03 November 2011

Papandreou's Move and the Future of Euro

Dubious Causality

When I first wrote about the Eurozone crisis, I objected to the misleading presentation of the problem as bailing out Greece (or Ireland or Spain or Portugal), when in fact, it was bailing out German and French banks whose combined exposure the Southern debt is almost a trillion euros.

This is done to create a bogus causality to shield reckless banksters. Blaming Greece is like saying the US housing bubble was caused by poor people who were offered huge mortgages. Banks pushed cheap money like there was no tomorrow and devised dubious ways to push some more. If my bank offers me ten million euros fully knowing I have no way of paying back, do I have the responsibility to tell them they are out of their minds?

So, everyone is scrambling to hide the banksters role in all this. They gambled for short term gains and lost. (Just like MFGlobal) But, as we know from the US, these banks are "too big to fail" which means that if they incur those losses they will need a serious injection of capital. Lending fresh money to Greece is a way of doing this. Just like AIG bailout was in fact a bailout of banks (Societe Generale, Deutsche Bank, Goldman Sachs and Merrill Lynch), this is an indirect way of rescuing these banks.

Dubious Solution

Just as I objected to that misleading causality, I took issue with the proposed solution. Despite all the scary predictions in case of a Greek default, I suggested that a default was a desirable outcome from the Greek perspective and they would suffer much less if they did it right away. I even gave the twin examples of Russia and Argentina who suffered horribly before they defaulted and did very nicely afterwards.

The other option that was given to them was a series of austerity measures, budget cuts, high unemployment and a permanently contracting economy. The lone defender of "austerity for growth" Professor Alesina and his controversial model  notwithstanding, no country ever grew using austerity as its main policy. In fact, if you looked at the so called Argentine miracle (bust to boom in a couple of years), you would see that it was the seriously Keynesian policies of Nestor Kirchner that made the transformation possible.

Besides, even if growth through austerity was theoretically possible it is not possible in this instance. Anyone without ideological bias can tell you that a contracting economy will not miraculously start growing, especially as you keep adding to its debt pile. (And remember, all that new debt is not for Greece but for its creditors.)

The New Deal?

But, you might argue, banks accepted last week that they would take a 50 percent haircut. Well, that is not entirely correct:
Charles Dallara, negotiating on behalf of the bankers, agreed to a 50 percent reduction in the amount of Greek government debt held by banks (a “haircut”), but the bankers are already trying to take a much smaller loss by monkeying with the fine print. By varying the details of interest rates and payback periods, bankers could end up losing a lot less than 50 percent—and Greece could end up getting a lot less than 50 percent debt relief.
Moreover, the haircut does not extend to ECB and IMF. They holding a little over 100 billion euros of Greek which will have to be paid in full with the fresh debt Greek tax payers will take on.

On top of that, as the haircut is mostly voluntary, some companies are now buying Greek debt, hoping that with the fresh money coming in they will be able to redeem the full face value of bonds that will be maturing in the next couple of years. They stand to make huge profits on old debt with the funds coming through new debt. According to the BBC:
Christopher de Vrieze, who writes on sovereign debt for the specialist news service Debtwire, says some hedge funds are targeting short-term Greek bonds due to mature in March next year.
If the troika does persuade banks to agree to a voluntary write-down, Christopher de Vrieze says "Greece will be financed for another couple of years, and will be most likely to be able to pay its shorter-dated bonds."
As a result, hedge funds which refuse to agree to a write-down will demand payment in full, from funds provided to Greece under the troika rescue plan. 
There is one other aspect of this deal. Greek banks and pension funds hold about 50 billion euros in sovereign debt. If they are forced to have a haircut, most of them will be wiped out. If they are not, then the debt burden will simply become larger with the additional of fresh debt to service old debt.

On top of that, reasonably solid Greek companies caught in a contracting economy became cheap buyout targets for foreign companies:
Restructuring specialist Haris Stamoulis, the chief executive of Athens-based LEADfinance, says Greece has many good companies which are saddled with bank debts they cannot pay. 
Because Greek banks have been forced to write down such debts, Mr Stamoulis says, investors can gain control of companies through buying their debts from the banks.'Trophy assets' 
"If a company owes €100m (£87m) to a bank and they cannot service it," he says, "and banks have been forced to provide for those losses, if somebody comes and offer cash for the remaining, that would be music to their ears."
To recap, Greece was offered cheap money with full knowledge of its inability to repay the loans. In fact, the money came with expert advice on how to hide it from regulators.

Now that it is clear it cannot pay that money, the same people are asking them to take on more debt to save these banks, to accept crippling austerity measures (like pay cuts, pension benefit cuts, soaring unemployment) for at least a generation, to allow hedge funds to make huge profits on that fresh debt, to sell off their prized assets at fire-sale prices and to acquiesce to the take over of their most profitable companies by foreigners for a song.

The reward for that?

You can stay in the Eurozone. Yay!

So, Papandreou pulled a rabbit out of his hat and said that the price is so high that he needed the actual approval of Greek people.

Despite the howls you hear everywhere, to me it is a very intelligent move.

If Greece defaults and leaves the Eurozone, it will recover reasonably quickly. It will not be a picnic but with neo drachma, its exports and tourism revenues will soar. But the other Euro countries like Spain and Italy and of course France (even though everyone assumes they are fine, they are not) will be in jeopardy. Once the exit possibility becomes real, bondholders will not wait for others to leave and will ask for their money. A run to the banks at that point could be catastrophic. And even Germany could not stop the collapse of the entire edifice.

So the Greek move highlighted the real problem. It is no longer possible to pretend that it was a solidarity effort to rescue those lazy, southern and reckless cousins. That is why German taxpayers did not want to bail them out. But now, politicians will have to explain to their people that they are actually rescuing their more Aryan brothers like Deutsche Bank and Societe Generale. And if they want to have a European economy, they need to pay up.

The irony is that, if they hadn't presented a dubious causality and a dubious solution, things would have been much easier to fix. Even now, it would cheaper to forgive the Greek debt and to do a bank bailout by fully or partially nationalizing them. But that might be ideologically impossible for them to fathom and they might continue to vacillate.

Finally, a well capitalized European Financial Stability Facility that can provide stronger guarantees on European sovereign debt may sound like a good idea and it might be in the short run. But structurally, they need to solve the inherent contradiction between the needs of the German, Austrian, Estonian (and to some extent Dutch) economies (low inflation and less government spending to cool off the economy) and those of the remaining countries (higher inflation and higher spending to start growth).

There is no way to have a common currency when the underlying economies are so different.

So, Papandreou gambit might save Greece and force Europe to take a long hard look at itself.

Or it might just be the beginning of the end for European Union.

Either way it is an admirable move that exposed a lot of funny plays.

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