And here is more on Target-2...

Just picture a wealthy German running into a wealthy Greek on a beach in Greece. The Greek laments that he has 10 MEUR in his account with, say, Alpha Bank which he would like to transfer offshore to his account with Deutsche Bank in Frankfurt. Alpha Bank has told him that they don’t have enough liquidity to make the transfer but if the Greek could come up with a new depositor who would put 10 MEUR into Alpha Bank, they could effect the transfer.

So the Greek now says to the German: “You are very wealthy. Why don’t you take 10 MEUR of the monies which you have on deposit with Deutsche Bank in Frankfurt and deposit them with Alpha Bank in Athens so that they can effect my transfer of 10 MEUR to my account with Deutsche Bank in Frankfurt?”

The German says to the Greek: “Do you still have all your marbles in place? You don’t expect me to transfer my money to a Greek bank so that you can transfer your money out of Greece; do you?”

That is exactly what Target-2 makes possible in an automatic way (i. e. the Greek bank doesn’t even have to condition the transfer abroad on the receipt of new deposits; it just makes the transfer and gets the necessary liquidity from the ECB).

The German on the beach thought that it was ridiculous to even think that he would put his money into a Greek bank so that his Greek counterpart could transfer his money offshore. Little does the German know that this is exactly what is happening behind his back. And not only for capital flight but, above all, to replenish the funds which Greece loses because Greece is spending so much on imports.

Footnote 

The German government has officially denied that this is taking place. They argue that Target-2 claims are not loans. They argue that Target-2 claims are just “reconciling items to make the books balance”. Well, the monthly charges to a credit card are not loans from, say, MasterCard. Instead, MasterCard sends out bills for payment of the monthly charges and those bills are “reconciling items to make sure that the books balance”.

A plea for Special Economic Zones (again...)

One of the themes since the beginning of this blog has been that Greece needs to use the instrument of Spezial Economic Zones (SEZ) in order to transform its economy. New liberalized laws & regulations alone won't do the trick in the short term because there is always resistance to mandated change. However, if people are shown alternatives which work well in practice, they will automatically want to copy them.

Greece ranks by far the lowest among EU-countries on the World Bank’s Doing Business 2012 Report (#100) and by far the highest on the TI’s Corruption Perception Index 2011 (#80). If Greece could be changed to rank among the top-ten in each of these reports, economic miracles would begin to happen there quickly.

There is NO WAY that one can change an entire country/society in a reasonably short time; at least not in a democracy. This is why I argue: "Don’t attempt to change the whole country in a short time because that won’t work anyway; instead, start with several 'pockets' (SEZs) which you structure in such a way that they are 'near-perfect' from day 1".

My role model is China. The old communists there realized that communism was not best answer for feeding one’s people on a sustained basis. They adhered to communism but they allowed several “pockets” where market mechanisms were put in place. And those initial pockets subsequently rubbed off on a much larger segment of Chinese society. And they are still communists…

Actually, I am not thinking of any special “perks” for the SEZs. Employees, companies and owners would be “perfect” tax payers. Unless you consider a liberalized business framework as a special perk (in present day's Greece you might have to...).

What would be offered to an investor in an SEZ? In general, pretty much everything that he would like to have. Specifically, no red tape in forming a company (for example: a one-stop office for all necessary permits and a 30-day turn-around); more or less free labor regulations; more or less free salary/wage negotiation between company and employees; guarantee of political risk for investments from abroad; etc. etc.

Now, let’s say I am a wealthy Greek with 50 MEUR in foreign bank accounts which yield me about 2% at the moment. For an attractive business opportunity in Greece, I would be willing to invest 5 MEUR out of those 50 MEUR. And, to use my favorite example, I see that all toothpaste in Greece is imported.

I educate myself how toothpaste is manufactured and I discover that one needs machines, ingredients and people for it. I do my math to figure out how much I can pay for machines, ingredients and people and still make a decent return on my investment (say 10%?). I don’t worry about market demand because I already know exactly how much that demand is (the amount of imported toothpaste).

Obviously, I will have to do my math in such a way that my price will be competitive with the price of imports. Even if it is, it might initially be difficult to get people to no longer buy imported toothpaste because they have gotten accustomed to it. So this is where I would ask the government for a perk: to temporarily apply a special tax to those imports so that people have an incentive to buy domestic toothpaste. I commit to the government that I will not “misuse” that temporary protection. In other words, I will hold on to my internationally competitive prices. And in a year or two, I ought to be able to get along without further protection.

