Greece’s 2nd Bailout

In the famous children’s movie Dumbo, Timothy the mouse and the cows (EU leaders) are trying to convince Dumbo (Greece) and the audience (Markets) that it has a magic feather and it can fly (survive the fall) despite its weight (debt weight). In the fairy tale, kids want to believe that Dumbo despite his floppy ears (Floppy reforms and economy) does fly. But reality is not a children’s movie. Convincing the markets that this is a sustainable solution and that Greece would be better off after the second bailout is a difficult trick to play.

Τα κράτη δεν πτωχεύουν ούτε χρεωκοπούν--αναδιαρθρώνουν.

Κερδος 20 Ιουλίου 2011


Όλοι πλέον σχεδόν καθημερινά αναρωτιούνται αν η Ελλάδα θα πτωχεύσει ή αν θα βγει από την Ευρωζώνη και άλλα τραγικά σενάρια. Σε αυτό το άρθρο θα επιχειρήσω μια πιο πραγματιστική προσέγγιση. Πρώτα πρώτα, τα κράτη δεν πτωχεύουν και εκκαθαρίζουν όπως οι εταιρείες, συνεχίζουν να υπάρχουν, δεν εξαφανίζονται. Τα κράτη το μόνο που κάνουν είναι αναδιάρθρωση των χρεών τους. Με τον ενα ή τον άλλο τρόπο αυτό πρέπει να κάνει και η Ελλάδα αυτήν την στιγμή. Όμως αυτή η αναδιάρθρωση αν θέλουμε να πετύχει και να βγάλει την Ελλάδα από τον βάλτο πρέπει να έχει ορισμένα χαρακτηριστικά. Η Ελλάδα πρέπει να σταματήσει να επαιτεί τους εταίρους μας που έχουν γίνει και πιστωτές μας. Είναι αναγκαίο να συγκρότηση μια ομάδα ανθρώπων της αγοράς οι οποίοι γνωρίζουν και τα νομικά αλλά και τα τεχνικά χαρακτηριστικά και ξέρουν πως να διαπραγματευτούν με καρότα και μαστίγια με τους πιστωτές μας. Οι πολιτικές λύσεις έπαυσαν να υπάρχουν από την στιγμή που οι εταίροι μας έγιναν πιστωτές μας.
Ας μην ξεχνάμε πως δεν αναγκάσαμε ποτέ κανένα να μας δανείσει. Αυτοί που αγόρασαν τα Ελληνικά ομόλογα ήταν και είναι επαγγελματίες θεσμικοί επενδυτές που πληρωνόντουσαν για να πάρουν ρίσκο. Δεν πρέπει να σώσουμε τις λανθασμένες επενδυτικές τους επιλογές.
Μια αναδιάρθρωση είναι πολύ σημαντικό να είναι ολική και όχι μερική. Δηλαδή θα πρέπει να αναδιατάξουμε όλο το χρέος τον 350δις και όχι μόνο μέρος του ή μόνο συγκεκριμένες χρονιές. Το Γαλλικό σχέδιο που είχε προταθεί έπασχε μεταξύ άλλων και από αυτή την αδυναμία. Μια αναδιάρθρωση σε δόσεις θα κρατά την Ελλάδα όμηρο των πιστωτών της εις το διηνεκές.
Θα πρέπει επίσης να συμπεριλαμβάνει μια περίοδο χάριτος τουλάχιστον 3-4 ετών στην οποία δεν θα καταβάλουμε ούτε τόκους μα ούτε και χρεολύσια αν θέλουμε οι αλλαγές στην οικονομία της Ελλάδος να δουλέψουν και να βγούμε ξανά στην ανάπτυξη.
Θα πρέπει να υπάρχουν κανόνες και κυρώσεις στην περίπτωση που η Ελλάδα δεν τηρεί τις υποχρεώσεις τις για να αποφύγουμε τον ηθικό κίνδυνο (moral hazard).
Αυτή την στιγμή το χρέος μας είναι 350δις και διαρκώς αυξάνατε. Ας είμαστε ρεαλιστές, η Ελλάδα δεν δύναται να εξυπηρετήσει, πόσο μάλλον να το αποπληρώσει. Η Ελλάδα δεν πάσχει από κρίση ρευστότητας όπως πολλοί ισχυρίζονται αλλά από κρίση φερεγγυότητας. Χρειάζεται να δίνουμε 7.7% του ΑΕΠ ή το 30% των συνολικών φορολογικών εσόδων μόνο για τόκους μεγάλο μέρος του οποίου φεύγει εκτός Ελλάδος ως φόρος αίματος χωρίς να έχει καμία πιθανότητα να επαναπατριστεί, αφού 70% του χρέους είναι σε μη Ελληνικά πιστωτικά ιδρύματα. Αυτό σημαίνει πως πρέπει να γίνει μεγάλη μείωση του κεφαλαίου. Αν λάβουμε υπόψιν μας, ότι είμαστε αναγκασμένοι να πληρώσουμε εξ’ολοκλήρου το ΔΝΤ και ότι θα είναι δύσκολο να κουρέψουμε διμερή δάνεια προς φίλια κράτη τότε η μείωση κεφαλαίου μπορεί να είναι μεγάλη στους υπολοίπους. Πρέπει επίσης να τονιστεί οτι για πρώτη φορά στην ιστορία της η Ελλάδα έχει δανειστεί με βάση το Ελληνικό νομικό δίκαιο. Είναι υψίστης σημασίας διότι σημαίνει πως οποιαδήποτε αντιδικία θα πρέπει να λυθεί σε Ελληνικά δικαστήρια και όχι διεθνή όπου ενδεχόμενες κυρώσεις θα είναι καταστρεπτικές. Αυτή την στιγμή μέσω του μνημονίου περνάμε μέρος του χρέους μας σε Αγγλικό δίκαιο. Σε 10 χρόνια αυτό μπορεί να είναι μοιραίο.

