Παρασκευή, 4 Νοεμβρίου 2011

A MODERN GREEK TRAGEDY:The Barber and the Referendum

Republished from the Business Thinker magazine, November 3, 2011

Sophocles, Aeschylus and Euripides after twenty five hundred years finally met their match. Papandreou, Venizelos and other Greek government officials are stunning the world not a bit less successfully than their ancient rivals. Some people used to say that modern Greeks did not live up to the legacy left by their ancestors but the current Greek government is proving them wrong. But let’s take a closer look to the storyline.
The deep fiscal crisis in Greece seemed to be finding a viable solution mid-last week when the long overdue haircut plan was finally put in place in the EU summit. As with the common
haircut at your barber, you cannot avoid the inevitable, you have to get a haircut and the longer it takes you to realize it and do it, the longer the hair is going to be. Hair, like debts do not get shorter by just waiting. The October 27th plan for the haircut on the Greek sovereign debt was desperately needed not only by Greece but for the euro and the financial markets as well. It was clear to everyone that despite the aid by the EU and the IMF, Greek debt was not sustainable and it was heading towards an uncontrolled default. In private business financing the picture is clearer and these situations are dealt with swiftly and usually successfully: the borrower and the lender come to an agreement so that the former is able to service part of its obligations and the later ensures minimized loses. The decision reached at the dawn of October 27th is a step towards the right direction for two reasons: Greece and the international community will avoid an uncontrolled default and

For the case of the Greek debt the 50% haircut was actually roughly 28%. This is because total debt is estimated to be €365 bn by the end of 2011. Subtracting out of this, €78 bn that represent the aid packages from EU partners, approximately €62 bn that are held by the ECB and €13.6 bn in Greek government short-term debt (maturities of less than 365 days), we are left with approximately €211 bn of privately held
Greek long-term bonds with 10.1 bn of those being guaranteed and not subject to a haircut. Thus, the remaining debt for a 50% haircut will be a total of €201 bn. After the haircut, Greek total debt by the end of 2011 will decrease by 28% to 264 bn. Thus, the debt to GDP ratio will be 117% of GDP down from 162% before the haircut. A major concern of these negotiations was that whatever the decisions made, they did not trigger a credit event for the ISDA (International Swaps and Derivatives Association). This would have serious and largely unknown repercussions not only within Europe, but mostly in the U.S. A credit
event would trigger billions of dollars in CDS contracts that would rattle the already unstable financial institutions. Many of them will not be able to honor the billions of dollars in CDS they issued in the recent past. This may lead the American economy into a serious depression and another banking crisis. To avoid all this, the haircut had to be labeled “voluntary”. To persuade private bondholders to agree to exchange each €100 bond with the new €50 bonds they were offered a €15 AAA rated guarantee through EFSF. Of course, as a result, many CDS holders realize that the “insurance” they bought on Greek debt becomes useless and unable to hedge their exposure to risk.
This scheme that will come into effect in January, not only reduces the Greek burden by €100 bn, but it also reduces annual interest payments by more than €5 bn per year, or an amount equivalent to 2.2% of GDP each year. The total benefit for the Greek government finances for a 10 year period and a coupon rate of 5% is discounted to the present €39 bn. So even this 50% haircut that is actually 28% bears significant
value to Greece and beyond. Europe will make a first successful step in decisively –although a bit late I would say- steering Greece out of an uncontrolled bankruptcy that would significantly impact through contagion not only its continent but the US as well. France insisted that ECB should provide the lender of last resort buffer to any EU economy that would come to the edge of a default is an effort to reassure the markets that no other European country would face the same problems as Greece and at the same time curbing speculators’ appetite for destruction. Germany had its way and this was not included in the agreement. Instead, it was decided that the EFSF’s remaining lending capacity of €250 bn would be leveraged to more than €1 tn using overseas funds from possibly Norway, China, etc.
Of course some grey zones still exist: there are no specifics as to what the maturity of the new bonds will be and what will be the legal jurisdiction that will govern them. What will happen if banks fail to privately recapitalize after the haircut? Greek banks have to raise €15 bn and another €11 bn recapitalization is needed for Greek pension funds. EFSF may risk its AAA rating when it will have to guarantee part of Greek, Portuguese, Irish and mostly Italian and even French debt.
This decision with all its shortcomings was long overdue for Greece and Europe. It is on the right track and could be the start of a long but stable road to reach the markets sometime in the next four to six years. Of course there are plenty of things to be done to head to this direction. The Greek government must put forward a significant privatization
plan once stock markets stabilize and start to reflect fair share values. Government property must be bundled up and serve as collateral through an SPV (Special Purpose Vehicle) that will assume a big chunk of the debt and collateralize it.
But to make the tragedy more interesting, the Greek Prime Minister George Papandreou decided to add some twist to the story surprising audiences around the world! Instead of going back to Greece and asking his cabinet to work hard in the direction given by the summit taking advantage of all the positive aspects of it, he decided to announce a referendum! This act is so strange and of course dangerous that creates a great block buster that any Hollywood writer would envy. Trying to understand this extremely incomprehensible move, one could translate it as a very short-sighted internal partisan rescue plan. Europe was stunned, the Greek stock market took a dive with bank stocks reaching historical lows and even the US market felt the aftershock of this suicidal decision. This move was so unexpected, that for the first time EU officials are urging Greece to come to its senses as they already have back-up plans for an EU without Greece and Greece without the euro. The state of confusion in the Greek government is so high that the even though the Papandreou announced a referendum, it is not clear to anyone what a “yes” question actually means: yes to the haircut, to the EU, to the euro? No one yet knows. It becomes certain that the Papandreou government will be history in a few hours and this play will have a new act.