The only one who loses in this game is the foreign exporter. But Greece is such a small market that losing it will not really harm any present exporter (and the exporter himself could opt to invest in domestic production!). Also, if things don’t change soon in Greece, the exporters to Greece may no longer want to export, anyway, for risk of not getting paid.

If I were a Greek politician, I would note the success of the new toothpaste company (less money spent for imports and new jobs, new personal and corporate taxes, and new taxes on dividends). I would ask for a list of other imports which could be substituted with domestic production the same way as the toothpaste example. And very soon there could be hundreds of new companies like the above.

If I were an unemployed Greek, I would try to get a job in the SEZ. I might get paid less than my friend at the National Railway but I know that my income will go up with productivity and not down because of austerity.

And finally: the Greeks outside the SEZ won’t be able to ignore that there are good things happening in the SEZ. In the beginning, the Greek political fundamentalists will brainwash them and explain that SEZs are nothing but sweat shops or exploitations of human beings. But when they see over time that the Greeks in the SEZs are happy campers who can steadily improve their living standard, they will undoubtedly begin asking why the whole country isn’t like an SEZ.

The beauty of import substitution is that it can be started literally overnight without any risk of insufficient market demand. Thus, SEZs lead to almost immediate improvement and they provide breathing space for the government to develop other economic activities which take time to implement and to find market demand (like new industries, etc.).

To sum up: if and when entire Greece becomes an SEZ as above, then Greece will have become a modernized country with a modern administration and a competitive business framework. But that takes a generation, at least!

Below is an excerpt from a previous post I had made on this subject.

A new Investment Law of constitutional rank must be established which assures the potential new investor all the internationally competitive business conditions which he desires. Since no one seems to trust any Greek law any more, the EU should guarantee compliance with this Investment Law so that investors do not have to carry any political risk (economic risk they have to carry!).

The investor would find an economic nirvana: he can produce competitively and he already has an assured market demand. And he is covered against all sorts of Greek political risk.

Wealthy Greeks hold hundreds of billion Euros in foreign bank accounts. The new Investment Law must aim at the voluntary return to Greece for new investment of parts of those funds. Greeks are good businessmen and they recognize a good business opportunity quickly. Why should wealthy Greeks prefer to earn 2% in Switzerland when they could earn a multiple thereof in Greece with the same security?

Why selective Special Economic Zones and not the whole country to begin with? Because one cannot restructure a country’s economy from A-Z at one and the same time; that would lead to a revolution. Instead, the objective has to be to make the Special Economic Zones work well and to hope that their economic framework will rub off on the rest of the economy over the years.

Of foremost priority is good business governance in the Special Economic Zones; everything must be on correct and transparent footing. If the Greek way of doing business (tax cheating, corruption) set foot in the Special Economic Zones, the project would be doomed from the start. There would have to be efficient control mechanisms such as regular audits by reputable auditing firms. Perhaps even periodic EU-inspections (after all, they guarantee compliance with the Investment Law).

The great risk associated with import controls is always that this protection of the domestic economy is misused by domestic manufacturers. Suppose an imported tooth paste costs 1 EUR per tube and the new internationally competitive conditions in the Special Economic Zones allow the domestic manufacturer to also operate profitably at that price. Assume further that a 100% special tax will temporarily be imposed on the imported tooth paste so that the domestic manufacturer can start up his business. Thus, the imported tube will now cost 2 EUR. The risk is that the clever Greek businessman may now want to sell the domestically manufactured tube at 1,99 EUR.

This is not how the system can work! The objective of the Special Economic Zones is to build up sustained domestic manufacturing. They cannot be misused by clever Greek businessmen to produce competitively but sell at twice the price. The benchmark always has to be the international price!

All of this sounds very much like a planned economy, but it isn’t. It all depends on the new Investment Law is formulated. The law has to establish firmly those rules within which entrepreneurs can act freely and to their profit. An effective Investment Law will offer the investor an attractive relationship between security, risk and reward. If that is accomplished, the investors will come on their own.

Chile showed in the late 1970s how a good Foreign Investment Law turned a formerly communist and planned economy in a short time into the „darling“ of foreign investors. Why should Greece not be able to accomplish the same? (particularly with the EU-guarantee, of which Chile had no equivalent).

Argentina has attempted several economic stabilization plans over the decades and for a limited period of time they all seemed to work. The foreign money of Argentines always returned quickly to the country and accelerated the recovery. However, as soon as the first clouds appeared on the economic horizon, that money left the country as quickly as it had come. Greece must accomplish the “trick” to create the kind of economic framework so that the foreign financial assets of Greeks stay in the country on a sustained basis.

