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Sunday, October 19, 2014

Why Greece Could Fail

In their book "Why Nations Fail", the authors Acemoglu/Robinson argue that the pillar for sustained political and economic success are a nation's institutions. They coin the terms "inclusive institutions" and "extractive institutions".

Prosperity is generated, so the authors, by investment and innovation, but these are acts of faith: investors and innovators must have credible reasons to think that, if successful, they will not be plundered by the powerful. Order without inclusive institutions may enable an economy to escape poverty, but will not permit the full ascent to modern prosperity. The authors' explanation is that if the institutions of power enable the elite to serve its own interest – extractive institutions – the interests of the elite come to collide with, and prevail over, those of the mass of the population. They argue that there is no natural process whereby rising prosperity in an autocracy evolves into inclusion. Rather, it is only in the interest of the elite to cede power to inclusive institutions if confronted by something even worse, namely the prospect of revolution. The foundations of prosperity are political struggle against privilege.

Yannis Palaiologos of the Ekathimerini blows into the same horn when he writes that Greece's closed society is central to the current malaise: "Some analyses went a little deeper and saw clientelism as the core pathology, an acid corroding everything in Greek life, leaving the country in the hands of well-connected mediocrities and spreading mutual mistrust across the body politic. But even that does not go deep enough. Greece’s biggest problem, which it has done little to deal with, is its lack of openness as a society. It is a stance with deep roots and wide-ranging implications, which decisively undermines its hopes of recovery".

The definition of a problem is always much easier than the proposal for a solution. It's quite a while since I read the book but I do remember that one of the authors' argument was: if a society is controlled by an entrenched elite, particularly a corrupt elite, then it is next to impossible to bring about change in a normal and evolving way.

Would that make a case for Alexis Tsipras?

Thursday, October 16, 2014

Greece - Why Go For Self-Destruction?

"It is impossible to imagine why the government, instead of stressing the increasing instability in Europe and the country’s good fortune at already having secured a loan from the IMF of 12 billion euros at a rate of 4 percent, insists on borrowing from the markets, where the yield of Greek 10-year bonds has skyrocketed to 7 percent" - Ekathimerini, October 16, 2014

"Typically, the more stable and reliable funding is more expensive while the 'hot' money may often be cheaper and less cumbersome to obtain. With Greece's sovereign debt, the opposite is true. The stable and reliable funding comes from EU institutions and, as far as I know, it accounts for almost 80% of Greece's sovereign debt by now. Its cost, if I am not misinformed, is 2% at the most; perhaps even closer to 1,5%. The cost of the anonymous bond money has been down to 5% earlier this year, albeit only for a 3-year tenors. 10-year bond money, which is still rather short-term, would probably cost today 6-7%. Somebody needs to help me out with logic: there is 2% stable and reliable money available but the current government does everything it possibly can to switch to anonymous bond money for shorter terms and at 5% more cost? There must be a reason for doing that except --- I can't fathom it!" - Klaus Kastner, October 2, 2014

There couldn't have been a better example than the last couple of days of what can happen if one throws one's luck into the hands of anonymous bond markets! This only re-emphasizes the question why the government is so eager to throw its luck into the hands of anonymous bond markets. My understanding is that the government's desire is driven by Alexis Tsipras' promise to 'tear up the memorandum' (Greek translation: 'get rid of the shackles of slave owners') once he is in power. So the government seems intent on pre-empting that promise, not by tearing up the memorandum but, instead, by letting it lapse.

The various, extremely painful downsides of the memorandums (if not to say their mistakes/errors) have been debated ad nauseum and I will not belabor them here. However, there has been far too little focus on the infinitely more valuable aspects of the memorandums. I will now be rather controversial and argue what would have happened to Greece if there hadn't been those memorandums; if there hadn't been EU-support; if there hadn't been support of the Euro financial system. Those who think that I am exaggerating are invited to look at Argentina. There it happened more than once during the last 30-40 years. 

