Greece: what would happen if she needed help right now?

Having had some more time to cogitate on the new rescue plan for Greece I have some further thoughts on it today. It is true that this plan does have more detail to it than the previous efforts but as I have thought about it some aspects of it continue to trouble me. Indeed my words from previous articles have come back to my mind so there are consistent themes here. For example we were promised more details on the role of the International Monetary Fund (IMF) and there is no sign of all of any conditions in return for the lending.

What would happen if Greece asked for the money today?

Here there are clear issues,say something happened today to plunge Greece into even more distress and she asked for the aid immediately. We hit an immediate flaw as the 30 billion Euros  in bilateral loans from other Euro zone members would have to be approved in the parliaments in each of the Euro-zone’s member states before it could be paid out. How long this would take is unclear and imagine the problems if a parliament said no for example as Ireland did to the Lisbon Treaty. For those unsure about how the IMF would deal with this then it would negotiate with Greece over its lending to it and any loan would then be approved by the IMF board, and could then be given to Greece.

So if the money was asked for today it could not be given. The one organisation that could act fairly quickly the IMF has provided no detail at all on its plans. Europe could take weeks or more and there is no guarantee that every parliament would say yes. They would be under enormous pressure but as I pointed out earlier that has not always worked for the European Union. After two months of dithering we get a plan was is still somewhat unwieldy. I set some criteria for a successful plan back in an article on the 17th February.

1. That action needs to be quick and decisive. A decent plan operated quickly is preferable to a perfect plan that is dithered about.

2. Such talk will improve markets but like the boy who cried wolf it only has a limited lifespan. So politician’s who feel that talk is sufficient (and I am sure there are plenty of them) must be made to realise that talk without action is only a short-term palliative.

Reading it again it is clear to me that point one has still not been answered and needs further work. One of the lessons of this crisis has been that things settle down for a while but that markets sooner or later fret over flaws in official plans.

Can anybody go bust in the Euro zone?

This question and the apparent answer to it provided by the Euro zones response to the Greek crisis has  clear implications. Taking the answer forward that no-one will be allowed to go bust has a clear implication for the countries in the Euro zone who have more prudent economic management and more favourable economic circumstances. You see if they feel that they are jointly liable for each others debts then why is Germany’s ten-year bund yield 3.1% and Greece’s ten-year government bond yield over 6 1/2%? A new Euro zone ten-year bond with an interest rate of say 4% would go down like a lead balloon in Germany and many of the other Northern European nations. It is an extreme example but illustrates the danger here.

Would another country get the same help?

In principle it should do but there are clear flaws here too. If we look at the likely candidates for help they are involved in the plan for Greece and accordingly are weakening their own position to take part. So if it is activated how would the Euro zone work out another rescue particularly as a possible candidate (Spain) is a much larger economy? The truth is that unless the next country to hit trouble is also relatively small it cannot.

No bail out clause

The Euro constitution had a clause stating that there would be no bail outs. This is a bail out and phrases from European Ministers at Sunday’s summit claiming that the interest rate on the plan is “non-concessional” are false.Markets have been wiling to loan money to Greece at around 6.5% before last week saw yields go even higher . Therefore an interest rate of 5% is at a subsidised rate when compared with market rates.When you consider that Europe’s taxpayers will be loaning money to Greece at a rate much cheaper than they, their banks or their pension funds are willing to then we may see this plan challenged in more courts that just Germany’s Constitutional Court.

What are the conditions?

So far there are none. This is simply not viable.

What will the IMF do?

Apart from vague promises and grandstanding we still do not know. As the IMF is the one organisation that could operate relatively quickly then this is a serious flaw that needs to be fixed immediately. It goes straight to my original point two for an action plan.

Term

There is a lack of clarity in this area. As Mr. Kowalski commented yesterday on here there are elements of a three-year plan. However we only have any detail from the Euro zone ministers for a 12 month action plan with a three-year maturity. So what they will do in years two and three is undefined or to use their own words ” this has not yet been determined.” The IMF assuming it finally gets round to publishing some details will have to have more than a twelve month plan and 3 years is perfectly reasonable. So this area needs a lot more clarification as there is a clear mis-match.

