Thursday, July 26, 2012

Seeing the erred ways of my thinking... (2)

I was not so naive as to think that EU-elites would be experts at finance, particularly at financial restructurings of sovereign debt but I did make the mistake of thinking that they would be capable (and not too proud) to seek professional advice from the right people. Advice they sought, but they sought it from those who would be the greatest beneficiaries if their advice was followed - the holders of sovereign debt instruments, the creditors of Greece & Co.

I would have never thought that the creditors could pull off the kind of chuzpe which they did pull off --- they presented themselves helpless. They had not made loans to Greece which they could now renegotiate, they argued. Instead, Greece had emitted public debt instruments, bonds, and such instruments have a life of their own in capital markets. Investors had bought those bonds under clearly established rules for public debt instruments and if those rules were not adhered to, there would be automatic default and a subsequent catastrophe in capital markets.

This was sort of like saying: “We would like to be helpful and reschedule our loans but we can’t because we don’t have loans. We have bonds and if a bond does not get paid, default will be declared automatically. There is nothing we can do about that”.

Joseph Ackermann of Deutsche Bank had the nerve to say in a CNBC-interview: "Measures must be taken that sovereign bonds are made risk-free again, which is what they should be!" I beg your pardon, Mr. Ackermann! Who ever said that sovereign bonds are risk-free? True, Basel-II stipulated that no reserves needed to be held against sovereign bonds but that doesn’t mean that they are risk-free. Sovereign bonds represent the full faith and credit of a national state; no less but certainly no more! And if you don't agree with that, Mr. Ackermann, look up EU-treaties where it is stated clearly that the sovereign debt of one country will not be bailed-out by another country. Why should there be a "no bail-out clause" if there was no risk?

The creditors would have had a case if the bulk of Greece’s sovereign bonds had not been held by themselves but by anonymous private investors instead; but they weren’t. More than 90% of them were held by institutional investors who were known; banks, insurance companies, pension funds, hedge funds, etc.

True, bonds are anonymous public debt instruments governed by specific capital markets rules. De jure, one cannot involve the bond holders in a restructuring if those rules do not provide for such a restructuring. Nevertheless, when sovereign bonds are held almost entirely by known institutional investors, one can indeed involve those investors in a restructuring through “forceful persuasion”. If the private investors had caused problems, one would simply have paid them out since they represented such a small portion of the total. That would have been good use of tax payers’ money (and very little cost!).

When private creditors get into the kind of mess they had gotten themselves into with sovereign bonds, there is only one party which can help them --- the government(s); the national governments and the EU. I would have thought that the governments would have been aware of their negotiating strength versus the private creditors. Message to private creditors: “You need help from us. So either we play this game together at our rules or you will be forced to stop playing”.

I would have thought that EU-authorities would have pursued one single objective in the beginning: to convert an uncontrollable situation into a controllable one. How would that have worked?

“Forceful persuasion” would have motivated the institutional creditors to participate in a new syndicated loan (or several syndicated loan packages) which would have prepaid the bonds they held and thus would have taken Greece’s sovereign debt off the public market. No more rating agencies. No more uncontrollable defaults. No more restraints to restructure the debt in an optimal way.

At the end of this exercise, every institutional creditor would have had the same Greek credit risk on its books as before. The only difference being that it would now have been a private loan and not a public debt instrument! Overnight, public discussion over "what happens with Greece's debt?" would have disappeared because there would only have been private debt with private discussions. All private creditors, perhaps several hundred of them, would have fit into a large conference hall. They would have selected a Steering Committee with which debt restructuring negotiations would have been carried out.

Since EU-elites had exactly zero experience with a sovereign debt restructuring within the Eurozone, I would have thought that they would have recommended Greece to go to the IMF, the world-wide authority in the field of sovereign debt restructurings. I would have never thought that EU-elites would be too proud (or too arrogant) to allow for the possibility that in certain fields other authorities are more qualified than they themselves. The Spaniards call such a thing "tontos con iniciativa". To really recognize the tragedy in all of this: I understand that Mr. Papandreou wanted to go to the IMF as soon as the crisis erupted but EU-elites prevented him from doing so.

