Here It Comes --- A National Economic Growth Plan for Greece!

Well, here is a piece of good news! Finance Minister Gikas Hardouvelis announced that the time is ripe for national economic growth plan for Greece. He said that "efforts should focus on making the economy export-oriented and making Greece attractive to foreign investors, stressing that 'the economy can no longer be consumption-driven'”.

It's now over 3 years since I wrote my first (hopefully passionate) plea for a Long Term Economic Development Plan for the Greek economy. I argued that in any financial crisis, first should come the turn-around plan and only then can the suitable financing package be structured around it. In the case of Greece it was different: Greece and the EU spent 4 years dealing with the financing and now, at long last, the planning is to begin. Well, better late than never.

Mr. Hardouvelis won't have to start from scatch. He could, for example, dust off the "Greece Ten Years Ahead" plan which McKinsey published in 2011. He could look up a couple of other plans which have been proposed by various organizations (including the EU Task Force for Greece). Or, he could look through drawers in his own office: I understand that the Greek government had, back in 2007, put together - with the help of think tanks - a comprehensive development plan for the Greek economy (which some people have suggested was then the basis for McKinsey's plan; in fact, some people have commented that McKinsey only copied what Greece had put together before).

So, I guess the challenge will not be to put together a plan. Instead, the challenge will be to really get down to doing it and, more importantly, to implementing it. If this is what's going to happen now, it can only be considered as outstanding news!

Keynes On Why Banks Don't Lend (and a proposal how to correct this)

One of the major challenges the ECB faces, so it says, is to get banks to increase their lending to the real economy. This is of particular importance in Greece where, I understand, one reason which slows down any economic recovery is that banks, burdened by non-performing loans, don't make new loans even to good borrowers. I came across a paper which John Maynard Keynes wrote in 1931 and where he described very aptly, in my opinion, why banks don't lend during economic crises.

"For, so long as a bank is in a position to wait quietly for better times ... nothing appears on the surface and there is no cause for panic. Nevertheless, even at this stage the underlying position (i. e. the large portion of weak loans on the books) is likely to have a very adverse effect on new business. For the banks, being aware that many of their loans are in fact 'frozen' and involve a larger latent risk than they would voluntarily carry, become particularly anxious that the remainder of their assets should be as liquid and as free from risk as it is possible. This reacts in all sorts of silent and unobserved ways on new enterprise. For it means that the banks are less willing than they would normally be to finance any project which may involve a lockuup of their resources".

According to the analyses which I have read, the amount of non-performing and/or impaired loans on the books of Greek banks is staggering. In such a situation, every bank will attempt to keep the remainder, as Keynes calls it, in good shape and only add to the remainder, i. e. make new loans, if they are literally perceived to be risk-free. In today's Greece, it is presumably next to impossible to find risk-free borrowers in the private sector. Net result: banks don't make new loans regardless of how much money the ECB throws after them.

By nature, bankers behave pro-cyclically: in boom times, they go overboard taking on risk because they have convinced each other that the boom will last forever. In recession times, they will slam the brakes on lending because they have convinced each other that the situation can only get worse. The credit rating systems which banks apply reinforce this pro-cyclical behavior: during the boom, ratings automatically improve; during the recession, ratings automatically deteriorate.

During recessions, lending officers of banks hear almost daily a message like the following from their managements: "Go through your portfolio. Identify all customers which might develop problems. Reduce exposures where you see potential problems. Negotiate more collateral. And by all means --- make new loans only where we don't increase our risk. We already have far more risk than we can handle!" It is quite impressive to observe how quickly formerly go-go lenders can convert into risk-averse administrators!

What can be done about that? The most effective way would be to take the non-performing and/or impaired loans off the books of the banks so that they are left with only the good remainder. Being no longer burdened with problematic and/or frozen assets, banks would quickly develop an appetite for making new loans. After all, banks need to make good loans to earn a profit. Banks would still not be making new loans to questionable risks but they would adequately supply the strong part of the economy with financing.

