Bank bail-out's and bank bail-out's

Two major forms of bank bail-out's have emerged over the years: a more cumbersome one and a more simple one.

The more cumbersome way
This works as follows: a bank is split into a good and bad bank. The old shareholders keep the bad bank and, as an incentive to go along with the plan, they get a small portion of the good bank.

The good bank is capitalized by the rescuer (typically the government but not necessarily) and dressed up for the wedding, i. e. for the sale back to new owners. That sale will lead to one of two things: either it generates more money than the capitalization had required or less.

The assets of the bad bank are liquidated in orderly fashion. In all likelihood, the shareholders' equity will be wiped out in total. Typically, there will be an additional loss for the rescuer because the bad bank's assets are worth much less than its liabilities.

If the profit on the sale of the new bank exceeds the losses taken on the liquidation of the bad bank (after wiping out shareholders' equity), then the rescuer has made a profit. Typically, the rescuer will make an overall loss but that loss is typically far less than in a bankruptcy scenario.

The more simple way
The rescuer (typically the government) takes preferred stock in exchange for his recapitalization. The deal is structured in such a way that the rescuer gets a preferred rank over existing shareholders to compensate for the new risk he is taking. If the rescue works successfully and normality returns, the rescuer sells his preferred stock, hopefully at a profit. The stock of the old shareholders is probably worth a lot less than before but at least it is still worth something (and it now has the perspective to increase in value again). This is what the US government did with US banks after the 2008 crisis (and similar to what Warren Buffett did with Goldman).

The Greek and Spanish bank bail-out's differ from the above practices. The ultimate rescuer is the ESM but it does no invest capital nor does it get preferred stock. Instead, it lends money to national entities in Greece and Spain so that those, in turn, can do the recapitalizations. How they do that is not yet clear to me but I have to assume that they get some form of stock in the rescued banks.

The critical question is the following: will the ESM, as a lender to national intermediaries which bail-out national banks, get as collateral the new bank stock issued? For example: the Hellenic National Stability Fund will put fresh capital into, say, Eurobank and get preferred stock of Eurobank. To finance this, the HNSF will obtain a loan from the ESM. Will the HNSF assign to the ESM its preferred stock in Eurobank as collateral or not?

Prudent banking practice would dictate that it should!

Beware of brilliant minds! George Soros maybe?

George Soros has made a prediction. Again. EU-authorities have a 3-month window to correct their mistakes; or else! To Soros, it is clear what is needed: a European fiscal authority that is able and willing to reduce the debt burden of the periphery, as well as a banking union.

Mr. Soros is undoubtedly a brilliant mind but as opposed to brilliant minds who come from academia, he is a brilliant mind who comes from the hedge fund industry. His claim to fame is having once successfully blackmailed the UK government. Would you entrust such a man the future of Germany’s tax money and bank deposits?

It is safe to predict that we will neither see a European fiscal authority nor a banking union in the foreseeable future, and that is good! The EU has enough institutions to solve its problems. What the EU lacks are political leaders who are pepared to call a spade a spade and to define problems in simple language. To stay with the language of hedge fund managers: there is always an underlying and a derivative. In today’s Eurozone crisis, the debt problems are the derivatives. The underlying is how some of the deficit economies work.

Take Greece as an example. After 4 years of crisis with dramatic declines in the level of economic activity (including a decline in imports from 64 BEUR in 2008 to 47 BEUR in 2011), Greece still ran a current account deficit of 8% in 2011. For 2012, it is likely to be lower but still well over 5%. Greece is still spending 1.380 Euros abroad for every 1.000 Euros it earns abroad. At it is importing even 2.205 Euros for every 1.000 Euros it exports. The numbers for Spain and Portugal are similar.

The normal procedure is that one first makes a business plan and then one structures the financing around it. For over 2 years now, EU-authorities have focused on financing structures without discussing a business plan for the Eurozone overall and for individual countries. This is like saying: “We don’tknow where we are going but the faster we drive, the sooner we’ll get there!”

The problem is that financial markets do not see today how the underlying of the Eurozone in its present structure can work again. The levels of competitiveness are too different between the Core and the Periphery. And as a result of this uncertainty, markets speculate with the derivatives.

The wonderful thing about a plan is that if it credibly points towards a light at the end of the tunnel, towards a turn-around from current chaos, then markets will cease to speculate against it.

