Much is being written these days about the Greek PSI. One reads about investors' playing games such as not wanting to participate in the PSI in order not to forego CDS-insurance. Or about investors' confidence in the continuing stupidity of EU-politicians by buying up Greek bonds maturing in March at enormous discounts (hoping that they will be paid in full with tax payers' money). None of that has anything to do with the real problems confronting Greece and possible solutions for them!
First of all, a PSI which is based on the premise that private creditors have to forego claims against a sovereign state after only a couple of years of crisis is doomed to fail. Unless there are one-time devastations, one simply does not foregive sovereign debt after such a short period of crisis! One reschedules it!
A PSI in the case of sovereign debt has 2 principal aspects: (1) existing creditors must keep their existing exposure; they should not be called upon to increase it but they should not be allowed to decrease it (“risk takers” must remain “risk carriers”); and (2) creditors must be flexible in the structuring of interest rates and forms of payment (cash payment versus capitalization of interest). That is all which should be required of creditors (and it is quite a lot!).
A PSI is not "a small part of the overall solution". Instead, it is THE starting point for an overall solution! Debt negotiations have to start between borrower and its private creditors. Governments do not come in at the start; they come in at the end!
Why will private creditors be prepared to negotiate reasonably if they are involved from the start? Because they know that by negotiating reasonably, they can preserve the value of their assets (and that they lose that value if they don't negotiate reasonably).
Why will private creditors no longer negotiate reasonably once governments have jumped forward? Because, like in any game, once the opponent has blinked one knows that he will blink again.
There have been many sickening reports about ongoings in Greece such as continuing corruption, rip-off's by parties and politicians, etc. Those things must, of course, be changed but changes of culture cannot happen overnight. They will take time and perseverance.
The sickening behavior of capital markets could be stopped overnight if politicians had the nerve to do it. All they would have to do is to announce that "We will no longer lend money to Greece for the sole purpose that Greece uses that money to pay off private creditors".
Would that be a problem for Greece? Not at all, as long as the EU continues to finance the Fresh Money needs of Greece (primarily the budget deficit). In fact, the EU and Greece could form a real alliance against the blackmail on the part of capital markets by the EU saying to Greece "We will finance the Fresh Money you need provided that we can both agree on a reform plan for Greece" and by Greece responding to the EU "That sounds like a fair deal; we will cooperate fully!"
Bond prices will collapse and create havoc? Who cares? During the Cold War, the real fear of the West was that if they played hard ball with a sovereign borrower in the West, that borrower might seek refuge in the East. In simple terms: a country like Greece could say to the West "If you don't help us with new financing, we will go to Moscow and they will help us for sure". That game collapsed with the collapse of the Soviet Union.
There could be a new game, however. A game where the EU and its members in crisis form alliances against capital markets. As long as a country is assured of financing for its ongoing operational needs, it has nothing to fear. Capital markets have to fear a lot because if the bluff is called in a confrontational way, financial assets in gigantic amounts will be destroyed irrecoverably. At the end of the day, tax payers will have to pay for some of that destruction, too, but then it would not be an expense but, instead, an investment into a better financial system.
The point is that it would never get so far. Why not? Because investors will become reasonable before they lose their assets (and their existence).
An anecdote from Soviet times
An American Ambassador talks to his neighbor, the Soviet Ambassador, over the garden fence. The American Ambassador laments "Why are they doing this kidnapping etc. only to us and not to you?" The Soviet Ambassador replies "Because they know what would happen to them if they did it to us!"
Conclusion
One country alone may be helpless against the forces of capital markets (or only against the force of one investor like the battle Soros/UK has shown). But there is no way that capital markets can prevail over the united political actions of a large economic zone like the EU (or the US, for that matter). The individual banker says "I will be happy to negotiate an extension of loan maturities and perhaps even a lowering of the interest rate if that means that I will eventually get my loan back". Capital markets have to be forced to think exactly like that.
First of all, a PSI which is based on the premise that private creditors have to forego claims against a sovereign state after only a couple of years of crisis is doomed to fail. Unless there are one-time devastations, one simply does not foregive sovereign debt after such a short period of crisis! One reschedules it!
A PSI in the case of sovereign debt has 2 principal aspects: (1) existing creditors must keep their existing exposure; they should not be called upon to increase it but they should not be allowed to decrease it (“risk takers” must remain “risk carriers”); and (2) creditors must be flexible in the structuring of interest rates and forms of payment (cash payment versus capitalization of interest). That is all which should be required of creditors (and it is quite a lot!).
A PSI is not "a small part of the overall solution". Instead, it is THE starting point for an overall solution! Debt negotiations have to start between borrower and its private creditors. Governments do not come in at the start; they come in at the end!
Why will private creditors be prepared to negotiate reasonably if they are involved from the start? Because they know that by negotiating reasonably, they can preserve the value of their assets (and that they lose that value if they don't negotiate reasonably).
Why will private creditors no longer negotiate reasonably once governments have jumped forward? Because, like in any game, once the opponent has blinked one knows that he will blink again.
There have been many sickening reports about ongoings in Greece such as continuing corruption, rip-off's by parties and politicians, etc. Those things must, of course, be changed but changes of culture cannot happen overnight. They will take time and perseverance.
The sickening behavior of capital markets could be stopped overnight if politicians had the nerve to do it. All they would have to do is to announce that "We will no longer lend money to Greece for the sole purpose that Greece uses that money to pay off private creditors".
Would that be a problem for Greece? Not at all, as long as the EU continues to finance the Fresh Money needs of Greece (primarily the budget deficit). In fact, the EU and Greece could form a real alliance against the blackmail on the part of capital markets by the EU saying to Greece "We will finance the Fresh Money you need provided that we can both agree on a reform plan for Greece" and by Greece responding to the EU "That sounds like a fair deal; we will cooperate fully!"
Bond prices will collapse and create havoc? Who cares? During the Cold War, the real fear of the West was that if they played hard ball with a sovereign borrower in the West, that borrower might seek refuge in the East. In simple terms: a country like Greece could say to the West "If you don't help us with new financing, we will go to Moscow and they will help us for sure". That game collapsed with the collapse of the Soviet Union.
There could be a new game, however. A game where the EU and its members in crisis form alliances against capital markets. As long as a country is assured of financing for its ongoing operational needs, it has nothing to fear. Capital markets have to fear a lot because if the bluff is called in a confrontational way, financial assets in gigantic amounts will be destroyed irrecoverably. At the end of the day, tax payers will have to pay for some of that destruction, too, but then it would not be an expense but, instead, an investment into a better financial system.
The point is that it would never get so far. Why not? Because investors will become reasonable before they lose their assets (and their existence).
An anecdote from Soviet times
An American Ambassador talks to his neighbor, the Soviet Ambassador, over the garden fence. The American Ambassador laments "Why are they doing this kidnapping etc. only to us and not to you?" The Soviet Ambassador replies "Because they know what would happen to them if they did it to us!"
Conclusion
One country alone may be helpless against the forces of capital markets (or only against the force of one investor like the battle Soros/UK has shown). But there is no way that capital markets can prevail over the united political actions of a large economic zone like the EU (or the US, for that matter). The individual banker says "I will be happy to negotiate an extension of loan maturities and perhaps even a lowering of the interest rate if that means that I will eventually get my loan back". Capital markets have to be forced to think exactly like that.
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