The government must assure that many investment opportunities are always on offer for investors. They must be well presented and accompanied by base case business plans, and they must be publicly tendered. The government could even involve some PR-coverage to stimulate a “run” on such new investments (based on the theme: “let’s get in before the door perhaps closes again”).

A cute tweet!

Everyone can guess for him/herself whether this was meant seriously or jokingly, but it certainly is witty! Unfortunately, I can't find the author of this tweet anymore.

...insolvent Greek media are waiting to cash out during elections season from the bankrupt parties who are indebted to the insolvent banks!

Update on Target-2

This post should be read in the context of my previous update on Target-2 and an interview which Prof. Hans-Werner Sinn gave Der Spiegel earlier this year.

Der Spiegel now comes with another article on this never-ending saga. It is quite amazing how many learned people can make a never-ending debate out of the question whether Target-2 claims represent risk or not. They undoubtedly do!

Once again: Target-2 is the name of the Eurozone's cash management system. The system balances liquidity surpluses with liquidity shortfalls within the individual Eurozone countries. When the Greek banking sector loses liquidity due to the current account deficit and capital flight, that liquidity is being replenished by other Central Banks through the Target-2 system.

There used to be a check/balance on the amount of liquidity which could be taken out of the Eurozone's liquidity system via Target-2 and that was the collateral requirement for "overdrafts" under Target-2: such overdrafts needed to be collateralized with investment grade securities (such as Greek bonds before the crisis). Beginning with the crisis, those securities lost their investment grade status. The formal consequence would have been for the Eurosystem to refuse to cover more overdrafts and to call for settlement of those overdrafts which were no longer sufficiently collateralized (margin calls). Had the ECB done that, entire banking sectors (like the Greek banking sector) would have collapsed.

The ECB found a Salomonian solution to the problem of the insufficient availability of eligible collateral. They delegated the responsibility for checking collateral to the national Central Banks (like the Bank of Greece) and signalled to them that they could/should be quite liberal in determining what kind of collateral was eligible or not. In many cases, this has lead to the following: a, say, Greek bank issues a promissory note for funds owed and the Greek state guarantees it, thereby making it an eligible security. In short, a national banking sector can get funding from the Eurozone basically at its own will.

Target-2 has become the equivalent of an unlimited credit card issued by the ECB in favor of national banking sectors. It is not a loan in the sense that the ECB can decide whether or not to disburse the funds. Instead, it's like a credit card where, at the end of each day, you see the amount of charges which have been posted during the day.

At February 28, 2012, the Bundesbank hat a total of 547 BEUR of claims against BIIPS-countries under Target-2. Italy and Spain were by far the largest "takers". Greece owed well over 100 BEUR under the Target-2 system.

Normally, the limitation of trends like current account deficits (overspending abroad) and capital flight comes through the lack of funding from abroad. Since Target-2 offers unlimited funding, a country like Greece can continue to overspend abroad and to lose banking deposits without any constraint. The only constraint would be that, at some point, ECB and the national Central Banks of surplus countries get cold feet and stop making funds available under Target-2.

That will be the day when national banking sectors of the PIIGS-countries will come crashing down.

Cuba - a lesson for Greece?

I have argued in this blog several times that Greece’s problem is primarily an international one: if Greece were sitting on the world’s largest oil reserves and didn’t need any funding from abroad, few people outside Greece would care what the Greek government spends money on and/or how much it wastes.

Instead, Greece has been foreign-funded as long as memory serves. Initially, world powers provided funding in view of Greece’s geopolitical importance. Then, Greek guest-workers remitted their earnings back to their home country during the 1960/70s. After joining the EU, the flow of EU-grants began. And, finally, with the Euro, the flow of cheap Euro-loans began. Had Greece not received any such foreign funding, its living standard today would be reminiscent of a developing country (or it would have tried harder to improve the living standard on its own…).

Thus, the Greek economy has become dependent on foreign funding in a similar way that Cuba had become dependent on financial support from the UDSSR (export markets for overpriced Cuban goods, loans and grants).

Greece should pay attention to what happened to the Cuban economy when Soviet support was dramatically curtailed after the fall of the Iron Curtain. During the 3 years following, Cuban GDP collapsed by 30-35% because imports had to be radically curtailed and couldn't be substituted domestically! The country which had become poor after the Castro revolution now became an economic basket case. The same thing would happen to Greece if foreign funding came to a halt.