Αν θέλουμε η Ελλάδα να βγει ξανά στις αγορές για να δανειστεί πρέπει να γίνει ριζική αναδιάρθρωση. Κανένας μα κανένας δεν πρόκειται να μας δανείσει αν πρώτα δεν ξεκαθαρίσουμε το “παλαιό” χρέος των 350δισ. Σίγουρα θα υπάρχει πιστωτικό γεγονός και θα χρειαστεί να βοηθήσουμε μερικές Ελληνικές τράπεζες να επιβιώσουν και ενδέχεται να υπάρξει μετάσταση του προβλήματος και σε άλλες χώρες. Δεν είναι όμως το τέλος της Ευρωπαϊκής Ένωσης όπως χαιρέκακα πολλοί προφητεύουν αλλά η αρχή μιας Ένωσης σε πιο στέρεες βάσεις.

Steve Pinker

The way we experience the world is not ‘the way it really is’ but the way that has proved useful to natural selection for us to perceive it.

Today is the date

Time: Voting starts at 2pm (Athens time or 12:00 London time).

First things first, it looks very likely that the government MP’s would vote the MTP with perhaps 1-2 losses. That is however enough. All the vocal objectors seem to have calmed down. Watching the debate in the Greek parliament, one thing struck me as very worrying. Many if not most government MP’s, even the MP who introduced the legislation to the house, said that they dislike the plan, that the plan is not good, unfair or that is defective, but they are voting yes because otherwise Greece would not get the 5th installment. This is hardly an endorsement by the ruling party of the wiliness to effect economic reform. In other words, after the vote, we may go back to square one. Their vote does not represent their commitment, dedication and tenacity to tackle the debt problem but rather their fear of losing their seat and their majority. And these are the persons who after voting yes, would have to implement just what they said they dislike. Europe and the EU share the blame for this though. The irony is that the highly divided EU politicians insist lecturing the Greeks on unity. The MTP includes a rather ambitious plan to sell assets (at the wrong time) instead of forcing the government to cut expenses by reducing the fat public sector.

French Plan

Now we have some more details of the French plan we can summarise them as follows:
Lets assume that 100 GGB (for ease of calculation, actual number is around 85bln) mature between now and 2014.

As the GGBs mature, investors who agree “voluntarily” to participate in the plan will get 30 cash (good for them).
The other 70 would go into buying Notes/participation in an SPV. The SPV would get the 70 and would use 40-50 to buy 30Y GGB with a 5.5% coupon plus some upside coming from a GDP warrant. The other 20-30 would be used to by 30Y zero coupon from a EU entity like the EFSF.
The SPV Notes would further be acceptable as collateral for funding purposes by the ECB but would be on restricted trading.

