Sunday, July 29, 2012

Seeing the erred ways of my thinking... (6)

I had made the big mistake to think that EU-authorities would be aware of the distinction between sovereign debt risk and country risk. Sovereign debt of Greece represents the obligations of the Greek state; no more and no less. But what happens with a sovereign country is that the moment the sovereign debt hits a crisis, the entire country hits a crisis, whether that is objectively justified or not. When Greek bonds are down-graded, all other foreign debt of Greek borrowers (particularly the foreign debt of the banking sector) is down-graded at the same time. Once there is a run on a country's bonds, there is the same run on the country banks (sometimes the run on the banks starts before the run on the bonds). The chances of ever stopping such a run against a sovereign country are very slim (ask George Soros about the UK).

This is not so in a federal state of to US. If the State of California would find itself, once again, unable to pay all of its bills, it would not necessarily affect the Wells Fargo Bank, one of California's largest banks. Why? Because depositors of Wells Fargo would not have to fear that the State of California could convert their deposits to a new currency and if the Wells Fargo Bank had no exposure to the State of California, markets would not see its risk affected by the state's near-bankruptcy. So, in extreme terms, Wells Fargo might continue to be rated AAA whereas the State of California defaults.

Here is what happens in a bank when the sovereign debt of a country like Greece becomes troublesome.

The responsible board committee requests, optimally by yesterday, a report on the ENTIRE exposure to Greece, i. e. loans to the government, the public sector companies, the banks, the private sector companies, etc. If the sovereign debt of Greece is down-graded to junk status, all other debt will be down-graded as well. And when debt is down-graded to junk status, every bank in the world will immediately try to get its money back while it still can. The strategy becomes: be the first one out the door! Or, grab the cookie jar while you still can!

Moral of the story
Had the EU-authorities understood that, they would have had to ringfence the entire foreign debt of Greece and not just the sovereign debt of the state. Above all, they would have had to make sure that private banks would not cancel their loans to the Greek banking sector.

The final question
If EU-authorities did not know that, why would they not have asked those who knew?

PS: previous posts in this series: P1, P2, P3, P4, P5.


  1. Mr. Kastner,

    I think the error you do, is thinking that the EU leaders had a "benign" attitude, wanting to solve this quickly.

    I will translate you Mr. Roumeliotis:

    "They were late to understand the magnitude of the problem.And while the IMF was pressuring the EU, saying that the EU had to create the necessary mechanism, they took weeks to decide whether such a mechanism should be built or not. The ECB was saying "no,no mechanism is necessary, the measures that Greece had taken in January were enough to allow Greece to return to the markets. Mistake! After delays, they decided to make the mechanism, but were late again to activate it. The IMF was again shouting and i remember since i was there, the Strauss-Kahn was pressuring Merkel, was pressuring Sarkozy to immediately activate the mechanism so to avoid further rise in spread, because initially, they wanted for the greek program to be funded partially by the IMF, partially by the EU and partially by the markets themselves! It was still possible. So the Europeans delayed in its activation. And of course, the spread skyrocketed.

    The other mistake. The IMF was saying: "Don't do such an austere, time-restricted program, because we have no example, internationally, of a country, that has succeeded in such a small time, such a big adjustment. But Germany and the countries that supported her, Austria,Netherlands and Finland, wanted to punish Greece, as to send a signal to everyone else that "do not attempt to make the same, because, we will reserve for you the same fate as Greece". But this punitive position of Germany, didn't help didn't help neither Greece nor the EZ itself. Because, when you know since the start, that such a program is condemned to fail, this failure, is a failure of Greece, but also of the EZ.

    From that point on, it took 18 months for the Europeans to understand these errors. 18 months.

    And something else. In the first discussions made in the board of the IMF, we said: "Ok, you want to make such a severe program that has so slim chances of success? Then add another element to the program too. That of the write-off of debt. Debt restructuring at THAT time. We are speaking of May 2010.If the debt restructuring had been done in May 2010, with much lower percentage, there wouldn't have been any problem, neither for the greek banks nor for the foreign banks. Basically, the Germans didn't want to give this possibility, because again, they wanted to punish Greece and of course, to protect their banks, thinking that in this way, they would lose less money".

