Thursday, 10 November 2011

Trojan Horses

Last Wednesday (2nd November) I watched the early evening news on the BBC which described how the Greeks were being difficult about accepting a deal that will “halve their debt”. The BBC made it very clear how unreasonable the Greeks were being for looking this apparent gift horse in the mouth. A similar theme continued in the Guardian the following Monday (7th November);

“Greece received a €110bn bailout in May 2010 with the latest aid package writing off half of the country's €360bn debt load.” describing the latest aid deal as “a €130bn bailout package.”

Sounds like an offer you couldn't refuse doesn't it? (And we all know the unpleasant horse experience linked to that phrase).

The Greek people, having themselves been the provider of a dubious gift horse in the past, are perhaps more able than most to perceive the need to be weary of such apparent largesse.

Which is why our friendly neighbourhood Franco-German “kingmakers” made it clear to the Greek Prime Minister that any attempt to ask the Greek people for their opinion should be abandoned – politicians tend to only support referenda when they think they will get the answer they want.

Greek sovereign debt is in the region of 350-360 billion Euros (£300-310 billion). If there really was a 50% write-off (or “haircut”) on all Greek debt then we should see 175-180 billion Euros wiped off the Greek debt mountain. This would bring the Greek debt to GDP ratio down from a unsustainable 157%, to a more manageable 79% - a level of debt lower than that of the UK, Germany or France (but not below the level of Spain, another “troubled” country, with sovereign debt levels at only 68% of GDP).

Yet, according to the Debt Sustainability Analysis leaked to the press during the recent Euro summit, IF the “ungrateful” Greeks accept the terms of the new “bailout” deal, AND assuming there are no other shocks to the economic system, AND if other proposals go according to plan including even more austerity measures, privatisations, and reductions in Greek sovereignty, they might, just might, be able to get their debt down to 130% of GDP by 2030. A level of debt greater than that carried by Italy at 120%, which the same BBC programme described as very worrying and an indication that Italy might be the next sovereign state in the firing line.

Obviously, something doesn't add up. The most obvious questions that might spring to mind are:
1) How come a deal to “halve Greek debt” doesn't?
2) Why, if Greece has now had two debt “bailouts” totalling 240 billion Euros, is Greek debt actually getting higher rather than lower?

As we will see, those behind the new bailout know that it only provides, at best, enough funding for a E26bn reduction in Greek debt - a 7% reduction not 50% - and even this depends on the level of take-up of a haircut that is only voluntary because of fears regarding the stability of the financial derivatives market.

Unfortunately, there is no simple way to explain why the bailouts don't do what they say on the tin, so I have split my attempt at an explanation into six hopefully more digestible chunks.
Part 1 Where we learn that not all debt is created equal.
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A closer look at the components of Greek sovereign debt allows us to roughly calculate that the Greek sovereign debt includes somewhere in the region of 150-160 billion Euros worth of debt in the form of bonds and loans owed to official agencies including the EU (E47bn), IMF (E18bn), the ECB (at least E45bn), other European central banks (about E13bn), legacy loans from the Bank of Greece (E6bn) and other bilateral/special loans. None of this “official sector” debt, it appears, will be subject to the 50% haircut.
That leaves about 200 billion Euros worth of privately held sovereign debt, including debt held by Greek and Cypriot commercial banks (E60bn), foreign commercial banks (E30bn), sovereign wealth funds (E25bn), public sector workers' pension funds (E30bn) and other private sector institutions.
A 50% reduction on this would see the overall Greek debt reduced by about E100 billion (30%) and, indeed, E100 billion was the figure used by the (now ex-) Greek prime minister in a speech to his party group last Thursday (3rd November) as he tried to convince his audience that the decision as to whether the Greek government would hold a referendum was one for the Greeks alone despite the fact that everybody knew that Merkel and Sarkosy had already said Nein/Non!
In fact, the final reduction is likely to be considerably lower than the E100 billion referred to by Mr Papendreou.
Part 2 Where we learn it's not just what you owe but how much you have to pay for it.

