Wednesday, November 28, 2012

An opinion on debt forgiveness and a summary of the 'deal'

Below are a couple of very interesting articles:

Greece does not need debt forgiveness (by Daniel Gros)
Another ad hoc deal or a step towards a solution? (by openeurope)

Daniel Gros describes very well that it is less the level of debt than the interest rate which matters. At the current (subsidized) low interest rates, a well-functioning Greek economy might not have difficulty servicing the debt as it presently stands.

openeurope gives a beautiful summary of the 4 elements making up the latest 'deal' (debt buy-back, interest rate reduction, deferral of interest & extension of maturities, dispersal of ECB-profits on trading Greek bonds). It also explains what the 'deal' means for future prospects of Greece and, most importantly, of Greeks.

Oh dear, the bond buy-back has been defined as a life-or-death issue!

The Greek Finance Minister is being quoted as saying that "the bond buy-back MUST succeed!" Or else?

For all I know, the buy-back could turn out to be a huge success or a dismal failure. Only insiders can really judge that at this point. Whether success or failure, it really doesn't matter all that much. Why? For mathematical reasons. An interest rate reduction on 100% of Greece's debt brings much more than the elimination of interest (because the debt was reduced) on, say, 10% of the debt. It's normally smart to focus on what gives you the greatest leverage.

To be sure: I hope the buy-back turns out a success because then it would be a good deal for everyone involved!

I criticize focusing on the buy-back (and even defining it as a life-or-death issue) because it is an instrument with uncertain outcome. At this stage, one should stay away from basing an entire strategy on such instruments because in case they fail, one has once again created a totally unnecessary decision point.

It's the frequency of decision-points which makes it so difficult to devote time and energy to the real important issues. There are major decision points every quarter (Troika) and there are multiple decision points in between. Sometimes it seems that every other week a new decision needs to be taken about Greece. One secret of any restructuring is to move decision points way into the future (so that real work can be accomplished) without sacrificing short-term control over activities. It's not a science but it is difficult.

So, cool down on the bond buy-back! It will definitely bring some result, perhaps even wonderful results. But even if the results are disappointing, there is no need to fear drama. All it would mean is that the official creditors would have to do more of the right thing, i. e. bring interest rates on official debt closer to zero. They have taken a first (albeit too modest) step this week. A failure of the bond buy-back would require them to take a larger step in the right direction.

And remember: a lowering of the interest rate on official debt means that official creditors need to lend less new money in order to pay themselves interest...

Tuesday, November 27, 2012

EU - still trying to be just a little pregnant?

I used to think that one couldn't be just a little pregnant. The EU has now been trying for over 2 years to prove that one can: they don't have the guts for an abortion but despite all their care for the pregnancy, they don't want to go for a delivery. And they certainly didn't achieve delivery earlier this week!

"Let's do something but just as much as absolutely necessary at this time!" - That kind of sums up what happened on Monday.

Interest rate reduction - absolutely the right strategy but, again, half measures. Instead of saying 'we'll stay interest for the next 10 years on official debt', they have have said 'we'll stay some of the interest on some of the official debt'.

Debt buy-back - perhaps it works, perhaps it doesn't. Let's believe it when we see it. But why make something whose outcome is uncertain a major pillar of a so-called new deal? The authorities may already have secured commitments from enough sellers at the price of 30% of nominal. We don't know. But if they haven't and if the whole success of the new deal is dependent on private bond holder's selling at 30% when the chances have risen that they will eventually get 100%, well, then the debt buy-back is a fairly chancy proposition.

Lending countries try to jerk tears by wailing how much the interest rate reduction and foregoing of ECB-profits will cost them. Well, the interest rate reduction is not going to cost anyone a thing. All it means is that lending countries have to make less new loans in order to pay themselves interest. And regarding the lesser pay-out of ECB-profits (to national Central Banks who would then pay out more to their governments): are governments of the lending countries really trying to suggest that the stability of their budgets depends on the collection of fictive gambling profits on the part of the ECB?

What would have been much nicer to see?

I would have preferred to see an interest rate reduction to zero on a specified amount of official debt for 10 years. That would have been a signal! What 'specified amount'? Well, I would have tied the interest expense of Greece to Greece's primary government expenditures. The latest calculation I made suggested that 6% of primary government expenditures should be allocated to interest expense (variable basis). That would have definitely assured the payment of interest to private creditors and those private creditors better be kept at bay after what we are presently witnessing with Argentina. Perhaps some money would be left to pay interest to official creditors. All other interest should have been stayed for 10 years. And the same should have been done with debt maturities coming up in the next 10 years.

That way, the Greek budget would have been relieved of much of the debt service during the next 10 years (except for the debt service due to private creditors).

And then I would have hung out a huge carrot for Greece in the form of a promise that, in ten years from now, a final reckoning would be made. The entire debt would be reduced to a 'sustainable level' (and I am thinking more like the 60% of Maastricht than the 120% of the IMF) with the rest to be forgiven. All of this against Greece's commitment to achieve a well-functioning economy by then. This huge carrot would have had to be coupled with a huge stick: if Greece did not achieve a well-functioning economy by 2022, all bets would be off and previous commitments would be rolled back.

The debt buy-back I would have titled as a 'try' to see what it brings. No more.

