Saturday, December 31, 2011

Closing 2011 with a minority view

The clear majority view seems to have become that the involvement of private banks in the debt crisis has been the greatest mistake so far. Furthermore, that the refusal so far to issue Eurobonds is the major reason why the crisis has seemingly drifted out of control.

Those who have been following my blog know that I take a different view and the approaching year-end is a good point to summarize it. Most of what I say below falls into the category of what "should have been done". I am not sure that what "should have been done" can still be done at this advanced stage of the crisis but perhaps my arguments stimulate thought.

What should have been done?

1) Above all, the possibility of a Euro-exit on the part of Greece should not have even be brought into discussion, at least not until some future time when stability has returned. A Euro-exit would bring along unpredictable political turmoil in Greek society.

2) The Greek external payments crisis should have been treated as quite a normal thing from the start. "Normal" in the sense that an external payments crisis is the most natural thing to happen when a country runs enormous current account deficits (financed with debt) for an extended period of time, and "normal" in the sense that this has happened innumerable times with other countries before so that Greece was neither a surprise nor an exception.

3) Under no circumstances should the Greek external payment crisis have been defined as a life-and-death issue for the Eurozone, not to mention for the EU. One should have reacted to this normal crisis in the normal way.

4) The normal way would have been for Greece to ask her lenders to reschedule debt as soon as it became apparent that a confidence run had started against the country. Looking back, that would have been at the latest by early 2010.

5) If Greece had not taken that initiative, then the EU should have prompted Greece to do so. Under no circumstances should the EU have given any signals that it was going to stand up for Greece's existing debt.

6) The rescheduling should have encompassed not only the sovereign debt but all other foreign debt of the country (i. e. including the foreign debt of the banking and other sectors). The debt to be rescheduled should have been split into separate categories with different terms for each category (i. e. better terms for government-to-government and short-term trade debt than for long-term bonds).

7) The general principle would have had to be: the existing debt will be rescheduled with existing debt holders ("risk takers remain risk carriers") and the needed Fresh Money (i. e. for the budget deficit) comes from the EU.

8) Banks' participation in the debt rescheduling would have been the "private sector participation". Nothing more required of banks. Under no circumstances should a haircut have been considered.

9) A haircut has disastrous consequences for both the international markets as well as for Greece. The long-term consequences on financial markets of the precedent of a haircut for a first-world country after only 2 years of crisis cannot be foreseen. The long-term consequences for Greece of having needed a haircut cannot be foreseen, either.

10) It was wrong to consider it as the foremost question how much sovereign debt Greece can handle (100% of GDP, 150% of GDP; more?). The only question which matters is how much interest Greece can reasonably be expected to pay on her sovereign debt.

11)  The interest rate on the rescheduled debt should have been split into 2 portions: (a) interest paid in cash and (b) interest capitalized.

12) The total cash interest should have been put on a variable basis (i. e. a percentage of total government expenditures). Interest exceeding that amount should have been capitalized.

13) The sovereign debt should have been split into 2 portions: (a) the amount within Maastricht-limits (60% of GDP) and (b) the rest. The Maastricht-portion should have been rescheduled at normal terms (maturities up to 20 years). The rest of the debt should have been structured as "evergreen bonds" (maturities up to 99 years).

14) A condition precedent for the rescheduling should have been that the EU provides the Fresh Money and negotiates with Greece the implementation of deficit reduction measures and reforms.

15) The deficit reduction measures should have focused almost entirely on revenue-raising to increase the government revenues from an unacceptable 38% of GDP to the more common level within the EU of 46-48%. Only little should have come from existing tax payers. The bulk should have come from those who have never paid (or underpaid) taxes. If Greece had needed EU-support for that, the EU should have sent legions of experts to Greece. The Greek population at large would certainly have applauded that.

16) Since Greek government expenditures were not at all out of line with EU-averages (around 50% of GDP), they should have only been reduced minimally in order to avoid too much of an ecnomic slump. However, they would have had to be restructured dramatically along the principles of fairness and utility ("stop taking money from the living so that pensions can be paid to the dead").

17) Parallel to the debt rescheduling, an investment program for the private sector would have had to be initiated, to be financed with foreign investment. Initial focus should have been import substitution products. Special Economic Zones with an internationally competitive business framework should have beeen established to attract foreign investment. Compliance with the respective new law(s) should have been guaranteed by the EU to provide security to foreign investors.