Soviet support (i. e. foreign funding) made the inefficient Cuban economy even more inefficient because there was no incentive to improve. Just like Greece is now importing agricultural products like olive oil, tomatoes, potatoes, oranges, etc., Cuba imported sugar. Since Cuba could export poor quality products at high prices to the former communist Eastern block, it didn’t have to try hard to develop an export culture. Greece didn't have to try hard to develop an export culture because it got cheap foreign funding from banks almost without trying.

So what did Cuba do in order to improve its situation?

Basically, Cuba did what this blog has argued all along (albeit with limited success in the context of a planned, communist economy): if you recognize that your biggest challenge is to get foreign funding, you have to figure out ways how to get that.

Cuba tried to attract foreign investment and tourists from abroad. Secondly, many Cubans became guest-workers (mostly in Venezuela) and remitted their earnings back to Cuba. Finally, Cuba found a new sponsor with Venezuela.

Despite all the progress since then, Cuba is still in an economic condition which Greece never wants to find itself in. But Greece could get there because its trade balance is not much better than that of Cuba and its tourism even lags behind Cuba’s (proportionally).

Cuba has secured voluntary foreign funding through increased tourism, new foreign investment, guest-workers’ remittances and – above all – through a new foreign sponsor. If the Cuban  economy is still a basket case despite of that, this only proves that the communist system is not a very good one.

I have found this – quite old – country review of Cuba by Rabobank which repeatedly points out the importance of the Balance of Payments (primarily the current account) when attempting to increase the living standard of a developing economy. Thus, the often stated message of this blog is very simple:

1. Curtail imports.

2. Substitute them domestically wherever possible.

3. Increase exports (Free Trade Zones) and tourism.
4. Attract foreign investment.

5. Stop capital flight with capital controls.

And if Greece does all that, it won't need to look for a new financial sponsor because the EU will be happy to support a well-functioning Greece.

Greeks solving their own problems

This very interesting Ekathimerini commentary by Alexander Papachelas focuses on one of the points which this blog has made from the beginning, namely: others can and should help, but in the final analysis it is the Greeks themselves who are the only ones who can solve their problems. Mr. Papachelas summarizes it as follows:

At the end of the day, they say Greece will only come out of the crisis when it manages to solve its political problems. That is, when we finally take matters into our own hands, when we finally pick responsible and honest people for the crucial posts, and when our politicians finally convince us that they have a plan and vision instead of invoking the troika bogeyman.

Nothing needs to be added to this!

Present day's Greek soul

Everyone who wants to follow a fairly radical and long exchange among Greeks about Greeks (in German!) should follow this link.

Euro-exit - all pain, no gain!

This is a very good article reflecting several of the themes of this blog.

What a prophesy!

In an article 2 months ago, Felix Salomon said: "Bondholders, in general, have a lot of experience going up against Walker, Buchheit, and Cleary generally. And whenever that’s happened, the sovereigns have won, and the bondholders have lost".

Well, reading that article with the benefit of hindsight, one can only conclude that this was a phenomenal prophesy.

In another article, Lee Buchheit warned against putting in place retroactive CAC saying "how opportunistic this would look, not to mention the precedent that would be set in Greece and elsewhere in the periphery".

With the benefit of hindsight some years from now, that will turn out to have been a phenomenal prophesy, too!

A plea for the right kind of austerity!

It is shocking to see how the expressions “overspending” and “austerity” are thrown around without the least effort of defining/explaining what they mean (or should mean). Overspending is what got Greece into trouble and austerity is causing the pains now. But overspending of what and austerity for what?

When a family gets into financial trouble, they need to reduce their expenses wherever they can and start living “within their means”. If they continue to spend more than they earn, they need to find someone to lend them money. If no one lends them money, they have no choice but to stop spending.

The government (state) does not function like a family. Where the family has to save in times of financial trouble, the government needs to spend in order not to damage its revenue base. It really isn’t government overspending which got Greece into trouble because Greece’s government spending, as percentage of GDP, is by far not at the top of the Eurozone (Greece: 50%; France: 56%). What got the Greek government into trouble is that the revenue base was far too low for that kind of spending. Also, the public sector in general absorbed a huge portion of national resources without generating an adequate level of value. While some austerity was undoubtedly necessary, the real austerity should have been applied elsewhere.

The country functions exactly like a family. When a country spends more abroad (for imports, services, interest) than it earns abroad (through exports, tourism, etc.), it is overspending. The gap is closed by funding from abroad. When that funding no longer flows freely, the country must do the same thing as a family: radically curtail spending abroad; radically increase revenues from abroad; or a combination of both.