Moral of the story
It's hard to persuade "tontos con iniciativa" to not use their own unqualified initiatives and to let other more qualified ones use theirs. I would have never thought that EU-elites would be such "tontos con iniciativa"

The final question
Could one have foreseen that EU-elites would behave like "tontos con iniciativa"? Based on the performance of EU-elites in Brussels in the past, yes, one could have. I did not.

PS: previous post in this series P1.


  1. "I understand that Mr. Papandreou wanted to go to the IMF as soon as the crisis erupted but EU-elites prevented him from doing so."

    From what we know now:

    1) Mr. Papandreou had been warned since before the elections (at least in September), by the director of Bank of Greece, that at that pace, the deficit by the end of the year, would hit double digit. This of course didn't stop Mr. Papandreou in his electoral campaign to say "there is money!". As a matter of fact he was saying there were 31 bln of non collected debt towards the state that remained not collected (in reality, he was lying to the people, because about 25 out of the 31, concerned debts of failed companies, that there was no way to legally get them anymore).

    2) At least since December he was in contact with Dominique Strauss-Kahn, in secret, to ask about IMF involvement. If i remember correctly, Strauss-Kahn told him that a unilateral move on the greek part would be unacceptable by the EU, which wouldn't accept without previous agreement the IMF charging inside EU's internal affairs.

    3) Later,when the crisis was pubblic, after Mr. Papandreou said the usual "we found hidden deficits", he again said he wanted to go to the IMF, but of course then it became issue of political interest inside the EU, which with the usual delay, ended up in the well known troika program.

    Ironically, there have been some articles claiming information from France, that Strauss-Kahn before getting arrested in USA, was about to go to Europe with an "improved" plan, which included early debt restructuring for Greek debt and a program prolongation as per IMF's "typical procedure". Of course with the arrest of Mr. Kahn for the maid affair, it all went bad, the alleged plan never arrived to Brussels.


    1. The way I read it at the time, EU-elites (Germany and France) warned Papandreou that if he were to go to the IMF, he would be considered a traitor.

    2. Yes, in Greece there was also the alleged information, that Sarkozy was particularly against the IMF coming in "EU matters", because exactly it was headed by Strauss-Kahn, who was sure to become his opponent in presidential elections.

      So, Sarkozy was afraid, that if Strauss-Kahn was to come in with a comprehensive solution and show ability of crisis-solving, this would reverberate to the french pubblic, which would see Strauss-Kahn as able politician.

      The other preoccupation inside EU, was alledgedly, that the IMF is primarily influenced by USA, so it would be a US "putting its nose" inside "Eu internal affairs".

      I think probably both were true, because they make sense. Eventually they had to admit reality (that they don't know where to start), but this didn't stop the european part of the troika setting her own rules of course. In Greece it is common knowledge that the european part of the troika is the one which the most harsh and refusing to be elastic.


    3. It's not only that. The IMF is a supra-national institution. Wherever they start implementing their programs, they are hated. But the hate goes against a supra-natinal institution. Once they EU got into the driver's seat, nationalities became involved and since Germany is the leading economic force in the EU, it got all the flak which would normally have been directed at the IMF. It't awfully hard to get emotional against the IMF because you don't know who you should get emotional at. It's awfully simple to get emotional against the Germans, particularly with the history of Germans in Greece.

    4. Well, in Greece, people were even more emotional against IMF actually. Much more than Germany. Germany became later, with the press, statements etc.

      If you try and find the first protests in Greece, you will see "ΔΝΤ" (ΙΜF) written often.

      The first chanting that was used against PASOK was a paraphrase of PASOK's motto "PASOK is here, united and strong" (To PASOK einai edo, enomeno, dynato". This became "enomeno, DNT". Also the first accusations about Papandreou were "he brought the IMF to Greece".