    He also added that some want Greece ousted from the euro for their internal political reasons.

    Note: Mr. Roumeliotis beyong being Greece's representative, was also alternate Executive director of IMF, with a seat on the IMF's board. So he knows enough.

  2. Some more "juice" by Mr. Roumeliotis:

    The IMF in the start, had been split in 2 camps:

    1) One led by Paul Tomsen, who didn't want early debt restructuring.

    2) And one led by Reja Moghadam,who was head of the Bureau of Strategy and policies of the Fund, very close to Strauss-Kahn, who since the start had said, and facts proved him right, that without debt restructuring, this program is dead end.

    Struass Kahn had adopted Reja Moghadam's position and was pressuring to that direction. But every time he was going to talk about this with the Europeans and especially with Mrs Merkel, he was finding in front of him, a wall.

    I was also pressuring the greek goverment to pursue a restructuring, but it didn't happen. But we had agreed with Strauss-Kahn, immediately after the approval of the greek program, to put again on the table the issue of a debt restructuring. I am sorry to say, that various advisors of mr. Papandreou, who were influenced by the position of the ECB, also didn't want to hear about debt restructuring, thinking that we are not a latin american country and we will make it without restructuring.

    But the Funs, that had experience with such matters, had predicted, that the sustainability of the debt, was not guaranteed with that program. Personally, i brought back the issue in July 2010 and i conveyed a message of Strauss-Kahn to the PM, saying that "you must ask debt restructuring here and now or will find this problem ahead of us. (Audio missing). At that time, even a 30-35% haircut, would have been tolerated by the greek banks, which had at the time core tier1 over 10%. They would have lost 12 bln, which was something they could cope. Those who won, were the foreign banks. They gained about 6 bln. Because they unloaded some greek bonds, selling them to the secondary market and reduced their exposure. So even with the bigger haircut of 53%, they gained about 6 bln.

    As i had written, the greek case will be taught in universities as a case of salvation-parody.


    1. If you read my blog from the start, or if you only look through the posts included in the summary at the top of my blog, you will find that I have essentially been saying all along the same thing which Mr. Roumeliotis quotes the IMF as having felt and Mr. Moghadam as having proposed. Because I am so smart? Certainly not! Only because I have lived through similar situations in Chile/Argentina in the 1980s. So if I came to that conclusion with a sample of only 2 precedents, no surprise that the IMF would come to those conclusions with uncountable samples over the last decades all over the world. Once again: Greece's (Papandreou's?) greatest mistake was not to have gone directly to the IMF from the start (or yielding to EU pressure not to do that).

      I have benefited much from your comments. Instead of elaborating here, I will write a post about them.

    2. Mr. Kastner,

      Mr. Papandreou, had not what it takes to stand up alone against the EZ, even more, when Strauss-Kahn had tole me that "EU wouldn't tolerate unilateral actions".

      If there was someone that had enough economic knowledge to make a self-diagnosis of the situation, it would be his father, ironically. And MAYBE,just maybe, his father would have been the only capable to ignore his fear of going up against the EZ, ignore Strauss-Kahn and do what you say.

      But not George Papandreou. He lacked the knowledge (he said once in greek tv "it's all new to us all, even i, only now learnt what CDS are) and he lacked the spirit and he lacked the entire mentality. Mr. Papandreou had not the character in it. Mr. Papandreou had always had an almost naive approach to EU problems, where "we are a family and a family always resolves things by talking to each other". This also explains why he signed Dublin II treaty. His father, was right. FIRST, you MUST belong to the Greeks, because the OTHERS, also first belong to the Germans, the French, etc.