When a family has a monthly income of 1.000 EUR and spends 1.400 EUR every month, it’s obvious what will happen once the bank stops making loans. From 2001-10, Greece spent 1.400 EUR abroad for every 1.000 EUR which she earned abroad. Until about 2008/09, foreign banks were happy to provide the funding for that. Since then, the funding had to be provided through recue and/or ECB-loans.

Since the peak overspending in 2008 (1.530 EUR spending for every 1.000 EUR earned abroad!), several things have improved: exports increased quite impressively and the growth in imports could be slowed.

Nevertheless: as late as 2011, the 3^rd full year of the crisis, Greece still spent 1.372 EUR abroad for every 1.000 EUR earned abroad! (that is overspending to the tune of 37%!).

Now, picture that those were the figures of a family and that you were that family’s banker. Imagine what you might say to that family? How would you communicate your feelings that, over 2 years ago, you had told them to stop overspending and you had repeated your warnings every quarter, only to now see that they were happily overspending as though nothing had happened?

It is inconceivable to me why Greece as a country would have done nothing to reduce the enormous level over overspending abroad. The first step would have had to be a “buy-Greek drive”. The second step would have had to be to promote domestic production of those products which should no longer be imported (thereby providing a stimulus for economic activity). And, probably, one couldn’t have avoided implementing some form of special taxes on selective imports to make them more expensive.

In short, the much needed austerity would have had to be applied to spending abroad! Instead, Greece continued to spend money abroad as though nothing had happened. The most ridiculous point is that Greece, a country which should drastically reduce spending abroad and which should import only those products which can definitely not be produced domestically, well, that such a country whose most important sector is still agriculture would import even agricultural products, and not in a small way!

How long will it take until people come to senses? That Greece as a country simply won’t be able to spend other people’s money forever?

From 2001-11, in only 10 years, Greece has received funding from foreign lenders to the tune of roughly 400 BN EUR! There was additional funding from EU-grants and foreign investments. There is simply no way that another 400 BN EUR of funding will come in the next 10 years for the purposes of overspending and capital flight! (there are no facts to support this argument; just common sense).

Why is it not obvious that Greece has to apply the greatest austerity imaginable to spending abroad? Even if it means controlling imports! And if import substitution is handled well, it would significantly add to domestic economic activity!



UPDATE PER 20.03.2012
In near disbelief I just saw the January figures. Unbelievably, the current account deficit had declined to 1,5 BN EUR from 2,8 BN EUR a year ago. Exports had increased and imports declined. All other categories improved, too.

Was this a "lucky month" or could it be the beginning of a change in trend? The next months will show. Mind you, if the January-trend were maintained throughout 2012, the annual deficit would still be about 10 BN EUR, a large figure but almost peanuts compared with the 35 BN EUR oof 2008.

http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_20/03/2012_433802

UPDATE PER 22.03.2012

Clarification from the Bank of Greece: "The improvement means absolutely nothing since it is a result of the recession both home and abroad. Unless we embark on structural reforms the weaknesses of the Greek BOP will be there to stay. However: Lower deficit means FDI. FDI means structural reforms. Structural reforms means less state interference, less politics, less corrupt politicians. In view of the forthcoming elections this looks too good to be true".

Is Greece going out of business?

It becomes very problematic for a country when the legal framework is such that actions which are perfectly plausible (and legal!) at the level of the individual are completely against the interests of the country.

A Greek who withdraws Euros from his Greek bank account to either hoard them in cash at home or to transfer them to a foreign bank account (both are perfectly legal) is being perfectly responsible to himself and to his family. The threat of a possible Euro-exit on the part of Greece has been talked about for a long time now. Should that Greek not protect against that risk, he would be less than responsible to himself and to his family.

A Greek who buys cheaper imports than domestic Greek products is being perfectly responsible to himself and to his family. Why should he waste his and/or his family’s resources?

There is obviously a small problem with this. If all Greeks behaved responsibly to themselves and their families as defined above, the country would go out of business even faster that it is doing it already.

As I just said, Greece is already in the process of going out of business. She will stay in business as long as foreigners provide funding. Once that stops, all hell will break loose.

Unless, of course, Greek leadership finally gets around to making some plans for avoiding that the country will go out of business!

A radical view! Perhaps not so much off the mark?

I recently had a very interesting email exchange with a Greek whose name/position I will not reveal in order to respect confidentiality. Below is a text from him.

Quote

When we really start to do things, improve ourselves, revamp Greece from the ground up, perform a radical national reformation like the one Ataturk did with Turkey, no less! We need to:

- free ourselves from our toxic mindset of cheap patriotism and slash the military by 90%

- cast away our habit of being subsidized

- stop believing Greece deserves anything in modern times only because of its past. The merits of the past stay in the past.