      Of course soon enough, the emotion was widened to include the novelty of the "troika", with Germany in prominent position.

      You can put ΔΝΤ in google images or youtube and you will find plenty of material.

      This is a combination of IMF+Merkel for example:


    5. Today's news (well, i have been saying the same since i first wrote here).

      Mr. Roumeliotis now that isn't anymore at the IMF seems to be emptying the bag on Mr. Papandreou.

      Mr. Papandreou isn't speaking, he is making leaks through anomymous collaborators of his, for the statements of Mr. Roumeliotis. Mr. Papandreou is frustrated. According to these anomymous collaborators of Mr. Papandreou, Mr. Roumeliotis should have resigned from his position in the IMF if he believed that the program was doomed since the start. They also claim that Mr. Roumeliotis didn't inform the goverment and that his statements, cancel the effort of the greek people in these years and the negotiation position (what? who negotiated? Where? How!) of Greece at the moment.

      Mr. Roumeliotis replied to these "leaks", by written statement, asking Mr. Papandreou to say whether or not he was aware of Mr. Strauss-Kahn's opinion about "the problematic sides of the greek program". He also asks Mr. Papandreou:

      1) Why didn't he pursue the immediate debt restructuring of the greek debt, as mr. Strauss-Kahn was advicing him.

      2) Why did he accept such a high interest rate from the EZ.

      3) Why did he accept such a short period to implement the program.

      Mr Roumeliotis also says that he personally informed Mr. Papandreou for all the above matters and is reserving himself to give to the pubblicity more evidence in the future.

      Well, the answer about why Mr. Papandreou accepted all that,was given by a former PASOK minister, Mr. Floridis. "Mr Papandreou didn't negotiate anything, he was just signing whatever Merkozy were putting in front of him".

      Is that a suprise?No.He was always a spineless son of his dad... Even now, he doesn't have the decency or political courage to reply to Mr. Roumeliotis on his own, he uses anonymous "collaborators" to do "leaks" to the press on his behalf.

  2. "Who ever said that sovereign bonds are risk-free?"

    Mr. Kastner, could you explain how the central bank transmits it's interest rate policy to the economy (aka to the banks)?

    Maybe then we can begin to understand why the monetary system needs a risk-free asset, and why this risk-free asset is sovereign bonds (albeit in countries which are, alas, sovereign).

    1. Regarding your technical question of how a Central Bank transmits its interest rate policy, I save myself some typing and link the information.

      You are not suggesting that all sovereign bonds of Hungary, a sovereign state, are risk-free; are you? Certainly if they are issued in foreign currency, they aren't. You could make a case that those which are issued in local currency and held by local investors are risk-free for those holders.

      Nothing is risk-free, not even most of the sovereign bonds (exception belows). Basel-II "deemed" sovereign bonds to be risk-free but, as many investors have found out meanwhile, they are NOT! Not always, at least.

      The exception are US Treasury bills. They are issued in the world's reserve currency which the US can print. Put differently, the US is the only country in the world which can print the curreny in which its foreign debt is denominated.

      As Warren Buffett once said about the risk of Treasury Bills: "The US will always be able to pay its debt (Treasury Bills) because it can print the dollars. The only question is what purchasing power those dollars will have when the debt becomes due". In actual fact, by allowing the dollar to devalue over the decades, the US has essentially benefited from economic haircuts facilitated by the rest of the world.

      Foreign debt is nothing other that claims on the future production/output/economic strength of the country issuing it. Read this:

      Last point: the importance of whether a country's debt is held by foreigners of by domestic investors is never zeroed into as much as it should. This is where Krugman's logic comes in: "Since most of our debt is held domestically, we owe our debt essentially to ourselves. So, let's not worry too much".

      Japan is a good example of that. Most of their debt is held domestically, so they can carry an enormously high debt level. The state can always pay its domestic creditors in local currency. The only trouble is: eventually the state has to take away from its citizens whatever it gives them.