Comments

Investors would get at least 30% of their principle back and a further 100 in 30years (30 would buy a zero coupon maturing at 100 in 2041). This is the sort of “Brady bond” guarantee. The main problem is however that long term yields are not very high (30Y swap is around 3.7%) and this does not help at all the Brady solution. Remember the higher the rate the lower the zero coupon (for example at 7% the zero would be at 13%). Investors would also get 5.5% coupon (plus some bonus if the Greek economy is resurrected) for holding a 30Y GGB risk. Thus, if we assume that the Greeks default on their 30Y GGB the investors get roughly 30(cash)+30 (zero coupon)=60 an implied haircut of 40 which is not bad considering that some GGB are trading at 50 now. A further complication is that they propose restrictive trading. Thus once you enter the scheme it is very hard to get out even if it becomes toxic. That does not seem to make much sense either economically or from a regulatory point of view. How much equity would they need to hold against this kind of illiquid asset?

Rating Agencies

Does it really matter what the rating agencies think of the plan? Well if you believe what they say, any rollover would be treated by some as a credit event. This is not such a big deal if Greece continues to pay the coupons on their bonds. The ECB would need to contortion once more the collateral rules and adopt some internal rating system rather than rely on external agencies. Would the Greek banks collapse? It depends. If the ECB or the Bank of Greece provides liquidity through repo or ELA there is no reason why the credit event should matter much. After all they mark their holding at 100 anyway irrespective of the CCC rating and the sub-par market.

Solvency issue still alive

The interest rate proposed for the new 30y GGB is 5.5%. It is not that it is high (considering the current market) but a quick back of the envelope calculation is as follows: Greece already is paying around 5% for the Bailout money. Assuming thus an average 5% for their interest rate payments on 350bln of debt (and growing) means 16.5bln a year in interest or almost 8% of the GDP (to foreign and not domestic investors) or close to 35% of their tax revenues. It is hard to see how they can survive such a burden which would hinder any attempt to grow the economy. In other words, it does not solve the solvency problem but only the liquidity for some time. In other words, Greece becomes a debt zombie. Greece would need a significant grace period in order to have a chance of ever coming out of the debt wormhole.

Finally, why go to such a complicated structure and don’t just allow the Greek Government to issue restricted (trading wise, like a Schuldschein) Bonds or loans which the Greek and other banks buy and then repo with the ECB. The scheme proposed resembles a hidden restructuring with a 40% haircut. It does fulfill the wish of politicians to share the load with the private bond holders and buys some time before the next restructuring. The truth is that the EU should have allowed this sharing of risk a year ago. Now anything that is proposed would leave a sour taste to all of the players, public and private and most of all to the Greek people.

Would the Greeks hit the sunny beaches or their politicians?

The debate on the MTP has started in the Greek parliament and you wouldn’t be a good politician if did not blackmail for a better cabinet position or increased publicity by expressing your doubts and possibly reluctance in voting the MTP.

Today (Tuesday 28th) the debate would start at (18:00 Athens time)
The voting would proceed in two stages:
On Wednesday 29th MP’s would vote for the whole MTP plan as a “concept”. If this succeeds then:
On Thursday 30th MP’s would start voting for the individual clauses.
It sounds crazy but that’s what it is. In theory, then, once the “concept” is voted on the 29th the MPs can out their anger on the 30th in voting down some of the clauses.
The conservative opposition has already said that they will not vote for the “concept” on the 29th but would vote positively for many clauses on the 30th. Sounds schizophrenic, but that’s Greek politics for you.

We do not expect any major surprises in the actual voting the next two days. Yes, there would major horse-trading and macho political posturing but we should be used to it by now. The immediate real challenge is coming from the people who are organising mass protests today and tomorrow. There are general strikes in Athens (London seems to envy) and contrary to last time the weather is good. We expect good attendance and possibly some trouble to satisfy the world’s media appetite for broadcasting material.

In the news:

1) French plan for saving the EU. There details of the French proposal are scarce and not very clear. What we know thus far is that the bonds maturing between now and 2014-15 would be involved. According to press reports only 70% (French banks own around 14bln so this means 9bln would be involved) of these bonds would be rolled over. In the case of France this means 4.5bln out of the 9bln would be invested in 30Y bonds (at around 5.5%). These 30Y bonds may have a GDP warrant attached to it (details unknown). For the rest, the GGB would be place in an SPV possibly secured by EFSF or some other European entity/state and the SPV would issue AAA tranches that would be bought by the banks.
Comment:
It is too early to judge the proposal as it is neither final nor detailed. However, for the first time we have a on the table hybrid Brady bond solution. We expect many revisions and plans to be put forward as the summer temperature rises.
From the Greek point of view, a 30Y extension is great news. But this plan as many others ASSUME that the debt is SUSTAINABLE and that this is a LIQUIDITY crisis and not a solvency crisis.
2) The big decisions would come on Sunday the 3rd of July. This is when the leaders of EU would decide whether to release the 5th instalment and any future bailout II.
3) Do not underestimate the 5th of July. This is when the constitutional court in Germany would rule on the EFSF legality. Although, being lawyers they would find a way out, it may make future decisions more difficult to take.

