgive some of the debt.

Repudiation of sovereign debt might be an exception to this. If a state passes a law stipulating that its debt will not be paid, that might work within its own jurisdiction (even though, with the EU, nationals of that state could probably sue successfully at the level of the EU). It definitely will not work outside its own jurisdiction. If the loan agreement stipulates that the loan is payable in Euros at a bank in, say, France, then that loan remains "unpaid" until there are Euros delivered to a bank account in France.

Argentina once pulled the trick (1980s) that they would repay USD debt in local currency equivalent at an Argentine bank account and, thus, consider the debt as repaid. Argentine courts agreed to this procedure. Foreign banks sued in foreign courts of law and obviously won the case there because, according to the loan agreements, the USD debt could only be considered as repaid if and when USD had been credited to a bank account in NYC.

What is the net result of this? Never-ending litigation until some consensual solution is reached.

There are always two aspects in connection with the repayment of debt: the borrower's ability to repay and the borrower's willingness to repay. A country is well-advised to observe the following rule of conduct:

As the objective ability to repay debt decreases, the displayed willingness to repay it must increase!

Since a sovereign state cannot legally go bankrupt (i. e. it cannot reduce its debt by going through bankruptcy proceedings), there is absolutely nothing to be gained by threatening not to pay debt. And the worst of all actions would be to repudiate sovereign debt because there is absolutely nothing to be gained from that, either! (Lenin allegedly once said that one of the greatest mistakes of his revolution was to have repudiated the debt of Tsarist Russia).

If a sovereign borrower gets into trouble, non-payment of its debt (default) will occur unless someone comes to help with new financing. Thus, something which will happen automatically does not need to be announced! Even less does it need to be threatened with because every thinking person already knows that it will happen.

If, on the eve of an unavoidable default, Greece were to announce that she will default the next day, nothing would be gained. If, instead, Greece announced that "we will work all night long to do everything possible to avoid default", a lot is gained. What is that "a lot"? It is the reputation that the willingness was there, albeit not the ability. If foreign countries argue that it is about time that Greece should declare herself insolvent, Greece should ignore that.

And what are the possible lessons for Greece?


1. Certainly, reinforce day-in and day-out the intention to fully honor all sovereign commitments. If not on time, then because of the lacking ability to do so but never because of the lacking willingness.

2. Refuse any offer for a debt forgiveness (haircut). A debt forgiveness with a sovereign state doesn't make sense from the creditors' standpoint, as explained above. It makes even less sense from the borrower's standpoint.

3. Work towards a rescheduling with existing creditors. Refuse a transfer of debt from private creditors to tax payers. If concensus is that Greece has 150 BN EUR more debt than she can sustain, then the solution is not a haircut. The solution is to convert that portion of the debt into a long-term (or evergreen) bond which from today's standpoint might not have a chance of ever getting paid but which might be paid in the future (the creditworthiness of a country can change quite significantly within one or two decades). And that new bond must be purchased by existing creditors and not by tax payers!

4. The level of sovereign debt per se in not very relevant. What matters is the amount of cash interest which flows through the budget. If cash interest expense reaches "unbearable" levels, then interest rates need to be lowered and/or interest needs to be capitalized (i. e. payable later). The term "unbearable" is subject to interpretations. Today, Greece's interest expense amounts to about 12-13% of total expenditures. In 1996, it was twice as high (24%).

5. Most importantly, the Greek economy needs to be jump-started. There are economically bankrupt states and there are bankrupt economies. If the economy is strong, the state can get away literally with "murder". Germany is today not far from being a bankrupt state but her economy is very strong. Only if the Greek economy becomes strong does the Greek state have a chance to become strong, too!

Mr. Ackermann's split views

In an interview with CNBC on October 14, 2011, I heard Mr. Ackermann say the following: "Measures must be taken that sovereign loans are made risk-free again, which is what they should be!"

In recent days, Mr. Ackermann was quoted in various newspapers saying the following: "The expectation todate was that sovereign debt would be repaid 100%. This principle has now been violated and this against all previous public pronouncements to the contrary. We will pay a high price for that in the future!"