      When the Fed does monetary easing via the pruchase of Treasury Bills, it is pure monetary policy. They don't buy risk. When the ECB buys sovereign bonds of, say, Greece, it is more than that. On one hand, it is still monetary policy but the ECB buys risk at the same time. Central Banks represent, in the final analysis, tax payers' money. US tax payers will not lose money through the Fed's risk (unless the Fed were to buy sub-prime paper). European tax payers, on the other hand, will lose money if Greece's bonds fail.

      Example: they are now talking about an official sector involvement in Greece (OSI). That could lead to the ECBs taking losses. That would require a recapitalization of the ECB. Its owners, the national Central Banks, would have to cough up the money. And whatever they cough up comes eventually from tax payers.

    2. Mr. Kastner, you say so yourself.

      Any sovereign that borrows in it's own currency, it's bonds are risk-free. And if it doesn't borrow in it's own currency, well, the joke is on them.

      Furthermore, these risk-free bonds are essential when it comes to the transmitting of monetary policy (as set by the central bank) to the real economy.

      The lack of any such risk-free bond when it comes to the Eurozone, is what is causing the current disruptions in Eurozone interest rates.

      The true function of Eurobonds (if structured properly) would be of a monetary policy tool, and not of a fiscal policy tool as if often erroneously claimed.

      In fact, ever since fiat money, that is the true purpose of government bonds.

      PS - The issue of central banks taking losses is more ambiguous than how you present it. Citi's Willem Buiter has covered it extensively in the following pdf:

    3. The highest level of domestic deposits which Greece ever had was about 242 BEUR (a little of 2 years ao). The national debt at that time was about 350 BEUR. Thus, there was no way that all of Greece's financing requirements could have been fulfilled by domestic capital markets.

      And, of course, there is no way that one can tap international capital markets with a local currency like the Drachma.

      So even with a local currency, you are going to have a good amount of sovereign debt issued in foreign currency. Foreign currency bonds have cross-default clauses. When one bond defaults, that's an event of default for all others, including the ones in local currency (normally, that is).

      So, please, give up your illusion that ANYTHING is risk-free in life; certainly not sovereign bonds (with the possible exception, as I said, of US Treasuries).

      Correct, the balance sheet of a Central Bank is not like the balance sheet of a bank. The Central Bank cannot run out of the money because it prints it. But investors still look at a CBs balance sheets.

      I normal times, so I was taught, total assets of CBs represent about 10% of the GDP. The ECBs total assets by now allegedly (I haven't checked) account for about 30% of EZ GDP. So at some point investors will ask how strong the EZ as a total is. And then it no longer an issue of Greece, Spain & Co. losing funding. Then it's an issue of the EZ losing funding. In fact, that has already occured in a major way in the last year.

      You can only strengthen CBs by giving them more of tax payers' money.

  3. KK said "I would have never thought that EU-elites would be too proud (or too arrogant) to allow for the possibility that in certain fields other authorities are more qualified than they themselves"

    Arrogance is not a characteristic peculiar to the EU elites, it's endemic within the societies of Western Europe and the European settler colonies of the Americas and Australasia, the so called Western Powers. Unsurprisingly this arrogance is more apparent among the elites, a recent example was the elites of Oxford University Press bribing Kenyan and Tanzanian authorities into buying OUP books. The EU may act as a magnifier, especially after it absorbed the former Warsaw Pact & Baltic states; but it is no more arrogant than other institutions like NATO, the OECD, the British Council, Alliance Francaise, Goethe Institut, World Bank - etc, etc.

    I was living in Singapore during the Asian Meltdown, I can vividly recall the imperium of Monsieur Michel Camdessus, if I could have gotten within arms length of him... I took great delight when Mahathir bin Mohamad, PM of Malaysia, told him what to do with his money. If Suharto had done similarly then he probably wouldn't have lost power, not that him losing power was a bad thing, but I don't think that was part of the Western Power agenda.