Loans can be taken off banks' books in two ways: (a) at book value or (b) at whatever the loans are deemed to be worth in reality. The difference between the two values is the potential loss behind those loans. If loans are taken off the books at book value, banks make a bonanza: they get rid of their problem assets without any negative effect to their bottom line. Instead, the potential loss is moved to the party which takes the loans off the books. If loans are taken off the books at whatever the loans are deemed to be worth in reality, the banks go bankrupt. After all, the reason why they haven't written down their loans to fair value is that they don't have enough capital to support the losses.

The Bank of Greece, I understand, refuses to take the bad loans off the books of the banks at book value and move them into a national 'bad bank' for a very good reason. That way, the BoG (i. e. tax payers) would assume all the losses and banks could merrily return to making good profits. If the BoG were to avoid these losses, it would have to take the loans off the books at whatever they are worth, leadings to immediate capital insufficies on the part of the banks.

Below is an alternative which I have not seen being discussed as yet. It rests on the (correct) premise that Greek banks, if they could unload all their problem loans at book value, would overnight become rather profitable institutions. Given the lending margins and service fees which I have seen applied by Greek banks, Greek banks should be among the more profitable ones in Europe if they had no credit risk to provide for.

Here is the alternative: the BoG would purchase all problem loans at book value with the only proviso that the banks will eventually, perhaps over a period of 20 years, have to buy them back out of their earnings. Put differently, as long as banks have problem loans 'outplaced' to the BoG, the entire annual pre-tax profit would have to go to the BoG. If it takes the profits of 20 years to buy back all the loans, it means no dividends for 20 years.

Banks enjoy a unique advantage over normal businesses in the way they operate. Whereas normal businesses need to turn their assets around all the time in order to make a profit (cash-inventory-finished products-accounts receivable-cash), banks get paid for keeping their assets on the books (make a 10-year loan; you work once and collect interest for 10 years without any further work). And banks are assured to get paid more for their assets than they have to pay for the funds which finance them. Thus, it is literally inconceivable that a bank would not make a decent pre-tax profit if it had no risk costs (this is assuming that the bank does only commercial business and no trading on its own account where it would face the risk of trading losses). Put differently, a bank has a built-in earnings power before risk and the only question is how that earnings power is used. Normally, it is used to provide for risk, build up equity and pay out dividends.

In my proposal the entire earnings power of the banks would be used to pay off, over 20 years, the problem loans which they sold to the BoG. If dividend pay-out is stopped for 20 years, the banks' shares might plummet and today's shareholders might feel wiped out. However, today's shareholders would know that, in 20 years from now, their children would be rich again. Obviously, if a bank needed less than 20 years to buy back its bad loan portfolio, it could return to paying dividends that much sooner.

In this proposal, the BoG would not be giving banks tax payers' money to make up for loan losses. Instead, the BoG would be giving the banks time so that they can finance their losses out of their own profit.

Greece - Staggering Amount of Private Debt!

One of my readers recently posted the following figures about Greece:

Private debt: 220 BEUR (122% of GDP)
Unpaid taxes: 68 BEUR and rapidly rising
Unpaid social security contributions: 20 BEUR

This article from Macropolis states the figures in a different way:

Unpaid private debt: 160 BEUR (88% of GDP)
Consisting of:
Non-performing loans: 77 BEUR
Unpaid taxes: 67 BEUR
Unpaid social security contributions: 16 BEUR

Whatever the correct figures are, the trend is clear: the figures are mind-baffling!

One difference between Greece's sovereign debt and the above private debt is that in the case of sovereign debt, most of the creditors are OUTSIDE the country. If the borrower doesn't pay, damage is occurred outside the country's borders.

In the case of the above private debt, both the borrowers and the lenders are INSIDE the country. If damage occurs, it occurs within the country's borders.

I understand that various ideas are being analyzed as to how to deal with the problem. I would offer 3 words as solutions: reschedule, reschedule and, again, reschedule. Allow the factor of time to make a contribution to the solution. If credit problems are solved too quickly, unnecessary damage might be caused (deterioration of assets values due to liquidation, etc.).

A private economic agent, be that an individual or a company, will not generate any optimism about pursuing new opportuntities if he has to worry that the creditor's 'guillotine' might fall down on him any moment. That guillotine must be moved far away so that people don't have to worry about it all the time. Furthermore, the farther the guillotine is moved away, the greater the hope of the private economic agent that he may eventually escape it.