Such a plan for the Eurozone must focus on bringing the flow of products, services and capital back in balance again. Free market forces alone will not achieve this because in a country like Greece, the free flow of imports into and the free flow of capital outside the country have ruined the economy. Instead, there will have to be – at least for a certain transition period – very strong incentives and disincentives to achieve the desired results. How that could be done should occupy the most brilliant minds.

The idea that surplus countries transfer money to, say, Greece so that Greece can import all the products it wants to have and that Greeks can transfer all their savings abroad – that is not a workable idea for either the surplus countries nor for Greece. Surplus countries simply will refuse do to it forever and Greece has deserved better than to assume the role of the recipient of donations from others.

Greece ranks as the EU’s least attractive place to do business (World Bank) and as the most corrupt country (TI). The overall objective of a new business plan would have to be to dramatically turn these two ratings around. Greece would have to start new production for import substitution. Financing should come from private foreign investment. The latter, of course, will only come if Greece becomes an attractive place to do business and less corrupt.

One cannot change an entire country from A-Z in a short period of time. One can, however, start from scratch in selective areas and wherever one starts froms scratch, one can start the right way. Special Economic Zones would be the right instruments for facilitating “new economic beginnings” in parts of Greece. If they work well, they will rub off on the rest of the economy over the years.

The surplus countries won't be able to have the cake and eat it forever, and Greece will not forever have food if it doesn't start baking cake on its own. These could actually be very good times for the Eurozone: the Euro has lost about 25% of its value in a rather short period of time. The Eurozone should normally be spending its time figuring out how to take advantage of this new competitiveness in world markets.

Instead, the entire focus is on financial acrobatics and Mr. Soros makes sure that it stays that way. Perhaps the brilliant hedge fund manager has a financial position to protect.

Is Greece European?

This is a very interesting article by Robert D. Kaplan whom Foreign Policy magazine has named as one the the world's "top 100 global thinkers".

The geopolitical importance of Greece, once very significant, has been played down since Greece joined the EU. Mr. Kaplan makes the case that "from the point of geography and geopolitics, Greece will be in play for years to come".

Prof. Yanis Varoufakis recommends a vote for SYRIZA (and I do not)

Prof. Yanis Varoufakis makes a powerful argument why one should vote for SYRIZA without reading its Economic Manifesto before, which led to the following exchange:

Klaus Kastner
Please allow me to quote Nikos Tsafos from the Greek Default Watch blog: “Greece has changed from being a fat kid that was going on a diet to a fat kid that wants to sue the candy company. In the end, the fat kid may get a check – but will he get any thinner?”

And here is a Greek proverb which I picked up recently:

“Any fool can throw a stone into the sea, but once he does, a hundred wise men can’t pull it out!”

I rest my case.

Prof. Varoufakis
Don’t rest your case quite yet. Thinking of a country as one person, or kid, is unhelpful and dangerous (you would not like it if I thought of Germany as one person; for that person would probably be hideous to you, if verging on the ‘representative German agent’). I know lots of Greek children who found it damn hard to survive in Greece during the ‘good’ times. Who worked during the day in garages and restaurants and went to night school. Now, they have to pay the price of austerity. Be careful Klaus. I expected more from you.

Klaus Kastner
I would not have seen anything offensive in Nikos Tsafos’ quote (BTW, I consider his as one of the best blogs on Greece!) but if others did, I apologize. Actually, I was under the impression that economists like to use metaphors like “fat kid”, “minotaur”, etc. and I, for one, find metaphors useful. As per your request, I won’t rest my case there and since you expect more, I will deliver more.

Your statement that some children did not have a party during the party years triggers deep feelings on my part. Indeed, not all Greek society had a ball while seemingly all Greek society had a ball and, indeed, those who had less of a ball then (or none at all) have now been asked to participate unduly and unfairly in the repair cost of damage with which they had little or nothing to do!!! Yes, today misery is over segments of Greek society and financial stress and emotional strain over a large part thereof. BUT: there is, in my judgment (and remember that I spend close to half a year in Greece), quite a large part of society which even today is having a very, very good life. And I am not thinking of the ultra-rich Greek families. I am thinking of the “smart and clever ones”.

