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Monday, May 27, 2013

One reason why foreigners shy away from investing in Greece!

I keep repeating undeterredly that Greece must implement an adequate economic framework to attract foreign investment and I keep getting reactions from Greek 'xenophobists' that everything would be fine in Greece if it weren't for big, bad Germany. When I dare to state that Greece, in many respects, still has the economic framework of a development country, I am often called a racist.

This NYT article focuses on how land ownership is presently handled in Greece. Here are just a few quotes:

"Greece’s land transaction records are still handwritten in ledgers, logged in by last names. No lot numbers. No clarity on boundaries or zoning. No obvious way to tell whether two people, or 10, have registered ownership of the same property". 

"Many experts cite the lack of a proper land registry as one of the biggest impediments to progress. It scares off foreign investors; makes it hard for the state to privatize its assets".

"Greece took more than $100 million from the European Union to build a registry. But after seeing what was accomplished, the European Union demanded its money back". 

"Experts say that even the Balkan states, recovering from years of Communism and civil war, are far ahead of Greece when it comes to land registries attached to zoning maps".

 "In the countryside, deeds reflect another era. Boundaries can be the 'three olive trees near the well' or the spot 'where you can hear a donkey on the path'".

"In general, experts say, Greeks are remarkably at ease with a level of irregularity when it comes to real estate".

Now, the land registry is only one, albeit it a very important one, factor in a foreigner's decision to invest in Greece. There are many, many other factors in Greece's economic framework which essentially scare foreign investors away.

I rest my case.

Saturday, May 25, 2013

Greece's Current Account: January-March 2013

Much has been written about the fact that Greece's current account is most impressively coming under control: in the 1st quarter of 2013, the current account deficit was down to 2,3 BEUR; less than half the level of the previous year.

The table below compares the 1Q13 with 1Q12. As a point of reference, the 1Q08 is shown on the right hand side because that had been one of the worst quarters for Greece in terms of current account deficit. That reference now serves to show the improvement which has occurred since then.




2012 2013

Revenue from abroad

Exports 4,9 5,4


Services (e. g. tourism) 4,7 4,1


Other income 0,8 0,8


Current transfers 2,6 2,8


---- ----


Total revenue from abroad 13,0 13,1


Expenses abroad

Imports 10,8 10,0


Services (e. g. tourism) 3,2 2,6


Other expense (e. g. interest) 2,6 1,8


Current transfers 1,2 1,0


---- ----


Total expenses abroad 17,8 15,4


Net foreign deficit (current account) -4,8 -2,3


1) There is no question that Greece continues to have a tremendous weakness in its trade balance, albeit no longer as extreme as in 2008, when the import/export ratio was 3,4 to 1. By 1Q13, that ratio had come down to 1,8 to 1. Still, this means that Greece imported 1.830 EUR for every 1.000 EUR which it exported.
2) The really surprising thing, though, is that what used to be primarily a problem of excessive expenses abroad is now converting into the challenge of increasing revenues abroad!
3) Expenses abroad have been brought down most impressively: 23,8 BEUR in 1Q08 compared with 15,4 BEUR in 1Q13! The bulk of that improvement came through a reduction of imports and most of the remainder came from lower interest expenses (primarily due to the PSI).
4) Revenues from abroad, on the other hand, are stagnating, at best. While exports have increased moderately of late, their 2013 level relative to 2008 seems modest when considering that Greece has become quite a bit 'cheaper' since 2008 (internal deflation and devaluation of Euro against third currencies).
5) In fact, all revenue categories other than exports declined relative to 2008. That should raise some serious questions!