      Or to put it in another way, there are 2 ways of adopting cosmpolitism. One is "monkeyism", where, you want to imitate the others, something very popular to greek pseudointellectuals that confuse culture with money. And often end up hating anything,anything, greek. You won't ever hear them say they are happy about something greek. This is typical of leftist pseudointellectuals. The other way, as prof. Yannaras says, is to bring to a union, something that they miss. Only then you will be useful to them and also embrace them as your missing parts. It is as a painter, Tsarouhis (, once said: "When i went in France, i discovered, that in order to become a true cosmopolite,i first had to feel Greek). It is the same concept of Kazantzakis when he wrote about "race".

      Mr. Papandreou, i doubt if he ever felt greek in the way a greek does. His own brother once wrote "i am an american disguised as greek".

      The rest was normal, having to deal with mrs. Merkel's Germany... A greek newspaper had once an offensive frontpage, which i won't quote here out of respect for your blog and possible german readers, but, things have proven it right.

      But, after all, the german goverment is elected to serve german interests and Mrs Merkel had the mentality she has, no surprise there, i would have been surprised if she had another mentality. It was mr. Papandreou's job to heed people like Strauss Kahn or mr. Roumeliotis, who repeatedly tried to wake him up...

      Honestly, if i were mr. Papandreou, i would have either shot my brains now, or retreated to Mount Athos for meditation. I would certainly woudn't go to vacations, canoeing, the Socialist International to give speeches, Harvard, etc. I would feel a terrible weight on my consciousness, not just for people who were economically destroyed, but even more, for those who commited suicide, being despared from a program that was doomed to fail and bring them despair.

      But, mr. Papandreou, has also proven, that was quite ruthless, when it came to politcal survival of his. He isn't as innocent, calm, sweet talking as he may appear to you. In greek political games, he showed that he is de-sensitized enough to live happily the rest of his life.

      On a final note, i hadn't watched mr. Roumeliotis' interview until last night. I had missed it.

      After watching it, it was worse than i originally thought about Mr. Papandreou's incompetence.

      And i now only hope for someone to put an end to this madhouse that Greece has been put in. I will even vote mr. Tsipras if it is to put a swifter end to it.

      And here i salute you. Good luck with your blog, but, what Greece now needs more is euthanasia of this program, to save whatever can be saved from the remainders of the country going to pieces.

      Best regards.


  3. "Above all, they would have had to make sure that private banks would not cancel their loans to the Greek banking sector."
    How do you do that under EU laws, to give orders to a company that they have to continue to do business with a certain customer, especially when there's objective reasons to stay away from that bad risk? Is such an interference legal at all? And, on a meta level, is it desirable to open up this Pandorra's box, to give politicians a say in management decisions and to burden businesses with risks that should be the job of the state, if at all? Isn't this a huge step towards a state planned economy, which you otherwise rightly oppose?

    Sorry, Klaus, I very much enjoy your experience based insights on the economy, but when it comes to politics, your ideas are sometimes a bit weird. Please take more care to ensure that possible side effects of your proposals aren't worse than the problem you want to solve. It looks as if you haven't really thought this "ringfence" idea through.

    1. There are no governments (or EU laws) involved in a private rescheduling. A private rescheduling is exclusively an affair between the borrower and its creditors. As the Chief Economist of Citibank once said: "The problem of the Europeans is that they were not aware that reschedulings have come a dime a dozen in recent decades".

      How does such a rescheduling work?

      A country invites all of its creditors to present a case to them. That case is that they need to reschedule their entire foreign debt. They propose a "rescheduling date" which is typically a date before the run started (so creditors who have successfully run for the exit door have to replenish). Then they make a list of all the debt which must be rescheduled (that is the tricky part). And then, the creditors agree or not.

      With the dimensions of a country like Greece, the creditors would know that if they didn't agree, they might as well walk over to their governments and ask for a bail-out. That's why they will agree.

      The IMF has blueprints for that; the EU did not. Had Greece gone to the IMF from the start, things would have played out differently and Greece would for quite some time now been able to focus on getting its economy fixed instead of endlessly talking about the debt problem.

    2. Mr. Kastner,

      The EU didn't know,but Strauss-Kahn was telling them repeatedly. The why they didn't want to pay heed to mr. Strauss-Kahn, is in mr. Roumeliotis words.