Despite all the headlines about the overall level of Greek sovereign debt, the immediate problem for Greece is the rising cost of servicing their debt, coupled with the fact that too much of the borrowing is over a short term period.

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Some of Greece's current problems have been forced upon Greece by a market that has become more risk aware (as recently as 2009, the level of Greek debt as a percentage of GDP was still lower than it had been some 7 years previously), other problems are self-inflicted - such as the largest shadow economy in “western” Europe (at some 28% of GDP) with high levels of tax avoidance and evasion badly impacting upon the level of tax revenues collected.

As with politicians in almost every developed country, Greek politicians have promised to deliver the public services the electorate demands, whilst being unwilling to collect the tax revenues needed to pay for them.

The net result is that Greece has borrowed from the market and as the level of Greek debt has risen, so the cost to the Greek government of paying for that debt has increased which means the Greek government has increasingly been forced to borrow on shorter terms from the market because the cost of borrowing short-term is (usually) cheaper (because the investors are only committing their funding for a shorter, and thus, theoretically, less riskier, period of time).

This has a consequence in an increase in the frequency that the Greek government has to go to the market looking for “new” borrowers in order to “rollover” (ie. re-borrow) significant portions of its debt.

Because markets have (belatedly) become more risk conscious, increasing concerns about the ability of Greece to repay its debts have caused the price of Greek bonds to fall in order to sell thus forcing up the cost of borrowing for the Greek government even more.
This, in turn, forces the Greeks to borrow on even shorter terms (forcing them to “rollover” their debt ever more frequently) and at ever higher rates of interest (increasing debt interest payments and reducing the ability of the Greek government to reduce its deficit) - in other words, the Greeks are stuck in a Catch 22 situation, with their debt levels and interest payments spiralling out of control.
Therefore, part of the plan to “rescue” Greece is not just to reduce the overall level of debt via a 50% “haircut”, but also to encourage bondholders to agree to swap their short-term bonds for longer bonds with maturities of, if possible, 30 years at lower market rates than those available via the bond markets. This would reduce the frequency of Greek sovereign debt “rollovers”, relieving pressure on Greek government finances (and reducing the impact of a negative or “bear” market).
Overall, the deal will have the effect of reducing the impact of a negative market on Greek government finances by removing the need for the Greeks to repeatedly go to the market to rollover their existing debt, which in turn may help to stabilise the cost of Greek borrowing.

Part 3 Where we learn that insurance is not always worth the paper it's written on

However, the proposed 50% “haircut” and bond swap programme referred to above is intended to be voluntary which has major implications in terms of reducing the debt burden.

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The reasons for the Eurozone deal-makers wanting the debt holders to agree to a voluntary haircut rather than a forced haircut is to avoid triggering Credit Default Swaps (CDS). CDS are essentially a form of insurance against the very thing that is happening here – the potential for the seller of a bond to experience a credit event and default on all or some of their payment obligations. Therefore it would seem the most obvious course of action would be to force a 50% partial default, triggering the ability for the bond holder to claim on the CDS to recover their investment. After all, isn't that what insurance is for?

The problem is that there are major concerns about the ability of the CDS market to cope with a sovereign default, even a partial one by a relatively small country, an economy that only accounts for a tiny percentage of Europe's GDP – many senior figures in the finance industry recall how, after the Lehman Brothers collapse in September 2008, it became clear that the insurance giant AIG was exposed to tens of billions of dollars of payments for CDS due within weeks without the ability to pay them. Having allowed Lehman Brothers to fail, the officials concerned were so panicked by the potential knock-on effect of a failure in the CDS market, that they reversed their policy of not using taxpayers funds to bail-out private companies, and bailed out AIG.

As of November 4th, 2011, the Depository Trust and Clearing Corporation (DTCC) held details of over 4,400 live single-name CDS contracts directly referencing Greek government debt with a Gross Notional of $74 billion. Many CDS experts have insisted that the headline figure worth noting is the much smaller Net Notional ($3.7bn) and that the problem with AIG was because it had a high Net Notional unlike Greek CDS, but, in the end, it all comes down to levels of trust. In a largely unregulated market nobody really knows what sort of chain reaction might be sparked by the triggering of the insurance supposedly provided by CDS.