Does Mr. Ackermann not understand that there is a world of difference between these two statements? "Risk-free" means what is says, namely: I buy a financial asset which carries zero risk as regards punctual payment of principal and interest. "Repaying debt at 100%" simply means that the borrower will never request a haircut or repudiate its debt. It does not explicitly mean that the debt will be paid punctually (sovereign debt is hardly ever "repaid"; it normally gets refinanced).

Financial history of only the last 100 years is full of precedents that sovereign loans are not risk-free (i. e. whenever sovereign debt was rescheduled). If Basel-II stipulated a different treatment in the books of banks, it means that the creators of that rule did not know financial history. Today, we know that this was one of the more costly mistakes in financial history.

On the other hand, the principle of repaying sovereign debt 100% has been violated only very infrequently in the last 100 years (i. e. whenever sovereign debt was forgiven). To my knowledge, this happened only in situations where either one-time devastations had occurred (Germany after WWII) or a country had indeed hit extreme poverty.

To depart from the latter principle in the case of a first world country (and any EU-member must be considered as a first world country!) after only a few years of crisis is a precedent whose long-term consequences on financial markets cannot yet be assessed! The same goes for continued unkept promises by financial and political officials as regards sovereign debt. Principle & precedent are among the most important features when it comes to confidence. In the last two years they have been trampled on!

Monday, January 23, 2012

Breaking news: 100% Haircut for Greece approved!

On February 31, 2012, after seemingly endless negotiations with creditors, all international holders of sovereign Greek debt will announce unanimously that they will forgive Greece 100% of her sovereign debt. Their official rationale will be: "If we keep spending all our energies on 3% of the Eurozone's GDP (without really accomplishing anything), we will neglect the other 97% of the GDP and the cost of that will be much higher than forgiving Greece all her sovereign debt now".

This means that the central government of Greece will no longer have any foreign debt. The domestic debt of the central government remains unaffected by this. Consequently, Greek banks, pension funds, insurance companies, etc. can remain hopeful that their loans to the central government will be paid.

Some time during March 2012, Greece will discover that things haven't really changed that much. Even though the government now has to pay much less interest than before, it still requires new financing in order to pay all the bills. They cannot raise this new financing in international markets because part of the 100% haircut deal was that Greece would no longer request financing in international markets until the country had regained creditworthiness.

At the same time, the banking sector begins having severe liquidity problems. Part of the 100% haircut deal was that the ECB insisted on freezing its lending to the Greek banking sector. They would not cancel their outstanding loans but neither would they extend new loans.

The banking sector loses well over 1 BN EUR per month in liquidity because import payments exceed foreign revenues from exports and services by that amount. Also, capital flight continues draining the banking system of another 1 BN EUR per month (or more!).

With new capital inflow from abroad to finance these deficits having come to a halt, the government has no choice but to take dramatic actions: imports taxes and capital controls are implemented and the government issues a new bond whose purchase is mandatory for all domestic savers. This bond serves to finance the continued budget deficit and to provide liquidity to the banking system.

Friday, January 20, 2012

A tale for children

Imagine a very large farm with a large family living and working there. The family makes a satisfactory living.

A bank comes along and offers the family cheap credit. The family figures that if they take the credit, they need to work a lot less and can still afford the same standard of living. They could even increase their standard of living. So, they take the credit and start spending money on other things than the ones they really need. And they work a lot less.

The family does all of its buying at a shopping mall which belongs to the bank.

One day, the bank informs the family that they have reached their credit limit. After long discussions, the bank agrees to extend further credit. It obviously helped that the shopping mall intervened on the part of the family because they didn't want to lose their business.

What should the bank have done instead? The bank should have told the family that they had to start running their farm again. The family might have said that they no longer had the tools and know-how for it in which case the bank should have made a loan, but only for that purpose.

So the family could again run the farm and support its own living standard. There are only 2 problems: the living standard is much lower and, then, there is still this debt which had been accumulated.

Again, the bank could play a meaningful role. It could "brainstorm" with the family how they could raise additional money. Perhaps a couple of the family members could get a job outside the farm. Perhaps they could rent some of the farm to tourists. Perhaps they could even sell some of the property.

One way or another, the family would have to understand again that they needed to work hard and smart enough to generate enough income to support their standard of living and to service their debt.

Who would lose if the family had to reduce their standard of living? You guessed right --- the shopping mall!