Without the memorandums; without EU-support; with the support of the Euro financial system ---

1) The Greek state would have had to default on a large portion of its domestic liabilities (wages/salaries, pensions, etc.).
2) Capital controls would have had to be implemented including a domestic deposit freeze.
3) The banks would have had to be nationalized.
4) Imports of many goods would have come to a sudden stop.
5) Within a short time, Greece might have had a GDP only half the size of what it was before.
6) Etc.

This is assuming that Greece would have decided to hold on to the Euro. Had Greece opted for the Grexit, the situation would have been even more dramatic.

Why does the Greek government fall for Alesix Tsipras' tactics instead of pursuing a self-confident and constructive strategy. A strategy which focuses on the positive aspects of the memorandums and which promises to correct the mistakes/errors of the memorandums which have caused unneccessary pain? 

My sense is that, in the present situation of the Eurozone, Greece could get from the EU just about everything it wants as long as it is within a constructive and controlled framework. If Greece wanted to reprofile its debt to official lenders with a significant extension of maturities, it would get it. If Greece wanted a reduction of interest rates on the debt to official lenders, it would get it. If Greece wanted some financial room for maneuver to establish a social safetey net for the one-third of the population in poverty, it would get it. Etc.

My sense is also that the only thing which the EU does not want is a Greece which returns to its former ways. A Greece which becomes destructive and uncontrollable, and - frankly - a danger for the Eurozone and a nuisance for the EU. Isn't that a legitimate case?

Even if that were not a legitimate case, it is still in the selfish interest of Greece to continue on a constructive and controlled course. The energies must be used for striking better bargains with the EU; not for self-destruction!

Tuesday, October 14, 2014

Sofia Voultepsi - A Government Spokesperson Gone Berserk

In the event that Alexis Tsipras as Prime Minister proceeded with “heroics in Europe”, Sofia Voultepsi, a government spokesperson is quoted as saying, “it won’t be long before the ATMs shut down in Greece, as they did in Cyprus".

I have written before that the best way to eventually start a bank run is to warn of it. I have also written before that, in the sensitive world of high finance, it is often impossible to retract statements after they have been made. And that the wrong statements can become very, very expensive.

Ms. Voultepsi's statement may have been prompted by her being upset about the fact that “SYRIZA curses all day, it is a sewer and a foul stench", as she said. What she may have overlooked in the hectic of events is that close to one-third of Greeks, according to polls, currently favor SYRIZA and it is not a clever political strategy to communicate to one-third of voters that they are a sewer and a foul stench. 

If I were a supporter of ND, I would begin to wonder whether a party which makes such statements really deserves my support.

Gone Missing --- Website of Greece's Ministry of Finance

My primary sources of statistical information about Greece have traditionally been

the Bank of Greece,
ELSTAT, and
the Ministry of Finance.

For quite some time now, I have not been able to access the website of the Ministry of Finance where they have detailed statistics about Public Debt and Budget Execution.

Is that a problem of my computer or a problem of the Ministry of Finance?

Tuesday, October 7, 2014

Sweetheart Deals for Greek Banks

I have read a translation of this article by Prof. Yanis Varoufakis in the German language Griechenland-Blog. It is a summary of all the support actions which the Greek banks have received from the state so far, namely:

1) A 41 BEUR recapitalization after the PSI.
2) Another 41 BEUR in state guarantees for ELA funding from the ECB.
3) Recognition of the 37,7 BEUR losses from the PSI as tax-effective losses.

At issue is point (3) which means that future profits (during the next 30 years) up to 37,7 BEUR will be tax-free. Obviously, if there are no future profits, there will be no benefit from saving taxes on them. If, however, there are future profits, the potential tax saving will be roughly 10 BEUR. In accordance with IFRS accounting rules, the banks record those 10 BEUR as 'deferred taxes' on the asset side. Put differently, a rather substantial portion of the banks' assets are future claims which will only be worth something if there is sufficient future profitability.

The risk that there might not be sufficient future profitability and that those claims might not be worth all that much was apparently too much for the bankers to sleep well. So, the government and parliament passed a law that, regardless whether or not there is future profitability, the banks will have that claim against the state. The side effect of this measure is that the banks can now count those 'deferred taxes' towards their capital base (subject to ECB approval).

