Wednesday 30 November 2011

Greece, the Eurogroup and the 6th Instalment

The meeting of the Eurozone finance ministers yesterday agreed (according to Greek press reports) to release the 6th instalment of the first bail-out package. Worth EUR 8 billion, the instalment is desperately needed to pay government salaries and unpaid debts, as well as international bond and Treasury redemptions worth between 4-6 billion EUR in December.

The decision to release the 6th instalment is fundamentally a political one. Greece and the Troika have admitted that the country will not meet its fiscal targets in 2011. Despite the heroic statements made by European leaders in the past few months that no further funds would be released if real progress were not made, the Troika has caved in to the political and economic reality of the Greek as well as the broader problems affecting Europe.

Wolfgang Schauble, German Minister of Finance as quoted in The Telegraph (6 September 2011):

"The troika mission must be resumed and it must come to a positive conclusion, otherwise the next tranche for Greece will not be paid out," Mr Schäuble told a budget debate in the German parliament. "Those are the rules."

Peter Altmaier, Chief Whip, German Christian Democratic Union, as quoted in Kathimerini (6 September 2011):

“It was very clear that we expect Greece to meet its obligations, that there can’t be more aid without adequate behavior by Greece.”

By any measure, Greece has not implemented the targets it was supposed to have implemented:

·         Closed professions haven’t been liberalised. Remarkably, despite all the damage done by the taxi strike, there is still no final law on taxi licensing.

·         The deficit has risen above the annual target, and will probably top 9% in 2011.

·         Many tax measures announced, such as the tax on real estate passed through the Public Power Corporation, cannot be implemented, and are either being rescinded or adjusted, resulting in lower tax revenue.

·         Privatisations have not taken place: the government will certainly not achieve its EUR 5 billion target in 2011.

·         The labour reserve has still not been implemented.

The record of implementation in Greece over the past 4 months has been disastrous. This started with Minister of Finance Venizelos’ attempt to find a “political solution” to Greece’s lack of progress in late August 2011; this lead to the withdrawal of the Troika’s monitoring mission. Conflicting statements and priorities, such as the Finnish collateral deal, absorbed valuable time and energy. Eurozone delays on EFSF leveraging have led to a very dangerous situation at present. George Papandreou’s disastrous referendum decision led to further chaos, and his departure. Antony Samaras’ posturing over his letter supporting the second bail-out led to a further delay.

By now, it should be abundantly clear that classical macroeconomic austerity prescriptions do not work effectively in a dysfunctional, highly specific economy and society. Because that is what Greece is, and unless policy measures are taken which are rooted in reality, there will not be a successful end to this process.

If the Troika really wants to save Greece, it will need to prioritise [at least] three policy interventions:

a.     Establish an independent social safety network to help Greek citizens adjust to the impact of structural reforms. This should include measures to assure that pensions and minimum wages for lower-income residents are unaffected, or even increased, while providing for additional measures such as school lunches or other support. This should probably be managed within the existing infrastructure, but by an independent authority. As much procurement as possible should be implemented in Greece, by an independent budgeting, payment and audit mechanism.  

b.    Accellerate business growth by independent management of community support framework and other funds. The Task Force for Greece is making some progress in this area, but it’s quite clear that the same political networks exist which are slowing down progress. The idea of setting up a business bank using EFSF guarantees and EIB capital should be accelerated and expanded.  

c.     Require capital controls on international transfers from Greece, while at the same time implementing an immediate and exhaustive audit of all Greek-owned offshore bank deposits in Switzerland, Lichtenstein, Cyprus, Luxembourg, London, and other jurisdictions. This process should be taken out of the hands of the Ministry of Finance, which is moving far too slowly and is protecting vested interests. The European Central Bank, the OECD’s Financial Action Task Force, and the IMF can probably do this extremely quickly. The results should be published, and any further aid to Greece made conditional on a proper accounting and repatriation of this capital.

Any further aid should be subject to equally strict conditionality, with a measure of realism. As conflicting and contradictory as the past 4 months have been, it’s clear that without Troika brinksmanship, the Greek government would have tried to do even less than it finally did.