Thursday, January 19, 2012

Hedge funds as the ultimate decision-makers over the fate of national economies?

If this article is not sickening, then I don't know what is! Hedge funds, allegedly, are thinking about sueing Greece in the European Court of Human Rights for violating bondholder rights in the event that Greece passes a new law affecting debt instruments which are subject to Greek law (the CAC).

And here is the cute (legally probably correct) rationale: changes in the terms of a debt instrument could be viewed as a property rights violation and in Europe, property rights are human rights. Now thank God that there is a European Court of Human Rights to protect the property rights of hedge funds. Of hedge funds whose only reason for having this property (the Greek debt instruments) is to use them as blackmail for taking (legally, of course) property away from someone else - from tax payers!

This is just one more reason why one should hope that we will see, next March, closing time to this charade of the last 2 years by allowing default to happen. The existing debt would be separated from the Fresh Money requirements. The latter would come from EU/IMF (for budget deficit) and from the ECB (for current account deficit). And the holders of existing debt would be invited to form a Steering Committee which has the mandate of all creditors to negotiate with Greece a rescheduling of maturities. No haircut; new evergreen bonds instead!

Obviously, at this point Greece has to start being serious about serious things. No more games about promises which are not kept, etc. Much more pain will have to come over Greece's public sector and public administration. But there should be a carrot for all of this.

That carrot should be a giant investment program for the Greek economy financed by foreign investors, EIB, EU Structural Funds, etc. (but not the Greek tax payers). So giant and so well thought out that one could expect hitting bottom of this crisis and returning to growth already in 2012.

The above Fresh Money for budget and current account deficits will be about 3 BN EUR per month. After hearing about 3-digit BN EUR figures for so long, European tax payers will find that amount to be quite reasonable, particularly since it would now serve a positive purpose (instead of throwing good money after bad). For once, there would be light at the end of the tunnel.

Wednesday, January 18, 2012

Good news: there may soon be a default!

Default seems to be approaching if everyone keeps his word: the hedge funds have vowed not to take part in the PSI which will cause the well-deserved miscarriage of that unfortunate idea. The EU has vowed not to disburse the next tranche if the PSI is not implemented. If Greece doesn’t get the next tranche, a 14 BN EUR bond maturing in late March (so they say) will not be paid. Greece will have to be declared "in default".

Bad news? Not at all! 

Every end of something is the beginning of something new. This should be viewed as the beginning of a Fresh Start to (a) resolve the sovereign/foreign debt situation of Greece and to (b) implement new concepts for the turn-around of the public and private sectors of Greece!

Here is an attempt to draft (certainly incomplete!) to-do lists which should assure that, at the end of the day, everyone is happy that things evolved this way.

To-do's for the Greek government
1. Start immediately (or re-enforce them if they are already in place) cash-preserving measures so that the country (state and banks) has enough liquidity when default happens. Banks should borrow from the ECB as much as they can and "park" that liquidity, if possible, with institutions outside the Eurozone. Precautionary arrangements should be made that international financial transactions (above all exports receipts) can be made via bank accounts outside the Eurozone (preferably China). The government should exercise even more "cash management" (accelerate receivables, slow down payables). Perhaps the government can arrange put options with "befriended counterparties" for the sale of certain state assets should liquidity be required. Etc., etc.
2. Hire immediately a most highly regarded advisor as regards debt reschedulings (my suggestion: William R. Rhodes). That advisor would be the liaison with foreign creditors and would know how sovereign borrowers, when in the midst of an external payments crisis, can make "offers which creditors can’t refuse" to their foreign creditors (in terms of structure and conditions). That advisor would also have the credibility with the Greek government to tell it what it "cannot refuse to do". In a way, that liaison would act as the intermediary between Greece and her foreign creditors. His stature would lend him the credibility to be perceived as an objective arbitrator whereas in actual fact he defends the interests of Greece.
3. Instruct the Ministry of the Economy to immediately start drafting a long-term economic development plan and to involve every possible outside resource (consultants, academia, etc.) in the drafting. That plan will be the key negotiating instrument which Greece will have once default has occurred. It must be a plan which no thinking person can object to! And the plan must be ready by late March!

