Tag Archives: Greece

Corporate Framework for Sovereign Debt

On Friday, a four-month extension of the Greece bailout plan was agreed upon, narrowly avoiding the otherwise imminent threat of default. The way I understand the situation is as follows: the financial crisis of 2009 left the Greek government with an insubordinate amount of debt, forcing them to seek loans from other European countries. The loans carried provisions and regulations as to how Greece would solve its economic problems, with the idea that a stimulated Greek economy would generate the revenue needed to repay the loans. The terms of those initial loans were due to expire, and Greece is no closer to being able to repay them as their economy has made little to no progress. Elections in Greece yielded a political party determined to renegotiate the terms of its obligations to its creditors, which brings us to where we are today. There are many problems that need to be addressed, but in my opinion, the most significant is that there is no precedent or framework in place on how to deal with sovereign debt. If Greece decides that it can’t pay back the debt, what happens? What legal entity exists to force Greece to repay the debt, or even follow the reforms outlined in the terms of the loan?

Another interesting topic that stems from the same fundamental problem is what role does democracy play? Greece’s voters elected a government to take some course of action, whether it is right or wrong is irrelevant, that’s just how democracy works. However, how can the government follow through on those actions when its policies are at the mercy of its creditors? On one side of the argument, there is the view that “If Europe says no to Greek voters’ demand for a change of course, it is saying that democracy is of no importance, at least when it comes to economics.” The opposing view states: “It is unrealistic for Greece to claim that its voters trump voters in other countries. Indeed, inside a currency union where no member is fully sovereign, it is inherently impossible for any newly elected government to claim that their new electoral mandate trumps everything else.”

In the corporate world, this problem is somewhat analogous to the distinction between equity and debt. Shareholders are the voters and get to decide the policies of the company, when everything is running smoothly that is. But in bankruptcy, it comes down to seniority- with senior debt holders coming first and equity shareholders coming last. There are certainly differences between corporations and governments, but I don’t see why the same principles shouldn’t hold. In both cases, the shareholders/voters elected a management team that was ineffective, ultimately leading to the distressed situation in the first place. They also effectively agreed to the terms of the debt by voting in a management team that accepted them.

 

The Euro Zone is a Failure

Breaking news out of Brussels today reports that talks to further Greek financing have broken down according to the Wall Street Journal.  Some economic backdrop on the situation, Greece is in a dire financial situation and needs financing in order repay debts and keep their government functioning. The Greek government, however, is not fond of the terms in which Greece will receive financing from the European Central Bank. Greece feels the terms put a further damper on their economy. But maybe the problem isn’t with Greece or the terms laid out by the officials of the ECB. Maybe the problem much deeper and is brought on by the existence of the Euro itself.

Last semester, I took a course on the European Economy that covered everything from just before the creation of the Euro to present day struggles. When the Euro was first introduced, it served as a unity symbol for all of Europe. The theory was that in order for European countries to be a leading global macroeconomic power, they needed to bind together. The Wall Street Journal has another article which discusses the Euro as a unity symbol and further describes the current Greece issues which can be viewed here. But surely 28 European countries did not form a single currency just to show they were united as one. Rather, the initial economic thought was that the Euro zone would benefit from economies of scale and that individual countries would benefit from a removal of trade barriers.

Now for the reality. There are also many harsh implications when uniting multiple diverse countries (and economies) into a single currency. First and foremost, monetary policy dissolves. The ECB still has control over monetary policy, but the needs of Germany may be very different from the needs of say Greece. When Greece is struggling with net exports, they are unable to set a more accommodating monetary policy via quantitative easing. This is a built in failure of the Euro zone. And it goes both ways. Former Fed chairman William McChesney Martin famously coined the phrase that the job of the Fed is to take away the punch bowl right before the party begins. The reason for this is to temper inflation. So if a country is experiencing tremendous growth with low interest rates, they are at risk of inflation. The Fed can simply raise the nominal interest rate. The German Bundesbank, however, has to leave that power up to the ECB. Ultimately, the Euro zone is too economically diverse to function as a single unit. It may take Greece falling out of the Euro zone to start a domino effect, but eventually, the Euro will fail.