The return of ECB-profits I would have restricted for a specific purpose. At the lower end of Greek society, there are extreme hardships by now. True European solidarity would call for a fund to be structured in such a way that those hardships can be dealt with outside the Greek budget. The ECB-profits would have been a good source for funding such a fund.

Finally, the most important point: growth measures for the Greek private sector. If there were any included in the latest deal, I certainly didn't see them. Without such growth measures, it is hard to get the feeling that the EU really wants to help Greece.

From the beginning of this blog, I have made these two arguments: (a) Greece is entirely responsible for the mess which it got itself in until about 2009/10; and (b) the EU is entirely responsible for the mess by which they have turned the Greek mess into a European mess. For over two years now, both sides seem to have been competing with each other as to who can make the mess worse: the EU by pursuing a policy of denial, and Greece by dancing around Troika-measures.

Of late, I would say that Greece has earned the benefit of an "earnest boker". The EU has lost it (if it ever had it).

Saturday, November 24, 2012

Greek debt. Or is it equity?

The level of Greece's debt would be irrelevant under two conditions: (a) the debt would never mature and (b) it would carry no interest. That debt would then be considered equity.

The mindset of lenders is totally different from the mindset of equity holders. Lenders get nervous when the creditworthiness of the borrower deteriorates and the ability to service debt declines. Equity holders get nervous when their company loses market share, when their company runs down investments. Lenders, when they get nervous, try to get their money back. Equity holders, when they get nervous, think about new business growth strategies.

In 1996, when Apple was going downhill and Steve Jobs was brought back into the picture, a lender would have wanted to call back his loans as long as there was still enough cash there. An equity holder should have invested as much as he could before Jobs made Apple the most valuable company in the world.

The mindset of equity holders has been totally absent from the Greek debt discussions to date. This is so much more of a problem because it should be clear to the lenders that at least a good portion of their loans has meanwhile assumed the character of equity. Put differently, they should protect their investment and make it grow.

The much-discussed austerity program may have been right or wrong in its implementation but there can be no doubt that a state of the size of the Greek state, particularly when it is so inefficient, must be downsized. When Steve Jobs took over Apple (again), the first thing he did was to cut out all divisions/departments which he thought were doing superflous things (even though they were doing them well). Thousands of employees lost their jobs.

BUT: parallel to this austerity, Jobs embarked on a major growth drive and bet the company on new products. Had the iMac not been successful, Apple might not exist today.

What has been desperately lacking from all 'plans for Greece' to date is, parallel to the necessary austerity, a growth strategy in the private sector. In the recent past, there have been very positive reports about the Cosco-investment in Piraeus and about Unilver's and HP's decisions to invest in Greece. Please note: those are just three names!

Some learned people are calling for the EIB to spearhead a growth initiative in Greece. I beg your pardon? Do these learned people not know that the EIB is a bank and not an investor? The EIB will indeed lend the money but there will be no EIB-lending if there are no investors with good projects in the first place.

I have been arguing from the beginning of this blog that what Greece needs is a long-term economic development plan for the private sector. A plan which will lead to a situation where not only Cosco, HP or Unilever decide to make investments but, instead, where a multitude of investors recognize the good business opportunities which Greece offers.

Who should put together that plan? Well, ideally Greece itself. The Greek population will only support a new long-term economic development plan if they feel that it comes as a result of Greece's initiative (as opposed to foreigners' orders). However, Greece would be well advised to draw on (or rather: to demand!) all possible resources which the EU offers for the development of such a plan.

A couple of years ago, an 11-year old sent a letter to Mr. Papandreou proposing his (very cute) plan how to solve Greece’s problems (published in the Ekathimerini). A year ago, McKinsey came out with their Greece Ten Years Ahead report proposing 500.000 new jobs and 50 BEUR new GDP within 10 years. I am sure that many other good ideas reside in Greek brainpower.

I wouldn't rely totally on an 11-year old and I wouldn't rely totally on McKinsey. But, for heaven's sake, can't Greek brainpower get their act together and work out a long-term economic development plan for the private sector which will make lenders very happy to have become equity investors?

What's the matter with Greece?
Greece needs growth, not austrity!
(actually, the second heading should read, in my opinion: "Greece needs growth as well as austerity!")

Thursday, November 22, 2012

EU - seek the advice of Bill Rhodes!

William R. "Bill" Rhodes is the retired Citibanker who turned himself into a legend when he almost single-handedly negotiated solutions for the various Latin American debt crises during the 1980s, solutions which worked. Following that, and until his retirement from Citibank a couple of years ago, he had been directly involved in just about every debt crisis anywhere in the world.

The American bank on whose behalf I negotiated the Argentine debt in the mid-1980s was not on the Steering Committee but since it was Argentina's 8th largest creditor, I was intimately involved with the workings of the Steering Committee and of Bill Rhodes who headed it. Everything I know today about sovereign debt crises I learned then.

I recommend to interested readers that they check out Youtube for videos featuring Bill Rhodes. Here are two very good ones (but there are many more on Youtube):

Tea with William Rhodes (The Economist)
William Rhodes interviewed by Steve Forbes 

Let me cite a few quotes from Bill Rhodes: 

"You’ve got to have a plan, first of all, that you can sell to your own population because if you don’t have the population of your country behind you, it’s not going to work".