1) One has to differentiate between 'success in terms of numbers' and 'success in terms of the real economy'. In terms of numbers, the improvement in Greece's current acccount is phenomenal. In terms of the real economy, it suggests failure.
2) Success in terms of the real economy would have meant that (a) at least part of the import reduction would have come as a result of import substitution and that (b) the export expansion would have been much higher. Both of these developments would have offset, at least to some extent, the negative impact of government austerity on employment. Instead, unemployment has sky-rocketed to over 27%!
3) In consequence, something is not working here as it should. The real Greek economy continues to shrink as a result of government austerity (which is expected) but there does not seem to be any offset in terms of new economic activity in the private sector.
4) The reaction from all sides is "How can there be new economic activity when austerity is killing the economy!" That reaction is false, which is the reason why things are as bad in the Greek economy as they are.
5) Total GDP combines the private and public sector. We are all Keynesians when it comes to understanding that the public sector must spend when the private sector deleverages so that overall GDP does not collapse. Why, then, is it so difficult to understand that the private sector must spend when the public sector has no choice but to shrink so that overall GDP does not collapse?
6) I can hear the pundits: "When the economy is in such free-fall, only a massive stimulus on the part of the public sector can help!" Well, Greece and the EU seem to have forgotten that, in the final analysis, it is private enterprise which generates sustainable growth!
7) The pundits will also say "How can Greece grow when the Eurozone as a whole is shrinking?" Well, Greece - by the size of its economy - is not a huge Titanic which is driven by the currents of the Atlantic. Greece should think of itself as a guerilla band which advances while the large army is forced to retreat. There are always niches for smaller players. Greece must find niches where it can display its strengths instead of sticking to those battlefields where it has little chance of winning.
8) There is no doubt in my mind that part of the enormous offshore funds held by Greeks will return to Greece for investment if and when there is an attractive economic framework for investment. Had specific steps to create an attractive economic framework for investment been taken in the last 3 years, part of that offshore money would already have come (such measures would have had to include EU-guarantees for political risk, including the risk of a Grexit).
9) Similarly, foreign investment by corporations could have been generated only if there had been specific measures to provide an attractive economic framework. A case in point? Look at Cosco! They came to Greece around the time when the crisis broke out. Despite the free-fall of the Greek economy, they tripled their business volume in the first 2 years of operation and they initiated new investments to the tune of 200-300 MEUR since then.

It may well be that 'success in terms of numbers' will eventually lead to 'success in terms of the real economy' but without specific and quick measures in the private sector, that will take a long time. Such measures would have to include every creative incentive in the book to attract foreign investment and to expand exports. I see no other way which could have a lasting positive impact on employment.

'Success in terms of numbers' will be celebrated outside Greece's borders. Without 'success in terms of the real economy', there will be no celebrations in Greece. Without the latter, it is difficult to see how a Greek government can continue to persuade Greek voters to stay in the Eurozone. Instead, I would consider it more likely that the electorate will eventually shout "Forget all those reforms! They only split the country and do nothing good! If that means we can't stay in the Eurozone, so be it!"

Friday, May 17, 2013

Time for jubilation about Greece yet?

Several things are happening in/with Greece today which I would have considered inconceiveable a couple of years ago. On the top of the list, I refer to the fact that Greece is achieving a more or less balanced current account (yes, even after interest payments!).

A balanced current account means that, in consequence, the capital account must be in balance, too. Put differently, with a balanced current account, Greece no longer has needs for net capital inflows from abroad. Paris/Brussels/Berlin are happy with Greece's performance? No wonder! They no longer have to put net new capital into the country!

Back in 2011, one of my arguments was that Greece's top priority should be to reduce its current account deficit. Had someone then predicted a balanced current account by 2013, I would have bet substantial funds against him. Now the current account may well turn out to be in balance for entire 2013. Am I happy? Not really! Instead, I am now recommending that 'Greece must have a current account deficit for some time to come!'.

The international news about Greece are becoming more positive with every passing day. Rating agencies have upgraded Greece's sovereign debt. Greek corporations have been able to raise substantial funds in capital markets. Hedge funds are discovering financial potential in Greece. Etc. All very favorable news; no doubt about it.

Nick Malkoutzis wrote a commentary in the Ekathimerini titled "Greece - a reality check". He pointed out and praised the good news but, at the same time, he warned that these good news may be covering up some of the bad news which still exist without really being properly addressed. I found myself totally in agreement with his commentary - until I read the comments. Many commentators blamed Malkoutzis for being negative. For once, there were reasons to be bullish and optimistic about Greece and Malkoutzis had no better things to do than to talk them down.

That hit home with me. I, too, have always argued that positive perspectives would have to be injected into the Greek mentality. I even went so far as suggesting a propaganda effort for that purpose. And now I found myself agreeing with Malkoutzis! Had I fallen victim to the same disease which I had previously blamed Greeks for?