All of the above assume a positive outcome in the Greek parliament and that the Greek would hit the beaches in the next few weeks and not their politicians.

Greek Sequel

News and timelines

The Greek government presented their Medium Term Plan (MTP) to the cabinet. Total package is for 28bln and half would come from cutting expenses and the other half would be new money from tax raids and fast tracking asset sales.

Voting on the MTP is scheduled for  the 28th of June, but they may move it forward to the 23rd , while the IMF has to release the 5th installment by 15th July and the negotiations with the Eurogroup would finish by the 20th June.

There are also press reports that the Greek PM would address the people today. If he does we do not expect to say anything life changing. A possible cabinet reshuffling is on the cards but it would probably come just after the MTP.

Germany vs ECB

It is now clear that Europe is totally divided with Germany favouring a new loan to Greece but on condition that existing holders of bonds maturing up to 2012 will be re-profiled. In other words they would reinvest “voluntarily” into new 7Y bonds with perhaps some sweeteners. This plan would probably be put forward in the next few hours by the German coalition and it would be contingent on IMF support and the german parliament.

On the opposite side is the ECB which opposes any sort of restructuring and favours adherence to fiscal austerity and reforms while providing bailout II. We believe that the ECB plan is more credible. Yes, with the German plan, private investors share some of the burden but here are our objections:

• The minute reprofiling is announced they would be a run for the exit from bond holders of Irish, Spanish, Portuguese and possibly Italian bonds for fear that they are next in line to be reprofiled. Thus we have a big contagion risk.

• Get your money now or NOT get your money in 7Y. The new bonds would have maturity of 7Y well into the ESM territory and thus with significant risk of being restructured to death. Unless, the reprofilers have some sort of immunity or credit enhancement which is by definition a credit event and CDS are triggered.

• Rating agencies have indicated that even a voluntarily reprofiling may be treated as a credit event.

• About 12bln of bonds maturing in 2011-12 are in Greek banks and in principle easy to coerce (sorry volunteer). But this is not in the best interests of the Greek economy as you would need healthy banks to drive you out of your death spiral.

Who is going to be bulldozed over? Sorry I meant roll over

The latest from the Greek mill:

International side:

There was an unscheduled Eurogroup videoconference yesterday.
Merkel met Obama and they seemed to ok extending the bailout.
The ECB may soften their opposition against the rollover of the Greek debt if private investors (i.e. Banks and Funds) agree to participate and the rating agencies approve.
The IMF would only release the 5th installment to Greece if Europe agrees on extending the plan.

Greek Side:

The Greek cabinet is meeting to today to approve the outline of the Medium Term Plan. This is NOT the full monty. The cabinet would approve a 2 page document only. The bill containing the measures (selling of assets etc) would appear in roughly 10 days and then we would see how harsh the opposition is. Lets not forget that both the 5th installment and Bailout II is contingent on Greece passing the MTP. A further complication may be the people's opposition to passing the bill. according to press reports, they are planning to block the entrances to the parliament to keep the MP from entering and voting.

Latest plan is to “convince” bond holders of Greek debt to rollover their holdings for another 7y and a further 90-100bln to cover Greece till 2015. Originally, the ECB opposed this idea and the rating agencies signaled that it would be a credit event and thus trigger the CDS. Current thinking is to replace the maturing Greek bonds with bonds that have some sort of enhancements in order to bypass the objections from the rating agencies. This may include:

1. Higher coupon
2. Introduction of CAC (Collective Action Clauses)
3. New bonds under International law and not Greek law
4. Credit enhancements or guarantees. (this would be a credit event for sure)

The first three (1) to (3) may escape the full default status although they rating agencies may chose to rate this as “Selective default” (A bit like a zombie, half dead half alive) which is one step higher than default (Full dead). The last one (4) is de-facto a credit event as it would subordinate the rest of the bond holders.

But who are the Private Bondholders that need to be rolled over (convinced). Some of them (Credit Agricole and SocGen came out in favour)

Referendum. Is Greek PM Gambling again?

