Experts Favor Debt Re-Profiling!

Back in 2011, I had written a whole series of articles on how the debt problem of Greece (or any other country, for that matter) should be handled whereby my views reflected the experiences which I had as an active participant in the debt reschedulings of Chile and Argentina in the 1980s. Interested readers can look up the respective sections in my blog inventory.

International finance and insolvency experts recently discussed this issue at a meeting in Santa Monica, California. The group included Lee C. Buchheit, often referred to as the laywer with the most experience with sovereign debt crises (Buchheit was legal counsel to Greece with the issue of the haircut). Here is the report of the meeting.

The report addresses the role of the IMF specifically but it would apply to official lenders in general (ECB, Troika, etc.; essentially the tax payers). The report summarizes the options available to officaldom as follows:

1. "Full Bailout" - Lend the country the amount needed to repay in full all obligations maturing during the program period.
2. "Pre-Emptive Restructuring" - Require a full restructuring of the country's debt at the outset of the program in order to remove any doubt about the sustainability of that debt stock.
3. "Re-Profiling" - Require a milder form of restructuring that pushes maturities out of the program period without imposing haircuts.

Back in 2011, I had argued ad nauseaum that Greece's debt should not be refinanced or forgiven but that, instead, it should be 're-profiled' ('rescheduling' was the term used in my day). I am glad to see myself supported by the views of the above experts who note the following benefits of a re-profiling:

* reduce the call on tax payers' resources
* allow time for diagnosis
* allow time for adjustment mesures to take hold
* lock in the private lenders
* allow time to hedge
* incentives for debtor countries

A very important benefit, not mentioned above, is that the country can continue to say that 'we will honor our entire debt' (regardless of whether eventually it will be able to do that or not, but 'eventually' is a long time off).

What does a re-profiling mean? That depends on how it is structured. In the extreme case, it could extend all maturities of principal and interest for, say, 10 years or more. In practice, this would be equivalent to a haircut for 10 years (or more). The debtor country has no debt service during this time and the lenders retain all their legal claims.

There is one major problem with that, and the report mentions it. There will always be holdout's. There will always be a small creditor and/or a hedge fund who will blackmail the majority (and legally he can do that!). The report does not offer a solution to that question, it only stipulates that the question of how to treat holdout's must be agreed upon at the outset.

My suggestion would be: pay them off and tell them that they will never do business again with any lender participating in the re-profiling!

The Gigantic Dimensions of Germany's Foreign Assets Position!

The table below shows the net foreign asset position of Germany as it is composed of foreign assets, reduced by foreign liablitities. All amounts are in BEUR.

	Assets			Liabilities			Net Assets
	2011	2012		2011	2012		2011	2012
A. Financial Sector	2.863	2.746		2.679	2.632		184	114
B. Private Sector	2.788	3.074		1.728	1.841		1.060	1.233
C. State Sector	238	295		1.271	1.349		-1.033	-1.055
D. Bundesbank	715	921		47	107		668	815
Grand Total	6.604	7.036		5.725	5.929		879	1.107
	Annual GDP ca. 2.660!

There are various ways to look at a foreign assets/liabilities position, depending on what point one wants to make. If one wants to make the point that Germany is exporting its savings, one has to look at the net position. Every country will always export some of its savings but it also imports the savings of other countries. When savings imports exceed exports, the country is a net borrower. When exports exceed imports, the country is a net lender. Germany clearly is a net lender to the rest of the world with 1.107 BEUR net foreign assets at Y/E 2012.

Net exports of savings and a net foreign assets position are a function of current account balances. Current account surpluses translate 1:1 into increases in net foreign assets. It should be noted that Germany's net foreign assets (net capital exports) are approaching 50% of its GDP!

If one wants to make the point that a country carries substantial financial risks outside its borders, one has to look at the gross foreign assets position. Why? Because, generally, there is no right of offset between assets and liabilitites (except, perhaps, in selective transactions like swap agreements between Central Banks). If the rest of the world went bankrupt, the German economy would be out of 7.036 BEUR (as per Y/E 2012) while the liquidator of the rest of the world would still have claims of 5.929 BEUR against the German economy.

Having said all that, the sum of German economic agents (banks, insurance companies, corporations, private individuals, the state, the Bundesbank, etc.) had 7.036 BEUR at risk outside German borders as of Y/E 2012. Is that a lot? Well, it is close to 3-times the GDP of the German economy. That's a lot!

What's wrong with foreign assets if they are wisely and safely invested? Well, they are subject to foreign jurisdictions, in the first place. Secondly, they can't all be wisely and safely invested. Money flows, directly or indirectly, from those who have it to those who need it, and those who need it are a greater risk than those who have it.

This article from the WSJ calculates that, from 2007-11, the German economy lost 575 BEUR of its foreign assets (just think of the losses which German banks and insurance companies have taken in sub-prime, Lehman, Iceland, Ireland, Greece, etc.). If that figure is only half-way correct, it would suggest that the German economy has lost 10% (or more) of its foreign assets during the period.