18) Temporary protective measures ("infant industry protection") should have been implemented to stimulate new domestic production (special taxes on imports) and to stop capital flight (capital controls).

19) A long-term economic development plan for the Greek economy should have been developed with the focus on getting the current account deficit under control by emphasizing domestic value generation and, thereby, reducing the dependence on imports.

20) Finally, the possible impact of the rescheduling on the stability of foreign banks should not have been an issue for Greece. If foreign banks had experienced problems, their respective governments would have needed to bail them out directly (instead of using Greece's balance sheet to bail them out indirectly). The same logic would have applied to any disturbances caused by the CDS-market.

So, here you have it. "Should have have been"; "could have been"; etc. An American manager might say: "I don't pay you for telling me what should have been done in the past. I pay you for proposing to me what should be done in the future!" One can only hope that 2012 will be the year in which Greece manages to do something about her future on her own!


  1. Good analysis.

    The worryign thing is that this is common sense stuff. The crisis was blown out of all proportion and the EU leaders first over dramatised the situation, caused panic in the markets and cut Greece loose to negotiate the economic storms that followed.

    I suspect some of this was as a result of some EU nations enjoying the distraction from their own ecomonic issues.

    MK - Greece/Cyprus

  2. Dear Sir,

    many thanks for your effort in presenting a picture of this crisis that, obviously, affects dramatically interests with the power to influence the mainstream of worldwide media opinions.

    Your germanic heritage witness a longstanding evidence of noble personalities that do not accept to minimize their opinion to pay respect to a "dorfishe" self-interest.

    I am pretty sure why I present things like this, even not being of Greek origin, in fact I am Italian.

    It is a shame personalities like you do not write technically policy maker suggestion for the coming months. I understand how often skilled individuals feel that nobody will listen to their opinion and advise because others weak-back characters are the only allowed to seat at the right desk of power.

    In my humble opinion voices like yours, anyway, represent a witness of how things may be dealt in a different way which, alone, cover of shame those sturdy and arrogant characters the "system" put in charge!

    I will be deligthed to ear more from your side.


    Francesco Gerardi,

  3. Somehow I don't quite get it: Was the Greek debt, in your opinion, to be reduced or not?

    Maybe my English, or my knowledge of technical terms, isn't good enough.
    But what is the difference between "rescheduling debt" and "private sector participation" on the one hand, and "haircut" (that you dismiss) on the other?

    1. "Rescheduling" = debt stays with original creditor, its maturities are moved way into the future but creditors maintain 100% legal claim.

      "Haircut" = creditors forgive part or all of their claims once and for all.

      See my Post "Default, bankruptcy, etc."

    2. I strongly feel that the ENTIRE debt of Greece should have remained in place without any haircut. It is simply against all principles of responsible finance to make a haircut on sovereign debt after only a few years of crisis.

      The entire debt should have been split into 2 portions:(a) the "manageable debt" (for example the Maastricht portion of 60%) and (b) the remainder.

      The manageable debt should have been rescheduled out to normal periods (20-30 years). The remainder as "evergreen bonds" (for example 99-year bonds like Mexico recently).

      The cash interest payable should have been set in form of a variable rate such as a percentage of government expenditures. The amount of interest demanded by creditors but above this cap should have been capitalized. Then the question would have been how much of total interest to allocate to manageable debt and the remainder.

      Where is the trick? The trick is that no one would expect the remainder to ever get paid 100%. At the outset it might trade at not much more than zero percent. But if the Greek economy can be saved and turned around that way, this debt would eventually trade at higher rates. And if, at the end of the day, it traded at 20%, creditors would have made a killing relative to a haircut. A lender who agrees to a haircut has no longer an incentive. If he holds a bond trading at near-zero but with the potential of going to 20%, he has a huge incentive.

      Fresh Money always come separate from a reschedulng but is part of the overall negotiating package. Normally, Fresh Money is brought up by existing creditors on a pro-rata share of their exposure. Given the exposures involved, this would have been far too much for creditors. Thus, it would have been quite defensible that Fresh Money (to finance the agreed-upon budget deficit, but nothing else) should come from public sources (Troika).

      Bottom line: risk-takers (original lenders) would have remained risk-carriers, one of THE principles of lending! Tax payers would only have been called upon to finance only Greece instead of bailing out the entire European banking sector. And Greece would have had the breathing space it needed.