Greek PM hinted yesterday at the possibility of holding a referendum for the approval of the medium term rescue plan. This would be a huge gamble for Greece and the Euro if it goes ahead. The Greek PM is trying to blackmail the Greeks into "accept the austerity and the rescue by IMF or vote yourselves out of the EU and the Euro". The great majority of the Greeks disapprove the IMF/EU/ECB rescue yet they want to stay in the Eurozone. This may be a cunning plot to get the mandate to push the reforms but is a dangerous one. Greek PM is playing Russian roulette.

It is conceivable that the dilemma for the referendum would be either vote for the Medium Term Plan or we don't get the money and we don't pay pensions and we drop out of Euro and all hell breaks loose. High stake strategy, but the danger of saying no has unpredictable consequences.

Senario 1.Greeks vote down the plan.

The government would have to go back to the EU and draw another plan armed with the rejection. Greek PM asks the EU to respect the plebiscite as this is a "democratic" union. Presumably, the EU would cough up the emergency money in between for Greece to avoid default and misery for the ECB (major bondholder). The danger is that there would be a run on the banks before the voting takes place or that the EU lifts the middle finger. On the other hand it is the perfect excuse to renegotiate the rescue plan. Politically, it bites at the heart of the opposition by passing the blame to them for the lack of cooperation and for pushing Greece into the abyss. Let us not forget that political polarization always helps the current government (devil you know). It also serves to unite the government party which basically opposes the PM's choices. Greeks may remember a similar dilemma in 1974 (fall of military junta) "Karamanlis or the tanks" (Karamanlis was the caretaker PM and uncle of the previous discredited PM).
Either the Greek PM got secret assurances that the EU would help even in the rejection case or he is planting a nuclear bomb at the center of the EU.

Senario 2. Greeks vote for the Medium Term Plan

In this case, obviously the Greeks survive to fight for another installment. The opposition is in disarray and the Greek PM is the new Machiavelli. Well, referendums do not give birth to money and what would be more important is the implementation of the measures and not the approval. Too many laws in Greece are not observed to make this the norm rather than the exception. The victory may be narrow, in which case it may hard for him to survive the political capital he expended. So he may win the referendum but loose the parliamentary majority. The problem with the Greek government is that the portray the rescue plan and reforms as dictated by evil economic interests and not as necessary reform for Greece.

More Money for Greece?

Today (3rd June) the famous troika inspectors are making public their report on the progress of Greece and its adherence/compliance to the memorandum singed. It is no secret that the Greeks have not exactly succeeded in meeting the targets set and in some areas they are very far behind. For example, income from taxes missed the target as the recession bites and tax administration and collection reforms have not as yet kicked in. Privatization of state assets and companies has not even started despite their promises mainly because the government is unwilling to “restructure” or downsize their own-controlled unions and supported. The current government (Socialist PASOK) is the party that spearheaded the expansion of the state sector the past 30y (22 out of 30y) and find it difficult to kill their own brainchild. Despite what they claim when they are facing EU officials the main opposition does not come from the conservatives but from inside their own party officials and even ministers. Yet they managed a 5% reduction of debt in 1y and have timidly started some reforms to liberalise the economy.

Where does this lead us? Default? Restructuring or some sort of re-profiling? Looking at the debt numbers it is clear that the Greek debt is unsustainable. The current state of the Greek economy simply cannot generate enough revenues to pay the interest, never mind the principle. The program of the IMF/EU/ECB was from the start a utopian one. One cannot turn an economy by 180 degrees in two years or expect them to make more than 15% fiscal adjustment in 3 years under the current economic environment. Their decision was a political one and not an economic one, in the same way it was a political decision to accept Greece, Italy and Belgium into the Euro despite not meeting the criteria.

Now all of sudden everyone is talking of default and restructuring.

