Wednesday, January 18, 2012

Good news: there may soon be a default!

Default seems to be approaching if everyone keeps his word: the hedge funds have vowed not to take part in the PSI which will cause the well-deserved miscarriage of that unfortunate idea. The EU has vowed not to disburse the next tranche if the PSI is not implemented. If Greece doesn’t get the next tranche, a 14 BN EUR bond maturing in late March (so they say) will not be paid. Greece will have to be declared "in default".

Bad news? Not at all! 

Every end of something is the beginning of something new. This should be viewed as the beginning of a Fresh Start to (a) resolve the sovereign/foreign debt situation of Greece and to (b) implement new concepts for the turn-around of the public and private sectors of Greece!

Here is an attempt to draft (certainly incomplete!) to-do lists which should assure that, at the end of the day, everyone is happy that things evolved this way.

To-do's for the Greek government
1. Start immediately (or re-enforce them if they are already in place) cash-preserving measures so that the country (state and banks) has enough liquidity when default happens. Banks should borrow from the ECB as much as they can and "park" that liquidity, if possible, with institutions outside the Eurozone. Precautionary arrangements should be made that international financial transactions (above all exports receipts) can be made via bank accounts outside the Eurozone (preferably China). The government should exercise even more "cash management" (accelerate receivables, slow down payables). Perhaps the government can arrange put options with "befriended counterparties" for the sale of certain state assets should liquidity be required. Etc., etc.
2. Hire immediately a most highly regarded advisor as regards debt reschedulings (my suggestion: William R. Rhodes). That advisor would be the liaison with foreign creditors and would know how sovereign borrowers, when in the midst of an external payments crisis, can make "offers which creditors can’t refuse" to their foreign creditors (in terms of structure and conditions). That advisor would also have the credibility with the Greek government to tell it what it "cannot refuse to do". In a way, that liaison would act as the intermediary between Greece and her foreign creditors. His stature would lend him the credibility to be perceived as an objective arbitrator whereas in actual fact he defends the interests of Greece.
3. Instruct the Ministry of the Economy to immediately start drafting a long-term economic development plan and to involve every possible outside resource (consultants, academia, etc.) in the drafting. That plan will be the key negotiating instrument which Greece will have once default has occurred. It must be a plan which no thinking person can object to! And the plan must be ready by late March!

To-do's for the new advisor/liaison
Under the supervision of the above advisor, a Task Force would develop alternative models to be offered to creditors for the rescheduling of Greece’s sovereign/foreign debt. Some key elements thereof would be:
1. Definition of the debt which is encompassed by the rescheduling; segregation of that debt into different categories; separate rescheduling terms for each category.
2. Interest rate structure: during the “reorganization period” (for instance the next 10 years), Greece’s cash interest expense must be variable and a function of the success of the reorganization. Cash interest expense would increase if the reorganization develops ahead of schedule, and vice versa.
3. The concept of “capitalized interest” (i. e. payable later) must be put in place. All interest which creditors have a reasonable claim to charge but which Greece cannot afford to pay (yet) should be capitalized.
4. The concept of “evergreen bonds” must be put in place. Example: all debt which exceeds Greece’s present ability to service should be structured as evergreen bonds (i. e. a maturity of 31.12.2099). This in lieu of a haircut.

Collateral measures
1. Greece must take preemptive measures to assure the uninterrupted financing of its budget and current account deficits.
2. Such financing should come from the EU (budget deficit) and the ECB (current account deficit).
3. EU/ECB should extend such financing against Greece’s unequivocal commitment to the following: (a) unanimous support of the long-term economic development plan by all political forces; (b) unanimous support of the short-term plan to restructure government expenses by all political forces (focus on redistributing expenses instead of cutting them overall, and on generating new revenues from “new" tax payers while relieving "existing" tax payers of some of their burden).

The carrot & stick
The stick is that, during the implementation of the long-term economic plan, the Greek people will have to be prepared to endure even more and very painful adjustment measures.

The carrot is that, in order to motivate the Greek people to go along with that, Europeans (and not Greek tax payers) will finance the long-term economic development plan. Put differently, whatever financial resources are required to successfully implement the long-term economic development plan will not have to come out of the pockets of Greek tax payers. And, last but not least, Greeks can have the vision of there being light at the end of the tunnel.

The carrot
1. A giant investment plan to promote growth in the Greek economy. The details of the plan would already have been developed by Greece (see above). The financing would have to come from sources outside Greece (Greeks who are “domestically wealthy” would certainly be invited to participate in this project as well).
2. The sources of financing would have to be foreign investors, the EIB, the EU Structural Funds and more of the same.
3. And, of course, these investors can only be expected to put up “giant” sums of investment money if Greece offers them the economic framework which they require for such investments. The EU should guarantee Greek compliance with that framework.

