The Name is Bondholder, Senior Bondholder

My friends have been telling me that my Eurozone commentary suggests that I might be a tad too critical of capitalist institutions and not critical enough of those periphery countries. You know, those notoriously lazy and irresponsible PIIGS.

As a contrarian, I am rather sensitive to polite accusations. Disagree with me violently, I am almost giddy. Insinuate slight bias, I am concerned. I stand for incontrovertible prejudice.

So, I thought the best way to figure this out would be to see the terms of successive bailouts in these countries and see who lost and who won. That would be a simple and straightforward way of prosecuting my case, right?

Let's start with Ireland.

Ireland

A while ago, I related in some detail how the Irish government was duped by senior bondholders to guarantee the private debt of Irish banks. But that was only part of the story. Since I wrote those lines I discovered that, at the time, European authorities were adamant that unsecured senior bond holders were to be paid in full. To put it differently, they wanted poor Irish peasants to bailout TBTF banks like Société Générale and Goldman Sachs.

We all know what happened.

What about Greece?

Greece

For Greece, I maintained from early on that they should default on their debt and leave the Eurozone.

European leaders had a different view. They told them they should stay put and implement austerity measures. Which meant a vicious cycle that would ensure that Greece would remain indebted for the foreseeable future. The ensuing Greek bailout was presented as a serious haircut for senior bondholders. In case you don't remember, this was a contemporaneous observation:

A myth is developing that private creditors have accepted significant losses in the restructuring of Greece’s debt; while the official sector gets off scot free. International Monetary Fund claims have traditional seniority, but bonds held by the European Central Bank and other eurozone central banks are also escaping a haircut, as are loans from the eurozone’s rescue funds with the same legal status as private claims. So, the argument runs, private claims have been “subordinated” to official ones in a breach of accepted legal practice.

Do you think that this was indeed the case?

If you were getting your information from corporate media sources, you had probably retained that impression. Well, that's not what the celebrated economist Nouriel Roubini retained:

The reality is that private creditors got a very sweet deal while most actual and future losses have been transferred to the official creditors. 

Even after private sector involvement, Greece’s public debt will be unsustainable at close to 140 per cent of gross domestic product: at best, it will fall to 120 per cent by 2020 and could rise as high as 160 per cent of GDP. Why? A “haircut” of €110bn on privately held bonds is matched by an increase of €130bn in the debt Greece owes to official creditors. A significant part of this increase in Greece’s official debt goes to bail out private creditors: €30bn for upfront cash sweeteners on the new bonds that effectively guarantee much of their face value. Any future further haircuts to make Greek debt sustainable will therefore fall disproportionately on the growing claims of the official sector. [emphasis mine]

More importantly,

The new bonds will also be subject to English law, where the old bonds fell under Greek jurisdiction. So if Greece were to leave the eurozone, it could no longer pass legislation to convert euro-denominated debt into new drachma debt. This is an amazing sweetener for creditors.

Remember my recommendation about defaulting and leaving the Eurozone? Now they are stuck with a much larger debt and absolutely no way of fixing their problems. They cannot devalue their currency, stimulate the economy or even print money to reduce their debt through inflation.

And they owe a lot more to senior bondholders.

Let's take a look at Spain.

Spain

As I wrote recently, Spain was doing reasonably well with a modern and diversified economy. Their main problem was (like everywhere else) in the banking sector. Their banks made risky real estate bets and lost a bundle when the bubble burst.  Just like banks in Iceland, Ireland, Greece, Italy (and of course the US).

The only difference, in Spain, the source of funding was somewhat different. Banks sold subordinated bonds (the ones designed to take the first hit in a liquidation) mostly to retail investors. Meaning, mostly regular folks and their retirement funds. Interestingly, in the case of Spain, European authorities rediscovered the concept of risk for these bonds and insisted that these bondholders should be subjected to a deep haircut.

You might say, okay, it is never too late to go back to a principled stance. Capitalism equals risks and rewards. Right? So, good for them.

Well, not quite. That principled stance did not cover the senior bondholders.

You see, under normal circumstances, senior bondholders should be bailed in, i.e. the debt they are holding should be converted into equity in the bailed out institutions. In fact, this is an integral part of the new banking regulation framework of the EU. Except, it was not applicable for the Spanish case. For one thing, European authorities postponed its implementation until 2018.  For another, the finance ministers overruled the ECB and refused to let senior bondholders to be bailed in or to get a serious haircut.