Default:

Greece would find it very difficult to declare a moratorium as they are not running primary surpluses. In other words, if they decide to stop paying their debt they are still short cash to pay pensions and salaries. But let’s say they do, what are the consequences? Well, bondholders would have to start writing their debt down. Most if not all the banks who hold Greek debt have moved it to the Banking book (Hold to Maturity) in order to shield it from the famous banking stress tests (they do not stress test the banking book). The GGB would stop being eligible collateral with the ECB. This would immediately mean bankruptcy for the Greek banks unless the Bank of Greece engages in ELA (like Ireland) on a massive scale. But the ELA is guaranteed by the state, in this case Greece which has declared bankruptcy….It all becomes very surreal. Many European banks and pension funds would suffer now real losses as opposed to mark to market losses and their local politicians would need to come to their rescue. Politicians prefer to kick the can down the road rather than dealing with them. Then we have the “small” matter of the ECB. The ECB took enormous risk by buying 45bln of Greek debt. They bended their rules in order to save the EU as the politicians argued. The ECB in essence has become the “Bad Bank” of Europe. They would need to raise billions of capital from their shareholders (the National Central Banks, including Greece) to cover their losses as they cannot print money (Maastricht treaty). Next, come the Irish and the Portuguese . They have every right to question the ethics of Greece escaping through default while they go through painful fiscal consolidation. They may be tempted to follow Greece or at least renegotiate their packages. Default also removes many levers that the EU has on Greece to push the reforms and may need to deal now with genuine civil unrest both in the peripheral countries but also in their home. You simply don’t give 110bln (55 have been disbursed so far) only to find out a year later that you are not getting them back any time soon.
Finally, there is the legal matter. Default and restructuring with a haircut is a messy business. The majority of the GGB are under Greek law (90%) which basically gives them a free hand to do what they want.
I am not mentioning the CDS as it is a minor problem. According to the latest figures there are about 6bln outstanding Greek CDS.

Reprofiling:
Recently, many EU officials (of greater or lesser importance) have talked about bondholders volunteering to extend their holdings. How would this work? The EU politicians pressure their banks and Insurances and pension funds to extend the holding period of their GGB after maturity with the same or better terms. This may involve credit enhancements or coupon increases. Apart from the fact that the ECB ruled this out (for their own reasons and agenda), this assumes that Greece has a short term liquidity problem and that their debt is otherwise sustainable. The ones that chose not to follow this re-profiling according to the Vienna principles get their money back while the re-profilers get more GGBs. If there is to be a restructuring in the future they would suffer even bigger haircuts as the IMF would get their money no matter what. But let’s assume that the Greek government pressures the Greek banks to extend their holdings (banks 45bln, Greek funds 30bln). Is this in their best interests? Not really. You need to have a healthy banking system to drive Greece out of the mess not just spreading the infection.

Trading GGB

Most market participants look at the price the Greek bonds are trading and they infer a high probability of default. Is this correct? Does the price of the GGB really reflect the true market? There is increasing evidence that this is not the case. Most of the GGB are not available for trading. Banks have moved them to the Banking book (to avoid stress testing) and marked them at par. As a result, selling them at the current screen price would mean taking a loss. This is a negative feedback loop. Only small sizes come out for trading by scared investors. The big ones are holding on to their GGBs. By depriving the market of liquidity they are pushing the prices down rather than up. This is the opposite of what one would expect in a normal market.

Future:

The most likely outcome in the next few days is that Greece gets the 5th instalment and that they also negotiate a further rescue package to carry them through 2013 possibly longer. In return, the Greeks would have to accept some sort of long term “supervision” and loss of fiscal sovereignty. This may not be as bad as it sounds. The EU needs to move to a closer Economic union (fiscal) if it is to survive the crisis and Greece may be the spark of this. The head of the ECB has already spoken in favour of a European Finance minster, and the French are pushing for “Economic Government”. There is only one problem. “No taxation without representation”. The EU is still a very undemocratic venture. The European parliament does not play any significant decision making role and there is a democratic deficit. If Greece is to become the first Fiscally consolidated European country, Europe would need to reform their democratic and accountability institutions and processes.

Who owns Greece?

If you lend €87 billion to Greek banks backed by an insolvent state, and 110 billion to the Greek state you are no longer a creditor: you are the owner of Greece.

Greek Banks repo around 140bln of securities with the ECB. In return they get around 87bln of cash to fund their balance sheet.

Greece got a bailout out from the IMF and the EU of 110bln. So far around 55bln have been given and a further bailout of around 60bln is being discussed in order to carry Greece to 2013.

Bloomberg Presentation on Greece and Peripheral Debt Crisis

A comprehensive summary of the debt crisis in Greece and the peripherals can be found in this seminar given by ITCM on Bloomberg.
Just go to
www.intouchcapitalmarkets.com
and press the link on peripheral debt. It is a Flash presentation.

Greece, A modern failed state?

