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).