The Gran Masoutis nearby is packed with shoppers (and prices are no less than 3-4 years ago if not higher, and many are higher than in Austria). Whenever I stop by IKEA, I hardly need to move on my own. People traffic carries me with it. On weekends, the parking lot of Cosmos Mediterranean (the largest I have ever seen) is full and the place is packed with families paying the same prices for fast food as in Munich. As the weather gets better, the weekend convoy from Thessaloniki to Chalkidiki is getting under way again (I just returned in bumper-to-bumper traffic). I could go on.

And then I read that a young couple living on a teacher’s salary has to get by with 588 Euro net every month! Nice guys finish last? Well, there are a lot of nice guys in Greece but there are also a lot of fast movers who are not paying their traffic tolls. In my judgment, one part of Greek society has taken the other part for an unbelievable ride since the EU and particularly since the Euro.

And here is my case now: who can/should fix all of this unfairness in Greek society? The Troika? The EU? George Soros maybe? Only Greeks themselves can fix domestic issues within their own jurisdiction and exactly this is what Greek brainpower should be concentrating on. Leave the Eurozone’s problems to Eurocrats. They will fix them or not (I lean towards the latter). But take on Greece’s problems and suggest ways how they could be solved!

I could give you an endless list of issues which Greece could/should tackle on its own. My blog is full of them. Just take the decline in the Euro as one example. Here the Euro (including the Greek Euro) has declined versus the USD by about 25% in a reasonably short period of time. Presumably also versus other currencies. Now if that is not a window of opportunity for increasing exports to non-Euro countries then I don’t know what a window of opportunity is. I am not even sure if Greece’s policy makers have noticed that exports have increased but they certainly have not done anything to “make a killing” out of such a window of opportunity. Attracting tourists from non-Euro countries might have been a smart idea at a time where Eurozone tourism is tanking. Etc., etc.

Now to Alexis Tsipras and SYRIZA. I have sent you links privately. Here is my post after I read the Economic Manifesto.

To recommend not to read a party’s manifesto but recommend to still vote for the party is not my idea of responsible voting recommendations. I would very much recommend to read the manifesto because I think it is a very interesting document which deserves a lot of credit for certain things.

I myself could not vote for SYRIZA because a vision where the predominant role of the state provides for happiness of the people is not mine, but I can see why others would have a different vision. But I am getting to the point where I think that it may indeed be best if the next Prime Minister with a stable majority would be Alexis Tsipras.

Best for the Eurozone because it would force EU-elites to either fish or cut bait. And best for Greece because it will tell Greeks how much the Eurozone likes them (or not). At least, all this meandering of the last 2-3 years would be over. But then again, who am I to say that, with Alexis Tsipras, the meandering would be over???

If there are more instalments to this exchange, I will insert them here.

A Sunday in Greece

The day started with bad news all over the internet. The coming week was going to be the week that mattered; the end was near.

Then we drove from Thessaloniki to Makrygialos where a cousin of my wife's has a small farm. Nearby, his friend and interior designer has a palace. My wife's cousin is approaching the mid-fifties; he has been in retirement since his mid-fourties. Coming from a poor village background, he had started his own textile manufacturing company where, he says, he worked like a horse for over 20 years. He sold his business, invested in real estate and now lives off rent. And not bad.

The small farm is in a location which could just as well be the Toscana. Absolutely charming with a view towards the sea and Mount Olympus. Other friends gathered. Three retired men and a lady who owns a pharmacy. None of them have anything to worry about.

Before lunch, we drove over to Katerini to visit the new Mikel coffee shop. It is the newest unit in the Mikel franchise chain and the cousin's friend had done the interior designing. Everything absolutely first class! (including the coffee!). And prices not even unreasonable. I heard that daily sales were over 3.000 Euros which comes out to about 100.000 Euros per month. Wait, 100.000 Euros per month? Who has all that purchasing power?

For lunch, we drove to a fish restaurant by the beach. The interior designer was, of course, well known there. The restaurant was full. Food and drinks were served in typical Greek quantities (and quality!). The bill was 25 Euros per person.

On the way back to Thessaloniki we passed a delivery truck carrying about 10 new Mercedes cars. And on the ring road around Thessaloniki a brand-new Porsche honked nervously because I had slowed down his speed. So I moved my Hyundai i10 over and let him pass.

All in all, a very nice day. Economic crisis? What crisis? Oh, that crisis!