What is to be made of all that?

First, there is no question that a state - if it wants to avoid total collapse of its economy - needs to bail out its large banks if and when they get in trouble. The cost to society of not doing that would be so much higher. So the question is not whether the state should have supported its banks. Instead, the only question is whether that support was commensurate and what the state got in exchange for the support it provided.

The logical answer would appear to be that if a bank gets into trouble and needs to be bailed out by the state, the state should get full ownership and the right to replace the board of directors and the management of the bank. That would be too simple a logic. If a bank has a temporary liquidity crisis (a bank run) but is otherwise relatively sound, the state should get less in exchange than from a bank which has essentially become insolvent.

The PSI essentially wiped out the entire aggregate equity of Greek banks. Put differently: even without the 'normal' problems like non-performing loans, etc., the Greek banks had lost their equity. That certainly was a situation where the state could have applied the above simple logic. Did it? No, it certainly didn't! Instead, judging from everything I have read about the recapitalizations, they were EXTREMELY shareholder-friendly! Far from full ownership! Why? No outsider will find the answer to that question.

The 41 BEUR guarantee for the ELA funding is a moot point, as far as I am concerned. Greek banks would have survived without this funding because they could draw on the ECBs target-2. ELA funding was less expensive, as far as I know, and - most importantly - it enabled the banks to buy government bonds. So here I think the benefit was rather mutual.

Recognizing the 37,7 BEUR losses from the PSI as tax-effective losses to be applied against future profits would also appear within the limits of normality. After all, the banks did incur these losses. What is totally out of the ordinary is that the state would guarantee the banks that they will get their future benefit regardless of whether they make profits or not. So that is quite a present for the banks, indeed. What did the state get in exchange? Allegedly, the state will get bank shares as collateral but I have not been able to find details about this collateral arrangement anywhere.

By and large, it seems that the Greek state has been extremely generous to its banks, particularly to the owners of its banks. Will the state need to be generous again in the future?

According to Bank of Greece statistics, the aggregate capital & reserves of all Greek banks is around 70 BEUR. That number is easy to remember because it is identical to the amount of non-performing loans in the Greek banking system. So, if all those non-performing loans were to be repaid in full, the Greek banking system would be in good shape. If they are repaid in half, the banks will again need equity and they will look to the state for support. And if the non-perfomers turn out be complete losses, then the banks' equity is - once again - wiped out. The only thing which is certain at this time is that the requirement on the part of banks of future state support can definitely not yet be ruled out.

Back in 2008, AIG needed to be bailed-out by the US government. AIG was the world's largest insurer at the time and no one really thought that the company was anywhere close to insolvency. However, they needed money in a hurry; a lot of money. It started with 85 BUSD and ended up with 185 BUSD. Given those dimensions, the US government struck a tough bargain (these days, lawyers are arguing in court that it was a 'punitative' bargain). Existing shareholders had to watch how what used to be 100% ownership eventually ended up being only 8% ownership and how the US government took a hefty 22 BUSD profit when it finally exited from AIG. Maurice R. Greenberg, the legendary former CEO of AIG and formerly one of its major shareholders, says he lost 90% of his multi-billion USD net worth in the process and he is now suing the US government for 40 BUSD in damages.

The way the US government bailed-out AIG was anything but shareholder-friendly. If the Greek government had done the same with its banks, all those banks would now have new owners, new boards of directors and new managements. Perhaps the Greek government should read up a bit on the AIG bail-out as it prepares for the next bank support program.

Sunday, October 5, 2014

President Kostas Simitis? Or Perhaps Kostas Karamanlis? Or Even Lucas Papadimos?

"Over the next years Greece will need a political President, with a deep understanding of the country's problems, who will have managed state affairs at the highest level and will be in the position to converse abroad and to demand the respect of political leaders. Based on all of the above, three candidates for the position of President could be Kostas Simitis, Kostas Karamanlis and Lucas Papadimos. In the present circumstances in Greece, there is no room for mediocrities and indifferent non-political figures" --- Antonis Karakousis in To Vima.

