Friday, March 9, 2012

Operation successfully completed! Patient cured?

All other numbers are somewhat less definitive because there is no official source of information. These are the key statistics:

206 BN EUR – public debt held by private creditors
177 BN EUR – sovereign bonds under Greek law; of which
152 BN EUR – accepted haircut of 53,5%
  20 BN EUR – sovereign bonds under foreign law; of which
  14 BN EUR – accepted haircut of 53,5%

Bottom line: through activation of the CAC, Greece will get private creditors holding 197 BN EUR out of the total of 206 BN EUR to accept a 53,5% haircut. That is 95,7% of the total private creditors. This percentage could increase depending on the outcome of the debt subject to foreign laws.

A grand success? Yes, certainly relative to what was expected/feared only a week ago.

The best of all worlds? No, not at all! The price which all parties involved will have to pay for this solution is far higher than what it would have been had the process been managed correctly from the start (as this blog has argued for over one year now).

What is the price which all parties have paid?

1. The precedent of a substantial haircut on sovereign debt of a first-world country after only 2-3 years of crisis (and without any one-time destruction) has been established. This is a historic first! No one can estimate at this point what this will mean for future sovereign financings.
2. For generations, Greeks will be reminded that they set a record in terms of wasting other people’s money (OPM): Bernie Madoff wasted 50 BN of OPM and got a jail-term of 150 years for that. Greece wasted 100 BN of OPM and got (short-term) praise for that. The fact that it was USD in the case of Madoff and EUR in the case of Greece is more or less irrelevant.
3. Private creditors accepted a 53,5% haircut without getting any upside in return. Normally, the upside would have been that in exchange for forgiving 53,5%, the other 46,5% become worth 100% (or close to it). As it appears, those “other 46,5%” will trade between 20-30% in the secondary market. A cynic could ask: why did you even bother if that’s all you got for it?
4. Greece as a country is as bankrupt after the PSI as she was before the PSI. While it is quite possible that a primary surplus in the budget will be achieved soon (which would be an outstanding success!), the Greek banking sector would collapse the day when foreign funders (ECB) stop funding.
5. Tax payers of other countries paid far more for this PSI than they should have paid. Tax payers should only have paid to finance the ongoing operations of the Greek government (budget deficit). They should not have paid to let private creditors “off the hook” and to allow wealthy Greeks to transfer their money offshore.

To explain my argument in more detail, let me use those terrible expressions of “what should have been done” or “what could have been done”.

First, Greece’s public debt of 368 BN EUR (or whatever it was at the outset of the crisis) should have stayed where it was then: with private sector creditors! That way, tax payers would not have seen about 100-150 BN EUR move from private sector risk to their own risk. Please note that these 100-150 BN EUR were kind of an upfront payment to private sector creditors which makes the 53,5% haircut ratio appear in a different light.

Secondly, private creditors would have needed to be persuaded to accept “evergreen bonds” for that amount of the 368 BN EUR in public debt which exceeded the Maastricht-level of 60%. These evergreen bonds could have had maturities between 50-99 years from now and they could have carried market interest rates. The point is that principal and interest would have been payable upon maturity; not before. These bonds would initially have traded at little above 0%. Thus, this would initially have been the equivalent of a gigantic loss but not a haircut. Should miracles occur in the next 50-99 years, the bonds would have regained value. Private creditors would have maintained at least the theoretical claim against some possible future upside.

Thirdly, the Maastricht-level debt of 60% would have had to be restructured based on a reasonable debt profile and interest expense for the budget. Presumably a variable interest rate depending on the progress made with reforms.

Fourthly, that way, all private sector risk takers would have remained risk carriers (which is one of the foremost principles in any restructuring of debt). However, none of them would have been forced to voluntarily forgive legal claims.

Fifthly, tax payers would still have had to come up with money for Greece. However, that money would have been in much smaller amounts because it would have only served to finance the ongoing operations of the Greek government (budget deficit) and not the repayment of private creditors, etc.

Finally, if a private creditor forgives 53,5% of his claims and gets in exchange a new claim for the 46,5% which is worth 20-30% of face value, well, then that is not a good deal at all. Any sensible businessman would say: “I won’t forgive you the 53,5% outright but I won’t ask for payment for the next 50-99 years”.

With this procedure, no principles & precedents would have been broken and no one would be worse off than they are today (except, perhaps, the shareholders of the private sector creditors). And certainly Greece and Greeks would be a lot better off today than they are.