Once again, I believe the answer lies in Greece's current account. I had argued that Greece's top priority should be to reduce the current account deficit and now that it is in balance, I am arguing that Greece should run a current account deficit. Isn't that a discrepancy?

There are only 3 ways to improve a current account balance: increase revenues from abroad (exports, services), reduce expenses abroad (imports), or a combination of the two. Greece's improvement in the current account came almost exclusively via a reduction of expenses abroad; via a reduction of imports.

Ideally, Greece would have reduced its current account deficit by increasing revenues from abroad. Increased exports/tourism would have had a substantial impact on domestic employment. However, that would have been impossible, ceteris paribus, given the dimension of imports only two years ago. Thus, a reduction of imports was unavoidable (I had even suggested special import taxes!). However, if one cuts imports and does nothing else, one essentially reduces living standard. If the reduction of imports is not 'decided' but comes as a consequence of collapsing domestic demand (which is what happened in Greece), the living standard really tanks.

My argument all along has been that Greece's (necessary) reduction of imports must be accompanied by domestic substitution of some of those imports. Any import substitution generates new domestic economic activity; economic value generation returns to the country; the country produces more of the products and services which it consumes; the economy becomes value-creating (as opposed to value-consuming); and - the country needs less net capital inflows from abroad!

I once established for myself 'early promising signals for Greece', i. e. developments which, if they happened, would signal to me that Greece has returned to a promising path. Here they are again:

* an obsession with import substitution
* an obsession with export expansion
* an obsession with making tourism/shipping competitive
* an obsession with private foreign investment; and, last but certainly not least:
* an obsession with the EU Task Force to do everything possible to modernize Greece's public administration and to make Greece a governable state

What has happened along those lines?

Import substitution: I have only read about one case which could serve as a prototype, the Sunlight investment. I certainly have never heard/read anywhere a public message like 'produce in Greece; buy Greek products!'

Export expansion: my gut feeling tells me that there is a somewhat new awareness that exports are important for Greece but my eyes/ears are not hurting from reading/hearing about export efforts all day long. The numbers show some improvement in exports but by far not the improvement needed and necessary (and possible!).

Tourism/shipping: 2013 seems to become a very good year for tourism but my sense is that this comes primarily as a result of lower prices for existing capacities instead of an entirely new focus. Regarding shipping, I read very little what is happening in that sector.

Foreign investment: I read very little about the tremendous success story of Cosco and the positive impact is already has on the Greek economy (and will continue to have! By 2018, the direct and indirect impact of that investment is expected to account for 2,5% of GDP!). Instead, I keep reading that Greeks continue to have an aversion against foreign investment.

EU Task Force: pardon me, what's that? Have you heard anything about it lately? Are they still around? At the beginning of the year, I had proposed to make 2013 'The year of the EU Task Force'. Well, the year is almost half over!

I think most of the negatives (or rather: reality checks) which Malkoutzis mentions in his commentary would not be as negative if there had been more focus on the above signals. Put differently, without a renewed focus on the above signals, I could indeed see a situation where Paris/Brussels/Berlin become more and more happy with Greece (because Greece no longer needs net capital transfers). But I certainly cannot see a situation where unemployment in Greece has a chance to decline to acceptable levels unless the pursuit of the above signals really becomes an obsession on the part of Greek society.

Tuesday, May 14, 2013

Alexis Tsipras: "Growth = Democracy + Investment"

That was a catching formula which I read that Alexis Tsipras had invented: "Growth = Democracy + Investment"!

I browsed the internet for a country with very high growth rates for longer periods and, bingo! - I found China. I then checked out China's political system and, oops - not a democracy. Well, I guess there are exceptions to every rule.

The question whether the political operating system called 'democracy' (at least the type of democracy lived in most EU-countries) is the best operating system to deal with economic crises is currently being severely tested throughout the EU. The rational Swiss may be an exception: when asked to vote in a referendum whether to increase the annual vaction period or not, they voted against it on the grounds that it would harm their economy. In most other countries, politicians do not win elections unless they offer gooddies to their electorates. This book makes a provocative case out of this issue.