To-do's for the new advisor/liaison
Under the supervision of the above advisor, a Task Force would develop alternative models to be offered to creditors for the rescheduling of Greece’s sovereign/foreign debt. Some key elements thereof would be:
1. Definition of the debt which is encompassed by the rescheduling; segregation of that debt into different categories; separate rescheduling terms for each category.
2. Interest rate structure: during the “reorganization period” (for instance the next 10 years), Greece’s cash interest expense must be variable and a function of the success of the reorganization. Cash interest expense would increase if the reorganization develops ahead of schedule, and vice versa.
3. The concept of “capitalized interest” (i. e. payable later) must be put in place. All interest which creditors have a reasonable claim to charge but which Greece cannot afford to pay (yet) should be capitalized.
4. The concept of “evergreen bonds” must be put in place. Example: all debt which exceeds Greece’s present ability to service should be structured as evergreen bonds (i. e. a maturity of 31.12.2099). This in lieu of a haircut.

Collateral measures
1. Greece must take preemptive measures to assure the uninterrupted financing of its budget and current account deficits.
2. Such financing should come from the EU (budget deficit) and the ECB (current account deficit).
3. EU/ECB should extend such financing against Greece’s unequivocal commitment to the following: (a) unanimous support of the long-term economic development plan by all political forces; (b) unanimous support of the short-term plan to restructure government expenses by all political forces (focus on redistributing expenses instead of cutting them overall, and on generating new revenues from “new" tax payers while relieving "existing" tax payers of some of their burden).

The carrot & stick
The stick is that, during the implementation of the long-term economic plan, the Greek people will have to be prepared to endure even more and very painful adjustment measures.

The carrot is that, in order to motivate the Greek people to go along with that, Europeans (and not Greek tax payers) will finance the long-term economic development plan. Put differently, whatever financial resources are required to successfully implement the long-term economic development plan will not have to come out of the pockets of Greek tax payers. And, last but not least, Greeks can have the vision of there being light at the end of the tunnel.

The carrot
1. A giant investment plan to promote growth in the Greek economy. The details of the plan would already have been developed by Greece (see above). The financing would have to come from sources outside Greece (Greeks who are “domestically wealthy” would certainly be invited to participate in this project as well).
2. The sources of financing would have to be foreign investors, the EIB, the EU Structural Funds and more of the same.
3. And, of course, these investors can only be expected to put up “giant” sums of investment money if Greece offers them the economic framework which they require for such investments. The EU should guarantee Greek compliance with that framework.

Other collateral measures
1. The Greek government must guarantee all savings deposits and retirement plans until the dust has settled on the debt rescheduling. If necessary, implement capital controls to prevent capital flight.
2. The EU must permit Greece, during the “reorganization period”, to depart from the EU-freedoms of free movement of goods and capital (so that temporary import taxes and controls on capital flight can be implemented).

What does all of the above mean?
Effect 1: no Euro-exit for Greece.
Effect 2: the existing debt is rescheduled with existing creditors. Risk takers remain risk carriers.
Effect 3: Fresh Money from European tax payers is required only for the financing of budget and current account deficits (approximately 3 BN EUR per month).
Effect 4: it becomes justifiable for tax payers in surplus countries to provide Fresh Money because (a) the amounts involved are now manageable and (b) they serve a meaningful purpose (supporting the long-term economic development plan for Greece).
Effect 5: risk takers remain risk carriers which will make the concept easier "to sell" to the voters in the surplus countries.

On the light at the end of the tunnel

Whether it is an individual, a family or a society at large, if there is no light at the end of the tunnel during a crisis, things become very tough. If sacrifices have to be made without seeing the purpose thereof, anger develops.

If anything has been done so far, by Greek or by the EU leadership, which could serve as showing the Greek people a light at the end of the tunnel, then I have overlooked it.

All technical measures (be it a rescue loan, a PSI, a budget consolidation, or whatever) become irrelevant if they don't have as their foremost objective to create a light at the end of the tunnel for the people affected by the measures. The perspective of avoiding bankruptcy is in and by itself not a light at the end of the tunnel.

When I lived in Chicago and met many Greeks there, I often asked them why they had emigrated to the US. Typically, the answer was: "The perspective that we could make a decent living through our own work and that our children would have a better future". Why could such a light at the end of the tunnel not also be created for Greeks wanting to stay in Greece?

