Greece Trusts Anonymous Capital Markets More Than Its Governmental Partners!

Financings can be differentiated by two different types: those financings where the borrower knows the lender and those where the borrower does not.

Where the borrower knows the lender (such as in the case of loans; like the bail-out loans), the borrower has someone to negotiate with. In case of trouble, the borrower can sit down with the lender to cure the problems; to cure defaults before they happen; to renegotiate the terms of the financing.

Where the borrower does not know the lender (such as in the case of capital market instruments; like bonds), the borrower does formally not know the lender. There is noone to negotiate with in case of trouble. A bond is a tradeable capital markets instrument which has an independent life of its own. That life is governed by the terms lined out in the bond prospectus. If those terms, for whatever reason, are not complied with, the bond goes into default and triggers all sorts of consequences such as cross-default. Even if one large bondholder were willing to renegotiate terms, he could not do so on his own.

I am surprised that this key difference between bond financing and loan financing has not at all been discussed in the case of Greece. In good times, bonds are a wonderful instrument: the borrower can raise large amounts of money in a rather simple way; there are no instalments of principal until the bullet maturity; one only has to pay interest annually during the life of the bond. Instead of a tough credit analysis, the borrower works out with the arranger of the bond a structure for which the arranger feels that there is 'investors' appetite'. They work out a 'story' which will 'sell'. The arranger has no credit risk responsibility other than the documentary responsibility (that the facts presented in the bond prospect are correct and, typically, one of the largest sections in a bond prospect is where the arranger spells out what he is NOT responsible for). The credit risk responsibility lies with the purchaser of the bond.

In bad times, investors' appetite goes out the window; bond prices go South and bonds cannot be refinanced upon maturity. In the worst case, it can lead to 'sudden stop' and NOONE can control that!

Hardly any country can 'repay' its bonds upon maturity these days. Virtually every country must refinance its bonds upon maturity. As long as there is investors' appetite, anonymous capital markets are a wonderful business partner. When investors' appetite goes out the window, capital markets are brutal because they can remain anonymous.

No investor of sound body and mind would buy the bond of a borrower who already has unsustainable debt, out of fear that, upon maturity in 5 years from now, the borrower might not be able to refinance. Unless...

Unless, of course, the investor has reason to believe that the implied support of a third party stands behind the bond. In the case of Greece, that third party is the EU. The most wonderful opportunities for investors are those where the real risk is much lower than the perceived risk. From the investors' standpoint, the perceived risk is that Greece might not be able to refinance in 5 years from now whereas the real risk, in the investors' estimation, is that of the Eurozone in toto. The investors get a return based on the perceived risk but only carry the real risk.

Greece has now opted to trust anonymous capital markets more than governmental partners (cynics could argue that Greece has opted to trust governmental partners that they will bail-out anonymous capital markets in case of need). If Greece were a stand-alone country with it own currency, a return to capital markets so early into the expected recovery would have to be considered as a sensational feat. It would indeed have reflected 'trust in the country's ability to exit the crisis' (Finance Minister Stournaras).

Trust is an elementary part of all financings. The only trouble is: one can only trust people whereas with anonymous capital markets there is noone on whom to bestow the trust. Greece has opted, at a cost of roughly 90 MEUR in excess interest expense annually, to trust anonymity.



PS: in reality, Greece has, of course, not totally trusted anonymity. Instead, it has trusted EU partners to bail-out anonymity in case it becomes necessary. The 3% interest premium goes to investors' P+L statements; it will be paid by Greek tax payers and, in the final analysis, by Eurozone tax payers.

Greece Has Issued the First Eurobonds!

Greece has successfully raised 3 BEUR in capital markets via the sale of a 5-year bond. Finance Minister Stournaras is quoted in the Ekathimerini as saying: "The international markets have expressed in the clearest possible manner their trust in the Greek economy, their trust in Greece’s future. They have shown trust in the country’s ability to exit the crisis, and sooner than many had expected."

Let me rephrase that a bit as follows:

"The international markets have expressed in the clearest possible manner their trust in the continuation of the Eurozone's bail-out policies. They have shown trust in the EU's continued ability to force tax payers to bail out banks and one wonders why it took capital markets so long to figure that out!"


PS: the headline was 'borrowed' from my reader Lennard.

Greek Bond Sale --- "A Hugely Significant Step?"