I am not aware of any studies which show that investment is correlated with democracy. Why do people invest? I find Warren Buffett's extremely sophisticated argument convincing: "People invest cash because they hope to get more cash back from the investment". Conversely, if people fear that they might even get less cash back, for whatever reason, they won't invest.

Which brings me to the question what is required so that investments have a good chance of generating a positive return? Of the many factors which would have to be considered here, it seems that the most important factor is the existence of an attractive economic and business framework (state of law, clear and consistent rules of the game, strong institutions, adequate regulations, contained bureaucracy, etc. etc.).

Alexis Tsipras should take a look at the World Bank's Doing Business 2013 report. Greece ranks last among all EU-countries in that report. If he used all his resources and talents to help Greece move up the list in that report, he might find that this leads to growth much faster than any rhetoric about democracy.

Monday, May 13, 2013

No growth trajectory without foreign investments!

I draw attention to this editorial from the Ekathimerini which states that 'without cash, in the form of  foreign investments, the debt-wracked economy will never manage to enter a growth trajectory'.

All I can say is --- SPREAD THAT MESSAGE!!! It's not only the cash from foreign investments which is needed. Equally needed is the know-how transfer in all areas that comes with foreign investors (provided than one choses the 'right' foreign investors)! If you want an example, just look at the Cosco investments!

A case for foreign investments

Proud of representing mega-rich crooks!

The NYT quotes the prominent Athens criminal defense lawyer Michalis A. Dimatrakopoulos (who allegedly represents many of the top political and business figures under government investigation) as saying that 'he has clients with many billions of Euros overseas who will never bring their money back to Greece as long as killers have better legal rights than tax offenders'.

Yeah, one could intuitively react. He is right! I mean, where is this world coming to if killers have better legal rights than simple tax offenders!

Let's think, for a moment, what the above statement means in the context of value structures of a society. Here is a prominent citizen of Athens who sees absolutely nothing wrong in stating publicly that he represents many clients who are mega-rich crooks. He doesn't seem to be worried at all that this might negatively affect his 'prominence' in society. It would be interesting to know if Athens society outcasts him for saying something like this. I kind of doubt it.

I have no qualms about Mr. Dimatrakopoulos (I have never heard of him before). He is certainly entitled to say what he wants to say. We are all entitled to say what we want to say. However, in societies where value structures are more or less ok, people tend to say and do what they think is tolerable within the society's value structure. Unless they want to become social outcasts.

Can you imagine a Swiss banker/accountant/lawyer publicly saying that he represents mega-rich tax offenders from other countries?

Since Mr. Dimatrakopoulos obviously enjoys giving interviews, I would suggest that an honorable Greek TV station and/or newspaper invites him for an interview so that he can elaborate for the public why he thinks he is doing society a service by representing mega-rich crooks.

Sunday, May 12, 2013

Greece MUST continue to have current account deficits for quite some time!!!

This article by Daniel Gros stands out for two reasons: (a) it is brilliant in the sense that it points out something which is obvious but which has been essentially ignored by EU/domestic politicians so far - namely, the ultimate importance of current account balances in the Eurozone's crisis; and (b) it is totally insensitive in as much as it ignores the impact of current account balances on domestic employment (particularly the devastating impact which Greece's now more or less balanced current account has on Greek employment).

I have written ad nauseum about current accounts being at the root of the Eurozone's debt problems. Those who want to read more about it should browse through the Position on Current Accounts in my blog inventory. Let me, once again, summarize the essentials.

While a government/state works totally differently from a family (refer to Prof. Krugman), a country as a whole works exactly like a family in its cross-border transactions: if it spends more abroad than it earns abroad, it needs to find capital abroad to finance that. These are the two simple but extremely critical formulas to understand:

current account surplus = exporter of capital (i. e. Germany)
current account deficit = importer of capital (i. e. Greece)

Mathematics (not economics!) require a country's Balance of Payments to balance. That balance is the result of two sub-balances: the current account and the capital account. Any surplus/deficit in the current account must MATHEMATICALLY be offset by an identical deficit/surplus in the capital account.