I once talked to a mountain climber who had conquered the Eiger North Wall about 50 years ago when this was still an enormous (and risky!) challenge for any mountain climber. They had gotten into bad weather and for days they were "lost" in the wall. Their energies were failing and they lost confidence that they would make it. Then, one day, when the clouds opened and they could see the path ahead of them leading them to the mountain top, they felt rejuvinated and reached the top that very same day. All the fear and pain (and a couple of fingers and toes which were frozen beyond recovery) were forgotten. Instead, those sacrifices were perceived as the prize for the ecstasy of reaching the mountain top.

Perhaps one should start a public competition among Greek brainpower to propose scenarios which could serve as a light at the end of the tunnel. Since my background is in business, I would approach it from a business standpoint. To me, the light at the end of the tunnel would be a long-term economic plan which shows me that I will be able to make a decent living through my own work and that my children will have a better future. Perhaps someone else will come up with more spiritual values. Perhaps one needs a combination of both.

But one clearly needs a light at the end of the tunnel and if Churchill came alive again today as a Greek, he would challenge his compatriots by crying out loud: "When should it happen if not now? Who should do it if not us?"

Tuesday, January 17, 2012

Greeks, don't give Merkozy and the rest of the world a KITA!

This article by Kevin Drum describes very nicely why it would not be very prudent for Greece to "piss off" (words of Keven Drum) Merkozy and the rest of the world.

Let me add a couple of numbers because there are still those who insist on giving Merkozy (and perhaps even the rest of the world) a KITA, returning to the drachma and then living happily ever thereafter within one’s own means. Before you do that, please think where you are going to cut out 29 BN EUR of expenses abroad because that is the annual amount, on average for the period 2007-10, which Greece spent more abroad than she earned abroad (“current account deficit”).

Now you could cut out 14 BN EUR which were spent on interest because you are no longer going to pay interest to foreigners. That still leaves you with 15 BN EUR of offshore expenses which you have to cut out.

You could, of course, cut it out of imports. They were 54 BN EUR and after taking out 15 BN EUR, you can still import 39 BN EUR. Bear in mind, however, that this would be the level of imports you had in 2004. How many cars, motorcycles, smartphones etc. did you import in 2004? It will be a lot less now because the oil which you have to import cost a lot less in 2004 than it costs today.

Since the Euro (from 2001-10), Greece has spent 197 BN EUR more abroad than she earned abroad. That is about 40% more expenses than income. That number includes interest but you cannot take out this interest because, without it, Greece could not have had any debt and without debt Greece would not have had a standard of living. Instead, Greece would have had exactly what she will have if those who want to give Merkozy and the rest of the world a KITA get their way.

Four EU Freedoms --- two too many for Greece!

One of the great achievements of the EU has been to create a frontier-free area within which (1) people, (2) goods, (3) services and (4) money can all move around freely. This four-fold freedom of movement is sometimes called “the four freedoms”. If the Greek economy is to have a future, two of these freedoms must be constrained during a period of transition --- the freedom of movement of goods and the freedom of movement of capital.

If I were a Greek, I would certainly transfer my Euro-savings to a bank outside Greece to protect against the risk that my Greek bank goes bankrupt, that my Greek deposits become frozen or that my Euro-deposits are converted into new drachma. Since EU-elites have warned me for almost 2 years that all of this might happen, I would consider myself prudent instead of unpatriotic.

If I were a Greek, I would certainly buy cheaper imported products instead of more expensive domestic ones. Since wasting money is not a prudent thing, I would consider myself prudent instead of unpatriotic.

So here you have it: what is prudent instead of unpatriotic at the level of the individual is unpatriotic and imprudent at the level of the entire economy. No economy can survive if its capital and production are withdrawn from it on a sustained basis (unless the country sits on the world's largest oil reserves).

"...and that, dear Abby, is how we got into trouble since the EU/Euro. What should we do? Your Greek friend."

"Dear Greek friend, if those 2 processes got you into trouble, just reverse them! Yours, Abby!"