"Austerity is just one part of reform. If you don’t have a pro-growth program, it’s not going to work. In Greece, they haven’t been able to reform the tax system (to increase revenues), they haven’t started the privatizing; etc. All they have been doing is ‘cutting’".

"In Europe, they have wasted 18 months because it was very obvious, when Mr. Papandreou came into office, that Greece had a major problem with the books. Paul Volcker taught me early on that time is of the essence in a debt crisis because the clock is always working against you".

"Time works agaist you in crisis. There has been too much bickering between Central Bank heads, the ECB, the bureaucracy in Brussels, various Finance Ministers publicly over what to do and what not to do. And finally they are bringing the private sector into it, a year late".

"I tell you what Greece needs. Greece needs time and it also can’t afford those interest rates".

"As regards privatizations, the Greeks simply have to move on it because otherwise the program won’t work". 

My understanding from people near Bill Rhodes is that he had offered EU-elites his advice from the start but it was rejected on the grounds that the experiences in emerging countries would serve as no basis for solving problems within the Eurozone.

My sense is that the Eurozone's debt problems would be well under control by now if Bill Rhodes had been the EU's chief negotiator from the beginning. But then, it's never too late and he could/should be involved even now.

Time for an ultimatum?

I picked up the following tweet from Prof. Yanis Varoufakis earlier today:

"The time has come for Athens to declare in favour of IMF's position: OSI now + an investment stimulus via EIB. Or no deal. If not now, when?"

Readers of this blog will know that I have stated from the start that Greece should have gone directly to IMF and that I consider it as Mr. Papandreou's (who allegedly wanted to do that early on) greatest fault that he caved in to EU-authorities. It's a bit different today because IMF/EU are allegedly not seeing eye-to-eye at present. While it would be fair for Greece to "declare in favor of", to alienate the EU could be chancy because it could be perceived as attempting to divide and conquer. So that strategy is more a matter of the right form than of the correct substance.

"If not now, when?" - I have also argued all along that the relationship between Greece and its creditors must be on eye level. So far, Greece has, to a large extent, acted like an order taker. Thus, to give eye-level-conduct a shot would appear sensible at this time.

I take exception to the either/or nature of Prof. Varoufakis' proposal ('either this, or no deal'). It all depends what Prof. Varoufakis means by OSI. If he means a haircut on official debt, then Greece would probably go into history as the first debtor country which has put an ultimatum to foreign creditors to take a loss or else go fly a kite. If Prof. Varoufakis believes that Greece has, in the last 3 years, already destroyed its reputation beyond repair anyway, then one more blow to it won't make much of a difference.

In principle, nothing is ever beyond repair and with specific regard to Greece: if Greece were to indeed make it from what is today perceived as a 'failed state' to a modern and well-functioning economy, then it will probably get a place in the hall of fame because I doubt that there is another country in the First World that has ever had to make such an extreme turn-around. That hope, however small the probability of its coming true is, should definitely not be jeopardized.

At this point, the OSI should be a mixture of the following: staying maturities of official debt for 10 years; reducing the interest rate on official debt to close to zero for 10 years; and having the ECB pay out to Greece the (immoral) profits it has made on trading Greek bonds so far. If that combination is put together cleverly, the resulting debt relief would probably be substantially higher than any haircut which could today be explained to the electorates of the paying countries.

To be sure: any comprehensive solution which is agreed upon must also be 'public-relations-friendly' to the electorates of the paying countries!

As regards the proposed investment stimulus via the EIB, any investment stimulus is urgent. Clearly, the EIB is the best suited official institution to drive such an investment stimulus but I do point out that the EIB generally only does large (mostly infrastructure-related) projects. What Greece needs just as badly as new large projects are a multitude of middle-market investments by the private sector. Ways and means have to be found how private investors can be incentivated to invest in Greece.

Final comment: the ultimate proof of success is when private investment capital flows voluntarily. I have written before about the Cosco-investment. More of late, Unilever has taken a major investment initiative in favor of Greece and this machine-translated article describes what HP is planning for Greece.

So here you have 3 major investment decisions in favor of Greece of late. Can you imagine the positive momentum which would develop for the whole country if such news came in the order of once-a-week?

Tuesday, November 20, 2012

European bankruptcies versus Chapter 11

I am no expert on bankruptcy laws but I do remember the general principles of bankruptcy laws in Austria and Germany from recent experience and those of the American Chapter 11 from distant experience. To make it easier, I will refer to them simply as 'Europe' and 'America'. In principle, I think the ultimate focus of Europe is to primarily protect the interests of the creditor and of America to primarily protect the interests of the debtor.

As a company gets into financial trouble in Europe, the creditors get involved. Not all creditors, that is. Typically it's only the banks. The first thing which banks do is to confirm and/or strengthen their existing position: where they have collateral, they make sure that all documentation is in order; where they have no collateral, they attempt to obtain some (all the way to a floating charge on all assets). And when it comes to the Fresh Money requirement, banks hesitate because they are fearful that it might be 'throwing good money after bad'.