As a foreigner observing Greece, I often receive comments that I really don't understand Greece and the Greeks. True. Sometimes, I, indeed, do not understand Greeks. Mr. Karakousis is a case in point with his article in To Vima.

I cannot pass judgement on the governing period of Mr. Simitis but I have read enough comments about Mr. Simitis to know that he is among those who are being blamed a lot for today's misery. Mr. Karamanlis's government certainly stood watch when Greece, financially, completely went overboard. And, finally, Mr. Papadimos did a terrific job from the standpoint of Greece's creditors but from the standpoint of those Greeks who are suffering, he might be seen as a culprit.

True, all three gentlemen have "managed state affairs at the highest level and would be in a position to converse abroad and to demand the respect of political leaders" but my sense is that either of the three would quickly fill Syntagma Square with protesters. But then again, I don't understand Greece and the Greeks...

Thursday, October 2, 2014

Here It Is --- The ECB's Plan For Buying Asset-Backed Securities!

In my recent post on the subject, I had expressed anxiety about the unveiling of the ECBs plan for buying asset-backed securities (ABS) from banks. Well, the anxiety is over; the plan is out for everyone to review in detail.

You won't find all that much exciting, new information in the plan. Essentially, the ECB is saying "we will buy directly from banks only such assets which we would have accepted as collateral for funding, anyway". So no big change. There is a bit of an exception for Cyprus and Greece because, to date, the ECB has not accepted Greek collateral but they will now consider purchases of Greek assets. Ok; no big deal. Since the ECB has put the focus on buying only senior tranches, there won't be all that much to buy in Greece.

The ECB has suggested that they would also consider buying junior tranches if satisfactorily guaranteed but they will announce at a later stage what such a satisfactory guarantee is.

Bottom-line: the ECB is apparently not starting another sub-prime Ponzi-scheme, which is good news. The bad news for the banks is that, without such a sub-prime Ponzi-scheme, they really won't get rid of their problem assets.

Ah, Those Ruthless Bond Investors!

"Greece discovers the ruthless nature of bond investors", this Bloomberg headline reports. Pardon me! Did anyone ever claim that bond investors were warm-hearted, relationship-oriented financial partners? If so, I have never heard of them.

Which raises the question in my mind why the current government is so eager to leave the official lenders and to return to the markets; the ruthless bond investors, so to speak.

One way to differentiate funding sources is by reliablity: there are stable and reliable funding sources and there are those which are reminscent of people selling umbrellas when the sun is out and disappearing from the surface of the earth as soon as the first raindrops arrive. Another way to differentiate funding sources is by cost. Typically, the more stable and reliable funding is more expensive while the 'hot' money may often be cheaper and less cumbersome to obtain.

With Greece's sovereign debt, the opposite is true. The stable and reliable funding comes from EU institutions and, as far as I know, it accounts for almost 80% of Greece's sovereign debt by now. Its cost, if I am not misinformed, is 2% at the most; perhaps even closer to 1,5%. The cost of the anonymous bond money has been down to 5% earlier this year, albeit only for a 3-year tenors. 10-year bond money, which is still rather short-term, would probably cost today 6-7%.

Somebody needs to help me out with logic: there is 2% stable and reliable money available but the current government does everything it possibly can to switch to anonymous bond money for shorter terms and at 5% more cost? There must be a reason for doing that except --- I can't fathom it!

A Superb Propaganda For Greece! (and good business, too...)

I was so excited after reading this article in the Ekathimerini that I decided to reproduce it here in full length. Those are the kinds of things which Greece ought to do more of! 

"Volkswagen has booked Costa Navarino’s entire Westin Resort unit for the promotion of the German automaker’s new Passat model, starting on Friday and ending on December 3. Preparations have been under way since mid-September, while the last departures are anticipated in mid-December, when the complex in the southwestern Peloponnese will shut down for the winter.

The event organizers are expecting the arrival of as many as 22,000 people, while a special course covering 22,000 square meters is being set up to allow for the testing of the new cars. 