In July, when the euro zone negotiated a bailout for Spain’s banks, the European Central Bank argued that they should be “bailed in” in cases where a bank is so sick it needs to be closed. At the time, the European Commission insisted senior bondholders would remain protected and the euro zone’s commitment to do so wasn’t tested, since none of the Spanish cajas were ultimately wound down.

In other words, if the bondholders were you and me and our retirement funds, too bad, we knew the risks: Haircut.

If the bondholders are the usual suspects, the senior bondholders, sorry, we have to make them whole, because, well, you know, they are senior bondholders.

I am guessing that by now you are noticing a pattern.

Let's take a look at the unusual Cyprus bailout.

Cyprus

The Cypriot case was similar to the previous ones, except for two key differences. Their banks, besides the usual reckless credit extension to dubious real estate projects, made a second bet on Greek debt, after Greece became a clear candidate for bankruptcy. When the final deal was decided upon the island banks were not among the senior bondholders that got the sweet deal. They were in the same category as Spanish retail investors.

The second difference was that since the early 2000's, Russian companies have been using Cypriot banks as a way of not paying taxes at home.

When the EU officials began to look for a bailout formula, they had this very controversial and dangerous idea. They thought that they should make the depositors pay for the funds to be raised. Originally, they wanted both the insured (up to €100,000) and uninsured (over that amount) depositors to take part in the scheme.

It is hard to emphasize how radical an idea it is to levy a fee on insured deposits. As far as I know, it is a first anywhere. Given the shaky foundations of the Euro it soon became apparent that touching insured deposits might lead to a run on the banks.

They eventually dropped the idea but since the uninsured depositors were mostly Russian, they focused on them instead. And they are the ones footing the bill.

If you read this far, you must be asking "what about the senior bondholders?"

Well, you'll be happy to know that even as they burned depositors, the EU authorities saved senior bondholders:

In the bailout deal that the euro zone and the International Monetary Fund hammered out for Cyprus, one class of investors once again made a lucky escape: senior bank bondholders. (...)

The euro zone has to far carefully avoided burning senior bondholders during a bank restructuring. (...)

With relatively little money to gain, officials decided that breaking two taboos — taxing depositors and burning senior bondholders — in one go, didn’t seems like a good idea.

The last sentence reads like a punchline, doesn't it?

I hope that through all this I established that I am NOT slightly biased about capitalist institutions.

It is a full-blown prejudice.

Things Will Get Complicated in Bangladesh and in the Region

I have been following the developments in Bangladesh with a mixture of concern and bemusement. I am not talking about the tragic loss of life in a makeshift garment factory. This was terrible but pointing to the horrific aspects of capitalism and our never ending desire to exploit people in search of cheaper items of consumption is not a novel perspective.

I was concerned about the ramifications of the case against the deputy leader of the opposition party Jamaat-e-Islami. I knew that regardless of the outcome many people would die. My bemusement had nothing to do with Bangladesh or these events. I thought the ignorance of the corporate media was almost funny. They presented the situation as yet another example of the rise of Islamist forces. They breathlessly reported about Islamists going after bloggers and demanding new blasphemy laws. This is mostly rubbish because it ignores the whole context of the issue.

Many people outside Bangladesh don't realize that there are two critically important elements at the core of the Bangladeshi identity. One is their language, Bengali. It unifies them, gives them a regional identity (Bengal) and it also separates them from their Urdu and Hindi speaking neighbors. The second element is the war of liberation in 1971.

In fact, the two are inextricably linked because one of the main reasons "East Pakistan" rose against Pakistan was the massive ethnic and linguistic discrimination they were subjected to on a daily basis. As you might know, after a particularly bloody war with millions of people dead, injured or displaced, East Pakistan became Bangladesh.

Notice Islam is not one of the core elements of Bangladeshi identity even though a huge majority of Bangladeshis are Muslims. That is partly because Islamic entities and especially Jamaat-e-Islami were against independence and they actively sided with the Pakistani oppressors. They tortured and killed thousands of intellectuals. And Bangladeshis never forgot that.

The current government was elected partly on a platform of setting up special tribunals to prosecute what they call war criminals. Nine senior leaders of Jamaat-e-Islami were charged with crimes against humanity and in January Abul Kalam Azad was found guilty in absentia and was sentenced to death. Then Abdel Kader Mullah was found guilty and sentenced "only" to life in prison. This led some bloggers to declare his punishment as too light.