      Just like mr. Papandreou, you ignore Strauss-Kahn once and you see spreads skyrocket. You ignore him twice, three times. After that, it means you don't want to hear, despite the evidence.

      As i said, MAYBE, just maybe, only Andreas Papandreou could have found the political and psychic courage to stand up alone against the Europeans. Exactly because he believed that "we belong to the Greeks", just like mrs. Merkel belog to the Germans, mr. Sarkozy to the French, before "we belong to the EU".

      His son was way too feeble in character and too less of a greek to do that.

      Yet another page of sorrow in greek history. I will put it at rest here.


    3. Mr. Kastner,

      Not related strictly with Gray's comment, but in general, i think too that you think very fast like a banker, but you don't think as fast as a politician :)

      To give you an idea, i had a debate in twitter about this with a greek ND MP. He defended mr. Papandreou saying "it was impossible at the time, in the EU that's not how things work. You don't go in there and give ultimatums or fait accomplis."

      It shows how big of a fear greek politicians have of the EU.

      After all, the goverments of France (above all) and others had interest in protecting their banks too...

      Now imagine an already weak in character mr. Papandreou going only to the IMF, despite his friend Kahn saying him "you can't do that, the EU will not tolerate unilateral action". I bet mr. Papandreou felt his knees go loose.

      Thucydides: "The strong advances up to the point that his strength allows him and the weak retreats to the point that his weakness dictates him". The weak and moron retreats even more, i would add. The great greek politicians in modern history, like Eleftherios Venizelos, were exactly those who grabbed the opportunity of the plans of big powers, but who also didn't fear to treat the big powers as his almost equals on the table of negotiations. Few politicians of small countries can do that. Most start with psychological handicap.


    4. Bankers, too, have a need to feel loved by customers and they try to be nice (at least in good times). But even bankers face moments where niceties can no longer be justified and where they have to "stand up and be counted". If they don't, they tend to lose their jobs.

    5. Maybe so, but exactly, a banker may lose his job. A politician in Greece may only temporarily lose his job and in the worst case, he can still go yatching in the islands.

      To give you another example. What you had said about Eu making an exception for importa taxes,capital control etc, is logical. But politically it can't be accepted. It is part of the "acquis communautaire", the core EU law. Compliance to it is asked even to candidate countries before being accepted. The EU will never breach these rules as they would be bad precedent and defying core principles. And for what? Greece? You read german newspapers better than me that i have to read only reports in greek.

      In the EU there is provvision for only TEMPORARY return of capital control, in case that a country declares that is in "state of emergency". In fact, should Greece default within the euro, this can be used, for the little it can help (only the naive and the brave have their money still sitting in greek banks).


    6. I can't tell you how strongly I disagree with you that the EU cannot agree to something which makes sense!!! The EU has already violated treaty clauses for something which does not make sense. If the EU, as a strong entity with one common purpose, would announce that "we have now embarked on a plan which will bring the flow of products and capital within the EZ back into balance. For that we will need to - at least temporarily - amend some treaty clause" --- I bet you, those who really believe in a "Europe" would rejoice!

    7. Thanks for the explanation, Klaus. Ok, sure both sides have an interest in reaching a compromise, especially if the creditors can't rely on the government to relieve them of the burden and the debtor has the real risk of a default threatening them. Looks like the EZ governments, eager to get to a quick solution, screwed that up with their interference.

      However, I remain unconvinced that the IMF would have done a better job on their own. They have become invoolved very early in the game, where is their positive influence? I suspect the increase of the VAT was their idea (it's straight from their rulebook), and that severely hurt domestic demand. Their track record of successfully bailing nations out is very meager, it's indeed a very mixed bag instead. And their public statements on Greece didn't show that their ideas were any better than those of the Europeans, neither. So, sorry, but I can't share your optimistic view of those experts.

  4. Just a last small comment. Mr. Samaras won't stand up to the Europeans either. He is a bubble, a bit like mr. Papandreou.