The Ekathimerini reports that Greece plans to sell 2 BEUR 5-year notes to foreign investors this week. That is quite a feat when considering events of the last few years; no doubt about it! Perhaps even a "hugely significant step", as the Irish Finance Minister is quoted as saying.

Greece pays about 2% (or even less) on bail-out loans. The new 5-year notes are expected to sell at just under 5,5%. That makes for a premium of about 3,5%. Multiplying 2 BEUR x 3,5% results in 70 MEUR surplus interest expense annually. Not the whole world but not a piece of cake, either.

What is that premium for? “It’s very much symbolic,” said Rainer Guntermann, a fixed-income strategist at Commerzbank AG in Frankfurt. "Even though it’s more expensive than the bailout loan it could mark the start of a return to normality.”

Money is a fungible entity, so it can never be said with certainty what borrowed money is used for. Since Greece now has a primary surplus, one can only assume that the 2 BEUR will contribute to paying upcoming interest and principal maturities. As far as I know, the upcoming maturities of principal and interest are due to official lenders (ECB, etc.). In short, money will be borrowed from Peter in order to repay debt owed to Paul. Peter is the private investor who will now get a superb return since he can feel confident that Paul, the official lenders, will pay him out in case Greece cannot. The latter is, of course, my assumption but events over the last years would suggest that it is a fair assumption.

When Warren Buffett invested billions of dollars in Goldman Sachs stock in the midst of the sub-prime crisis, that indeed marked the start of a return to normality for GS. The difference with Greece is that Buffett did not have an explicit and/or implicit pay-back guarantee from the US government. Buffett was gambling of the future of GS and his investment showed that he believed in that future. And, as time went on, other market participants started sharing Buffett's belief. Beliefs reinforce themselves mutually and the herd instinct of financial players swings into full force.

All of this may happen in Greece, too. Or not. Time will tell. The 70 MEUR surplus annual interest expense is a bet on the chance that it will happen. If it does happen, it will have been a good bet. If not, it will have been a waste of money.

There is another difference between GS and Greece. In the case of GS, it is highly unlikely that there will be a management crisis and/or complete management replacement when the company is on a solid recovery track. In the case of Greece, a complete government change cannot at all be ruled out. When GS recovers, there may still be periodic but manageable setbacks. Not much needs to go wrong in Greece and there could be a complete set-back. In that case, Greece would - once again - face a moment of 'sudden stop' as regards foreign funding. Put differently, there is only limited assurance that the return to the markets will be a sustainable one.

To cut a long story short: I would not opt for a return to the markets at this stage. The premium for doing that appears too high when compared to the benefit which might possibly be derived from it. Instead, I would go after cheap bail-out money as long as I can get it and I would do it to the fullest extent possible.

Good Competition and Good Regulatory Framework = Big Impact on Growth!

"What struck me most was that Greece was a relatively closed economy and that Greek consumers did not have at their disposal enough options for goods and services because of the lack of competition. Therefore we took a very, very thorough and in-depth look at the question of competition. And competition helps in many ways, not only in terms of empowering the consumer. It brings with it investment, management skills, access to other markets; it helps combat corruption. What you will find, which has inevitably and invariably been the case, is that one measure will count for one, but two measures will count for three, and three for 25. Measures are mutually reinforcing, they don’t work in isolation. Put good competition and a good regulatory framework together and you will have a big impact on growth – you can have an increase in growth in the next 5-20 years of between 5-20 percent of GDP".

Angel Gurria, Secretary General of the OECD, in this interview with the Ekathimerini.

Beware of Greeks Bearing Primary Budget Surpluses!

"A primary budget surplus is a surplus of revenue over expenditure which ignores interest payments due on outstanding debt.  Its relevance is that the government can fund the country’s ongoing expenditure without needing to borrow more money; the need for borrowing arises only from the need to pay interest to holders of existing debt.  But the Greek government has far less incentive to pay, and far more negotiating leverage with, its creditors once it no longer needs to borrow from them to keep the country running. This makes it more likely, rather than less, that Greece will default sometime next year".  

This was written in the Geographis Blog last December. Today, nothing seems further from reality than a Greek default: the country is receiving accolades from all sides; financial investors are lining up to get a piece of the action before the recovery goes through the roof; Greece's borrowing costs are declining to levels last seen only before the crisis; etc. 

