Thursday 10 December 2009

A Better Plan for Restoring Greek Consumer Liquidity

The vast contradictions in Greek government policy regarding the financial and banking sector were on full display in yesterday’s televised Cabinet Meeting. The Cabinet session was opened with an impassioned plea by the Prime Minister that—due to problems inherited from the previous government—Greece had lost its credibility in international markets, and was in danger of losing its territorial integrity. Unfortunately, he didn't say much about what he was going to do about it, except that they were working hard on the issue.

This was eventually followed by Dr. Louka Katselli, Minister of Economics, Development and Shipping, who presented a draft law on restoring liquidity in the Greek market. On the one hand, I was struck by the background to the presentation: it was made on Powerpoint, and it involved consultations with over 1,000 citizens. This is a good first step towards more rational policy-making.

On the other hand, the bill is logically incoherent. Among its major provisions are a court-ordered moratorium on personal debt payments, a restructuring of personal debt, and a forgiveness of a small part of debt for the chronically unemployed or other at-risk groups. While these are all worthy goals, I couldn’t help but be struck by the overall incoherence of government policy:

• On the one hand, the government has pumped EUR 28 billion into the Greek financial system, with the demand that banks lend money to SMEs and individuals. Banks have done this.

• Despite the fact that banks have received this financing, as well as additional credit lines from the ECB, at an extremely low rate (the ECB benchmark rate is 0.5%; Greek banks have higher lending rates), they are loaning this capital onwards in the Greek market at a minimum of 7% for certain corporate loans; 10%+ for corporate overdrafts; 10% minimum for consumer loans, and 22% for credit card loans. Thus, the banks are making record profits on public money.

• The government now steps in and says, “Hold on: because you’ve lent too much, to people who are not really qualified to take on a loan, we will now force you to restructure the debt.” The immediate question which arises is: “What did you expect?” Did the government really believe that lending money to Greek consumers, most of whom are on fixed incomes, or are operating micro-enterprises in a disastrous market environment, is a sustainable solution to Greek problems? Yet both main parties have repeatedly called for more bank lending.

• If the government is worried about liquidity, how will it handle the contradiction of encouraging lending on the one hand, and then penalising banks for lending on the other? What is the impact of moral hazard on personal financial decisions? We already have a country where people build houses even though they know they are illegal: they figure these houses will all be legalised in the future anyway. Are we now entering the same territory with consumer lending?

• If the government wants to avoid the issue of credit defaults or excessive interest rates, it has to tighten credit policy. In fact, it has done precisely the opposite. Real estate loans, for instance, are now given for 100% loan-to-value, in an attempt to shore up the real estate market (another over-leveraged, over-supplied sector). Credit cards are approved for practically anyone who applies. Between the 20:00 evening news and the 23:00 late news programmes on Greek TV, you will probably see 75 advertisements for consumer loans—especially popular now that Christmas is here.

• The idea that the Greek court system will be in a position to handle debt restructuring and moratoria is a joke. Given that 21% of Greeks live (in terms of official statistics) at the poverty line, and given that thousands of people will be expected to take advantage of this law, it is inconceivable that the court system will be able to handle the burden. Court cases are already 5-7 years late due to the tremendous backlog, and frankly, from what I know of most judges in the Greek justice system, this is going to turn into an ideological rubber stamp process than a real assessment of debt forgiveness.

I have two sets of recommendations for solving the root cause of the problem, which is in fact two problems. The first problem is that most Greek consumers and businesses are overleveraged: they have too much debt, at a too-high interest rate, and no way to repay the debt even under normal business conditions. The second problem is that the Greek state, which controls 40% of GDP in public expenditure in Greece, is the largest problem in terms of liquidity: it does not pay its bills on time.

The suggestions are the following:

1. Rationalise credit policy
Taking on more debt will not solve the crisis. The government needs to tighten consumer credit policy, at least for consumers who are over-leveraged. Lending money to banks to lend onward at predatory rates merely postpones the problem. The government should implement three simple and temporary rules:

a. That any new credit offered to Greek consumers or companies using ECB or Greek government public capital should be at a preferential rate: perhaps about 4% per year.

b. The government should make available a consumer debt refinancing line at preferential interest rates, offered through the major banks. Thus, a consumer who owes Eurobank EUR 20,000 at a 10% rate, would be able to borrow EUR 20,000 from this credit line to repay Eurobank, and would be charged a preferential rate—perhaps 4%. This would simultaneously (i) solve the problem of non-performing consumer and credit card loans in the Greek financial sector, and (ii) generate a small but substantial interest income for programme management. Greek banks could have an additional benefit from a small processing fee—perhaps EUR 50—for each application, paid for by each loan applicant.

c. That any credit offered to Greek consumers or companies using capital of any resources should use a mandatory credit rating on the borrower, using accepted international practise. Thus, there should be no further consumer lending if the consumer already has consumer or credit card debt of over 35-40% net annual income.

2. The Government must promote liquidity beginning with itself
In order for the government to increase liquidity in the market, it should consider the following policies:

d. The government itself should pay its debts to suppliers on time. At over 40% of GDP, the government is the largest contractor in Greece. In some sectors, it has not paid vendor invoices for over 48 months. It does not even pay the salaries of its permanent and temporary staff on time.

e. The government should allow a 12-month moratorium or restructuring of debt owed to government entities, including for income taxes and/or social security taxes. This should be interest-free.

f. The government should increase the minimum wage by 15%, should decrease all social security obligations by employers and employers, by an equivalent percentage, and should increase the tax-free bracket to EUR 15,000 per adult, regardless of family status. This will result in greater take-home income for wage-earners, which can be used to pay down debt or otherwise maintain their standard of living.

These six measures would do more to increase liquidity in the market and solve the problem of excessive leverage than any others. The main problem, of course, is that the government does not have the funds to undertake any of these initiatives. This is the root cause, for instance, why the government takes 48 months to pay a vendor for hospital equipment.

I therefore suggest the ECB and the Greek government cooperate to issue a quasi-sovereign loan of about EUR 20 bln, to be released in four tranches of EUR 5 bln each. This loan would be made to:

• A consortium of major Greek banks, co-headed by the National Bank of Greece and the Central Bank of Greece.

• The ECB loan rate would be 1%; the loan capital would be used for credit re-financing under points a-b-c of this proposal.

• Each tranche would be released per quarter, and subject to the proper monitoring and due diligence of loan refinancing and loan repayment.

• The loan would avoid the central budget: it would be made directly to the Central Bank of Greece, for setting up credit lines in the major banks. It would not require an act of Parliament or any government interference of any kind, which would likely slow or cripple the loan policy.

• The Greek banks would agree to accept early loan repayment for outstanding principle and only that interest levied until date. In exchange, they would receive an immediate capital injection through loan refinance by ECB capital, and assured income from a processing fee of EUR 50/application. This would also help stabilise their balance sheets, account for non-performing loans, and hopefully restore their credit ratings after the Fitch downgrade.

• The spread of 3% (between the ECB base rate of 1% and the onward loan amount of 4%) should be used for by the Central Bank of Greece and the participant banks for setting up the programme, monitoring repayments, and eventual future credit interventions in the Greek banking system.

I believe that such a plan would, in the short term, increase liquidity, stabilise credit risk and shore up the balance sheets of a significant portion of Greek consumers and banks. If the programme is successful, it can easily be replicated for micro-enterprises and SMEs and extended further to consumers. But it should be implemented in tranches, and its deployment carefully monitored and audited to make sure that neither the Greek banks nor the Greek government take unfair advantage with the financial resources provided by the ECB.

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