This is, however, not to argue that all reforms undertaken were successful. They are not. As stated in previous posts, the reforms need to be prioritised. There is absolutely no gain to be had in liberalising professions such as taxis or pharmacies in the midst of a recession, when the root causes of the problem are far different from the solutions suggested by “liberalisation.” The benchmark for liberalisation should include consumer or operator benefit, within a normal operating framework. For instance, “liberalising” pharmacies when the social security funds still set prices for certain drugs, determine which drugs are on the approved list, and then delay reimbursement to pharmacies, will not bring much by way of benefit.

Furthermore, indiscriminate tax increases and austerity cuts across-the-board affect Greece’s pensioners, young and middle classes, and exacerbate the decline in consumption and GDP. The social fairness of these policies is in doubt, and may not be cost-effective. For instance, the total benefit from cutting pensions of private sector employees is estimated at between EUR 1.2-2.0 billion per year. Yet there are 140,000 large tax debtors who collectively owe EUR 37 billion to the state. Where should the government’s priority be?

Ultimately, receiving the 6th instalment will enable the government to address very short-term funding needs and possibly avoid a technical default. But it’s obligations in terms of unpaid bills are EUR 6.5 billion, and including social security funds and hospitals, may reach EUR 9 billion. Greece will confront nearly the same situation 1 month from now.

(c) Philip Ammerman
Navigator Consulting Group

Tuesday 29 November 2011

Deck Chairs on the Titanic

Friends and business acquaintances keep asking me what the real situation in Greece is like. Here are some anecdotes:

My [late] grandmother’s apartment building in Pangrati is populated largely by retirees, usually single ones. Their pensions, already low, have been cut to the point where they have a simple choice: either buy heating fuel (a common expense which has to be done by the entire building) to warm their apartments, or buy food. They can’t do both. They opted for food, and now 70-year old widows are shivering in their unheated apartments.

Most Greek retirees have seen their pensions cut by 20-30%. These pensions were typically the result of IKA contributions, which total 44% of payroll between employee and employer. Most private sector employees have seen a substantial loss of their pre-tax income to IKA; average pensions for white collar workers were usually somewhere between EUR 1,000 – 1,300 per month. These have now been cut, usually to EUR 800- 1,000 per month, with a further loss of 1 monthly pension. And yet IKA is bankrupt, and is forced to borrow at short-term rates of 3-4% per quarter, usually from other pension funds, to keep benefits paid. And, of course, IKA is mandatory.

A friend went to a central hospital for a minor operation. After waiting in two lines, the doctor finally arrived to do the surgery. The doctor asked the nurse to bring the anaesthetic, to which the nurse replied that they haven’t had anaesthetic for months now. So the operation—sewing up a small, severed artery in a finger—was done without anaesthetic.

Another friend, recently divorced, and continues to live with her two daughters in the suburbs of Athens. While she formerly gave private language lessons, this market has now collapsed, and she makes do by giving haircuts (the real kind, not the financial kind) and living off whatever she grows in her garden.

An acquaintance works for the semi-governmental natural gas company of Greece. Their greatest debtor is in fact the state Public Power Company (DEH). Their second largest debtor, at about EUR 150 million, is a private company that recently released a quarterly “record earnings” statement, conveniently ignoring its debt.

Developers and real estate owners are selling off whatever they can. One friend, a developer, owns 28 apartments: most are empty. Of the five which are occupied, only one is paying rent on time and in full.

Most private sector salaries have been cut, legally or illegally. Young people are being employed on a 4 hour per day basis, and being paid EUR 30-40 per week, or EUR 160 per month. The staff at one large retailer was given a choice recently: be fired, and receive a termination payment, or voluntarily resign, and be re-hired at the minimum wage. All this is causing real pain and hardship, since most people are locked into mortgages and other financial commitments, and most costs are going up due to higher taxes. The enforcement of labour laws is non-existent. Greece finds itself in an inflationary depression.