Having spent most of my career in banking, I have seen innumerable cases how energies can be wasted between borrowers and lenders with things which cannot be changed anyway. If a borrower can't pay, he can't pay. Why talk to him every day about this situation? That won't make the situation better!

These private debtors must be put into a situation where they can devote their energies to new value generating enterprises, whatever they are. The more value they create, the more debts they will be able to settle later.

Argentina - Significance for Greece?

The world of international finance no longer is what it used to be 40 years ago when I grew up in it.

Then, it would have been inconceivable that a country of the 1st World (remember: as an EU member, Greece IS a country of the 1st World!) would receive a haircut on its sovereign debt after only a couple of years of crisis. Why? Because the holy principle was that sovereign debts must be honored unless one wants to chance getting excluded from financial markets for a very, very long time. And any haircut would have represented an inexcusable precedent.

Then, any country which would have retroactively changed the terms of its foreign debt documentation (like Greece did with the retroactive CAC) would have chanced its reputation as a good place for foreign investment for a very, very long time. Why? Because the holy principle was that laws cannot be changed retroactively and any such action would have represented an inexcusable precedent.

In short, the world of international finance then was a world where principle & precedent ruled. In the years since the crisis, we have seen repeated examples how principle & precedent simply went out the door. What the long-term price for that will be, no one can tell today.

A hedge fund by the name of Elliott Associates brought the sovereign country of Argentina to its knees. Argentina is in default. And? Prices on the Argentine stock exchange exploded this morning! That, too, could not have happened 40 years ago.

Elliott could not have been successful 40 years ago. Why? The international financial community would not have allowed Elliott to be successful!

When Argentina rescheduled its foreign debt in 1983, I was the chief negotiator of the 8th largest creditor bank. Argentina had around 500 creditors at the time. There were no Goldman's; no Elliott's --- they were all banks. The banks did not hold any anonymous bonds; they had official loans.

Citibank, the most exposed but also most experienced bank in Latin America then, was the supreme organizer of the sovereign debt reschedulings in Latin America and Bill Rhodes was their supreme leader. If decision makers of today would only know how Citibank and Bill Rhodes dealt with the problems then!

Every creditor bank knew, of course, that, at the end of the day, they would restructure their loans; i. e. stretch the maturities way into the future and possibly agree to lower rates. What else can you do when a country has no money to pay back its loans? No bank in its right mind would have ever expected to be bailed out by any government. Still, while the end-of-the-day result was known upfront, the activities and negotiations during the day were hectic. Principle & precedent had to be observed. Voluntariness of the participating banks had to be pretended so that loans could be kept on performing status.

Yes, there were hold-out's among the 500 banks; at least some which attempted to be hold-out's. Those hold-out's experienced what coordinated pressure of the international financial community can mean.

What if a major creditor bank had behaved like Elliott? That major creditor bank would have been reminded by the international financial community that no bank can function exclusively on its own; independent of financial partners who provide funding and other services. That major creditor bank would have been reminded that it might lose support from the international financial community if it did not 'play ball'.

Obviously, there were always some hold-out's who could not be persuaded. Typically, those were very small banks with very small exposures. To deal with them was not worth the effort. They were simply paid out by the other creditors.

What could all that mean for Greece?

Well, principle & precedent are no longer the forces which they once were. That opens a lot of new options for the conduct of debtor countries like Greece. If you know that you are not going to get crucified for violating principle & precedent, you might as well try to do it. Perhaps the Athens stock exchange explodes the day after Greece goes into default. No one can predict any longer.

There are clearly established rules of conduct in the world of international finance. They are not in writing but they are understood by all. Argentina violated just about every such rule in the book in the last 15 years. First, they unilaterally repudiated part of their debt. Then, they blackmailed creditors into an enormous haircut. And then they played a lot of silly games which might be fun games at a private party but which have no place in the world of international finance. That certainly played into the hands of Elliott because Elliott could argue that a country which plays such games shouldn't complain if creditors play similar games.