When savers lose 10% of their depositis, there is an uproar. Why was there no uproar (yet) despite the significant loss of foreign assets? Because those losses have not been felt directly by the German tax payers. They were recorded at upper layers of the economy (banks, insurance companies, etc.). 

When do losses of foreign assets hit the tax payers? In the short term, mostly when they flow through the budget. Those losses flow through the budget when the state itself loses foreign assets (i. e. when the state writes off a, say, rescue loan to Greece) or when the state has to spend inordinate amounts of money to bail-out a bank like HypoRealEstate because that bank lost tons of foreign assets.

As I said in the beginning, gross foreign assets are heavily driven by current account surpluses and net foreign assets are driven entirely by current account surpluses. Once Germans begin worrying about their country's foreign assets position, they may perhaps be persuaded that an economic model which continually increases that position (i. e. excessive and chronic current account surpluses) is perhaps not in the best interest of Germany.

If reason does not work, just scare Germans that their pensions and future living standards are not safe. That will work any time!

"F***ing Psycho!"

Former Spanish Premier Jose Luis Rodriguez Zapatero claims in a new book that French President Sarkozy became enraged with Prime Minister Papandreou at the G20 summit in Cannes in November 2011 and called Mr. Papandreou a “f***ing psycho".

If only Mr. Papandreou had taken a negotiating seminar before that summit! Had he done so, he would have known that he holds the strongest card when the other sides loses control. What a poor performance on the part of President Sarkozy!

And an even poorer performance on the part of Prime Minister Papandreou! I wrote an article prior to that summit titled "Mr. Papanadreou - A Mrs. Thatcher or 'The Son of the Father'"? Regrettably, it turned out that Mr. Papandreou was only the son of the father.

Real Estate Taxes - A Morality Play?

This blogpost by Robert Danon discusses the impact of real estate taxes on the Greek economy. Without going into the merits of his arguments, my attention was caught by the following sentence:

"One of the basic pillars of Stournaras tax on property is this, that since a substantial part of the black money must have been invested in property we must tax property ownership to catch this laundered money".

Well, I must admit that I was not aware that Greek real estate taxes were based on a moral justification. I always thought the logic of Greek taxation since the crisis was a bit like: 'if you need more taxes, (a) first hit the ones who are taxed at the source because they can't hide; and if that is not enough, (b) tax the real estate because that can't be hidden'.

Now a moral justification for real estate taxes is introduced: 'if you have evaded taxes and bought real estate with the proceeds, it is only fair for the state to get some of that real estate back'. Makes sense on the surface. But how can such a moral principle be implemented in a just way?

When I own a house and take out a mortgage, I have a 'private property' and 'private debt'. If I can't pay my debt, it seems legitimate that my lender takes away my property.

However, when I have private property but no debt, my private property is indeed private property. Whoever takes it away from me is interfering with the principle of private property.

My sense is that, if the real estate taxes were indeed based on the above moral principle and nothing else, there would have had to be very selective implementation. An implementation which assures that one hits those who deserve to be hit but not those who don't.

One way to do this would be to verify in each individual case how the real estate was financed. If it could be proven that it was not financed with 'black money', one should not try to get some of it back via new taxes.

Just thinking how much of an administrative effort this would entail leads me to believe the government most likely followed the following logic: 'let's tax real estate because we need the money and afterwards we build a nice narrative around it!'

The Most Effective Argument against Germany's Surpluses

At long last, I have seen an article which outlines the best arguments why it is in the interest of the Germans themselves to reduce their current account surpluses. I will start off by mentioning, once again, the key formulas which I have mentioned on several previous occasions:

Current account surplus = net exports of capital
Current account deficit = net imports of capital

Germany's current account surplus is not generated by the German state. Instead, it is generated by all of the economic agents residing within German borders (mostly the exporting businesses). The resulting capital exports are not made by the German state. Instead, they are made all by of the economic agents residing within German borders (to a large degree: banks, insurance companies, etc.).

As a mathematical (and not economic) consequence of the above: excessively high German current account surpluses MUST lead to excessively high German net capital exports. Germany, allegedly, is now the highest current account surpluser in the world. As a consequence, Germany is now the largest net capital exporter in the world. The world's largest lender. Gross foreign assets of the German economy already exceed 7.000 BEUR (!), more than twice one year's GDP.

The above has recently begun to develop into something which I have referred to as 'the battle of current accounts'. Clearly, looking at this situation from the rest of the Eurozone, Germany is perceived as a threat to balanced economic growth. Even the US has now joined the line of those who claim that Germany, out of its responsibility as one of the largest economies in the world, must do something to correct those imbalances.

'Germany must reign in its exports!' has become one of the popular slogans whose popularity is exceeded only by its silliness. 'Germany must increase its imports' is an intelligent slogan but it won't carry the day in Germany. 'Why should we if we don't need them?' the Germans might ask.