SYRIZA's "Economic Manifesto"

"It is for you that we all embark on this struggle! To put shoes on your feet, food in your children's mouths! We are fighting to change your life, to raise you up from poverty and humiliation, to make you men!"
                                                                         Greek patriot in early 1940s


I had to think of the above when I read through SYRIZA's new Economic Manifesto (n. b.: I used Google translation, so I may have misunderstood details of the Manifesto but I think I got the overall message pretty well).

In general, I found Alexis Tsipras' presentation an arousing document. It included all the right soundbites which a domestic audience suffering pain and humiliation likes to hear. The presentation could have aimed at arousing people against some new enemy, for example foreign powers. It didn't do that and this deserves a compliment.

Mr. Tsipras begins by explaining in detail what SYRIZA means by an Economic Manifesto, by a program. They mean values, principles, clear guidelines, fixed lines, etc. He contrasts that beautifully with, say, Mr. Samaras' habit of shouting out 18 action steps or the like. And he even used the famous Churchill phrase "Who, if not us? When, if not now?"

If Thomas Jefferson had held in impromptu speech early on during the formation of the American Union, he would probably have used some of the same soundbites which Alexis Tsipras used.

The problem with soundbites is that they are never tangible. By defininition, soundbites consist of sounds and not of specifics. The Economic Manifesto is extremely short on specifics. Actually, specific measures are not even included in the presentation but, instead, only in the short Annex 1.

Soundbite 1 - a public register on all properties. SYRIZA deserves 100% agreement and support as regards the absolute necessity of a complete, nation-wide electronic real estate cataster. That is the minimum standard required if one wants to assess property taxes. A society which has administrative problems with the assessment of income taxes must also use the instrument of property taxes.

Where SYRIZA is wrong is when they call for a registry of ALL properties. To declare all personal properties beyond real estate is a confidential matter between the individual and the tax authorities. A property tax form requires the individual to list all his properties and the tax authorities are charged with verifying that.

Soundbite 2 - "internal devaluation". The Google translator suggests that Mr. Tsipras considers internal devaluation as wrong. If this is a correct translation, then it is Mr. Tsipras who is wrong. A country which still as a significant current account deficit after 3-4 years of recession has a massive problem with its real exchange rate. There are only 2 ways to solve that problem: either internal devaluation (the long and drawn-out adjustment) or external devaluation (return to the Drachma). There is nothing in between. And SYRIZA has ruled out a return to the Drachma.

Soundbite 3 - government revenues/expenditures. SYRIZA proposes to reign in expenditures at a maximums of 45% of GDP (presently around 50%) and to increase revenues to about 45% of GDP (presently slightly under 40%). Should SYRIZA accomplish that within the 4 years they say they need, they would deserve a Nobel Prize for Public Administration (n. b.: I suspect that the 45% of GDP expenditures do not include interest. If so, that 45% figure would be far too high and much higher than it is today)! SYRIZA does not explain how they plan to reduce expenditures by another 5% of GDP but they are specific as regards the revenue increase.

Soundbite 4 - tax reform. SYRIZA quotes the Greek constitution as saying that Greek citizens have equal rights and equal obligations to "contribute without distinction to public charges and in proportion to their means". Quite sensationally, SYRIZA seems to include even the Church among those who have obligations. A tax reform following this constitutional mandate could only be good. Details, however, are missing in the Manifesto.

Soundbite 5 - reform public administration. If all the mentioned soundbites were to become reality, Greece would have one of the most modern and efficient public administrations in the world. However, I hasten to add the following sentence which I found somewhere in the Manifesto: "The administration should organize an "invasion" of democracy, meritocracy and democratic planning in daily operations". That has a very bad sound to it (but perhaps it is poor translation).

Soundbite 6 - nationalizations, etc. Here, SYRIZA gets very ideological about how an economy works. There is a clear mindset that "the state" (or society at large, whatever that means) must play the role of the "visible hand" in the economy. Otherwise, more or less evil forces would begin to take over society. Thus, there can be no thought of privatizing companies which are still state-owned. Instead, the impression is left that one might even look at new nationalizations and in the banking sector they would certainly be planned.

Nationalizations as a tactical measure of necessity can become necessary (examples: the nationalization of AIG; or the partial nationalization of US banks in 2008/09). Nationalization as a strategic goal generally leads to disaster. And Greece is a country which has the advantage of being able to see already what disaster some of its nationalized companies have created.

If the Hellenic Financial Stability Fund has to recapitalize Greek banks, it should certainly get shares for it. However, it would have to pledge these shares to the ECB/ESFS which are refinancing these recapitalizations. 