Solvency

I have been asked about the long-term solvency of Greece going forward and so let me explain what I think on this subject. There are various factors at play in such a situation.

a. She is in a severe austerity plan which intends to cut her public sector by the equivalent of 4% of GDP this year.There will be further cuts in future years.

b. Her national debt is already high in comparison with her GDP at around 114% and as even under her austerity plan she will still be borrowing substantially over the next 2/3 years this will deteriorate (rise) further.

c. Greece’s forecast going forward assume optimistic growth rates for her economy.

d. Sustained high yields on Greece’s government debt will mean that she has to replace cheaper debt with more expensive debt and she is also having to make a lot of new borrowing because of her high fiscal deficits. So she will be carrying an increasing deadweight going forward.

This is an area where Europe could have helped her by acting quickly as if you look forward from February this year then it was plain that most of her borrowing for this year would take place by the end of May, but now much of this has happened and to make matters worse for Greece she has had to pay high rates on it which she will have to pay until the bonds are redeemed/repaid. But it is now too late for much of this and is the reason for my cost of delay section yesterday.

To put this into numbers consider an interest rate of 6.5% on government debt and consider Greece’s position in 2012 when she will have a national debt of say 140% of GDP. This would mean that of her economic output some 9% would have to be spent on financing her debt. Now this is an extreme example as whilst Greece has plenty of new borrowing planned for 2011 and 20112 and many maturities she would still retain some cheaper debt but it does give an illustration of scale. Comparing with the UK at current levels and saying our national debt might be 85% of GDP in 2012 then using our bond yield of 4% gives 3.4% of economic output. These are back of the envelope calculations so please do not quote them with precision but they do illustrate the scale of Greece’s problem I feel.

So now looking at this as an overall position Greece will need to grow substantially to be able to pay for this. The problem is that her forecasts already assume decent growth. The next problem is that her austerity programme combined with increasing costs from her government debt are likely to make growth negative for next year as well as this. This is why I feel that she needs a debt restructuring to be negotiated as otherwise the numbers simply do not look like adding up as we go forward.

Speculators

We have heard a lot of criticism of these during this crisis. However if you think about it probably the best opportunity to make easy money took place on Friday. As rumours circulated of a deal on Friday it seems clear that security was not as tight as it should have been,however those not in on the deal might have dismissed it quite reasonably on the grounds of another potential false dawn. This leads me to think that it is possible that some people may have had what is called an “early wire”. If you knew about the deal buying Greek government bonds on Friday was likely to be almost a risk-free and certainly highly profitable trade.

Such an action would of course be unfair on those trading without such knowledge. So I hope that the same Greek government which has recently imposed restrictions on those going short of Greek government bonds will cast its eye over those who bought them on Friday. Perhaps those who bought on Friday and sold on Monday might be a place to start. The credit derivatives that have recently been so criticised might be another. What is sauce for the goose is also sauce for the gander.

I am reminded of the words of a friend who once told me that he only thought insider trading had been made illegal because what he called the establishment had realised that they were no longer the only players in town.

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23 thoughts on “Greece: what would happen if she needed help right now?

  1. “Speculators

    We have heard a lot of criticism of these during this crisis.”

    Yes, and some of the most strident criticism has come from the Greek government. In view of the continuing uncertainty you describe and the fact that, publicly at least, the government continues to maintain that they can manage without a bailout, it seems to me that Greece is now relying on those very speculators she derided to buy her bonds. I see reports today confirming that the US “roadshow” will go ahead at the end of the month with a view to selling dollar denominated bonds thereafter and no sign that there will be an appetite for them at other than “speculative” interest rates.

  2. If at the next debt issuance point Greece goes to the market at 6%-7% rather than call on this cheaper facility we can be confident that no such facility really exists.