In America, control over the company goes to a trustee. The first thing which happens is that service of bank debt will be put on hold. Then, all litigation against the company is stayed or put on hold. A new loan made to a 'Chapter 11 company' is super-senior to all other debt. Thus, it is fairly easy to obtain financing for the Fresh Money requirement.

The idea behind both bankruptcy philosophies is undoubtedly to maintain a 'going concern'. Never is damage greater than when a debtor has to be liquidated. Europe goes about achieving that goal by focusing more on the creditor' interests, America does the oppositve. My own experience is that better long-term solutions typically come about when one focuses on the debtor' interest (provided that the debtor justifies that).

It seems to me that the Greek debt has so far been managed very much along European philosophies. The American philosophy would be more like saying: 'Let's do everything to make the debtor strong, even if it costs us interest income in the short term. If and when the debtor has made it, we'll sit down with them and negotiate a restructuring of debt'.

Monday, November 19, 2012

'Awesome' is the word to describe the development of Greece's current account!

'Awesome' is the word to describe the development of Greece's current account during 2012. Below are the numbers:

(in BEUR)

January - September

2011 2012
2011 2012
Revenue from abroad

Exports 15,1 16,1
1,9 1,9

Services (e. g. tourism) 22,7 22,0
3,2 2,9

Other income 2,5 2,3
0,3 0,3

Current transfers 3,7 4,5
0,1 0,2

---- ----
---- ----

Total revenue from abroad 44,0 44,9
5,5 5,3

Expenses abroad

Imports 36,0 31,7
3,9 3,2

Services (e. g. tourism) 10,7 9,4
1,1 0,9

Other expense (e. g. interest) 8,9 4,4
1,2 0,1

Current transfers 3,0 2,9
0,3 0,3

---- ----
---- ----

Total expenses abroad 58,6 48,4
6,5 4,5

Net foreign deficit (current account) -14,7 -3,5
-1,0 0,8

Of particular note is that, while the revenue side has performed quite strongly, it is really the expense side which contributed to the very significant improvement. And on the expense side it is imports and interest which make the difference.

The reduction in interest is probably due in a large part to the debt restructuring of early 2012. This just goes to prove how important it is for the Greek economy to limit the level of debt service. I have argued in a previous post that if interest expense were capped at 6% of primary government expenditures (presently around 12%), the private sector debt could be comfortably serviced. All one would have to ask the official creditors would be to defer the collection of interest for, say, 10 years.

At the end of those 10 years, one would see if the Greek economy was restructured succcessfully or not. If not, the issue of debt becomes academic, anyway. If yes, one could sit down and negotiate a 'comprehensive final solution' for the Greek debt. That would have to consist of 2 elements: (a) restructure (or rather: structure anew) that part of the debt which is considered 'sustainable' by a well-functioning Greek economy (say, for example, the 60% Maastricht level) and (b) forgive the rest.

Anyway, if someone had asked me a year ago whether Greece would have, a year later, the kind of current account figures which it shows now, my answer would have been 'not the chance of an icicle in hell'. Amazing how wrong one can be!

PS: bear in mind, though, that industry analyses project that sales (imports) of mobile handsets will increase to 3,4 million units in 2013. To import machinery & equipment with at least part of that money would appear more sensible.

Sunday, November 18, 2012

Wipe out all of Greece's sovereign debt?

The Head of Business Treasury, Global Banking and Markets at Royal Bank of Scotland is quoted as follows:

"They would try as much as possible to kick the can down the road with respect to Greek sovereign debt and if they can do that, they will. I can't imagine that we will get an agreement on the Greek debt reduction next week. If you really are serious about getting the Greek economy back on its feet and also about Greece staying in the eurozone, you need to cancel its sovereign debt. It is as simple as that. Otherwise, they would keep contracting, more people would be laid off work, and they won't be able to raise their tax revenue. That is the only way". 

Well, I am not surprised that RBS failed so spectacularly when it has executives saying such nonsense!

So far, the level of sovereign debt has had exactly zero to do with Greece's recession/depression. Why? Because every single cent of Greek debt service has been paid by foreign creditors. They have basically paid out of their left pockets what they collected with their right pockets. Every profit they took on lending margins and guarantee fees, they have paid to themselves. What is the evidence for that? A primary deficit is the evidence because a primary deficit means that one has to borrow in order to pay interest.

If Greece's debt had been 100% forgiven 2-1/2 years ago, the country would still have required very substantial Fresh Money. Now one could argue that, if Greece hadn't had any debt 2-1/2 years ago, it could have borrowed Fresh Money in capital markets. Correct, but all that would have meant is that the borrowing wheel would have been put into motion once again with you-know-what-kind-of-results in 10 years from now.

It is the Fresh Money requirement which made Greece dependent on the Troika. That Fresh Money requirement has now been reduced significantly: the primary budget balance is approaching break-even and the current account is approaching tolerable levels. Everything fine now?

No! The price for all of this has been over one million unemployed. This would suggest that the structure of the Greek economy is still such that it can only employ its people if it gets new funding from abroad all that time. Since the latter is more or less out of a question, the Greek economy has to be restructured in such a way that more employment is generated without new funding from abroad. Only more domestic manufacturing, also for exports, can solve that problem (i. e. create new jobs).