Still, the argument is in and by itself correct: the government can now pay its domestic bills without requiring money from abroad. Furthermore, with a current account surplus, the entire economy can now survive without funding from abroad. As long as Greece had a primary budget and a current account deficit, its negotiating strength was the nuke. Using it would have brought down Greece itself as well. With surpluses in domestic and external accounts, the nuke has turned into a strong weapon.

Perhaps Greece should use this new weapon to introduce a new kind of conditionality. So far, conditionality has meant that Greece gets money in exchange for reform commitments. However, the tone has changed already. Where previously Greece was told to "do this, or else...", the German Finance Minister Schäuble, the old fox, now says in a remarkable Ekathimerini interview that the terms of any new program for Greece "would certainly be much lighter. Help from the European rescue mechanism can only come with conditionality. But this obligation for a commitment to reforms served one purpose only: to bring growth to Greece".

This is exactly the argument on which Greece could rest its own demand for a new kind of conditionality: "We accept your conditionality because, as you say, it is meant for growth, i. e. for our own good, but that will only work if you also arrange for new foreign direct investment in Greece". Put differently: just barely keeping Greece alive while saving the Euro is no longer good enough. There now have to be measures which help the patient to speedily recover. Or else...

By foreign direct investment, I do not mean financial investors who acquire Greek financial assets. Instead, I mean foreign companies which transfer money and know-how to Greece to create new economic activity/value in Greece, preferably stimulating new exports. That, in my opinion, is the only way to achieve an accelerated increase in employment.

Would that new conditionality mean asking too much of foreigners? Not at all! Foreigners wouldn't be asked to give anything; instead, they would be offered the opportunity to make good investments! Foreigners will immediately reply that there simply are no good investments in the Greek real economy as long as the economic framework remains as it is. Fine. So both, potential foreign investors and the Greek government, will have to agree on something which is satisfactory for both sides. A new Foreign Investment Law would be a suitable instrument to accomplish this.

In certain ways, the window of opportunity for a constructive approach to a new kind of conditionality as above may not be open forever. Given everything that SYRIZA has said so far, it would be almost reckless of them not to use the new weapon of balanced internal and external accounts should they come into power. But given everything SYRIZA has said so far, it would appear highly unlikely that they would use the new weapon in a constructive way.

Incidentally, I came across the Geographics Blog through John Mauldin's newsletter which, as always, is very interesting to read. This time, his analysis of "The Lions in Europe" seems particularly fitting the current situation.

The Euro --- A Most Successful Currency!

When the Euro was introduced, it started with an exchange rate of 1,17 USD/EUR. The Euro initially lost value against the US dollar, hitting a low of 0,82 USD/EUR within two years. Soon thereafter, the Euro recovered, returning to and exceeding the initial value of 1,17 USD/EUR and never falling below it again. It peaked in 2008 at 1,60 USD/EUR. Nowadays, the Euro is trading close to 1,40 USD/EUR.

An American who converted all his dollar savings into Euros when the Euro was introduced would today be substantially better off than he is with his dollars: the currency appreciation on one hand and higher interest rates on the other.

Wikipedia states that 332 million Europeans use the Euro and another 210 million worldwide use currencies pegged to the Euro. The Euro is the world's second largest reserve currency.

So what's wrong with the Euro? Nothing really, as long as one believes that the primary purpose of the Euro was to be a strong international reserve currency.

However, take Greece as an example. Suppose the austerity of the last 5 years have made Greece 15% 'cheaper' within the Eurozone. Relative to third currencies, that effort was wiped out by the revaluation of the Euro by about 15% in the last 2 years.

What a deal! You go through all sorts of pains to become more competitive pricewise and due to factors totally beyond your control, that pain turns out to have been for nothing. Well, not really for nothing because Greece does much of its trade within the Eurozone but the rest of the world could potentially hold very much promise for the Greek economy and that potential has been damaged by the Euro.

Prof. Hans-Werner Sinn Agrees With Alexis Tsipras!

Prof. Sinn has published a new book titled "Gefangen im Euro". I have only read a brief summary of it but the following stands out.

Sinn proposes a European Debt Conference to relieve the periphery countries of some of the excessive debts they have. If memory serves well, that is also a major point of Alexis Tsipras. Perhaps the two should combine forces.

Sinn, of course, also makes numerous other proposals (e. g.: a mechanism for 'temporary exits' from the Eurozone; a European Confederation following the example of Switzerland; etc.) but for him to propose a European Debt Conferrence with the above-stated aim is something I would not have expected to come from Sinn.