Unemployment has reached an “official” 18%; if subsidies by OAED to maintain labour positions are removed, the true unemployment rate is probably around 22-24%. I estimate it will hit 20% by the end of 2011 and reach 24-25% in 2012, not taking into account OAED subsidies. Somehow, we are supposed to believe that the recession in 2012 will “only” be 2.8%, according to the latest budget planning basis.

The number of home invasions and burglaries is reaching epidemic proportions. One family living in Halandri spent their last savings installing steel shutters and an alarm system. In one weekend, two friends reported four burglaries in their respective neighbourhoods. Two of these occurred using sleep gas: the burglars pumped in the gas, then emptied the apartment while the family was knocked out. Our vacation home was burgled over the weekend: nothing was taken—the burglars were apparently looking for money.

The number of illegal immigrants crossing the border from Turkey reached record levels. These immigrants cannot be kept in prison, because there are simply too many of them, and they can’t be repatriated, because of legal and financial issues. Greece cannot let them travel onwards to their European destinations, also because  of legal issues. And Turkey, no slouch when it comes to respecting [some] international law, refuses to take them back. As a result, the SE Asian immigrants you see at nearly every traffic light in the Athens suburbs are not only growing in number, but they are getting hungrier and hungrier because no one has money to buy their meagre offerings or windshield washing anymore.  At least they will soon have a mosque in the centre of Athens, which will no doubt bring some of them spiritual relief, but very little temporal relief.

The only new professional service firms you see setting up are consultancies specialised in renewable energy. Why? Because they charge a fee for submitting an application to the state-run “green energy” scheme. Three such consultancies have set up along Kleisthenous Street near my house in the past year. The fact that the high feed-in tariff (55 cents/kwh for photovoltaic) and the apparently unlimited number of applications permitted means that most consumers will see a much higher electricity bill very soon, made higher by value-added tax, the property tax, the municipal tax, and other taxes. Every other type of store has been closing: the number of “for rent” signs is high. The crash in renewable energy is not far from occurring, as it’s clear that neither the Public Power Company nor various other authorities (nor the citizens) will be able to pay the higher cost.

As a parenthesis: you can always spot a distorted market sector in Greece by the number of consultancies working in it.

In yet more evidence of market distortion, the retail price of olive oil has now fallen below EUR 2/litre in many supermarket chains, albeit for “special offers.”The off-channel price has been below EUR 2/litre for over a year now. Yet more evidence of a dramatic oversupply of oil, in no small part due to EU subsidies. For all consumers in London or Paris: whenever you go to a Tesco’s or a Carrefour, ask yourselves why the Greek oil on the shelf starts at EUR 7/750 ml bottle, and often reaches EUR 12 or 13/bottle.

The only thing that is occurring in Greece today is something similar to the re-arrangement of deck chairs on the Titanic after the iceberg was struck. The Greek political class and the Troika are as removed from reality as a polar bear in the Sahara desert. Greek parties and Europe can trumpet their commitment to social democracy and welfare, but the reality is very different.

(c) Philip Ammerman, 2011
Navigator Consulting Group

Friday 25 November 2011

The End of Leverage

We are clearly present in an era of great unwinding. In financial terms, we could call it the end of the Age of Leverage. In simpler, ordinary terms, it’s the great unwinding. The unwinding of the trust which underpinned the great political experiment of the Eurozone. The unwinding of the social contract between the baby boomers who put the West together after World War II, only to see their pensions and healthcare systems collapse. The unwinding of the idea that any family could aspire to buy a house in a real estate market with 5-7% per year appreciation and loans 20-30 times their annual salaries. The unwinding of 80% debt:GDP ratios, which were formerly considered ‘safe’.

This moment has been a long time coming, but the previous time it occurred was probably on October 29, 1929, on ‘Black Tuesday’ which marked the Great Crash and ushered in the Great Depression.

We’ve had crashes since then, notably the 1979 oil price shock, the 1988-1990 savings and loan scandals, the 1999 crash, and the 2008-2009 financial crisis. But until now, these were either sectorally- or geographically-isolated, and none of them led to a serious challenge of the status quo.