When one speaks of failed states, Iraq, or Afghanistan may come into mind. Yet there may be modern western equivalent to this notion of a failed state. One only has to look at the characteristics of a failed state in order to find analogues. Lets look at the case of the Greek state:

• Citizens/State relationship is on of distrust, denial and abhorrence
  
• Brain drain of professionals and educated workforce.
  
• Nationalistic or stereotypical political rhetoric.
  
• Sticky political memories. Parties invoke past deeds (historical) to justify their policies.
  Extensive corruption or institutionalized corruption.
  
• Sharp economic decline and flight of capital.
  
• Reliance of the state on debt or handouts. Bankruptcy of state finances.
  
• State responds with more authoritarian rules to cover their inability to govern.
  
• Tax collection which delimits the power and defines a state collapses.
  
• Inability to control crime and civil unrest.
  
• Racist or sectional violence.
  
• Ballooning expat communities.
  

Worryingly, most of these indicator boxes are ticked in the case of Greece to a greater or lesser degree. The problem is that they are worsening all the time. Maybe Greece has not reach the full indignation of a failed state status but certainly it is a failed EU state. In many ways, however, Greece had never reached the status of a modern state so to say that it has failed may be inaccurate. Unfortunately, the signs are that the country needs to go back to its drawing board to rethink and redesign the the whole venture.

Greek Tax Incentives

Historically, one of the key hallmarks of a successful state is the ability to impose and collect taxes. From ancient Egyptian times, to the Roman era and more recently to the Ottoman and American empires, tax collecting is not just a money raising activity but delimits the scope of the state’s power and its effectiveness. Sometimes it goes even further as a means of defining citizenship or nationhood. It comes therefore as no surprise that a sure sign of a failed society or a state is its inefficiency and negligence to collect taxes.

In this respect, the demands of the IMF on the Greek government to improve their tax collecting efficiency goes beyond a pure technocratic measure. It is akin to a call to rebuild a state and a society that lays in (Greek) ruins.

Before attempting to provide explanations of the mechanisms that are responsible for this mess it is instructive to illuminate the mess.

In essence, the Greek tax laws are very complicated. On average 5 tax laws are passed every year (17 so far in 2010) with tax officers unable to keep abreast of the most recent whims of their ministerial masters. While in the late 80’s tax arrears totaled €200mln in 2010 that figure is a staggering €33bln. The information technology revolution seems to have escaped the attention of the modern Greek state where paper filing is still king. Sporadic attempts to introduce computers only resulted in a proliferation of different systems and databases that do not communicate with each other. As a result the cost of collecting taxes is 2-3 times the European average. Corruption among tax officers is rife and has never been dealt with effectively. Tax evasion cases take on average 7-10years to be resolved in Greek courts by which time a tax amnesty is bound to happen. There is one tax amnesty almost every 3 years, which by amazing coincidence correlates highly with election time (the latest in Nov 2010, is the 10th since 1985). Thus, one can argue that it is almost a state policy not to collect taxes. In fact most economists would describe the Greeks as acting rationally within their own economic habitat. Volunteering to pay taxes is not a human trait. Some say it is a God given right to avoid paying taxes.

On the surface, one is puzzled by the inability of the Greek government and the political establishment to raise tax revenue as this is the lifeblood of the state and the essential nutrition of the bureaucracy and the political elite. A clue is given by the exponential growth of tax arrears in the years 1995-2010. Governments have a big incentive to develop the economy and the tax collecting effectiveness, because, this is how they survive and exercise their power.
Against this incentive, a Government needs to balance the unpopularity of the taxes they are imposing and in modern democracies this costs votes. Thus a healthy equilibrium is reached and we have a functional state.

This equilibrium of incentives was violated in Greece and in other peripheral countries, first in the 90‘s by the extension of European subsidies with no strings attached (a cost free cow to be milked) and secondly by the entry into the Euro system and the availability of borrowing at very low rates. Politicians did not have to make hard financial and political choices. They used the subsidies in order to get re-elected and the cheap borrowing to cover any shortcomings. Economic productivity was decimated as traditional industries fell prey to the rising globalization and was replaced by borrowing. GDP growth came from consumption which was fueled by even more cheap borrowing. Why bother with fixing the tax system when you can borrow at low rates with the implicit European guarantee? The spread to the Bund which now stands at roughly 900 basis points was at 10 basis point in 2002 and was close to 70-100 for most of the time. One can mitigate his unpopularity by yet one more tax amnesty. It is possible to delay dealing with hot potatoes until the opposition is in power and then to sabotage any attempts to fix things in order to get re-elected once more. Politicians became debt junkies.