    1. On that one, I will wait a bit to pass judgment. The new government has most surprised me by the fact that they have been so quiet so far. Perhaps that means that they haven't done anything yet. But it could also mean that they have a master plan which they are working on. Let's be optimists and think that it will be the latter. We will know in a few months' time.

    2. Do not confuse Mr. Stournaras, with Mr. Samaras. Different things. Mr. Samaras, was promicing "no more cuts to wages and pensions",before the elections, not to speak about his populistic "anti-memorandum" war, which was forgotten overnight. The position of "keep quiet" is mr Stournara's strategy. He and mr Hatzidakis are the best in that goverment. Mr. Samaras has proven in time his little worth. If you go to the museum of the Acropolis, ask the employees "how many of you are Messinians". The answer is "all". They were hired by mr. Samaras when he was minister of culture (and he is Messinian).

      Also, mr. Samaras, had presented in "Zappeio III", not 11,5 bln, but 18 bln of "alternative measures", which would avoid cuts. Do i need to tell you that they were lies?

      And to add to all, you now have Mr. Venizelos,as well as ND MPs, that they program as is, can't be made. Do you remember who signed the program? Correct, also mr. Venizelos and Samaras.

      It depends on what you call as success. One thing is sure, in the best case, next year, Greece will be at least at 10% recession.

      The problem with the blunder made, is that it can't be undone. The economy had suffered so violent cuts, that it has collapsed. The other differnce is, that had the haircut been done as mr Roumeliotis says, now, there would be no big fear about Grexit and maybe some investments would have come. At least they wouldn't have left the existing ones. And as a result, the program would have been lighter on the population and with a prospect.

      You can't undo that. What mr. Samaras can do is reforms, but, if he continues on the suicide path, the end will come reformed. It is as a saying in Greece: "The operation was (technically) successful. Unfortunately the patient died).

      So, rather than mr. Samaras, the question is, what mr Stournaras can do and how much of the pre-electoral lies of mr Samaras can he absorb as social impact.


  5. Mr. Papandreoy drowning his sorrow and washing away his sins, in Patmos' waters:

    Patmos, the island of Revelation. Unfortunately, some people never have a revelation in their life.

  6. Mr. Roymeliotis also says:

    The plan as is now, is not going anywhere.

    To have a chance, the greek goverment must demand:

    1) To recapitalize the banks through ESM (like Spain), instead of the way the program predicts. This to do something about this debt that everyone knows that can't be paid.

    2) Demand something, like the goverment and Hollande were saying pre-electorally, about growth, to break the vicious circle "deficit-recession", which is now self-fueling.

    3) The goverment must commit to the program and show that is doing things, after a long period of ingovernability where the pubblic administration "relaxed".

    And so as he says, these tasks may the job of the goverment very difficult.

  7. Oh Mr Roumeliotis also says that the prolongation of 1-2 years is needed.

  8. What never ceases to amaze me with my compatriots, is that, most (well, at least those with a certain education), know that the speeches of the politicians are not fruit of their own mind. Yet, they continue to believe them or to judge them from their speech instead from their past history. Logic says, that if you are enthusiastic with a speech by politicians that read text and you know that they don't write the speech themselves, then, you should be enthusiastic with their "logografoi", who are the ones who actually wrote the speech and not with the puppet that reads it!

    And then comes the next question. Why don't i vote for the logografos instead of the puppet? Those who were enthusiastic with mr. Papandreou's speeches while he was in opposition, in reality were enthusiastic with... Prof. Varoufakis!!! They should demand Prof. Varoufakis as candidate of PASOK, not mr. Papandreou!

    But, you will say, that this is a philosophical issue. I agree.

    Again, good luck and good endurance.


  9. Very good posts Klaus P1-P6, i liked most P3. You would better understand situations, people and general perception, from many trully capable economists because you could easier "win" friends and "identify" enemies.


    1. Help out my ageing brain: should I know what MS stands for? Send me a mail. Thanks, anyway!