The current crash is markedly different:  We are experiencing the simultaneous, synchronised downturn of public sector/sovereign debt, commercial/residential real estate, and personal (household) debt. The latter is perhaps the most overlooked, but it is clear from multiple markets that the greatest long-term economic impact will be on reduced household expenditure.

Why is this occurring? For a number of reasons. First of all, the “West’s” (a term I will use loosely  to describe the United States and most of Europe) economic competitiveness is in dramatic decline for the broad majority of the population. We see this in the dramatic worsening of the trade balance in manufactured goods in most Western countries, as well as in rising unemployment, declining birth rates, and an ageing society. This means that most Western consumers consume more imported products (often on credit), but have fewer high-paying jobs to sustain their lifestyle.

Second of all, global capital and manufacturing is now too delocalised, or globalised, to count for much in terms of traditional measures of national economic activity. Apart from a few “commanding heights” industries, which today arguably includes innovative IT and financial firms as well as strategic industries, the balance of trade works in favour of multinational enterprises and against national governments in most countries. Hence the rise of offshore centres such as the Cayman Islands , Hong Kong or Switzerland, which will emerge stronger from the crisis. Hence the fact that in most countries, salaried employees now typically account for 75% of tax revenue, versus 25% from companies. 

Third of all, the fact that the West has moved from a manufacturing to a service-based economy also means that (a) employment is lost through productivity, and (b) services are increasingly offshored. This means that most wages for average service jobs continue to decline. We see this reflected in declining real incomes in nearly every country.

These fundamental challenges to economic competitiveness have been concealed in the West by a number of factors:

a.     Financial deregulation and the investment of surplus savings from countries such as China or Saudi Arabia has meant that the average consumer could borrow unprecedented amounts of money on a very low asset or income base. The idea, for instance, that an average Greek or American consumer could be given a credit card with a credit limit of 25% his annual after-tax income, and then receive additional credit cards, beggars belief. Yet it is common practise.

b.    The growth of a global financial industry headquartered in the United States and the United Kingdom meant that for these two countries, overall GDP numbers were “massaged” by financial sector performance, concealing declines in a number of other areas. The intimate links between the financial sector and the political finance system also meant that no meaningful reform was, or is, possible.

c.    Surplus capital and the end of individual credit limits meant that real estate and property development became relatively easy, leading to a boom, and subsequent bust.

d.     State-led development has retained its primacy in most markets, largely because the state could afford to exchange political favours (such as employment or contracts) in exchange for continued power. This is seen perhaps clearly in the United States, where the political finance and military budgets remain immune to common sense, or in Europe, where the concept of “social democracy” has led to a massive increase of government regulation and state apparatus in nearly every domain conceivable. It’s a common problem, but its manifestation differs from country to country.

The end of these runs now means that a number of fundamental problems remain to be addressed. A critical issue is the impact on population aging, as well as in multiculturalism. European societies, for instance, have changed massively in terms of culture in the last 30-40 years, driven by Islamic and African migration, urbanisation, and the end of formerly mono-cultural societies and religions. It remains to be seen whether these societies will retain the cohesion necessary to continue in their present geographic form. Aging populations not only challenge cohesiveness, but they threaten to tear apart the social contract and the pay-go social insurance system.

Taken together with increasing austerity, an end to state benefits, and a continuing economic decline for the average taxpayer and consumer, it is clear that we are entering territory familiar perhaps in 1930, but unknown in our times.

What can we forecast for the next 10 years?

It seems hardly likely that the financial systems and sovereign debt systems will remain intact in the midst of this market crisis. Europe’s funding needs are simply too large to be met entirely by the existing private sector. Either there will be a move towards the creation of a European Federal Reserve, with the power to print money, or there will be a break-up of both the Eurozone and the banking system. Either way, it is clear that the role of the state in the economy in most European countries will shrink, as it will in the United States. This is not to say that privatisation will offer any meaningful solutions: it is simply to confirm that given demographic and economic change, the state can no longer afford its current and future liabilities, and can no longer borrow money from external sources either.