Other collateral measures
1. The Greek government must guarantee all savings deposits and retirement plans until the dust has settled on the debt rescheduling. If necessary, implement capital controls to prevent capital flight.
2. The EU must permit Greece, during the “reorganization period”, to depart from the EU-freedoms of free movement of goods and capital (so that temporary import taxes and controls on capital flight can be implemented).

What does all of the above mean?
Effect 1: no Euro-exit for Greece.
Effect 2: the existing debt is rescheduled with existing creditors. Risk takers remain risk carriers.
Effect 3: Fresh Money from European tax payers is required only for the financing of budget and current account deficits (approximately 3 BN EUR per month).
Effect 4: it becomes justifiable for tax payers in surplus countries to provide Fresh Money because (a) the amounts involved are now manageable and (b) they serve a meaningful purpose (supporting the long-term economic development plan for Greece).
Effect 5: risk takers remain risk carriers which will make the concept easier "to sell" to the voters in the surplus countries.


  1. I agree with much the writer set out.Not however, staying in the eurozone.

    Think of Greece "Pre-euro" - precisely - and project THAT state of affairs forward to today.

    Actually, there would be no crisis to speak of. Greeks would still be making their own decisions and being pushed around by German bureaucrats.

    To your excellent concept of a 'controlled default' - add return to the drachma.

    Same trauma for 3 maybe 2 years - then Greece will be out of the fog. Democracy, hijacked by the Brussel's incompetents, will be restored.

    No matter what the French and Germans say, the Greeks have a huge following of friends in Western Europe. These people will willingly pay a little more to buy Greek and save a great little country from the jack boots of the EU Commission.

    Zito Hellas!

    1. There is only one reason why I shy away from the thought of Greece's leaving the Eurozone, and it is not an economic reason. Economically, Greece as a society would definitely be more comfortable today (albeit with a much lower living standard) had she never joined the Euro.

      My problem with a Euro-exit is strictly of a political nature. I think that there could be anarchy. Why?

      Greeks now have over 24 months where, month-after-month, they were showered with bad news. Many Greeks have suffered enormous economic hardships. And now, one day, they wake up in the morning and hear that all their domestic financial assets (savings, pensions, etc. etc.) have declined in value by 40-50% (or even more). And the righteous Greeks who have been taken for a ride by "the other Greeks" for over 10 years now, they suddenly see that they again take the losses whereas "the other Greeks" have already taken steps to protect their wealth.

      By golly, I just can't see how social peace can survive that! If it did, then I would agree that after 2-3 years Greeks would again be happy to have left the Eurozone.

    2. On the issue of leaving the Eurozone: many us are hoping for it. Speaking as just another nobody from the (rapidly becoming destitute) multitude in Greece, don't be so quick to assume that social peace is a line in the sand for us. Violence has been and is being committed against us. Yes, we've had 24 months where we've had blow after blow. We've also been reading the newspaper. Just because we're poor, that doesn't mean we also haven't taken whatever measures we believe are necessary to protect ourselves, and will continue to do so. Yes, certainly our quality of life will decline further for at least a few years - but we've been hearing about it and preparing for it for 2 years now, and that *without* the all-important "light at the end of tunnel."

      Anarchy is a pretty good word for many aspects of the relationship that the Greek government and the Greek people have with each other. We're not as afraid of it as you might think.

      Great blog! Thanks for an excellent article. :)

  2. Man ... I'm speechless ... How myopic can one be ? You drew a nice To-Do list for the Greek govt. Fair enough. But stop for a moment and ask yourself : what part of this list actually needs the default to happen beforehand ?
    1. Start cash-preserving measures ? What exactly prevents the Greek govt from preserving cash by reducing the pension payments and the state payroll right now ? Nothing, lest you realise that Greek govt doesn't respond to the imperatives you think it should
    2. What exactly prevents the Greek govt from hiring whoever you recommend right now ? And making offers creditors can't refuse right now ? Especially since it has the backing of Germany
    3. Why exactly is a default needed in order for the Greek govt to have a long term economic development plan ??? I mean, if they were able to create, as you so well say, an economic plan no one can object to by late march, where exactly would a default be needed / helpful ?

    1. No default is "needed", of course. The point of this post was to suggest what Greece would need to do if default happened or rather if it could not be avoided (or if it were "allowed to happen"). All of the things could definitetely be done before a default. Chances are that they won't be done until something is about to hit the fan, and perhaps not even then. But if default occurs and there are no specific plans how to deal with it, then good night Greece!