Why is it so important to never forego a legal claim on sovereign debt too hastily? First, it is the issue of principle & precedent on which sovereign lending is based. But there is one other equally important reason.

The economic fate of sovereign states can change relatively quickly (not within a couple of years, of course, but certainly within one generation). Do you remember that Russia was bankrupt in 1998 and now has one of the highest foreign reserves of any country in the world?

Let’s assume a few miracles for Greece. Let’s assume that a new Age of Renaissance and/or Enlightenment comes over the Greek people, above all the Greek leadership and/or upper class with the result that problems are attacked rationally and not emotionally. Let’s further assume that the world’s largest oil & gas reserves are discovered under the Aegean. Let’s assume that Greeks begin with some serious utilization of the country's competitive resources and advantages. Could one not envisage that Greece could become the economic tiger of the Eastern Mediterranean? Maybe not, but certainly not for sure!

Whether it is a family, a company, a public sector or an entire country --- they are all social systems. The larger a social system, the more energies it can generate if its resources are marshaled well.

A madman showed in the 1930s what destructive energies a society can generate if its resources are marshaled the wrong way. JFK showed how Americans could “land a man on the moon and return him safely to earth before the decade is out” even though that appeared totally impossible at the time. Interestingly, today – without JFK and without a national desire to accomplish such a goal – the US wants to return to the moon but they may now need twice as long to accomplish that, if ever.

Alfred P. Sloan, who in the first half of the last century turned GM from a collection of car manufactures into a corporate empire, allegedly once said: “Give me an organization and I can perform miracles”.

Leadership can mean many different things to different people but it undoubtedly means the following to all people: to marshal the energies of an entire social system towards a positive goal and a better way of life for all.

What the government under Prime Minister Papademos has accomplished in the last 3 months is remarkable: steady and solid work to undeterredly reach a previously targeted goal; and they reached it.

In my opinion, the real goal for Greece is not to make financial markets happy. Instead, the goal should be to achieve a modern, value-generating society where citizens want to stay in order to contribute instead of wanting to leave in order to have a better life elsewhere.

If that goal were reached, financial markets would undoubtedly also become happy (as a side-product).


  1. I don't understand the meaning in some parts but especially in 2???

    I remember some others participated in two WW causing huge casualties.
    They should be kept "in jail" for years?
    Definetely not.

    "Greece wasted 100 BN of OPM and got (short-term) praise for that".

    Yes we are helped a lot, but we are also paying -fairly-the price, in short term.

    But all Greece = Madoff???

    1. Points 1-5 describe the most important damages resulting from the form of PSI chosen which come to my mind. I am sure more will become apparent as time goes on.

      Point 2 simply states that future generations of Greeks will have to pay for the form of PSI chosen. The argument I listed is only one of many which will come up, and those are not my words. They are the words of one of Austria’s better known journalists.

      I have argued since the beginning that a forgiveness of sovereign debt after only 2-3 years of crisis (and without any one-time destruction like a tsunami, etc.) is about the worst alternative for both the creditors and for Greece. Why it is terrible for Greece I have stated in this article:

      I have written more about this subject. Look up my blog inventory; there is an entire section on it.

      A PSI is, of course, required when a country hits external payment problems. There is no other way to resolve such a situation. But, until Greece came up, political leaders and lenders understood that a PSI must take the form of rescheduling maturities of principal and interest but not the hasty forgiveness of debt. Incompetent EU-elites managed to turn the tables on dealing with external debt problems upside down.

      Here is an example: private creditors forgave 53,5% and got new bonds for the 46,5% which bonds, so I read, are already trading between 20-30%. If they are trading at 30%, this means that private creditors presently have a value of 13,95% of their original investment (46,5% x 30%). To only get 13,95% on your original investment and to not have any upside at all is not a good deal by far. Most bankruptcy laws say that a company can only come out of bankruptcy “clean” if at least 25% of the debt is taken care of.

      If you know that you are only going to get 13,95% on your original investment, you are much better off to say that you will settle with evergreen bonds for that amount of debt which exceeds the 60% Maastricht limit and capitalize interest thereon. You may initially have 0% value on that and no cash interest but you do have the potential of an upside. If one of those miracles which I suggested happens, you will really have an upside!