It means that the average voter and consumer will deleverage to a massive extent. This will either take place due to an aversion to incur more debt, or to a foreclosure process that will seize his or her assets. This means that EUR 660 Apple iPhones or EUR 6 Starbuck’s coffee will soon be a thing of the past. It also means that McMansions and the practise of 30-year mortgages will end as well.

And finally, it means the inevitable rise of nationalism, xenophobia, and the political return to an imagined, idealised past. Who would have thought that the bouffant hair and wide shoulderpads of  the 1980s or the grunge of the 1990s would one day be synonymous with the Roaring 20s? Yet that is almost inevitably what will happen. The entire Republican Party’s platform in the United States is based on this. In Europe, the rise of the ultra-right is merely a different symptom of it.

We are almost certainly going back to another form of protectionism. Tariffs on manufactured goods and finance will be levied. Restrictions on immigration will come back into place. The “new rich” of Brazil or China will be tolerated, so long as they are discrete, and they spend. There will almost certainly be a political and popular backlash against certain ethnic or religious groups within certain countries.

What does this mean for the average worker? Further declining incomes and lower job security. Less access to public benefits such as public health, housing loans or retirement. Longer working lives, and longer working hours within these.

There are at least three wild cards in this relatively bleak outlook, and I’m almost sorry to mention them. The first concerns the demographic changes we are seeing will lead to an increase in mortality of the baby boomer generation in the next 10-15 years. This means that, for some people at least, their relative paucity of present economic benefit will be supplemented by inheritance. It also means that Western governments will benefit, as they will naturally tax this inheritance to the best of their abilities.

The second wild card is that of foreign investment. It is entirely natural that as asset values in the West decline, there will be increased investment from abroad. There will also be investment fleeing to the relative “safe havens” that may remain. Whether this will be greeted with friendship or xenophobia remains to be seen, but it is clear from present trends that in the next 10 years, Europe is set to receive hundreds of thousands if not millions of Chinese and other Asian investors, but temporary and permanent residents. How Europe deals with this will be instructive.

The third wild card is that of political instability in the face of changing expectations and rising population growth. We should not expect China to retain its monolithic internal political control without a massive struggle. Moreover, we should not expect the rise of China to be peaceful. There are hardly any examples in history of a peaceful empire rising, and China’s rise to date has not been peaceful either.

This is the End of Leverage. The end of our confidence in debt and in a positive future. The return to self-reliance, thrift and far less conspicuous consumption. In many countries, the average family will spend the next 2-3 years dealing with basic economic survival in the face of a crumbling financial, government and social system. It will be an age of McDonald’s rather than an age of Starbuck’s and for all-too-many people, it will be the age of Tom Joad rather than that of Jay Gatsby.

(c) Philip Ammerman, 2011

Wednesday 23 November 2011

The Bondfire of the Vanities

I was on my way back to the work after lunch in Limassol this afternoon when a friend called from New York with the news “The bond auction in Germany failed.” At first, I couldn’t quite understand what he was saying. We finished speaking, and my first action was to check Reuters, where the shocking news was on display.

It’s difficult to comprehend the magnitude of this event. From a EUR 6 billion, 10-year bond offering, only EUR 3.64 billion was raised. The Bundesbank stepped in to buy most of the rest. Analysts blame the low coupon offered (2%). 

This event is disturbing for a number of reasons:

1.     It is perhaps the first German bond auction to be under-subscribed at this low a rate since Germany entered the Eurozone. It shakes investor confidence of the idea that Germany is a safe haven, and that Germany will continue borrowing at low rates.

2.     It is the last of a long sequence of bond sales which have seen rising yields and/or rising rates: Spain issues a 3-month treasury bill at 5.11% on Tuesday, up from 2.92% one month earlier. Italy’s 10-year bonds traded at above 6.7% this week.

3.    The EFSF’s bond yields are similarly rising, caught by uncertainty over France’s AAA credit rating and a general lack of understanding of their structure or future plans.

The impact in Europe was immediate: the Euro and the European exchanges fell.