The current account is something like a country's 'statement of cross-border operational cash flows': it captures the imports, exports, cross-border services, etc. If a country spends operationally more abroad than it earns abroad, it needs to get capital from abroad to finance that. That capital doesn't have to exclusively come in the form of debt; it can also come in the form of EU-grants, foreign investment, remittances by residents working abroad; etc. In the case of Greece, it came mostly in the form of debt.

The principal issue is NOT the sovereign debt of a country like Greece. Instead, the principal issue is its FOREIGN debt (that is foreign debt of the entire country and not only that of the state). If all of Greece's sovereign debt had been held by Greek residents, there would have been a lot less excitement between Paris/Brussels/Berlin in the last 3 years. One party's debt represents the savings of another party. If all of Greece's sovereign debt had represented the savings of Greek residents, Paris/Brussels/Berlin might have casually advised Greece 'to work that problem out with your own residents'.

Greece's principal problem (as a country, that is, and not as a state) was/is that its debt represents the savings of other countries, and that was/is only possible because Greece had current account deficits. And it can become very difficult for a country 'to work that problem out with the residents of other countries'.

Consider this: from 2001-10, Greece accumulated current account deficits of 197 BEUR. By definition, Greece had to import at least 197 BEUR in foreign capital during that period (in actual fact, Greece imported as much as 283 BEUR foreign debt during this period, not even counting other forms of imported foreign capital). Had Greece imported all that capital in the form of foreign investment, EU-grants, remittances by residents working abroad, etc., Greece would not have an external payments crisis today (perhaps still a domestic economic crisis but definitely not an external payments crisis).

Is a current account deficit bad per se? Definitely not per se! It all depends which form the resulting capital imports take and what that imported capital is used for. Let's return to the family.

A family which spends more than it earns needs to borrow. If it borrows to finance the next vacation, the pleasure is gone when the vacation is over but the debt is still there. If it borrows to invest in a, say, hotel and that hotel operates successfully, the family can service its debt out of operational earnings and it increases its wealth in the process of running the hotel.

Greece didn't spend all that debt on vacations abroad. Neither did Greece spend all that debt on building hotels. Instead, Greece spent all that debt on imports and, to a large extent, on consumption imports. So the pleasure of consuming the proceeds of that debt is gone but the debt is still there.

I maintain that, contrary to what the memorandum stipulates, the Greek economy MUST have a current account deficit for quite some time; i. e. Greece MUST continue to import capital. Why?

This is where Daniel Gros fails by not pointing out the terrible impact of a balanced current account on Greek employment. Modern Greece has a history of almost 200 years where it was proven time and again that the Greek economy cannot employ its people at satisfactory levels if there are no financial stimuli from abroad. By now, Greece's current account is rather close to being balanced (certainly before interest). The results of that can be visited in the unemployment figures.

An economy can only employ its people satisfactorily if there is sustained domestic economic activity (i. e. domestic value creation). If such domestic economic activity is a direct function of current account deficits, it collapses as soon as the current account is brought into balance. It works the same way in the opposite direction: Germany's current account surpluses are primarily a function of its exports. If something happened to Germany's customers in the rest of the world, Germany's unemployment would explode.

Greece MUST continue to import capital for the simple reason that the Greek economy does not generate enough domestic savings to finance the growth required for better employment. If Greece continues with a balanced current account (or even drives it into surplus as the memorandum stipulates), unemployment will continue to remain sky-high. It is simply not envisageable that Greece can increase its export activity so much as to bring enough foreign capital into the country to finance the necessary domestic growth.

If the only objective were to stabilize the external payments situation of Greece, a balanced current account (or even a surplus) would be enough. If the objective is to also create employment, Greece must continue to import capital.

Thus, the principal question should not be whether or not Greece should continue to import capital. It must! The principal questions are: what form should that imported capital take and what should it be used for? If it takes the form of loans and is used to import consumption products, we will see the 2000s all over. The employment situation would improve but only as long as the loans keep coming.