The simple fact is that many in the financial industry and in the political realm are scared stiff of the very insurance system meant to guard investors against credit events like a Greek default.

So, rather than trigger the CDS, the deal will look for a voluntary haircut from the private sector even if that means that the potential reduction in Greek debt will be considerably lower than might otherwise have been the case.

Part 4, Where we learn that you can only have the haircut you're willing to pay for.

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Back in May 2010, the European Union and the International Monetary Fund funded a E110 billion package to “rescue” Greece, by providing it with the funds to meet its obligations for 2010-2012.. The IMF pledged E30 billion, with the EU offering E80 billion provided by the other Eurozone countries.

Of the E110 billion, approximately E10 billion was allocated to recapitalise (“bailout”) those Greek banks most affected by the debt crisis.

So far E65 billion of the funding has been disbursed in 5 payouts between May 2010 and July 2011 – E18 billion from the IMF, and E47 billion from the EU supplied by the Eurozone taxpayers including Germany (13.5bn), France (10bn), as well as the Italians (E9bn) and Spanish (E6bn) who might be considered to have enough problems of their own. Included in this total is E3.5 billion that has gone directly to recapitalise the banks.

Of the other E61.5bn disbursed, most of this has gone to meet the E43bn Greek deficit for 2010 and 2011 which included E27.5bn in debt interest payments to the holders of Greek debt (including payments on the loans provided as part of the bailout package itself).

The next EU/IMF payout of E8bn is due to go to Greece as soon as it accepts the terms of the latest bailout package. This left E37 billion still in the pot (including E6.5bn earmarked for bank recapitalisations) however this has been reduced to E34bn after Slovakia declined to take any further part, and Portugal and Ireland also themselves became recipients of bailouts.

However, by July 2011, it had become clear that the first “bailout” had failed to reassure the market about Greece's problems, leading to a second proposed E109bn “bailout”, subsequently increased to E130 billion on October 26th..

Of this new funding pot of E130 billion, some E30 billion will be made available for more Greek bank recapitalisations. Added to the E6.5bn left over from the recapitalisation pot for the first bailout, this means that E36.5 billion is available to prop up the banks directly.

Another E30 billion will be made available as “sweeteners” to encourage existing private sector bondholders (including banks) to swap their existing short-term bonds at a 50% haircut for longer term bonds maturing in up to 30 years.

That leaves E70 billion, along with the remaining E27.8 billion from the first bailout for a total of E97.8 billion to keep the Greek government solvent over 2012-2014.

Over that time period, the EU/IMF/ECB “Troika” who are now effectively governing Greece, predict that the Greek government will actually run a primary balance surplus of E14bn.

However, after allowing for the Greek debt interest payments which total E49bn over the same period, the surplus turns back into a deficit of E32.7bn, to which must be added another E2.3bn due from the failure to meet the deficit target for 2011 When this deficit is added to the E6.5bn of arrears that the Greek government owes to hospitals, local government, state bodies, social security funds etc, that leaves roughly E56bn available for the 50% “haircut” that was supposedly going to halve Greek sovereign debt.

Part 5, Where we learn that the 50% haircut....isn't

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The Institute of International Finance, the organisation negotiating of behalf of many of the banks as to how the new bailout should work, estimates that there is some E150bn of the E200bn private sector owned Greek sovereign debt due to be rolled over in the 2012-2014 time period. It is this debt that will be eligible for a voluntary haircut and bond swap.

Back in July, the IIF estimated that the offer of a 21% haircut and swap to longer-term bonds would be taken up by some 90% of private sector bondholders, holding E135bn of Greek debt. The IIF proposal provided four options for bondholders, only two of which included the haircut, with a result that the overall reduction of Greek debt would actually have been just 10% of the E135bn at E13.5bn.

However, the value of the bond held by the institutions who actually signed up to the original deal would appear to have been closer to E112bn – meaning that the plan would only have seen Greek debt reduced by about E11-12bn. It is easy to see why the EU and IMF were less than impressed by this proposal and instead insisted on a bigger haircut of 50%.