Thus, instead of forgiving all the debt and hoping that things will be fine (which they wouldn't be), all resources should be devoted to the issue of how Greece can increase its manufacturing. That should be the top priority, and not the playing around with abstract 'debt sustainability' ratios.  It is the 'economic sustainability' which counts in the first place.

If it were necessary to put all of Greece's debt service on hold for, say, 10 years in order to achieve that, then this should be done. Only if and when Greece reaches 'economic sustainability' is the right time to talk about debt forgiveness.

Put differently, debt service should be put on hold for, say, 10 years with the proviso that this time is indeed used to achieve 'economic sustainability'. The incentive for Greece's doing that should be the commitment that, once 'economic sustainability' is reached, the debt will be restructured/forgiven in such a way that it becomes sustainable.

Friday, November 16, 2012

Privatizations - reality or illusion?

The draft of the latest Troika-memorandum (MoU2) lists 34 transactions to be completed by the end of 2014. They break down into the following categories:

Share deals: 15
Concessions: 11
Real Estate: 8

If the idea is to use the proceeds of these privatizations for repaying debt (which I believe it is), then I would enter a wager that these privatizations will not happen. Certainly not as long as Greece remains in the Euro-limbo. At the same time, I explain below why they should happen and how.

If the government proceeds as planned/committed, there will be mass demonstrations every time a privatization comes up. The battle cry will be: "We cannot sell state assets now because we may need them if and when we exit the Euro!" A rather convincing battle cry. How the government will withstand those battle cries escapes my imagination at present.

Having said this, I reaffirm my conviction that privatizations, in principle, are the route to pursue. My principle argument is know-how transfer. Even though some of these companies may perform quite well now, there is no question in my mind that they would all benefit significantly from the know-how which a new owner brings.

Thus, the critical decision is to choose the right new owner. It's easy to describe what a wrong new owner would look like. Examples: a financial investor who is aiming at short-term returns; a multinational who is exclusively interested in buying market share; etc.

The 'right' owner would be an owner who has a commitment to Greece as a location for doing business in the country and, possibly, to use Greece as a hub for the Eastern Mediterranean region. Thus, the 'right' owner would not only lay out money for the acquisition but, above all, he would commit to substantial new investments going forward. The experience with the Chinese company Cosco and the port of Piraeus comes to mind.

Whenever the state tenders a company for privatization, the rules of the tender and the criteria for selection must be published. I would suggest that the top criteria should be 'the right owner' with a clear definition of what is meant by that.

Now to the proceeds of the privatizations and I begin with the example of the German state of Bavaria. About 30 years ago, Bavaria was considered as the Southern fun and beer loving state which required transfers from the North to support the living standard of Bavarians. Then, the Bavarian government took a historic decision whose consequences can be witnessed all over Bavaria today. The state sold assets on a massive scale. However, instead of 'spending' the sales proceeds, the money was invested into making Bavaria competitive: research & development, education at all levels, clusters for future-oriented technologies and industries, etc. etc. And, incidentally, Bavaria is still fund and beer loving!

Today, Bavaria is probably Germany's most successful state and the largest contributor to the domestic transfer system in Germany. Bavaria's educational system is considered the best in Germany. R&D centers exist all over the state. Clusters for future-oriented industries are in place. Some entirely new industries are now settled in Bavaria (e. g. aerospace). Etc. etc.

This could be a role model for what Greece should do with privatization proceeds. Greece's creditors will not allow that? Well, that depends. If the state were to re-invest funds in similar fashion as the state has invested in the past, then one certainly should not allow that. However, it should not be too complicated to find a structure where the decisions to re-invest are supervised by invididuals/institutions which can assure that the Bavarian model is followed (and not the Greek model repeated).

If, and this is the million-Euro-assumption, if it could be warranted that Greece would follow the Baravian model for re-investing sales proceeds from privatizations, the creditors would be foolish not to support that. A strong Greece in the future could pay back a lot more debt than a bankrupt Greece can now!

Wednesday, November 14, 2012

A quick-and-clean solution the the Greek debt

Nowhere in the seemingly innumerable comments on the Greek debt do I see reference to those instruments which I have found to be key instruments in debt restructurings in my banking career:

* variable interest rates
* capitalization of interest
* extension of debt maturities 'way into the future'

First, a comment on what the overriding objective should be. With the present political dissens in the 'paying countries', the overriding objective should be that the politicians of the 'paying countries' can tell their electorates "we have not forgiven Greece one cent of debt and/or interest!" This, of course, while at the same time achieving for Greece the debt relief which the country needs.

Now to the instruments in detail:

A. Variable interest rates
Greece will pay about 12 BEUR in interest in 2012. While that is down from about 15 BEUR in 2011 due to the debt restructuring in early 2012, it is still way too much, given that Greece doesn't even have a primary surplus yet.

Greece's primary expenditures will run close to 100 BEUR in 2012. Thus, 12 BEUR of interest expense represents about 12% of primary expenditures. To make the interest expense tolerable, it should be capped at "6% of primary expenditures". In other words, Greece would commit to always allocate 6% of its primary expenditures to interest, no less but also no more. If public expenditures go down, so does the interest expense (and vice versa). This rule should be valid for 10 years, at which time a renegotiation takes place.

