Sunday, March 24, 2013

Thinking of Cyprus and remembering Greece

As incredibly wise men and women meet in Brussels to find a solution to the Cyprus problem, I am reminded of the proposal which I had made for Greece at the outset of the crisis.

STEP 1: Reschedule maturities of all sovereign bonds and other sovereign debt with existing creditors way into the future. A couple possible ways: (a) add, say, 10 years to every current maturity; or (b) multiply the current tenors by, say, 3 (i. e. an outstanding 10-year bond would become a 30-year bond); or (c) replace all existing bonds/debt with 3 or 4 categories of new bonds; etc.

Consequences of step 1: Original creditors remain creditors (i. e. 'risk takers remain risk carriers'); no new debt is required to repay maturing debt; long 'breathing-space' as regards the refinancing of debt.

STEP 2: Implement interest capitalization in such a way that, in sum, cash interest expense is capped at, say, 5% of government expenditures (the remainder being capitalized).

Consequence of step 2: Enough of a burden for the budget to assure discipline but not so much as to suffocate justified spending.

STEP 3: Reschedule the entire foreign debt of other public sector companies, other private companies and, above all, of all banks in similar fashion.

STEP 4: Obtain commitment from foreign banks that suffient trade finance lines for Greek banks are kept open.

Comments on steps 3 & 4: always following the principle that 'risk takers remain risk carriers'.

STEP 5: Negotiate with IMF the Fresh Money financing requirement of the budget deficit.

No haircut. No deposit cut. No cut whatsoever.

The IMF would be the principal actor in this scenario and assure 'behind the scenes' that all creditors involved go along with the proposal.

Results for Greece? There would still have been an IMF-program with austerity and all that. The big difference would have been that, from the start, the debt situation of the sovereign, of other public sector companies, of private companies and, most particularly, of the banks would have been regularized. Thus, there would have been peace and quiet to work on all the other things that required working on.

Essentially, this is what Lee Buchheit is recommending for Cyprus.


  1. Mr W Schäuble, was not to accept STEP 1 at any case.This proposal was on table but it seems not to have discussed at all!
    The first proposal on Saturday was to cut 60% of deposits and there is a talk about 40% after midnight.
    From one side there is the necessity for changes in banking sector to prevent from future crisis totally logical but from the other there are indications that some 6-7 countries -tax heavens- in europe try to attract russian deposits from Cyprus!
    New rules with accountability for all? Or a joke?


  2. Well, Klaus, like Varoufakis you make the error of identifying the problem and offering the optimal solution. Politicians do not function like that...

    How do they function? They are confronted with a problem that has to be solved, but they do not look for the best solution to the problem. Instead, they look for an opportunity to get some political or financial benefit, while also pretending to solve the problem. Of course, they cannot completely fail to address the problem: they do need to maintain some sort of pretence of being serious and honest brokers.

    What is the opportunity here? Basically, I would say it is a strong German opposition to Cyprus having large flows and investment from Russia; it is a moral position also, that a small island should not be a serious financial centre, when Germany attempts this too. It is also a mass delusion that the German protestant Schauble has insisted on, that Cyprus needs to come down to earth, be realistic: their banks were laundering money obviously (Germans don't need to prove it, because this is a moral assertion and correct)...

    So, for Germans and some others, including the idiot French, the cypriot banking situation is not a problem. It is an opportunity to humiliate one more country, to gain political capital to show their voters how strong and moral they are... the only real issue was with the first agreement, which actually threatened the integrity of the entire eurozone banking system. They started to get scared with the global reaction to that, which they now think that they have got away with.

    In the meantime, the Cypriot economy will go the way of Greece, entirely because two banks bought Greek government bonds to the tune of 4 billion euros. No other reason, really, because they would have survived their other mistakes without that.

    1. Even if you are right (which I guess you are) that politicians "look for an opportunity to get some political or financial benefit, while also pretending to solve the problem", I would still make the following point: there is an intelligent and competent way to get some political or financial benefit out of other countries' problems, and there is a dumb way. If, at the end of the day, you are the most hated nation in Europe and people paint your face with a Hitler-moustache, then you know you have done it in a dumb way.

      Americans, after WW2, did it in a smart way. Yes, the Marshall Plan and debt forgiveness cost them a bit but the return which the US economy and its businesses got for it was enormous. American corporations literally 'invaded' Europe and, as Jean-Jacques Servan-Schreiber described it in his book "The American Challenge", they didn't even bring funds over from the US for that but, instead, borrowed the money in Europe.

      It is quite obvious that, from the start, Merkozy had one top priority - to save their own banks. They did it via Greece's balance sheet and called that 'help for Greece'. In the end, they did not only save their own banks but just about every speculative investor from Wall Street to Peking (with tax payers' money). To believe that such manouvers would not be seen through is plain dumb.

      At the start, Merkozy should have transferred primary responsiblity for Greece & Co. to the IMF because that's the place which has the competence when countries hit external payment problems and need to restructure debt. They adamantly refused to do that (even though, I understand, Mr. Papandreou had first wanted to do that) and then they messed it up real good. That is incompetence.

      A smart way for Germany would have been to say to Greece something like: "You have a problem and we have an interest. Your problem is that you are going to have to starve the public sector which will shrink your GDP. Our interest is to compensate for that GDP decline by implementing incentives for our German companies to steer their foreign investments to Greece. We will also make sure that they are really investing long-term and not trying to cash-out short-term. All we are asking is that you welcome our investors and that you grant them business conditions which are attractive. We can offer advice for that, too. And, by the way, you are doing a lot of importing from China and China is not a member of the bail-out team. Why don't you try to shift some of those imports away from China to us and/or other Eurozone countries?"

      Obviously, the motive on the part of Germany for something like this would still be self-interest. But it would be much more balanced because Greece would have a benefit from it, too.

      I guess it was Adam Smith who coined the logic that the engine behind economic betterment was the pursuit of a healthy self-interest on the part of individuals. The more modern thinking is that to really achieve sustained betterment, the pursuit of self interest must be accompanied by the pursuit of benefits to the group.

  3. I don't disagree with any of that. After all, I did not say that this crowd of lunatics are clever people -- far from it. Obviously, the greatest politicians do what is needed to stay in power, and also try to deliver to all affected parties along with some vision of where they are going. Obama tries to do that, but is too careful (and inexperienced) about going in new directions and more worried about appeasing all interests. (He is mostly risk-averse = conservative.)

    As far as group interest is concerned, the problem as I see it in much of Europe is that the group size being considered has shrunk to a very small part of society. Until recently, at its worst the group size was a class, occasionally it was most of the country (e.g. after world war II), but it was rarely so few people as now. This is actually reminiscent of the feudal period, where the distribution of resources and power was so unequal. We might also look at some very backward societies, such as Afghanistan, to see where Europe is heading under the German domination. A society composed largely of people in serious poverty, many competing factions of local barons -- each with little real power -- and one overarching framework of privileged and corrupt politicians who abuse their power on a continuous basis. Oh, and no rule of law -- just a pretence at it.