Such events are a blessing for units such as Costa Navarino, which has also been booked for one of next year’s biggest tourism events, the annual conference of the Association of British Travel Agents on October 12-14. The ABTA conference will be returning to Greece after 15 years, having been hosted by Kos in 2000. The Peloponnese region secured the hosting of the 2015 event after beating rivals from Portugal and Indonesia".

Public Spenders - Read This Before You Embark On Spending!

"This paper employs a new empirical approach for identifying the impact of government spending on the private sector. Our key innovation is to use changes in congressional committee chairmanship as a source of exogenous variation in state-level federal expenditures. In doing so, we show that fiscal spending shocks appear to significantly dampen corporate sector investment and employment activity" --- Study by Harvard Business School 2011.

The trick which the authors apply to come to their conclusion is somewhat unique American: they have determined that whenever a committee in Congress gets a new chairperson, that new chairperson uses his/her influence to steer public/federal money into his/her constituency. In other words, increased public spending. They have measured that federal funds which flow into their constituencies increased by 9% during the first year. Public orders which are given to the private sector in those constituencies increased even by 24%. According to theory, that should make for a significant impulse for the private sector in the constituency.

The opposite development was observed. Private companies reduced their investment in machinery & equipment on average by 15%. Expenditures for R&D also declined, as did employment in R&D. The authors conclude that increased public spending seems to crowd out activities in the private sector.

Perhaps EU policy makers should take a look at this study.

Wednesday, October 1, 2014

The Miraculous Conversion of Bad Loans Into Good Loans!

"Mr Draghi, ECB president, will this week unveil details of a plan to buy hundreds of billions of euros’ worth of private-sector assets – the central bank’s latest attempt to save the eurozone from economic stagnation" - Financial Times.

The unveiling of this plan will be most interesting. The ECBs declared intent is to buy only good loans. If banks sell their good loans, their demise is programmed because all they would have left on their books is bad loans. So there is a gap which needs to be bridged.

The logic is as follows: an individual loan may be worth nothing. A package of individual loans may include loans which are worth nothing. But the package will also include loans which are worth 100%. Typically, it takes quite some time to find out which loans will eventually be repaid and which not. Thus, one buys a whole package of loans and assumes that a certain percentage of it will be paid for sure.

Greek banks hold bad, or non-performing, loans of about 70 BEUR. Some of them will no doubt eventually be paid in full. Other may turn out to be a complete loss. No one can tell at this point with certainty what the eventual outcome will be. If anyone can make a good projection, it is the ECB because they have just subjected all those loans to intense examination. Let us assume that 30% of these loans, 21 BEUR, will eventually be repaid in full with great certainty. Let us further assume that another 30% of these loans, another 21 BEUR will be repaid at least in part. And, finally, let us assume that the remaining 40% of these loans, 28 BEUR will never be collected. The challenge is that, upfront, one doesn't know which loan is which. So let us retrieve the recipe of sub-prime and make tranches:

Tranche A: this is the Senior Tranche and we will put 21 BEUR of those loans into it which, today, seem to be of the best quality of the lot.
Tranche B: this is the Junior Tranche and we will put the next 21 BEUR of those loans into it which, today, seem to have a fair chance to be repaid, at least partially.
Tranche C: this is for gamblers; we will call it the Equity Tranche and we will put the remaining 28 BEUR into it.

Tranche A will get a rood rating and therefore the ECB can buy it at par. The return on this tranche ought to be a reasonable market return for good quality loans. The rating for Tranche B is going to be much lower but the ECB apparently also intends to buy a bit of Tranche B. The return on this tranche will be fixed considerably higher because there is considerably more risk. And those who buy the Equity Tranche will have a stasggering return potential or --- a significant loss.

This is all fine and dandy but the Greek banks are not helped if Tranche A - or even Tranche B - is taken off their books. They want to get rid of the entire 70 BEUR. And if the entire 70 BEUR is part of Mr. Draghi's plan, someone will have to take a very significant loss. Otherwise, the losses stay on the books of the Greek banks.

Since no one wants to intentially take a loss, the plan will have to be structured in such a way that it appears that every buyer of any of the tranches has a fair chance to make a return. It will be interesting to see how the potential losses are hidden and/or who will eventually end up with the losses.