If this event had occurred in isolation of everything else occurring in Europe, it could perhaps be shrugged off. After all, German 8-year bonds have a 3.25% coupon; German 15-year bonds have a 6.5% coupon. It’s likely that issuing 10-year bonds in the present climate at 2% is something of a pricing error, perhaps reflecting some tendency of arrogance or complacency.

German Bonds, 23.11.11 (c) Bloomberg

But the problem is precisely that this event does not occur in a vacuum: It occurs amidst a swelling tide of market caution, which some may even choose to call panic. 

French and Belgian bond yields have been rising; Austrian banks have been issued stricter loan conditions for Eastern Europe; France appears about to lose its AAA rating; the EFSF does not appear to be able to raise the remaining EUR 250 billion in credit it has available; the US debt supercommittee talks appear to have failed—expenditure cuts will only start occurring in 2013, at a time when Federal debt:GDP will be higher than 100%; and total public debt higher still.

As I wrote in yesterday’s post:

Absent a major political reform in the Eurozone, or a dramatic improvement in market confidence, we are heading for a European crash in days or weeks, not months. … Everything is now based on market sentiment, and on a European banking system which is rapidly showing signs of weakness, if not collapse. I am not counting on sentiment to recover any time soon.

I wonder if this is Europe’s Lehman moment, and what else lies ahead.

© Philip Ammerman, 2011 

Tuesday 22 November 2011

Political Credibility—and why it Matters

The demand by Eurozone countries that four key members of the Greek government—the Prime Minister, the Governor of the Central Bank, and the leaders of the two main political parties—issue a written letter of support for the October 26th Agreement may seem naïve, unless considered through a simple prism: no one trusts Greek politicians anymore.

In terms of logical reasoning, this may seem like a tautology. After all, we are all conditioned to certain truths, such as “all politicians are liars.” Yet on the strength of these liars, European taxpayers are being asked to spent a further EUR 100 billion for bailing out Greece, plus EUR 30 billion in direct “incentives” for their own banking systems as a consequence of the PSI haircut.

Whether we look at the Greek situation through the eyes of a banker or consultant working on a debt work-out, or a European politician working on the basis of “solidarity,” we would expect to see the following commitments undertaken by Greece:

a.    A clear working model of sovereign and corporate turn-around, which can be measured against objective indicators. The disbursement of additional loans or support is made conditional upon fulfilling this plan.

b.     The commitment of the political and economic class to implementing the plan.

c.     A specific schedule of implementation, with prioritisation on key actions, and slippages on minor points, but also exceeding the plan wherever possible.

Unfortunately, we see no such indicators wherever we look over the past two years:

·       The Papandreou government initially denied that there was a crisis. When it signed the first bail-out in May 2010, it continued to act in a largely partisan manner, reverting to traditional Greek patronage schemes and launching white-elephant projects which had little to do with either economic reality or sound business sense.

·     Worse than this, the government continued to make commitments to the Troika, but then never really implement them. Matters came to a head in September 2011, when Minister of Finance Evangelos Venizelos asked for a “political solution” to the fact that Greece wasn’t making its targets.

·       This was compounded by the disastrous proposal for a referendum on the October 26th agreement. This decision was made after the negotiations had already taken place, without prior consultation with Greece’s creditors.

This dismal performance has been compounded by a series of technical errors which should have been corrected from the outset, but which never were.

The first error is the fact that the initial bail-out package ignored the fact that not all Greek public debt had been consolidated. This meant that despite the initial restatement of debt made between November 2009 – April 2010, a second restatement followed in November 2010. This meant that Greece lost further credibility, and automatically placed the achievement of the 2010 targets in jeopardy. Yet numerous analysts—myself included—were well aware that not all debt had been consolidated. My post of June 26th, 2010 First Steps in Consolidating Greek Debt, is indicative. The impact this consolidation might have on Greece’s GDP numbers are explored in my September 10th, 2010 post, Some Progress, Major Problems Ahead.

The second error is the fact that the initial bail-out package listed in significant detail the revenue and expenditure impacts of public sector cuts and higher taxes, but it somehow failed to take into account the impact of higher interest costs, or the compound effect of interest. So while annual savings on the order of EUR 5-6 billion per year were being forecast, these were overshadowed by annual interest costs of at least EUR 15 billion.