If the same number of private sector bondholders are willing to accept the 50% haircut (with the added incentive of the E30bn of sweeteners referred to earlier) the cost of the haircut will be the E56bn identified earlier. Given, however, that the E30bn of “sweeteners” to encourage private sector involvement will subsequently be added to the Greek debt, the net change will, in fact, be E26bn or 7% of Greek Debt.

This assumes of course that all of the private sector bondholders who were willing to take up the July deal with a 21% haircut that became 10%, will sign up for the October deal with its larger 50% haircut that is really a 23% haircut.

In other words, it would appear that of the E240bn of taxpayers' money that have gone to “reduce” the Greek sovereign debt, only E56bn at most will actually be available to buy bonds at the haircut price of 50%, leading to a gross reduction in Greek debt not of 50% but of 7%. 

However, financial industry scuttlebutt is that only 60% of the private sector bondholders are supportive of the latest "50%  haircut" deal and thus the likely outcome due to the “voluntary” nature of the haircut is a debt reduction of just E15bn or just over 4% of Greek sovereign debt.

 Part 6 Where we emphasise that Greece has not been bailed out

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This is not a bailout of Greece.

A real bailout of Greece might be looking at a moratorium on debt interest payments (which will see the Greek government pay out over E76bn over 2010-2014), it might look at underwriting longer term Greek private sector bonds encouraging holders of short-term bonds to swap into them to reduce the rollover effect.

In return the Greek government might have been tasked to agree binding targets to collect the taxes avoided and evaded, often by many of its wealthiest citizens, and then investing the additional revenues thus collected (in the region of E25bn/yr) into modernising and “greening” Greek public infrastructure and services, creating jobs rather than imposing austerity measures that destroy jobs often by abandoning infrastructure investment and reducing key services.

As in the UK, austerity has served to stifle the Greek economy forcing it into recession, killing off revenue generation, and creating social conflict.

This isn't a bailout of the Greek economy, it is a bailout of banks and other financial institutions - a Trojan Horse in which at least E190bn of the E240bn “bailouts” will go to compensate banks and other financial institutions in order to prevent them from forcing Greece to default on the loans that those same institutions willingly lent to Greece.

If banks continue to be compensated by the taxpayer for making “bad loans”, bad loans are what they will continue to make.

As a result it seems increasingly likely that this Greek tragedy will now be played out again in a much larger Roman arena – with the implication that Greece could merely have been playing the Bear Stearns role to Italy's Lehman Brothers.

The financial sector has become an end in itself and whole economies are being devastated to serve it (and pay for its mistakes), rather than the financial sector serving those economies in order to improve the general condition of the populace as a whole.

The road to serfdom, indeed.


  1. It's also interesting to note how democracy is effectively being cancelled in 'bailed out' countries.

    The new Greek PM, Papademos, is an MIT educated central banker - known for his closeness to the banking industry - who's never been near an election in his life.

    The potential new Italian PM, Mario Monti meanwhile, is an elite educated (Bocconi and Yale) career European economic bureaucrat - known for his closeness to the banking industry - who's never been near an election in his life.

    It's plainly apparent the money markets and bankers have performed a coup in both of these countries.

    It's also plainly apparent the electorates of these countries would do the opposite of these unelected bankers and create a disorderly default destroying the banks if they were allowed to actually vote.

  2. It seems my estimate of lost tax revenues due to tax avoidance and evasion of E25bn/yr was too conservative;

    "€60bn - How much Greece is losing in uncollected taxes each year according to Horst Reichenbach, head of the EU task force charged with overhauling the debt ridden country."
    source: Daily Telegraph City Briefing newsletter, November 18th

  3. Bristol Blogger

    Monti has now appointed a cabinet of entirely unelected technnocrats to impose the "neccessary" austerity cuts,

    Meanwhile, Papademos has appointed four ministers from the far right, to create a government that some Greek commentators say has echoes of the Military Junta that ran Greece until 1974.

  4. Thanks for this Tony - the best explanation I've read so far as to just how badly the Greeks are being screwed...