Greece's capital imports must be shifted to the form of non-interest bearing and non-repayable capital. The classic forms are foreign investment, EU-grants and, possibly, remittances of residents working abroad. From 1950-74, remittances by Greeks working abroad represented by far the largest portion of capital imports (and those capital imports were spent reasonably well by the families of the guestworkers). Going forward, Greece must secure the maximum of EU-grants available but that alone won't carry the day. In short: there are only 3 solutions for the capital needs of the Greek economy - foreign investment, foreign investment and, again, foreign investment. Mind you, foreign investment not only brings capital; it also brings the badly needed foreign know-how in all areas!

Daniel Gros argues that 'as soon as the current account swings to surplus, the pressure from financial markets abates. This is likely to happen soon. At this point, peripheral countries will regain their fiscal sovereignty'. True! As I have explained, there can be no need for net foreign debt if current accounts are in balance. But what good does fiscal sovereignty do when the sovereign is looking at unemployment of more than 25%?

Daniel Gros' most cynical comment is 'the larger the fall in domestic demand in response to a cut in government expenditure, the more imports will fall and the stronger the improvement in the current account – and thus ultimately the reduction in the risk premium – will be'. That is academically totally correct but it also totally ignores what should be the real issue for the Eurozone - namely, to have real national economies which can employ their people on a sustained basis out of their own value creation!

In summary: Greece can continue on the road towards achieving surpluses in its external accounts. The government may even qualify for the next Nobel Prize for Responsible Governance. I do suggest, however, that there will be more than a million Greeks who won't applaud the Nobel Prize!

This is what I suggest Greece MUST do: attract foreign capital to invest in the creation of domestic value generation (a combination of import substitution and export expansion). To attract foreign capital, a current account deficit is required. The current account deficit is, primarily, the result of importing more than exporting. If Greece justifies a current account deficit by importing machinery and equipment for investment in domestic value creation (instead of consumption products), domestic economic activity (and employment!) will improve.

What is required of Greece? Very simple! Create the economic framework to attract foreign investment and, for God's sake, don't scare foreign investors away!!!

Friday, May 10, 2013

Enemies of Democracy

This article by Angelos Stangos in the Ekathimerini on the potential dangers of Golden Dawn concluded with the following statement:

"Much thanks to Greeks’ lack of self-knowledge, Golden Dawn has so far been treated as a fringe phenomenon, a by-product of the financial crisis that has hit the country. Much like soccer hooliganism, far-right violence has been treated as the work of a small bunch of idiotic thugs. This could not be further from the truth. The ideology of Golden Dawn, the vocabulary, the aggression, the body language, the actions are all in tune with the whims of a far larger chunk of society that have in the past been manifested in an isolated, disorderly fashion. The ground is fertile for Golden Dawn to grow even stronger. If it is to survive, our democracy must keep its guard up".

Sounds ok, I thought. And then I began reading the comments to the article.

Almost every comment demands tolerance as far as GD is concerned and quite a few are openly supportive. I have no first-hand knowledge of GD but I have seen enough videos about them on Youtube to have the clear impression that love & peace are not their top priority. In fact, I remember one GD candidate running for election being asked what he would do with 'all those foreigners'. He rambled about 'sending them home' or 'sending them away' and, sort of as the last option, he said 'burn them!' And the people around him had a good laugh.

Well, well, well. This does not sound good!

Thursday, May 9, 2013

Investments become Greece's government's key goal!

According to this article from the Ekathimerini, PM Samaras has underlined that there is a 'changing mood by attracting investments to Greece'. Could it be that they are finally on to the real thing?

I have written ad nauseum that there are, in the final analysis, only 3 solutions for the Greek economy: foreign investment, foreign investment and, again, foreign investment. The economy needs financial stimuli from abroad in order to employ its people and it is simply hoping too much if one hopes that such financial stimuli will continue to come in the form of voluntary foreign loans. Thus, foreign investment is the key ingredient both from a Balance of Payments standpoint as well as, and probably even more importantly, from the standpoint of attracting foreign know-how in all areas.

One has already seen what a 'right' foreign investment can lead to in the case of Cosco (expected to contribute 2,5% to GDP by 2018). Greece needs a whole avalanche of such 'right' foreign investments!

Tuesday, May 7, 2013

Greece could copy this from Portugal!

This video is a rather sensational way of Portugal's presenting itself to the rest of the world. Greece should be motivated to do something similar!