Moral hazard and the disequilibrium of incentives is a very powerful force. It is like compound interest. It acts on a long timescale and it passes undetectable on a daily basis. Slowly, the voices of reason and common sense started fading away. Politicians who advocated restrain and prudence became political eccentricities and increasingly unelectable. Populism rose and an arms race of nepotism and exuberant political pledges took over.

The roots of what has happened in Greece are in completely analogous to the situation in Arab states that discovered oil or to African states with mineral deposits. In all cases the shift of economic incentives for the ruling party/government acted as a retarding force for the economy and created dysfunctional and failed states. In the Arab world, oil supported totalitarian regimes and in Africa contributed to economic misery, civil wars and gun democracy.

The European bail out of Greece and perhaps of other peripheral states, is dealing with the symptoms of the crisis and not with the root causes. None of the moral hazards or the imbalances of political incentives is dealt with in a European level. Once the IMF finishes its work and leaves, the irresponsible behavior will resume in Greece and in other European member states. By that time a more coherent bail out package would exist and a transfer of creditworthiness can resume from the rich north to the south either through a European Bond or some other mechanism. This is not what European citizens want. The current crisis is an opportunity to reset the core European foundations on a more concrete and moral footing ready to meet the challenges of the future. In this respect the current crisis could do us a great service only if we draw the right conclusions and act on them.

To Default or Not to Default

In a recent debate about the Greek debt and the Greek government's Don Quixotic efforts to reduce it, a very rare consensus was achieved. Both the government who implements the directives of the triumvirate (ECB, IMF, EU) and the opposition who vehemently opposes the austerity measures, agreed in anathematising the event of restructuring or default of the Greek debt. Despite the fact of the mathematical inevitability of restructuring and default both agreed that the debt can be sustained and/or repaid in full. They argue that it could be done if Greece had a 6% primary surplus, or growth of more than 4% for the rest of eternity. Armchair generals could not come up with a better scenario. But maybe they are right! Maybe Greece can pull 350bln rabbits out of the conjurers hat and repay the debt. Any real Greek tragedy must have a Deus ex Machina to finish the plot. Or maybe, the Germans or other good willing Europeans can forgive the Greek debt binge.
The Greeks may not be wrong in this one. The word "fail" is not something that Europeans like. Failure is not part of the European way of doing business or part of Europe's cultural heritage. While in the United States of America failure is seen as a necessary trial and the only way to gain experience and wisdom, in Europe, failure is a miasma, a taboo a total no-no. Failure is not an option in a similar way "Resistance to EU policies is futile". When failure comes, it is either swept under the carpet or is dressed as a "moral success" and achievement of some higher yet unforeseen good.

The arguments they employ against default are typical of a drama queen. First, they argue that default of a country would lead the country out of the EU, next, that the Euro would collapse as more peripheral countries (another derogatory name for PIGS) would follow. It naturally follows that the EU would disintegrate, the German dream of European conquest would be achieved and/or the Americans would see their influenced in Europe reestablished. The gloom and terror that follows easily competes with the best traditions of the Christian Hell and countries that leave the EU would be placed in a sort of European limbo. And all because a small and, lets admit it, an insignificant country like Greece or Ireland cannot meet their debt obligations. Why European politicians are so afraid to face real life? Would a 350bln default trigger the collapse of our societies as we know them? When Lehman collapsed more than 650bln were wiped clean and despite the pain and suffering of the bond holders most of them seem to be doing ok 2 years later. What is missing from Europe is more defaults that would put an end to the accelerating moral hazard and less socialisation of losses.

The attention span of most politicians is very short, until the next election. Naturally they don't want to be known in history as the bankruptcy leaders but as the saviors. The Greek prime minister Mr G. Papandreou got one better, in a televised interview he proclaimed that he will "save Greece" and he does not care about "not being re-elected ever again". Quite obviously, one is obliged to ask the negation of his statement; was he striving to bankrupt Greece in the process of being re-elected all these years? Many would agree with the later statement even if they have faith in the current intentions of the Greek PM.

Lets get one line of reasoning out of the way. Countries do not liquidate on bankruptcy, like corporates do, they Restructure their debt and continue to exist (happily or not) thereafter. Thus the real question is not whether Greece or Ireland can repay their debt obligations but what is the price for doing so. If these countries embark on an all out strategy to repay their debt in full they may find their societies in a far worse predicament 20 or 30 years from now.