And that is why Jamaat-e-Islami has begun asking for new blasphemy laws against bloggers. And that is why they have been protesting violently. In other words, they were basically acting as a partisan force and not necessarily as easily offended Islamists.

Since then Delwar Hossain Sayeedi was sentenced to death and yesterday it was Muhammad Kamaruzzaman's turn. Each time one side took the streets to express jubilation and the other side to stop them. As you can imagine, many people died in the process.

I knew that if the Kamaruzzaman outcome was a lighter sentence, people were going to protest and there would be clashes with Jamaat-e-Islam. If the sentence was the death penalty, then I assumed that the Jamaat-e-Islami supporters were going to escalate their protests.

Either way, I fear many people will die needlessly. And things will get complicated.

You see, the war of independence had three parties. Pakistan, the loser, Bangladesh the winner and India the supporter. Pakistan is about to go to polls. They are currently in a bizarre tug of war with India: where each side kills a prisoner every week to revenge a previous killing.

The outcome of the Pakistani elections is hugely important.

Moreover, the domestic tensions in Bangladesh will almost certainly have repercussions in India-Pakistan relations.

I am worried.
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I wrote (and thought published) this on 9 May at an airport lounge. I realized now that the wi fi system kicked me out before my publish command reached Blogger. Consequently, the date references (like yesterday) are off. My apologies.

Israel and Palestine: Interesting Signs

Unless you found this humble soapbox through a misguided Google search, you already know where I stand on the dual Palestinian Kurdish peace processes. I already covered the latest developments on the Kurdish one.

There are signs that a major initiative is about to be launched in Israel.

A Symbolic Change

Let me start with a symbolically significant sign. Yesterday Google announced that it was changing the name Palestinian Territories to Palestine across its product line. So if you click on Google in Ramallah you will see this:

Why is that relevant?

Google is a giant multinational corporation. They don't take risky steps. Steps that can alienate large segments of their customers. If they did it, they must have researched it thoroughly.

And there was almost no reaction to it. Google it, you will see. Both Aljazeera and Jerusalem Post used the same canned piece (though JP couldn't help a provocative headline) and reported the same tepid reaction from a single Israeli official. Normally, you would get a solid Israeli reaction supported by US Congresspeople and  Senators repeating the same talking points. This time, nothing.

As for the non symbolic signs there are several and they are quite important.

Israel's First Referendum in 65 Years

First of all, a week ago, the Arab League made a public concession to Israel. Previously, a peace plan developed by Saudi King Abdullah called for the creation of a Palestinian state within the pre-1967 borders in exchange for all Arab countries recognizing the State of Israel. This time, they made it clear that they no longer insist on a complete withdrawal.

In Washington Monday, Qatari Prime Minister Sheik Hamad Bin Jassem Al Thani tried to allay some of the Israeli concerns. Speaking on behalf of an Arab League delegation, he reiterated the need to base an agreement between Israel and a future Palestine on the 1967 lines, but for the first time, he cited the possibility of "comparable," mutually agreed and "minor" land swaps between the Israelis and the Palestinians.

Note the central role played by Qatar in these arrangements once again. You can be certain that the change of heart was due to relentless US pressure. Qatar has been able to punch above its weight largely because it carries the US' water.

Tzipi Livni, the Israeli Minister of Justice (and the minister in charge of negotiating with Palestinians), reacted positively to the news. And she did so right away.

At first Netanyahu was silent.

Then, while meeting with the Swiss Minister of Foreign Affairs, he casually announced that he was going to call the first referendum in the 65 year history of Israel to let the people decide the outcome of the peace process.

Clearly, he was letting his coalition partner Naftali Bennett and the settler movement know that he was going ahead with the peace process. More importantly, he was warning them that he was not stupid enough to pull an Ariel Sharon and take on the settlers directly. He intends to commit Israeli people first and make it that much harder for the settlers to oppose it.

By pledging to put any deal to a referendum, Netanyahu could be hoping to avert any immediate far-right backlash to a decision to talk land-for-peace with the Palestinians, promising that the Israeli people would have the final word. 

"There is a very serious effort under way to get talks to resume," said a senior Israeli official who declined to be named. "People are devoting a lot of time and effort to this. It is possible and it is doable."