The 6% of government expenditures allocated to interest should easily cover all interest due to private creditors. Thus, there would be no need to renegotiate with these private creditors. All the adjustments would have to come from the official creditors.

B. Capitalization of interest
When capitalizing interest, the interest due is added to principal instead of having to be paid in cash. The debt goes up but the cash debt service goes down. Creditors do not forego any legal claims against Greece.

Once the private creditors are paid interest out of the 6% interest allocation, the remainder of the 6% allocation goes to the offical creditors. Obviously, that will cover only a small portion of the interest due to official creditors. The large portion of interest which is due to official creditors but which cannot be paid out of the 6% interest allocation should be capitalized for 10 years.

C. Extension of debt maturities 'way into the future'
It is futile to attempt a 'complete and final' debt restructuring in the middle of a depression because there is no way of assessing what the debt service capacity of a well-functioning Greek economy would be. By the same token, it is futile to determine a 'debt sustainability' at this time: it may be 120% or 60% or even zero by 2020. It all depends on how the Greek economy develops (and, by the way, how interest rates develop).

A very large part of the official debt must be rescheduled 'way into the future' whereby 30 years would have to be the minimum period. More appropriately, it should be a 99-year bond which I have often recommended. How large should that part be? I would recommend an amount equal to all debt exceeding the Maastricht limit of 60%. Under no circumstances should it be less than 100 BEUR.

The remainder of the official debt (i. e. that portion which is not rescheduled 'way into the future') should be rescheduled to mature in 10 years, the same time when the interest capitalization period ends. Would that require Greece to repay all that debt plus capitalized interest in 10 years from now? No! Instead, the agreement would be: "In 10 years from now we will know if Greece made it, or not. If Greece made it, we will have a clear picture how the total debt maturing then should be structured based on the strength of a well-functioning Greek economy, and we will then structure it accordingly".

And if the Greek economy doesn't make it? Well, no one will be worse off then than he is today!

The importance of leverage
No creditor wants to offer a borrower too generous terms out of fear that they give up leverage on the borrower. Well, if Greece must allocate 6% of primary expenditures to pay interest for the next 10 years, creditors have all the leverage in the world because every time Greece needs to borrow money to pay interest, they can exercise pressure. If that is not sufficient leverage for creditors, they can build into their agreements acceleration clauses which stipulate under which circumstances a renegotiation has to occur before the 10 years end.

And what about the 99-year bond?
None of today's negotiators will live to see the maturity of this bond. Instead, the secondary market value of this bond will depend on the expectation that at least some interest is paid. In 10 years, at the end of the interest capitalization period, a new interest mechanism needs to be structured for this bond. It will have to be structured in such a way that investors can have the hope that at least some interest will be paid.

The 99-year bond will trade near zero during the first 10 years of interest capitalization. Depending on the development of the Greek economy in the next decades and on the new interest mechanism, they might increase in value. Perhaps to 10% of nominal, perhaps to 20%, perhaps even more. Whatever the case, any interest paid on a bond which started with a value of zero represents to investors an infinite return.

IMF - a late vindication of Mr. Papandreou?

My understanding is that, back in late 2009 when it became clear that Greece's Balance of Payments was headed for trouble, the newly elected Prime Minister George Papandreou wanted to go directly to the IMF for help. EU-elites, ever so confident that they are smarter than the rest of the world, used all available pressure to prevent Mr. Papandreou from doing that. And Mr. Papandreou, not known for the leadership strength which his father had displayed, caved in.

That was the prodigal sin in the whole Greek and Eurozone debt problem!

The IMF is the world's center of competence for Balance of Payments problems of countries. They may not always have the right recipes for economic turn-around's (and more often than not they don't) but they have all the blue prints for restructurings of sovereign debt. Furthermore, when countries develop ire at austerity measures, which they naturally always do, their ire goes against the IMF as a supra-national institution and not against individual countries (i. e. like against Germany).

I am certain that the IMF would have followed the traditional policy that "risk takers must remain risk carriers". In other words, the focus would have been on rescheduling existing debt with existing creditors instead of using tax payers' money and Greece's balance sheet to pay out private creditors (and call that 'help for Greece'). Only the Fresh Money requirements, which were about 20% of the total rescue funding disbursed todate, would have been handled by official institutions like the IMF, EU and/or ECB.

So, Mr. Papandreou can indeed tell the Harvard students at his lectures there that he had the right idea from the start and that things would be much better today if the EU had allowed him to pursue his ideas. That's quite a vindication. However, he should also be prepared to answer the following question which a clever Harvard student might ask: "If you were so convinced that you had the right idea for your country, why did you cave in?"

Tuesday, November 13, 2012

Germany & Greece - perhaps time for a marriage counsellor?

In this recent commentary, the editor of the Ekathimerini argues that it is time for a German move now because Greece does not have the time to wait for the next German elections in 11 months from now. A very reasonable argument.

A reader by the German-sounding name of Sebastian Schroeder who apparently lives in Patras wrote an extensive comment (reproduced at the bottom of this post) essentially arguing that Germany has made so many unanswered moves so far that it is asking quite a bit to (again) demand of Germany a move (again).

I suppose a marriage counsellor who interviews husband/wife separately comes away from each conversation with the feeling that he has just heard the full truth. Unfortunately, the two truths don't match one another. If he cannot find common ground between the parties, the marriage will fall apart at great cost to both.