Monday, May 6, 2013

The Bankers' New Clothes!

After Joseph Ackermann announced (and repeated undeterredly) his 25% ROE-target for Deutsche Bank (incidentally, during his tenure, Deutsche's ROE averaged less than 12%), he was often called upon (in TV shows; by business leaders; by politicians) to justify such a ridiculously high expected return on equity.

Ackermann's standard answer to that question was something like: "Look, that's really not as high as it seems. It's common and acceptable for corporations to have ROE's of 8-10%. Corporations have about 3 times our equity. If we had the same level of equity as such corporations, our ROE wouldn't be higher than 8-10%, either".

Good answer for gullible questioners. The proper reaction would have been the following question:

"Why, then, don't you increase your equity to the same percentage of total assets as corporations have? That would make Deutsche a much safer bank; shareholders would carry much less risk and would be satisfied with a lower ROE. And, by the way, society would not have to ever step in and bail you out!"

I have just finished the fascinating book titled The Bankers' New Clothes. It argues professionally and with enormous empirical evidence what I have argued in this blog on several occasions: the way to control banks and to make them safe is by limiting their leverage; by requiring them to have a greater portion of equity as a source of funding.

Most large European banks (TBTF-banks) fund their assets with less than 3% of equity; i. e. for 97% they rely on debt. Take a bank which has assets of 100, debt of 97 and equity of 3. If the value of its assets declines by 3%, its equity is wiped out (and society has to come in and save the bank because it is too big to fail). If it had had equity of 20 and debt of 80, the 3% decline in asset values would have reduced equity from 20 to 17. Solvency would not have become an issue; liquidity perhaps.

There is only one reason why, historically, large banks have been able to rely so little on equity, and that is: large banks operate with the implicit guarantee of society. The Eurogroup can dream up all the 'liability chains' it wants to dream up; no liability chain will ever be applied to a large multinational bank doing business in multiple jurisdictions with multiple subsidiaries around the world, and with nearly unlimited interdependencies (contagion!). A liability chain simply can't be enforced properly and quickly with such a structure (see the uneven damage which Lehman caused). And no lender will ever lend less money to a, say, Deutsche because of the threat of a liability chain for the simple reason that the threat of a liability chain won't work with Deutsche (or JP Morgan Chase; or...).

Before reading the book, I would have thought that large banks should be forced to return to equity/total assets ratios of 6-8% which they used to have not too long ago. The book argues that there is no reason why banks should have lower equity requirements than the free market typically requires of corporations (20-30%; at least). That argument is made convincingly!

The book is marvellous at taking the smoke screens of banking lobbyists apart. Higher equity requirements would have lower economic growth as a consequence? No evidence to support that! Equity is on the right side of the balance sheet; loans are on the left side. Equity only impacts how the bank funds itself. It does not necessarily impact how the bank applies that funding!

Basel-2 (and its successor Basel-3) is based on the terribly mistaken assumption that 'risk-weighted assets' should drive the capital requirement of banks, which led to terrible distortions: German banks did not lend to the German Mittelstand in the 2000s but, instead, purchased so-called 'risk-free' bonds of the Eurozone which required no capital allocation and AAA-rated paper (i. e. sub-prime) which required little capital allocation. The German Mittelstand still exists; the other papers have shrunk in value.

Banks will reduce loans if they are forced to increase equity? Not if the requirment is to increase equity in percentage AS WELL AS in nominal terms. In fact, with more equity, banks may end up making more loans because they are stronger.

There is not enough equity for banks in the market? Certainly not at book value and possibly not right away and in the full amount. The immediate measure to increase equity is to ban the payment of dividends. Bank share values would evaporate if banks discontinued the pay-out of dividends? Well, check back with Warren Buffett. Berkshire Hathaway, a financial concern in Buffett's own words, has never paid a dividend. It has a high equity ratio and its stock value has increased all the time.

Incidentally, the book shows that in the 3 years following the US government's TARP, the beneficiaries of TARP paid out about half of TARP-funds in dividends. Smart application of tax payers' money!