- let's create a country we can be proud - because of our merits in modern times

- destroy our childish attitude of believing that others do not understand us

- erase our psychological obsession with blaming others, and especially Germany. Our sins are our sins. We are to blame for our own failures, not the others. If Siemens or Deutsche Telekom have abused our system, it's because our state is abusable and because we as a nation are abusable

Only if WE do these things we will have the right mindset to start enhancing our country - and only then will our brand image or our reputation improve. And that's exactly the way it should be.

Regarding the Greeks' love for putting themselves in the victim's role - I am amazed by it and find it incredible. And it's the proof of a miserable mentality with no real pride and self-esteem. Greece needs to be completely re-invented. And I believe that the April elections will be a seismic change. If you have seen the elections surveys, they are absolutely devastating.

End of quote

How you get your money back from a borrower

It took me many, many years in banking until I understood the essence of making good loans. I, like everyone else, had started out with credit and other sophisticated analyses. And when a borrower got into trouble, one had to make sure that one's collateral was ok and that no more money would go out the door without special approval.

The truth, however, is quite simple: if you want to get your loans repaid, you have to make your borrower strong and not weak. Bankers' meetings (with lawyers also present) focus on getting one's money back without considering how to make the borrower strong. That does not work.

Case study Greece: if anyone has made proposals so far as to how to make the Greek economy strong, please let me know. All I have heard in the last two years are rescue packages, PSI, CAC, Eurobonds, etc. etc. 

Where are the plans to make Greece stong?

Activation of the CAC for the benefit of 7 BN EUR?

According to statements by the Greek government, "subscription" to the bond swap was slightly over 85% when they decided to activate the CAC in order to get the percentage to slightly over 95%. Thereby, they increased the PSI-participation by an alleged 7 BN EUR.

Was that worth it for 7 BN EUR? (7 BN EUR out of about 370 BN EUR in total public debt).

With the stroke of a CAC, Greece threw out the window 2 years of fighting for the cause of avoiding default and making all sorts of silly financial acrobatics just for the sake of accomplishing that; months of negotiations with the IIF to work out the PSI; etc. etc. Put differently: having kept the financial world on its nervous toes for 2 years and now a default.

One wonders what the role of EU-elites was in this decision to activate the CAC. Did they steer the process into that direction? Or did Greece make a short phone call last Friday to say something like: "You know, we are only at 85% but we want to get to 95% so we activate the CAC. Just wanted to keep you informed. Bye, bye".

It’s not the CAC per see which is the issue. The issue is that the CAC was implemented post-facto with retro-active effectiveness. As I have pointed out before, that is the kind of thing which assures that foreign investors will stay away from Greece for a long time.

This blog has argued from the beginning that the process chosen by EU-elites was wrong. At the outset of the Greek crisis, in early 2010, they should have pushed for a debt rescheduling with existing private creditors with the EU providing the necessary Fresh Money. Instead of a haircut, evergreen bonds should have been issued for the amount of debt exceeding the 60% Maastricht-level. This would have required private creditors to write-down perhaps 50% (or more) of their loans but they would have maintained legal claim to 100% of it. If that had entailed a default, it would have served a good purpose.

As it turns out, private creditors are left with about 15% on their original investment (if the new bonds indeed trade between 20-30%) and they no longer have any further legal claims in case of an upside in the Greek economy.

And what does Greece have? A pyrrhic victory, albeit it a very impressive pyrrhic victory. The Greek government, with excellent legal advice, sat at the poker table with a stern face and every time the others came with a bluff, they seemed to be saying without the hint of an emotion: “I raise you, partner. Show me your cards!”

Mind you, Greece managed to square the circle: disbursement of the new funding achieved AND a default at the same time! Very impressive!

Greece now is on historic record for having caused the most giant haircut on sovereign debt ever. For not having shied away to even trigger retroactive CAC just to maximize the haircut by another 7 BN EUR or so.

It is a shame that the Greek government 2 years ago did not have the professional legal advisors whom Mr. Papademos hired when he assumed office. It they managed to achieve this pyrrhic victory now, they probably could have achieved miracles if they had been involved from the start. 

That doesn't change the fact, though, that Greece now has a pyrrhic victory!

Is 13,95% on your original investment a good deal?

It is quite amazing how much relief (if not applause) is being voiced over the unique opportunity of losing about 86,05% of one's investment. How do I come to that figure?