If one wants to get the attention of Germans, one has to warn them that 'their pensions might be at stake!' That will get their attention immediately. And, as the article so convincingly shows, that argument is absolutely correct! Thus, it is in the utmost interest of the Germans themselves to reign in their current account surpluses so that their net capital exports are reigned in so that the foreign assets of their economy are kept at a reasonable level.

Rough estimates are that the various bubbles since 2007 have already cost the German economy a 3-digit BEUR figure of its foreign assets (sub-prime, Lehman, Iceland, Ireland, Greece, etc.). Why have the Germans not been shocked by that? Because, so far, the bulk of these losses has been recorded at layers above the tax payers (banks, insurance companies, etc.). But the fact of the matter remains: if losses hit the foreign assets of an economy, that economy has lost assets; that economy has become poorer.

So what would be the most effective way to convince Germans that they should reign in their current account surpluses? Let me phase it casually: just scare the living daylights out of Germans that their pensions are at stake; that their sustained living standard is at stake for the simple reason that they export so much capital which is the consequence of the much praised virtue of being world champion with current account surpluses.

Would that be a lie? On the contrary, it would be the absolute truth! Money flows, directly or indirectly, from those who have it (surplusers) to those who need it (deficiters). The Germans may think that their foreign assets are all invested wisely and safely (if they haven't read the papers in the last 5 years). What Germans have to wake up to is the fact that their savings are, in the final analysis, in all those deficit countries whose risk they fear so much.

In a couple of months we will see German newspaper headlines exclaiming 'Record Current Account Surplus for 2013!' I wonder if a German publisher will have the nerve to publish the following headline instead: 'Shocking News! German Savings Put At Risk Abroad Reached Record Levels!'

It's the current account, stupid!

P.S.
Given that Germany will have a current account surplus for quite some time, my advice would be that Germany export its capital more via investment than loans. Particularly investments in the South so that a country like Greece can build up productive capacities to make some of the products which Germans would buy. As of today, regardless of how much Germany would stimulate domestic demand, it would help Greece very little because Greece has only very little supplies to deliver.

Liberty Going Out Of Fashion in Germany!

"Of freedom and of life he only is deserving
Who every day must conquer them anew".

Johann Wolfgang von Goethe coined this verse a couple of hundred years ago in Faust. Move over, Johnny and meet the Germans of today. They are quite different!

Liberty is a value going out of fashion in today's German society, a study by the John Stuart Mill Society in Heidelberg has found. Egality, justice and security are the themes on which successful political campaings must be based. There is a desire for 'more state'.

The dream of Germans is the 'caring' and 'protecting' state and not the liberal one. That caring and protecting state is more just, wealthier, more human and more liveable.

Greeks ought to start asking the Germans the following question: If 'caring' and 'protecting' is so important to you, why do you want others to be so 'competitive'?

Alexis Tsipras - Convert 7 Key Aims Into Just One!

This article reports the answers which Alexis Tsipras gave when asked by the newspaper Avgi what his key aims would be during his first 100 days of governing (the bold emphasis is mine): 

* Cancelling the EU-IMF memorandum and replacing it with a national reconstruction plan.

* The plan will include bringing back collective bargaining laws and restoring the minimum wage to the pre-crisis level of 751 euros, from which it was reduced by 22 percent in 2012.

* The creation of an assets register to help with taxation, and the drafting of a new tax system.

* The renegotiation of Greece’s loan agreement.

* Increasing social welfare.

* Reopening public broadcaster ERT and legislating for the awarding of digital licenses.

* The overhaul of Greece's banking system, providing greater state control of lenders and the creation of small, regional development and cooperative banks.

I would suggest that the way Tsipras formulates his first key aim (in bold) may have as a consequence that his government won't last for 100 days. I would recommend to rephrase that key aim as follows: 

"Negotiate with our EU-partners to consensually transform the current EU-IMF memorandum into a long-term economic reconstruction and development plan for the Greek economy. The plan’s objective will be to transform, within one generation, Greece into a self-sustaining, value-generating economy on the basis of a sound, market-based private sector supported by an efficient and modern public administration, adequate in size and competency. A major pillar of the plan will be a focus on direct foreign investments in Greece’s productive sector, thus bringing not only financial resources but also know-how in all areas to Greece; thus enabling Greece to increase its productive capacity, to increase employment and to import less; thus enabling Greece to make products which other countries will want to buy. The primary responsibility for developing such a plan will be with Greece but we seek active participation of and know-how contribution by our EU-partners. We are confident that, once that comprehensive plan is on the table, our EU-partners - seeing that the plan has our unequivocal support - will willingly assist with financing it because such financing will be a good investment”. 

I would further suggest that if Tsipras were to focus on the above key aim, all his other key aims would fall into place naturally (because they would be part of a long-term economic reconstruction and development plan for the Greek economy).