The basic premise of the book is that, for making banks safer, the cost to society of prevention is almost infinitely lower than the cost of later repair. If a bank had 20-30% equity, it could lose 20-30% of its assets before it became insolvent. There is no precedent where a bank had to write off 20-30% of its assets. If, despite higher equity, repair would still become necessary in some cases, that repair would not be costly to society because it would have to solve only the liquidity problem and not the solvency problem.

I wish everyone Happy Reading of the book!

Saturday, May 4, 2013

Greek cash - where it came from and where it went

There is a very interesting Statement of Sources & Applications of Funds for the Greek government from 2010-12 (source: IMF) in this GreekDefaultWatch article. Highlights are:

* the Greek government raised 247 BEUR in the period 2010-12
* 206 BEUR thereof, or 84%, was ultimately devoted to Greece's debt
* put differently: only 41 BEUR thereof, or 16%, went to finance the government's primary deficit and other government operations

One can't find a better example than this to show how imprudent the Troika's rescue efforts for Greece were. Had EU-elites listened to people who had experience with countries confronting external payment crises, they would have learned, back in 2010, that a rescheduling of sovereign debt has been the most natural thing in the world for decades. What would that have meant in the case of Greece?

Tax payers in lending countries would have seen that Greece would require 'only' 41 BEUR for the period 2010-12 to stay afloat. It’s one thing for tax payers of the lending countries to hear that Greece needs 200-300 BEUR; quite another if that figure is 41 BEUR.

Tax payers of the lending countries might still have had to come up with most of the rest of the money but then they could not have been fooled that it was ‘help for Greece’. Instead, they would have seen that is for the bail-out of their banks. And for that bail-out, they would have gotten something in return; equity in those banks, that is.

I don’t think I have ever seen a major restructuring in my 40 years of banking (and that includes 2 sovereign debt restructurings) which did not involve a rescheduling of debt. The maturities of principal and interest are moved into the future; interest is divided into a cash portion and a portion for capitalization to ease the borrower’s cash requirements. There would have been various ways of doing that (terming-out; new bonds to repay maturing debt, etc.). There wouldn’t have needed to be a PSI so quickly.

For Greece it wouldn’t have made all that difference because Greece needed Fresh Money and Fresh Money comes only with terms. But the overall perception that Greece is a bottomless pit requiring hundreds of billions would have been put into perspective.

There would have been a tremendous benefit for the Eurozone overall. The Greek solution would have served as a template for all other countries. The Eurogroup could have justifiably said: “We’ve got the template; who wants to be next?” That, perhaps, would have motivated banks to make more of an effort to find solutions among themselves without any EU-template.

Greece will probably pull through!

In this article, Hugh Dixon of Reuters comes to the conclusion, after spending one week in Greece, that Greece will probably 'make it'. I asked him how high he expected unemployment to be when Greece had 'made it' in his definition. He tweetet back:


I would agree that, when looking only at internal and external accounts, Greece has a fair chance of making it. After all, the primary budget is already in surplus and the current account is approaching break-even. Remarkable achievements! Where I have trouble recognizing success is when unemployment remains, on a sustained basis, around 30%. Granted, if by some miracle unemployment were to fall below 20%, that would be heralded as a great success. But can one envisage a society sticking together when unemployment is close to 20% on a sustained basis?

What is painfully missing is some form of a narrative which explains how the Greek economy can and will employ its people on a sustained basis without subsidies from abroad. The only narrative so far seems to be: let Greece become competitive pricewise (i. e. cheaper); implement the reforms and then wait to see how all pieces fall into place. That might indeed happen at some point but I would fear that it will take a very, very long time if the process is not accerated by incentives.

My own narrative is simple and well known to the readers of this blog: incentives for import substitution where Greece ought to have the necessary comparative advantages (agriculture, etc.); incentives for export expansion where Greece ought to have the necessary comparative advantages; focus on tourism and shipping; attract direct foreign investment as a source of funding and know-how transfer; modernize the state with the help of the EU Task Force; and - start spreading good news instead of whining about the past.

One might want to dust off the Greece Ten Years Ahead report by McKinsey, too!

Wednesday, May 1, 2013

Depression in Greece? No reason for tourists to stay away!

A very nice promotional video! Watch the scene where the TV in the background announces that Greece may be nearing the end of the world while the people in the taverna can't stop laughing!