    Default and/or IMF.That’s all there is.

    • Well todays offering apparently bought Greece 1.5b Euro’s at 4.5% for 6mth paper and 4.85% for the 12mth. Seems we will have to wait a little longer for the inevitable.

      • Still expensive if you think about it as they compare with 1.38% and 2.2% that they replace. So they still are having to pay a decent rate for even short term money. Although it does buy some time for them.

  3. Can anybody go bust in the Eurozone? Well, no. It’s a political entity, and while it survives, no country will be allowed to default. The real question is, can the Eurozone survive bad financial behaviour by a large country? The answer to that depends on the mood of the Germans. If, to preserve the Euro, they really want to help out (say) Spain, they will do it, though it will cost them and perhaps others a lot. Otherwise they may prefer to return to the DM and ditch the ‘Teuro’. Even a country with very deep pockets has to have some limits, a fact that speculators are doubtless well aware of.
    I imagine that Germany is trying very hard to ensure that the larger Eurozone members don’t go the way of Greece. I also imagine that the speculators are presently considering how to make their next attack on the Euro, having exposed its key weakness for all to see.
    It will be fascinating to watch Merckel, Sarkozy, Trichet et al in action over the next several months.
    A worthy distraction from the UK’s own problems!

      • Hi Andy,
        I’m intrigued as to why you think the UK should do that right now? Surely right now, being outside of the Euro is the only excuse the UK has for NOT helping in the ‘bailout’.

      • Because it appears that Euro monetary union implies that any state with
        profligate spending policies to point of self destruction (which we have) will
        in fact be rescued.

        I am of course being a bit mischeivous.Howver in the final solution
        the UK will end up further monetizing the debt,with a cost to us all.

        Whilst 10 year gilts sit at 4% teh attraction of easy access to euro money at say 5% seems pointless.However a couple of years on we may be glad of.
        In particular as it seems this money comes with no strings attached

      • Yes, in that case I can see the gain in a medium term point of view. But, if I’m also allowed to be a bit mischevious, perhaps the uk stays out while others are ‘bailed out’, then jump in only when our coffers are empty 😉

    • If we start with Germany’s courts then according to Reuters

      Joachim Starbatty, a professor at Tuebingen University and prominent euro skeptic, was quoted by the Rheinische Post paper as saying the aid package breached the EU’s Maastricht Treaty.”We will file a suit at the Constitutional Court against the credit from euro states,” Starbatty told the paper.Several other academics and constitutional lawyer Wilhelm Hankel, who failed to prevent the introduction of the euro in 1998 at the Constitutional Court, are working with Starbatty.The Rheinische Post said Starbatty viewed the aid package as a subsidy which was forbidden as the interest rate offered was under the market rate for Greek bonds. Starbatty, who has for weeks been threatening legal action if aid for Greece was granted, was not immediately available to comment.
      The court would have to decide whether to halt the aid, at least temporarily, to assess whether it was legal or whether to let it go ahead and possibly decide later it was not in accord with the constitution.

  4. Shaun,
    thank you for the extensive and thoughtful analysis.

    The Reuters reported (April 13) that every country will activate the mechanism to support Greece as each one sees fit. (“The Commission will not issue guidelines. Each state may proceed as it sees fit,” said Economic and Monetary Affairs Commissioner Olli Rehn’s spokesman Amadeu Altafaj.)

    In the case of Italy, this means that they need to pass a new law through parliament (their share is 5.5 billion euros). I think the loans to Greece will have to be approved by parliament in the case of several countries.

    Meanwhile, PIMCO did not buy any of the short-term Greek debt offered today, apparently because, as El-Erian more or less put it, the aid package tackles the liquidity problem but not the solvency one. Ditto from Goldman’s Nielsen.

    Shaun, if a consensus emerges that Greece is insolvent, what would be next?

    js

    • Actually I think that there is a consensus of those who think about the situation. But it involves thinking that on current and likely trends Greece will in the end be unable to finance her national debt rather than her being insolvent right now. How quickly this happens depends on events but she would have to be very lucky to escape it now. Perhaps world trade and economic output will shoot upwards, but much more likely not….Something like cold nuclear fusion being found to be workable!