It all depends on how the new bonds will trade. So far, I have read comments that they are presently trading, before all i's are dotted and all t's are crossed, between 20-30%. One can only hope that they will be trading at higher rates once the i's are dotted and the t's are crossed.

Assume they will trade at 30%. This means that holders of 100% debt accepted, in lieu of payment, new and better bonds for 46,5% thereof and they now see those bonds trading at 30%. The simple formula is: 

46,5% x 30% = 13,95%

Now, if I am an investor and if I see myself ending up with only 13,95% of my original investment, I surely want a better deal. What do I want?

Very simple! All I want is the potential of an upside. In other words, I do not want to forgive all my claims for the 53,5% outright but, instead, I am willing to wait for principal and interest for, say, 50 years. If someone tells me that I should wait for 99 years, that's fine with me, too. I will not live to see the 50 years, much less the 99 years.

But there is one thing which I may see much sooner. If I accept the above type of settlement for all debt exceeding the 60% Maastricht-level, the remaining debt will be within the 60% Maastricht-level and it should be quite solid because it is in a senior position to all other debt. Thus, it should trade close to 100%.

If that happens, then the future outlook for Greece will change quite rapidly. And if accompanied by some sensible growth strategies, Greece might soon be in an upbeat mode. And then the above evergreen bonds which started trading at near 0% will begin trading at higher rates. Mind you, something which starts at 0% and goes to, say, only 2% has just experienced an infinite percentage increase!

Greeks afraid of FYROM? Not at all!

It is quite amazing how market forces can be more powerful than political ideology!

Greece's favorite neighbor to the North, the FYROM, was the shooting star of the World Bank's "Doing Business 2012" report: they moved up from position #24 to #22! Greece, on the other hand, remained around position #100 (by far the worst ranking of any EU-country).

These 2 articles show that Greeks themselves find the FYROM a good place to do business:

Greek businesses like Macedonia

Another Macedonian invasion 

I am reminded of a FYROM marketing presentation where a team of slick government officials explained convincingly why the FYROM would be an excellent place for foreign investment.

I am also reminded of a Greek commercial on CNN where blue skies and blue seas were shown and a wonderful voice intoned: "The Gods could have chosen any place in the world and they chose Greece!"

So should foreigners do their serious investing in the FYROM and drive down to Greece when they feel like having some blue skies and blue seas?

It is entirely up to Greece to convince foreigners that they can get both in Greece --- the serious investment opportunities and, of course, the blue skies and blues seas. But Greece better start doing that soon!

Operation successfully completed! Patient cured?

My starting point is that Greece’s total public debt was 368 BN EUR per 31.12.2011.

All other numbers are somewhat less definitive because there is no official source of information. These are the key statistics:

206 BN EUR – public debt held by private creditors

177 BN EUR – sovereign bonds under Greek law; of which

152 BN EUR – accepted haircut of 53,5%

  20 BN EUR – sovereign bonds under foreign law; of which

  14 BN EUR – accepted haircut of 53,5%

Bottom line: through activation of the CAC, Greece will get private creditors holding 197 BN EUR out of the total of 206 BN EUR to accept a 53,5% haircut. That is 95,7% of the total private creditors. This percentage could increase depending on the outcome of the debt subject to foreign laws.

A grand success? Yes, certainly relative to what was expected/feared only a week ago.

The best of all worlds? No, not at all! The price which all parties involved will have to pay for this solution is far higher than what it would have been had the process been managed correctly from the start (as this blog has argued for over one year now).

What is the price which all parties have paid?

1. The precedent of a substantial haircut on sovereign debt of a first-world country after only 2-3 years of crisis (and without any one-time destruction) has been established. This is a historic first! No one can estimate at this point what this will mean for future sovereign financings.

2. For generations, Greeks will be reminded that they set a record in terms of wasting other people’s money (OPM): Bernie Madoff wasted 50 BN of OPM and got a jail-term of 150 years for that. Greece wasted 100 BN of OPM and got (short-term) praise for that. The fact that it was USD in the case of Madoff and EUR in the case of Greece is more or less irrelevant.
3. Private creditors accepted a 53,5% haircut without getting any upside in return. Normally, the upside would have been that in exchange for forgiving 53,5%, the other 46,5% become worth 100% (or close to it). As it appears, those “other 46,5%” will trade between 20-30% in the secondary market. A cynic could ask: why did you even bother if that’s all you got for it?
4. Greece as a country is as bankrupt after the PSI as she was before the PSI. While it is quite possible that a primary surplus in the budget will be achieved soon (which would be an outstanding success!), the Greek banking sector would collapse the day when foreign funders (ECB) stop funding.
5. Tax payers of other countries paid far more for this PSI than they should have paid. Tax payers should only have paid to finance the ongoing operations of the Greek government (budget deficit). They should not have paid to let private creditors “off the hook” and to allow wealthy Greeks to transfer their money offshore.