What reactions can be expected to SYRIZA's Economic Manifesto? 
Some will undoubtedly throw it out the window without reading it simply because it comes from the Left. If Mssrs. Samaras and Venizelos did that, it would be a shame because they could adapt some of the soundbites for their own purposes.

Those who are still doing rather well despite the crisis will definitely object to it because the Manifesto would require a greater future contribution from them. And those who have a vision of Greece as a an attractive place to do business; as as well-functioning economy which is not dependent on subsidies from abroad; as a mature partner in the European Union - well, I regret to say, those should object to it.

And, finally, those who are in the lower half of today's totem pole of Greek society will fall for the soundbites. They will read into the soundbites all those wonderful things which Greeks back in the early 1940s read into soundbites like the one I cited at the beginning of this post. Without wanting to de-motivate those Greeks, I would only alert them to the following Greek wisdom:

"Any fool can throw a stone into the sea, but once he does, a hundred wise men can't pull it out!"

Stimulus vs. austerity

John Maynard Keynes allegedly once said that, in a recession, it was smart for the US government to pay a man to dig a hole and then pay him again to close it. True? Well, that depends...

If that man spends all the money he earned on the purchase of a new car imported from Japan, the government has stimulated the Japanese economy and not the American one (except, perhaps, for some employees at car importing firms). If, on the other hand, that man spends all his money on purchases from an American supplier who, in turn, makes all of his purchases from American suppliers, and so forth..., well, then it is a stimulus for the domestic economy.

This simple example shows that it is very irresponsible to simply hammer in the headlines of stimulus versus austerity. It all depends on what stimulus money is spent on and where austerity hits. Thousands of businesses have closed in Greece since the beginning of the crisis. To make a purely theoretical example out of this: if all these business had been selling imported stuff and if all the resources set free could have been redeployed in new businesses involved with new domestic production and exports, this would have been the most perfect example of "creative destruction". Obviously, reality turned out different from theory.

Some argue that the Eurozone must become a transfer union so that economies like that of Greece's can get back on their feet again. Well, it helps to remember that the entire EU has been a transfer union from the start. I recently read (but cannot confirm it) that Greece has received 135 BEUR (in current Euros) in grants from the EU since it joined it. Only the four times larger Spain received a slightly larger amount. Those 135 BEUR are equivalent to about 60% of Greece's current GDP. To put this into perspective: the often-cited Marshall Plan was equivalent to 0,5% of German GDP for a period of 4 years, that is about 2% of GDP for the total of 4 years.

The Marshall Plan was a form of seed-financing: drop a little gasoline on the charcoals so that the fire gets going. If the charcoals are not put into the right place or if there is no one to manage the fire, the gasoline will be nothing other than a strawfire.

When the government's role as a "stimulator" is forced to shrink, someone else has to fill the resulting vacuum at least partially in order to avoid what we see in Greece today. To keep the government's role from shrinking is self-defeating if the money it spends is spent on the wrong purposes. The external accounts of Greece show quite clearly: imports have come down in the last couple of years due to the recession. Should the government bring more money into circulation through more spending, much of that money would leave the country right away for imports. That's like giving a hungry man a fish instead of showing him how to fish.

I have argued since the beginning of this blog that the above-described vacuum must be filled largely by the private sector and the only quick-growth options the Greek economy has are import substitution and export expansion. Suppose the government were to establish Special Economic Zones near Athens and Thessaloniki, large population centers with many unemployed, and invited private sector investments there for the above-mentioned purposes, new jobs for unemployed would come into existence. An employee loses his job in a shop selling imported stuff but has the chance to take up a new job in a business producing that stuff which was previously imported.

Two things are required for such Special Economic Zones: (a) an absolutely internationally competitive business framework and (b) guarantees for new investors for the political risk arising from political developments in Greece. Since investors would not trust the guarantee of the Greek state nowadays, those guarantees would have to come from the EU.

That way, the EU would use its strength not to transfer tax payers' money to Greece for spending but, instead, to facilitate the transfer of private sector money to Greece for investment.

Last questions: what's the point of investing in new production when demand in and all around Greece is evaporating? Well, import substitution does not require new demand. It only covers existing demand from different sources. And regarding new exports, Greece's current share of EU exports is so small that an increase which is significant for Greece might not even be noticed in the overall picture. Greece would have to apply guerilla tactics instead of moving like a large army!