      As to why it does not get more publicity well I used to work for a firm which was a broker and represented its clients. I saw the change to a dual function where it became both broker and market-maker which was not good for market behaviour in my view. Also firms have merged so the numbers have reduced. So we have fewer firms all of whom are likely at some point or another to be looking for government business, so whilst they will issue reports there is a clear moral hazard in my view. Another way of defining this change is that investors like Pimco feel the need to talk publically,so some of what brokers used to do has gone to the customer. Of course there is a clear moral hazard here too!

      So in a way a consensus is around but it is not publically trumpeted, the smart money moves on and the ordinary investor is often left out of the loop. At its worst the small investor is in fact deceived. And Greek bond yields are unaffordable except for the very short term.

      • Shaun,

        than you for the clarification and the reality check! I have been wondering!

        Now, if we assume that the EU finance ministers are somewhat competent, they must have figured out the end for Greece as well. And they have additional direct information from Eurostat and IMF who have looked at the books — and any such info is likely to look much worse than what we already know.

        So, what are they supposed to do? What can they do? Damn if they support Greece, throwing more good money after bad to delay the inevitable; damn if they don’t, the german and french banks will lose big, plus the euro will go down the toilet.

        Any ideas?

        I am wondering whether EU are trying to slowly get Greece to default and get out of the Euro (to be able to devalue and pay domestic bills), but in a way that people do not freak out and innocent (or not-so innocent) bystanders like Portugal, Spain get too much hurt.

        js

  5. My understanding is that the EU package will be quick and decisive (no approval from parliaments); EU decided that it will not allow any of its members to default; I don’t understand why the spreads remain high (at least only for Greece; I begin to think that rumours for some sort of conspiracy against the Euro by other ‘players’ is correct; attack the weakest link and then take them all one by one). If spreads remain high without aid, of course Greece will default, any country would default. I think that the system should get rid of speculators who make money out of people. This system does not serve the real economy and it is full of contradictions. I believe that this will be the long term consequence. The markets are not wrong, they are a scam.

  6. Shaun,

    Do you know who bought yesterdays offering of Greek debt? This may give us a clue about market confidence going forward i.e was it bought internally by Greek banks or was there really some foreign appetite for the debt?? Thanks

    • Hi Graham
      I was just reviewing the comments section and spotted that I had not replied to this,so apologies. I never really got an answer to this question which is not so unusual because if I remember rightly it was Treasury bills rather than bonds. I guess whoever bought them is grateful for them being short-term and that someone is guaranteeing they will be repaid…

  7. The only real answer IMVHO is for Greece’s creditors to take a 50% hit on their debts; Ambrose Pritchard says 65%. This way the European banks, the EU and Greece all survive, albeit with nifty haircuts. Greece is frozen out of credit markets for years to come and (rightly) enters a grinding depression.

    • How does anyone arrive at these 50%, 65% haircut numbers?
      Greece is running a significant primary deficit — 4-7% of GDP. How is the Greek economy going to manage to get into surplus to pay any of the debt and interest? Doesn’t it look more like a 100% hit?

      js

  8. ” I think that the system should get rid of speculators who make money out of people. This system does not serve the real economy”

    Oh yes it does… speculators are rather like detectives who exploit weaknesses. In doing so, they point them out in advance.. a market warning system. Greece would’nt have said anything until the day it defaulted, bet on it.

  9. The simple people, workers etc. in China or even in Germany have to withstand low wages (sometimes ridiculously low) and work long hours to have a ‘competitive’ economy (while s small elit of bankers and speculators become super rich). This is a bad deal for the people. System has to change. What’s the point if I have no decent money to live only to become ‘competitive’. If IMF comes and cuts salaries in Greece even lower, if unemployment goes to the roof, I assure you, people will revolt. They will have nothing to lose.

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