Greece has accomplished a lot of positive things, particularly of late. I hasten to add that Greece didn't have much of a choice because otherwise the whole problem would have blown-up in its face.

Germany, too - albeit mostly at the last minute - has done quite a few positive things (if prolonging bankruptcy by making new loans is considered a positive thing). I hasten to add that Germany didn't have much of a choice because otherwise the whole problem would have blown-up in its face.

Regrettably, there are no provisions to dissolve the German/Greek Euro-marriage. So unless both parties want to take chances that the whole problem really blows-up into everybody's faces, they might want to start looking for a counsellor, a mediator or whatever else is adequate to help find common ground in two opposing - but possibly equally right! - positions.

I suppose it wouldn't be difficult to fill a room with competent people who can argue that Greece is right. Neither would it be difficult to fill a room with competent people who can argue that Germany is right. The sad truth is --- the graveyards of the world are full of people who were right!

Europeans can be quite arrogant when it comes to appraising Americans. In recent times, sophisticated Europeans have expressed dismay over the fact that the two large parties in America cannot find common ground when the future of the country is at stake. Well, Europeans would have the chance to, for once, show Americans how mature they really are by demonstrating amongst each other a behavior which the two large American parties have not yet been able to demonstrate.

So, Europeans, speak up now and show that you are worth your salt, or forever keep your peace!

Letter to the Ekathimerini by Sebastian Schroeder, Patras
Lets see some German/EU Moves and the Greek reactions:

1. Mr Roesler came down 2-3 years ago and offered Greece assistance with the funding of a KfW like institute to support Greek small and medium size companies. The Greek media reaction was to call him a German-Japanese Nazi, the Greek political reaction was non existent.
2. Mr. Reichenbach was sent down to help Greece on more effective absorption of EU funds. The Greek media reaction was to call him Gauleiter, Anarchists have threatend him and his family and burned his car even in Berlin.
3. Germany has offered to support the renewal of the Greek tax system with 180 tax specialists that would have worked for free down here. Greek reaction was negative again while money kept flowing out of the country.
4. Mr. Fuchtel was sent down to establish grassroots connections between German and Greek communities. Media welcomed him with Nazi comments and Greek polticians tried to play smart ass on him.
5. The EU offered Greece already 4 years ago support to overhaul the Asylum System and to establish detention center. Reaction = Zero until GD showed up.
6. The EU supported Greece with money to establish a nationwide cataster. Result is known, money is gone.
7. Mrs. Lagarde offered a nice list... result is known.

All of the above are moves from Germany and the EU that were badly rejected by Greek polticians and also by parts of the Greek population.

In Greece everybody thinks the world is turning around Greece and that everybody is just waiting for the Greek Vouli and money will flow. The decision in the Vouli though is just a first step that will be followed by necessary democratic (parliament) approvals in the other countries.

Don't overestimate also the power of Merkel and the importance of Greece for the next election campaign. Germany has plenty of challenges within the country that could even bring down Merkel's anyway shaky CDU/FDP coalition before next fall.

From all European leaders Mrs. Merkel is within her country most likely the most restricted, first of all constitionally and secondly due to her weak coalition partner. In the outside media though she is seen as a leader that decides everything on her own. Something is not fitting!

Monday, November 12, 2012

A video about Portugal (and Greece, too?)

I received this very impressive video, allegedly produced by Portugiese Conservatives with the aim of having it broadcast in Germany. Frankly, I was taken by the video. Thus, I sent it to a friend of Portugiese origin (now living in Canada) and asked him for his comments, which are below. It seems to me that parallels can be drawn between Portugal and Greece.

Comments by a Portugiese
Well, I think we have a case here not of propaganda but of how the truth and the facts are displayed and juxtaposed. Perhaps some comparison between Portugal and Greece would be a good framework to depart.

Both countries did advance upon EU accession and the flood of funds from Brussels, living standards rising even faster once the Euro was adopted. But, I recall long before the crisis seeing comparative statistics where Portugal (with Greece trailing not far behind) had the highest share of public sector weight in the then EU with Ireland having the least. This weight factor was not just in terms of gross costs but the actual total number of employees in the public sector. In a 12-month calendar year, the law stipulated that all employees (public and private sector) were paid 14 salaries, 1 extra at Christmas and 1 in the middle of the summer. The social umbrella was complete and pretty comprehensive, meaning that it was prone to abuse.

Like Greece, there are numerous incidents of "pensions" being paid to spinster daughters, who never worked a day in their lives, when the parents passed away. Undoubtedly, under a social umbrella welfare system provisions need to be made for those in need and it is not in the 9 or ten thousand such cases that the system was weighted down. More to the point is the "nomenklatura" in Government irrespective of the party in power since the 1974 revolution. Let's say that you Klaus are the Sub-Secretary in the Ministry of Public Works. You draw a salary for your actual position, you are given a good German car with a uniformed chauffeur who gets paid overtime because he is on duty 24/7 not just to drive you on official functions but also your wife and children. You have a very well appointed restaurant in the ministry costing anywhere from 1/2 to 1/3 of the cost in a normal restaurant. And, of course, you have a government pension. Now, you are appointed "Delegado do Estado" (Representative of the State) in e.g. the boards of the electricity or ports or highway state companies or even more such companies, something that is not uncommon. You not only draw additional salaries for these 3-4 year "temporary" posts, which may consume a maximum of 2-3 hours per week of meetings, but you also accrue additional pensions from each of those posts. Since many of these posts are sourced by the party in power from the ranks of MPs  elected (called "Deputados"), if reelected for a successive 4-year term, i.e. 2 terms as an MP, and subsequently lose in a third election, you now have a pension for life that rises yearly pursuant to inflation.