The following day, Livni flew to Washington to meet with Kerry to discuss the Arab League plan. Tellingly, she was accompanied by Netanyahu's special envoy Yitzhak Molcho (Molcho is a member of Netanyahu's inner circle and he has always been entrusted with sensitive missions).

Later in the day, she met with the UN Secretary General Ban Ki-Moon and afterwards, she told the media that she was optimistic about the process.

Taken collectively, these are significant signs.

Rapprochement With Turkey

While these diplomatic steps presage an upcoming announcement on the peace process, behind the scenes Israel has been working overtime to set up all the necessary elements for this to succeed. The most important is to make sure that Turkey is part of the process and on the side of Israel.

Israel has two trump cards to ensure this.

Energy

After Netanyahu's carefully drafted apology, an Israeli delegation went to Ankara to offer a major carrot to Turkey. The idea was to build a pipeline to Turkey to connect the natural gas reserves discovered in 2009 near Haifa. Tamar field is estimated to hold 10 trillion cubic feet of gas and it has just began producing 300 million cubic feet/day. There is also the nearby Leviathan field that is being developed with a 17 trillion cubic feet capacity.

Such a connection would provide Turkey with an important source of energy and would reduce its dependency on Russian and Iranian gas. Moreover, it is estimated that buying its natural gas from Israel would mean an annual savings of at least 1 billion dollars.

If the Leviathan field that will come online in 2017 is also connected to Turkey to reach European markets, the project would be a significant boost to Turkey's aspiration to become a major energy hub.

The Israeli gift is also significant for Turkey for another reason. The Tamar field is adjacent to the smaller Cyprus reserves. Previously Israel promised help to Cyprus in exploiting these fields. But in recent months, they distanced themselves from both Greece and Cyprus to focus their attention to Turkey instead.  Without Israeli involvement, Cyprus is unlikely to find the economies of scale to profit from these discoveries. Seen this way, Israel might have the right leverage to persuade Cyprus to adopt a more flexible stance towards its northern neighbor.

Syria

The second Israeli trump card concerns Syria. Both Turkey and Israel have a lot to loose if Syria were to become a failed state. It it vitally important for them to have a clear transition plan for post-Assad Syria. There are reports that Turkey and Israel have been conducting joint covert military operations inside Syria for some time. For instance, an American analyst made these remarks recently:

It has been obvious to everyone here that Turkey and Israel had been working in covert cooperation including during the time of their diplomatic breakup. 

Their aim is the destabilization of Syria and Iran. They are working with Georgia, Azerbaijan, the Arab states, working with NATO; there they have been involved.

Specifically, the two sides are interested in limiting the influence of Jihadis in FSA and in ensuring that the stockpile of chemical weapons do not fall into the wrong hands. As you can imagine Turkey has a larger role on the former and Israel is focusing on the latter.

In all this, what is interesting is how these two peace processes are intertwined. It is a highly complicated chess game played on a large board.

But I still think that they will happen and we will soon see a Kurdistan and a Palestine.

Francois Hollande's First Anniversary

France is not doing well.

And François Hollande is not doing well at all. His popularity rating is hovering around 25 percent, an all time low.

Former president Sarkozy's pop star wife Carla Bruni has recently written a song entitled le Pingouin (the penguin  making fun of him for being indecisive (Mr Neither yes nor no is his nickname) and for being utterly ordinary:

'Neither ugly, nor beautiful, neither tall nor short, neither cold nor hot, the penguin, neither yes nor no.

(For the actual French lyrics, click here)

"The Penguin"

After Nicolas Sarkozy, who was dubbed the "bling-bling president" for his high-roller friends, his glamorous wife and his appetite for the good life, Hollande is quite simply boring. He is known as Mr. Ordinary. Coloring his hair is about the only vain thing about him and even there he seems to be relying on a supermarket jar rather than the elaborate efforts of a high end coiffeur.

"The Penguin" and "the Rottweiler"

But Mr. Ordinary's presidency is not going smoothly and it is certainly not as low key as his appearance. Early on, he had a minor scandal caused by his girl friend Valerie Trierweiler. She tweeted her support for the candidate running against Hollande's former partner and the mother of his three children, Segolene Royale. Royale lost the election and Hollande looked well, weak. Most people thought he should have stopped her.