While the role of principle & precedent has been weakened dramatically in recent years, I would still argue that adhering to the rules of conduct remains as important as it has ever been. Should Greece, in the future, decide that certain principles and precendents should be tested in dealing with its sovereign debt, Greece would still be well advised to adhere to the rules of conduct. In fact, the more one adheres to the rules of conduct, the more chances one can take regarding principle & precedent.

If Greeks Are Bold and Wise, Then They Can Truly Be Rich!

"When I look at Greece I see one of the richest places in the world with untold potential for a booming sustainable economy, one with more than enough human and natural resources for everyone to live very, very well. So let us indeed think like the ancient Greeks, and look forward into the unknown with vision and courage. Otherwise we shouldn’t even call ourselves Greeks, as we will not deserve the wealth of this land. It is ours to safeguard, not squander through petty-mindedness. But If we are bold and wise, then we can truly, be rich” - see original article by Pavlos Zafiropoulos.

Nikos Dimou argued that Greeks are using all their energy to widen the distance between wishful thinking and reality, and he defines that distance as the 'misfortune of being Greek'. True, living in fantasy without any relation to reality is not a good recipe for happiness, at least not for sustained happiness.

On the other hand, Martin Luther King once spoke about 'having had a dream' and one can rightfully wonder if the US would have a black president today if King had never had that dream.

Regarding Greece, I come down on the side of Pavlos Zafiropoulos. If the distance between dream and reality is as wide as it presently is in Greece, the issue is how to bring reality closer to the dream and not how to wipe out the dream in favor of reality. Zafiropoulos' dream may be unrealistically beautiful; only time can tell. But there can be no doubt about the fact that Greek reality today is a lot worse than what the country has potential for.

It wouldn't hurt if Greek leaders of all walks of life read Zafiropoulos' article and, instead of explaining why that dream cannot ever become reality, started asking 'why not?'.

Greece - A Triumph for Hedge Funds?

As Greece stabilizes financially and as Greek debt instruments increase in value, there are frequent articles like this one extolling the success of hedge funds which have benefited from the Greek tragedy. As much as I mistrust hedge funds and pure financial investors as possible creators of an economic turn-around, I think a clarification is in order before one concludes that hedge and/or vulture funds exploit the impoverished local tax payers.

If a hedge fund purchased Greek paper when it was trading at 14% and sold it when it was trading at 50%, the fund made a ton of money but that ton of money did not come out of the pockets of impoverished tax payers. Instead, it came out of the pockets of those who had purchased that paper at 100% and now sold it at 50%. Theoretically, Greek tax payers themselves could have made that ton of money: Greece would have had to obtain enough financing to re-purchase all of its debt at 14%. However, chances are that there wouldn't have been enough sellers at 14%.

Now, what happens if vulture funds à la Argentina buy the Greek paper at 14% but don't sell it in the market at 50% but, instead, wait for final maturity and insist on getting paid 100%? Again, Greek tax payers don't pay more than the amount of debt which they had originally contracted. The difference is that they cannot benefit from the haircut which other creditors were willing (or had been forced) to accept. Still, that could be interpreted as 'exploiting impoverished tax payers' because when the majority of creditors agrees to a debt restructuring involving debt relief, they do so because they recognize that they cannot get their money back from impoverished tax payers. If a minority does not go along and succeeds in getting paid 100% in the end, they have taken their profits from impoverished tax payers and not from 'the market'.

A 30% Reduction in Total Public Sector Payroll?

"According to the figures, in 2009 the number of people working in the state sector either as permanent employees or on fixed term contracts came to 952,625 people. In December of 2013 that number had fallen to 675,530 - a drop of 277,095 or about 70,000 per year". See original article.

Now, I must admit that this small detail had escaped my attention... if one can consider a 30% reduction in total payroll a small detail. On the contrary, one of the angry comments which I heard frequently from Greeks was that "so far, they haven't fired one single public sector employee". And the Troika is making a big fuss out of sending 12.000 public sector employees into the mobility scheme.

How does that square with the above numbers? And, furthermore, how come that there has been so much discussion about a few thousand lay-off's and no reporting at all about the reduction of a few hundred thousand?