To use a personal example, my Father was a Chemical Engineer and head of the water company. Pursuant to statutory requirement he retired with a very good pension at 65. No sooner did he retire when he was asked by the Government to sit in the board of a "mixed capital corporation" where the 51% was private. So he did and there being an agreeable meeting of the minds over the years, he resigned from that Board of his own accord at age 83 on the grounds that "he felt a bit tired". Long preceded by my Mother, by the time he passed away at age 90 -- actually 1 month after he turned 90 -- his pension was manifold what he had ever earned in active service. While my sister that followed me to Canada, her husband, my wife and I would shake our heads at this situation, which my brother-in-law called a "Disneyland situation", both my Father and my only other sister who never left Portugal, where she and her husband work for the Ministry of Education, saw nothing wrong with the system. What happened in the case of my Father is actually a "minute" situation -- where he actually worked half-days every day for that Board since I read many of his reports and commented on them -- compared to some of the scandals that only became seriously revealed upon the onset of the crisis.

In the private sector, agriculture almost disappeared under the so-called "EU standards". So, our oranges that taste and smell phenomenally have spots in them and may not be so golden as Florida's or California's. The farmer gets paid for not farming and not harvesting. Wine, brandy, Port, Madeira, liqueurs and eau-de-vie survive nicely and represent nice domestic and export revenues. However, go to any supermarket and it is flooded with the same products from the rest of Europe plus South Africa and South America at competitive prices. The textile sector, once vibrant and very good, is gone or at best haute couture "boutique-like". The shoe manufacturing sector, since it is a real brand quality name, continues to flourish but is a pale shadow of what it once was, especially in exports. Fisheries, the inseparable sea and the Portuguese of time immemorial, cannot compete with the massive industrialisation of the sector by the Norwegians and the Spanish. Go to any supermarket to buy the indispensable dry salted cod and it is "Norwegian", even though all cod are fished off the shores of Newfoundland since the 15th century.

Industry and manufacturing in general and the financial sector may be traded in the Lisbon and Porto bourses but are controlled and  back in the hands of the few families that owned them during the decades of Salazar's dictatorship. It is almost as though the 1974 revolution never took place. As for the banks, who would seize properties for mortgage arrears, these were still accounted as "live assets" in the balance sheet until very recently when Ireland and, specially Spain, started auctioning such properties. The numbers are staggering all over Portugal, something like 440 homes delivered by hard-pressed owners, who are no longer able to pay their monthly mortgage installments  or seized by the banks on a daily basis. And in the tourist sector, where Portugal, specifically the Algarve, has enormous potential as well as a good tourist infrastructure, the power of the Euro has made it fashionable for the Portuguese themselves not to enjoy vacations in Portugal but in exotic locales. TAP, the national airline is "broke" beyond repair and negotiations of a takeover by Q'Atar seem to have come to a standstill. It no longer flies to Toronto, in a country where one million Portuguese reside, of which 500,000 are domiciled in the general Toronto area and vicinity. But, go to Punta Cana in the Dominican Republic and you will see a posh TAP counter in the airport. Etc.

The above -- with or without the Troika -- has not changed since the Crisis. What has changed is that the 13th & 14th salaries are now gone, statutory age has been increased from 65 to 67 years of age and contributory pensions will be reduced for anyone receiving a pension in excess of Euro 500 per month. What is also changed is the scandal of the current PM -- beloved by the Troika -- telling the educated youth of the country to emigrate, an advice that tens of thousands have already taken to heart and acted upon such that when standing at a certain vegetable counter in a large and popular Portuguese supermarket in my neighbourhood I once overheard two youngsters talking to each other in elevated and cultivated Portuguese while cleaning and stacking lettuce and cabbage. They are most probably illegal migrants in Canada, but they are most certainly graduates of the classical universities of either Lisbon or Coimbra.

The population in general has taken to blaming Germany and/or Northern EU, but mainly Germany, for their woes, an attitude that has not changed but has become exacerbated by the apparent disregard of the Troika for the excesses of the "nomenklatura" at the expense of the rest of the population. Austerity measures are popularly regarded as applying to most and not the minority. Incidentally, in one of my recent posts I had closed it with the quotation that "The law exists to protect our friends, to persecute our enemies and to be applied to its fullest extent on those that are ignorant". The author of that quote is Paulo Portas, the NO. 2 person in the current Portuguese government.

So far, all demonstrations are indeed peaceful with none of the drama we see on TV when it comes to Greece and/or Spain. For how long more, I don't know and let us not forget the armed forces, so far professional, disciplined and in the barracks. They did it before in 1928 putting Salazar in power and again in 1974 toppling the Salazar regime and they can certainly do it again.