"Greece has to become competitive!" is one of today's slogans. Certainly a very plausible slogan but completely implausible from the standpoint of short-term realization. The irrefutable wisdom says "You have to learn how to walk before you try to run". Exposing the Greek economy to international competition and expecting it to compete successfully would be like sending a talented but not fully developed Greek soccer player to Real Madrid and warning him, once he got used to the standard of living there, that he had to improve his game so that he wouldn't get kicked out of the team.

"Infant-industry protection" is the technical jargon for what I am talking about. The purpose of it is to protect a nascent and/or developing economy from unbearable foreign competition so that it can develop its own competitive advantages. The problem with infant-industry protection is that when it is misused for the protection of national insufficiencies instead of the development of competitive advantages, it defeats its original purpose.

And "capital controls" is the technical term for making sure that capital is not withdrawn from the economy.

Now, free marketers will scream when they hear expressions like "infant-industry protection" or "capital controls". So why don't I scream when I am a convinced free marketer? Because it all depends on the implementation. If the instruments are embedded into a long-term economic development plan and if the respective laws are transparent and for a limited transition period where everyone knows at the outset what will happen at the end of the transition period, it can work successfully.

Some time ago I wrote this article where I proposed one way to accomplish the above. There certainly could be many other ways. What matters is to reach the result that Greece becomes a value-generating economy which can employ its people. If that result is not reached, Greece will be dependent on subsidies from abroad forever (or become very, very poor).

Monday, January 16, 2012

Why so much fear of a default?

I have raised before the question why everyone is so scared of the possibility of a Greek default. A default typically has 2 major consequences for the borrowing country: it wrecks the country’s creditworthiness and it makes it impossible for the country to return to capital markets for quite some time. Well, Greece has already paid that price.

Obviously, a Greek default could have major consequences on financial markets but allow me to ask whether this should be primarily Greece's concern or someone else's?

The table below shows that Greece has been in default about half the time since her independence. Somewhere else I had once seen a statistic putting that figure at two-thirds. Either way, a default now would not be a radical precedent in the history of modern Greece.



It all depends how a default is handled. The first question is: was default provoked by the borrower or did it come about after all attempts to avoid it had failed? Greece would be foolish to provoke a default but she could consider letting it happen.

Once default happens, all hell can break loose --- outside the country! In the country, it all depends on whether the government has "put aside" enough liquidity to allow normal operations for a reasonable period of time. Here I would have confidence in "Greek creativity" on the part of the government that such liquidity has been put aside.

A liquidity run on Greek banks? Could very well happen which is why a temporary freeze on deposits (with only minimal withdrawal possibilities for personal use) must be imposed.

Bankruptcies of Greek banks? Would be a real threat considering that banks would have to write-down the value of their Greek bonds. The government would have to be prepared to put in place a bail-out package.

The most important thing is that Greece can reach as soon as possible a situation where she is deemed by the EU to be acting in good faith to reschedule her debt with existing creditors. If that can be accomplished, Greece should expect the EU to provide bridge-financing for the budget and current account deficits. Based on numbers of the last few months, this should come to about 3-4 BN EUR per month in Fresh Money requirements when including full interest expenses. Since significant reductions of interest would be part of the rescheduling negotiations (and perhaps even capitalization of some interest), the monthy cash requirement could be reduced quite a bit.

Could creditors boycot the above action plan? Yes, they could but it wouldn't make sense for them because they have much more to lose from a boycot than from an orderly and fair debt rescheduling. And for those who predict the end of the world should governments not pay out private sector creditors, the EU should have lists prepared of all the sovereign debt reschedulings which have been made since WWII so that private sector creditors (and the public!) understand that a debt rescheduling is quite a normal thing to do.

Tax payers of surplus countries who have become accustomed to hearing amounts of first 110 BN EUR and then another 130 BN EUR should be quite relieved when they now hear that "only" about 3 BN EUR per month are required.

And parallel to the debt rescheduling negotiations, a giant private sector investment stimulus would have to be arranged for Greece (private foreign investors, EIB, Structural Funds, etc.).

Footnote
If this process is managed swiftly and successfully, a very surprising thing could happen in financial markets: within only one year, and even if the debt rescheduling has not been completed yet, one might see the prices for Greek bonds increasing in value again. Why? Because once there is good news for a positive future perspective for Greece, investors will start speculating that this positive perspective might indeed come true.