      But the debt up to the 60% level will really be quite solid after the above form of an PSI. In fact, I don’t see why that debt could not trade at 100% over very close to it. Why? Because it is preferential to all other sovereign debt of Greece.

      Below is the article where I described my position in more detail.

    2. 1)I understand those retail private bondholders who lost a lot of their savings and i feel awkward for them.
      But from the moment many countries of eurozone discover the solution of restructuring debt with PSI+ this solution would have dire side effects.

      2)Now for the journalist thesis.
      You mention his opinion probably because his point of view is rational and acceptable from most people in country.
      He represents " a kind of common sentiment" right?
      Conclusion, the average people of Austria might think the average Greek as a thieve.
      This sentiment it might be true in generall but is not the objective reality which is always more complicated and not black or white.
      So which is the solution? To exclude Greece from euro? After Greece, Portugal and Co.?
      It might be.

      Generally most of people interpreting the facts based on a general given opinion and to what people want to here in order to find an "enemy" to justify the economic eg downturn.
      This is happening in Greece but also in mass media and the same in other contributing countries.

      But all forget the details of a siuation and the extensive coverage or some small but promising news covered full from bad sentiment.

    3. Frankly, I don't think that journalist had a thesis nor do I think that he gave this too much thought. He just expressed feelings which come to the minds of people who have to foot the bill.

      Everyone knows, of course, that Greece has a lot more debt that she can handly (even now after the haircut). So the question is not whether every creditor can ever get his money back. The principal question is whether or not one opts for a solution where creditors maintain the legal claim (even if it is worthless in the near future) or whether creditors are forced to voluntarily give up much of their legal claim.

      The EU said that creditors should give up much of their legal claim and they even encouraged Greece to implement CACs retroactively. Both, the EU and above all Greece, will pay dearly for these 2 mistakes (in my opinion). Future generations of Argentines will hear from financial markets that some of their ancestors repudiated part of the country's debt around the turn of the millennium...

  2. Let's NOT forget that the Troika( IMF,ECB and european Commission ) signed an MOU with Greece in May 2010, and the -wrong according to many economists- decisions on handling Grek debt was largely due to them , i.e. Troika.
    So, the considerations of the Troika, in conjunction with the Greek government, where possibly aimed at something else, NOT merely handling debt the best possible way.
    One example of this are the destructive austerity measures they enforced, that were bound from the start to throw the ecomony into deep depression-thus defying the ''purpose of the exercise''.

    1. I simply cannot believe in things like hidden agendas and/or conspiracies. Not in the case of Greece and not in any other case.

      I guess outsiders simply were not familiar with the Greek situation. They thought that applying the standard IMF-medicine would work. That medicine can indeed work (even though it fails just as often) but it can only work where certain conditions precedent are in place. For example: the economy works more or less ok and has the famous self-healing forces; reforms are put in place swiftly so that self-healing forces can start healing; etc. None of this was the case in Greece. If you don't have a workable framework for self-healing forces to unfold, they can't unfold.

      In terms of cutting government expenditures, Greece has done more than probably any other country in history (minus 15% of nominal expenditures in 2 years!). In terms of reforms, Greece has done very little so far. So, one has scraped on the surface but one has not gotten into the substance. Overall, I am not aware that Greece ever had a plan on her own. My sense is that Greece handed over her fate to the Troika and promised to comply with their wishes. That approach, of course, has zero chance for success.

      Again, I simply can't imagine that someone intentionally wanted to cause suffering for Greeks and/or destroy something there. Cui bono? However, every one knew that Greece had to become cheaper by at least 30-40% in a hurry. They thought cutting government expenditures would achieve such an internal devaluation but - surprise, surprise - it didn't. Greece today is still far, far too expensive in order to be competitive. I recently read an analysis which said that Greece would have to become 31% less expensive in order to be able to compete with Turkey. I don't know how people calculate things like that but what I do know from my own experience is that, today, Greece is still - on average - far more expensive than she should be. Some things are indeed very cheap in Greece (i. e. train transportation). Other things are ridiculously expensive.

  3. what about trilion of mortgage loans that us flooded eu bunks,
    money that american citizens received but they didnt pay back.

    1. Big difference between "normal" debt and sovereign debt. Normal debt is forgiven all the time and investors/lenders lose money for having poorly assessed risk. Sovereign debt is a holy cow because a sovereign country cannot legally go bankrupt and because it will live forever (as opposed to Enron which disappeared after the bankruptcy was finished).