The third error is that there has been absolutely no real prioritisation of measures taken. The Troika and the government appear to have gone into the austerity programme with a “big bang” economic restructuring in mind. Yet this failed to take into account the basic fact that PASOK, the ruling party, was never truly behind such a “big bang.” As a result, rather than prioritising the reforms that were truly important, the government has lost credibility through its failure to fully or adequately implement arguably minor priorities, such as the liberalisation of taxi licensing or pharmacies.

The fourth error is that there has not been an adequate communications effort to back the reforms. What reforms Greece did undertake in the first 2 years since October 2009 have been historic. However, they have not been adequately communicated either within Greece, or outside it. As a result, the Greek population sees austerity taking effect, but no real hope for an exit from the crisis, while the Eurozone creditors see a series of targets which have not been met (the failure of which they bear at least equal responsibility for), and equally, no visible signs of recovery.

These technical errors were then compounded by the classic political / operational issues so prevalent in Greece. The first and foremost of these is that no other Greek political party has taken its national responsibilities seriously. The ND opposition party has been against the first bail-out since its announcement, but has not provided a meaningful policy alternative. LAOS voted for the first bail-out, and since then has voted against every measure introduced by the government. The two (three) left wing parties (to the left of PASOK) appear to be living in a fantasyland of “worker solidarity” and, at one extreme, renationalisation of banks and hospitals.

Even when finally forced to work together, the Greek “home-made” solution is inadequate. It is absurd that a government of “national unity” will work for three months. No one realistically believes an unelected Prime Minister will be in power long enough to continue the reform programme. Everyone understands the risks of the political campaign scheduled to begin on January 20th, for elections on February 19th, and the hysteria and demagoguery this will unleash. And finally, no one understands how Mr. Antonis Samaras can claim to support the October 26th agreement, but not support new measures (or other measures).

Taking these errors into account, it is not surprising that European partners are insisting on a letter of guarantee for sticking to the reform programme in exchange for future funding. They are beset by their own internal political and economic situations; they are unaware of the real situation in Greece; they would probably do anything possible to avoid further financial guarantees to a country which has proven itself incapable of honest, effective governance.

The real irony is that even if Mr. Samaras finally signs a thousand letters, I very much doubt whether this will be enough. We are now in a situation where Greece’s poor internal performance has been overshadowed by a truly disastrous external situation. Absent a major political reform in the Eurozone, or a dramatic improvement in market confidence, we are heading for a European crash in days or weeks, not months.

Under the present political and economic conditions, it is therefore impossible to see how the second bail-out of EUR 130 billion will take place. This money can only be raised through an act of Parliament in 16 Eurozone countries, which agree to a further sovereign guarantee to raise loans on the open market. This is simply impossible now; it will be worse in January-February when they finally get around to voting.

These market conditions already make it impossible for the Eurozone countries to raise funds to bail out Greece, because (a) they will be fighting to raise money to refinance their own debt, and (b) it makes little economic sense for Spain or Italy to borrow at 6% and lend the money to Greece at 4%. With the French rating at risk, and the UK not participating in the Eurozone bailout, this means that four of the five largest European economies will not be in a position to raise money for the second bailout.

So many commentators have remarked that Europe needed at least EUR 2 trillion to properly combat the crisis. Yet this has been ignored in favour of small, incremental steps that are always behind the curve, and never complete. The fact that the EFSF is unable to raise the funding it needs quickly enough is indicative of the fundamental miscalculations made by European politicians, including the Greek ones, who have apparently believed they could use other people’s money forever.

Everything is now based on market sentiment, and on a European banking system which is rapidly showing signs of weakness, if not collapse. I am not counting on sentiment to recover any time soon.

© Philip Ammerman, 2011 

Monday 21 November 2011

Has the Hard Default Arrived?

On October 27th, George Papandreou returned from Brussels having participated in an all-night negotiation session which resulted in a PSI agreement of EUR 100 billion (pending bank acceptance) and a second bail-out package for Greece worth EUR 130 billion (of which EUR 30 billion was actually part of the PSI agreement).