In the highly macho culture of France, having an affair is nothing but having an outspoken female partner could be a major problem.

She was quickly dubbed the Rottweiler and the tabloid press began to publish many colorful inside stories about how bossy and difficult she was.

Then, as he was vacillating about various tax positions (and being put on the defensive by Gerard Depardieu's very public departure), a major scandal erupted. This time it was his budget minister Jerome Cahuzac (a former plastic surgeon) who confessed to having a Swiss bank account with 600,000 euro in it. The bad part is that his confession came after months of very public denials (think about several highly rated "I never had sex with that woman" TV moments). And when he eventually admitted his wrongdoing, his vociferous denials made whole thing doubly damaging for Hollande and his government. It looked like a good example of elite hypocrisy: while they were arguing for the need to increase taxes, they were placing their own money away from the state's grubby little hands. And this was his budget minister.

As unemployment rose (it did for 23 straight months to reach an all time high in March) and the economic figures got worsened, Hollande opted to focus on gay marriage. While the majority of the electorate support the notion (and it was a campaign pledge of his), the opposition sensed that this was a perfect issue to launch an attack against him. Led by the Catholic church (which is becoming a significant force in France, as religion is reclaiming its pre-modernity position all over the world), opposition parties managed to organize several unexpectedly large rallies and challenged him openly. Since he had the votes, the law was passed by the Assemblée Nationale but it felt less of a victory and more of an unnecessarily bruising fight.

Hollande tried to salvage this situation by going after the Jihadis in Mali. French forces swept the country quickly and that led to a brief moment of national pride (maybe even some colonial nostalgia). But given the woeful economic situation, people rapidly began to question the wisdom of undertaking costly military campaigns in Africa.

Mali notwithstanding, French foreign policy seemed to be in disarray. The most damaging was a perceived loss of voice  in European affairs. As the largest and the second largest economies of the EU, Germany and France had always dominated the European debate. People thought that Franco-German alliance was the backbone of the Union. Most of the EU institutions were created after the French model and France has always been a very important player in them. Apparently, not anymore:

"You can see a shrinking presence, a progressive disappearance of France on most issues that concern the economic agenda," said Fredrik Erixon, director of the European Centre for International Political Economy, a Brussels think tank. 

European diplomats from a range of member states, speaking on condition of anonymity, are more blunt. 

"You don't hear France's voice at all. They are nowhere, just nowhere," said a senior European diplomat who is in frequent contact with other member states.

Given Sarkozy's high profile presence with Angela Merkel (she openly supported him for his reelection bid), this shrinking presence is directly attributed to Hollande's ineptitude.

Besides dismal foreign policy, the economic picture is also getting darker with each passing month. Yesterday, the European Union released a new report. It indicated that France is going to slide into recession this year and the next and unemployment will continue to rise through 2014. Since France is supposed to meet the EU budget requirements (reducing deficit to within 3 percent of output) in 2014, it is not possible for Hollande to undertake vigorous stimulus spending. French debt is too high and there is no willingness to move funds from one spending area to another. (Despite contradictory announcements he only froze the defense budget but did not actually reduce it).

In short, the year ahead looks rather grim for Francois Hollande. To put salt to his wounds, his nemesis Nicolas Sarkozy is now very popular in opinion polls and  if elections were held today, he would handily trounce Hollande.

Given that overall somber picture, I was not surprised to see social media rumors about Hollande having an affair with Julie Gayet, a wistful looking 40 year old actress who had some modest fame in the 90s.

What better way to brush up your ordinary image than getting social media make lurid allegation about your virility? Forget about being indecisive. Forget being controlled by a domineering girl friend. He was seen outside her apartment. Forget the penguin, the man is a hound dog!

I had many French friends telling me that they heard it from very well placed sources that the affair was for real. Sure, I said. French people maintain their innocence when it comes to PR coups and viral marketing campaigns through social media. I am a tad more cynical. Maybe there is something to the rumors, maybe there is not. But it is almost certain that the idea of an affair was made public for a PR reason.

And it worked somewhat. After an initial reaction of "how does he find the time?" and "where is Valerie?" these rumors seems to have given him some boost in the public's esteem. I don't think it will last but it might somewhat alter his image of an ineffectual penguin.

Only in France can a politician hope to recover lost ground by starting rumors about an illicit liaison.

Vive la France, indeed.