To explain my argument in more detail, let me use those terrible expressions of “what should have been done” or “what could have been done”.

First, Greece’s public debt of 368 BN EUR (or whatever it was at the outset of the crisis) should have stayed where it was then: with private sector creditors! That way, tax payers would not have seen about 100-150 BN EUR move from private sector risk to their own risk. Please note that these 100-150 BN EUR were kind of an upfront payment to private sector creditors which makes the 53,5% haircut ratio appear in a different light.

Secondly, private creditors would have needed to be persuaded to accept “evergreen bonds” for that amount of the 368 BN EUR in public debt which exceeded the Maastricht-level of 60%. These evergreen bonds could have had maturities between 50-99 years from now and they could have carried market interest rates. The point is that principal and interest would have been payable upon maturity; not before. These bonds would initially have traded at little above 0%. Thus, this would initially have been the equivalent of a gigantic loss but not a haircut. Should miracles occur in the next 50-99 years, the bonds would have regained value. Private creditors would have maintained at least the theoretical claim against some possible future upside.

Thirdly, the Maastricht-level debt of 60% would have had to be restructured based on a reasonable debt profile and interest expense for the budget. Presumably a variable interest rate depending on the progress made with reforms.

Fourthly, that way, all private sector risk takers would have remained risk carriers (which is one of the foremost principles in any restructuring of debt). However, none of them would have been forced to voluntarily forgive legal claims.

Fifthly, tax payers would still have had to come up with money for Greece. However, that money would have been in much smaller amounts because it would have only served to finance the ongoing operations of the Greek government (budget deficit) and not the repayment of private creditors, etc.

Finally, if a private creditor forgives 53,5% of his claims and gets in exchange a new claim for the 46,5% which is worth 20-30% of face value, well, then that is not a good deal at all. Any sensible businessman would say: “I won’t forgive you the 53,5% outright but I won’t ask for payment for the next 50-99 years”.

With this procedure, no principles & precedents would have been broken and no one would be worse off than they are today (except, perhaps, the shareholders of the private sector creditors). And certainly Greece and Greeks would be a lot better off today than they are.

Why is it so important to never forego a legal claim on sovereign debt too hastily? First, it is the issue of principle & precedent on which sovereign lending is based. But there is one other equally important reason.

The economic fate of sovereign states can change relatively quickly (not within a couple of years, of course, but certainly within one generation). Do you remember that Russia was bankrupt in 1998 and now has one of the highest foreign reserves of any country in the world?

Let’s assume a few miracles for Greece. Let’s assume that a new Age of Renaissance and/or Enlightenment comes over the Greek people, above all the Greek leadership and/or upper class with the result that problems are attacked rationally and not emotionally. Let’s further assume that the world’s largest oil & gas reserves are discovered under the Aegean. Let’s assume that Greeks begin with some serious utilization of the country's competitive resources and advantages. Could one not envisage that Greece could become the economic tiger of the Eastern Mediterranean? Maybe not, but certainly not for sure!

Whether it is a family, a company, a public sector or an entire country --- they are all social systems. The larger a social system, the more energies it can generate if its resources are marshaled well.

A madman showed in the 1930s what destructive energies a society can generate if its resources are marshaled the wrong way. JFK showed how Americans could “land a man on the moon and return him safely to earth before the decade is out” even though that appeared totally impossible at the time. Interestingly, today – without JFK and without a national desire to accomplish such a goal – the US wants to return to the moon but they may now need twice as long to accomplish that, if ever.

Alfred P. Sloan, who in the first half of the last century turned GM from a collection of car manufactures into a corporate empire, allegedly once said: “Give me an organization and I can perform miracles”.

Leadership can mean many different things to different people but it undoubtedly means the following to all people: to marshal the energies of an entire social system towards a positive goal and a better way of life for all.

What the government under Prime Minister Papademos has accomplished in the last 3 months is remarkable: steady and solid work to undeterredly reach a previously targeted goal; and they reached it.

In my opinion, the real goal for Greece is not to make financial markets happy. Instead, the goal should be to achieve a modern, value-generating society where citizens want to stay in order to contribute instead of wanting to leave in order to have a better life elsewhere.

If that goal were reached, financial markets would undoubtedly also become happy (as a side-product).