Today, on November 20st, nearly a month has gone by with George Papandreou being forced from office over his absurd referendum plans, a government of national disunity in place, and the contagion of the European sovereign debt crisis now affecting core Eurozone economies. Recent Italian and Spanish bond rates were above 6.5%, despite extensive European Central Bank purchases. Interest spreads of French and Dutch sovereign bonds rose last week. Perhaps most critically, recent offerings of European Financial Stability Fund (EFSF) bonds were cancelled due to poor market sentiment. Given that the EFSF must raise at least a further EUR 250 billion, it is difficult to see how this will occur.

The financial markets remain dominated by risk-averse thinking, which is quite reasonable given the current situation:

a.    Banks are forced to write down EUR 100 billion in Greek debt (the 50% PSI) while at the same time raising core capital ratios to levels which imply a further EUR 100-150 billion in new capital.

b.  The Greek PSI of 50% is far higher than what the industry was willing to accept, and creates justifiable fears of moral hazard with other highly-indebted countries, in terms of both private and sovereign debt.

c.    Non-performing loans are rising across the Eurozone, led by commercial and household real estate loans. The next step will be a decline of prime real estate values in France and the UK, accelerating the negative feedback loop.

d.     Core economic indicators in Europe and Asia continue to deteriorate. In Europe, this is due to government austerity, private and corporate deleveraging, and declining consumer spending.

e. The ratings agencies are in a risk-averse mode, with banks across Europe being downgraded, and several countries (including France) at risk of losing their current ratings status.

Given these factors, the spectre of a hard Greek default can therefore no longer be ignored in the short term. In the longer term, it remains to be seen whether the second bail-out and PSI will actually be implemented.

1. The Sixth Instalment will meet less than 2 months cashflow requirements
Greece is focussing on the 6th instalment of the original bail-out package, as the public sector has run out of funds. Salaries have not been paid; suppliers are unpaid as well. However, the 6th instalment of EUR 8 billion will not be sufficient to cover Greece’s urgent funding needs, which include bond refinancing of EUR 6 billion in December and EUR 3 billion in January, in addition to a salary arrears of at least EUR 1 billion and higher-than-usual December salaries and pensions. The government has official arrears of EUR 6 billion; unofficially these are higher.

While the government is betting on higher-than-normal tax revenue at the end of the year, all previous months have shown that actually revenue income is typically lower than forecast.

2. It is not certain that the Second Bail-out can be implemented 
It now seems extremely difficult that the second bail-out, of EUR 130 billion, can actually be implemented. This funding must be approved by the Parliament of each Eurozone member, a process that will likely be completed by February 2012 under normal circumstances. However, the capital remains to be raised in financial markets. Normally, this would be done by issuing a sovereign guarantee and turning to markets.

But the original bail-out includes an important proviso: that if national conditions are such that raising funds is impossible at rates below those offered to Greece (which then was 5%), these countries may opt-out of the bailout. Spain and Italy currently fall into that category, as do Portugal and Ireland (which have already opted out of future debt participation for Greece).

It is currently impossible to forecast whether the remaining EUR 130 billion can actually be raised, in no small part because it must be raised from the very same financial institutions who have been strong-armed into a EUR 100 billion write-down of Greek debt, and who are being asked to raise core capital ratios. And who face ratings downgrades as a result of their exposure to Greek, Italian, Spanish and other debt.

Much depends on capital markets between now and Christmas. The trends are negative, and worsen due to the US Supercommittee’s inability to make further cuts to US debt before triggering the automatic debt cuts. With elections in the United States and France in 2012, debt and austerity have become hopelessly politicised.

In Greece, meanwhile, the country is paralyzed by Mr. Samaras’ refusal to sign a letter agreeing to the October 26th (27th) agreement. Mr. Samaras may find that by the time his ego allows him to sign the letter, the train of European solidarity has already left the bail-out station.

Given the collective irresponsibility of the Greek political class, a default may be the only rational option left.

© Philip Ammerman, 2011