The Problem with Government Bankruptcy

Greece and the Eurozone met today to talk about a possible renegotiation of the bailout. Here is what we know:

“Greece’s bailout from the eurozone runs out on Feb. 28. At that moment, without an extension, it will lose its last €1.8 billion disbursement from the currency union’s bailout fund, €1.9 billion in profits from Greek government bonds held by the European Central Bank and around €11 billion still sitting in Greece’s bank bailout fund. The fate of a €3.5 billion transfer from the International Monetary Fund is less obvious, since the IMF’s program for Greece runs until the end of 2016. What is clear is that Athens won’t get any money from the fund without an agreed aid deal with the eurozone.”

Unsurprisingly, as of today’s conversations, no conclusion was met.

Government debt is a vicious cycle. If Greece were a corporation, they would either be in chapter 7 or chapter 11 bankruptcy. In the event of chapter 7 bankruptcy, they would be liquidating assets in order to pay off their secured debt to the most senior creditors, and would cease to exist. There would be a legal system with a court and a judge to oversee and enforce this process, and that would be that. Obviously, that is not the case. As a country, Greece can’t just liquidate itself and stop existing. Chapter11 bankruptcy would mean that, with the approval of a judge, they could continue operating and attempt to restructure their debt and reorganize management. They would use the cash flows from the newly organized company to pay down the debt in an ideal situation. If not, they would concede to chapter 7. However, the problem is that Greece is stuck in the limbo that is government bankruptcy. The problem is that there is not a legal entity to oversee the process or use force if necessary, which is why government debt is a vicious cycle. Greece is unable to meet its payment obligations, but there is no one forcing them to do anything about it, which means the only option is to borrow more money to pay off the old debt.

The question is what lessons can Greece and the Eurozone learn from corporate bankruptcy? One of the key features of corporate bankruptcy is organizational restructure. When a company is failing, leadership has to be held accountable, and organizational pivots must be made to address those failures. Without the presence of a legal body, this obviously cannot be mandated as it would be for a company. But why should Greece be left to its own devices to come up with its own strategy.

Whose Moral Hazard?

If you think of the Greek debt crisis as a result of “irresponsible lending” instead of irresponsible borrowing, the implications of a Greek default for “moral hazard” change. A debt write down would not just be seen as a bailout, but as a rational adjustment that allows a better allocation of risk between borrowers and lenders.

The conventional wisdom is that Greece overborrowed from bond markets. They lived beyond their means and the chickens are now coming home to roost. As such, allowing a partial Greek default would encourage future prolifigacy. Instead, the troika should hold Greece to their debt promises so as to prevent future moral hazard.

But another way of looking at it is to ask: “who the hell decided to lend to Greece at German-like interest rates”? Even as late as October 2008, the yield spread between Greek and German 10 year debt was under 1%. In the context of a longer history of interest rates, this was absurd. Reinhart and Rogoff’s history of financial crises shows that Greece has been in default for roughly 50% of its history since independence in 1830*!

Under this framework, the debt deal in 2012 was a massive bailout for non-Greek banks. When governments stepped in, private banks had the chance to offload their holdings of Greek debt.

So instead of considering how a Greek bailout will affect the Greek government’s willingness to borrow, think about what a bailout would mean for those investors lending to Greece. Leaving all of the creditors whole could be seen as encouraging international investors to not worry about bond spreads between Eurozone countries. This is yet another form of moral hazard. A failure to write off debt would be a sign that debt repayment will be prioritized over economic growth in future negotiations. This would signal to creditors that they can reach for yield even if they think that low bond yields on potential troublemakers such as Greece are not sustainable.

Instead of insisting on austerity, the move should be to write off debt and then implement substantially higher capital buffers on Eurozone banks. Both steps are important. First, a partial debt write off would allow Greece to get back on its feet. Austerity, instead of substantially reducing Greece’s debt to gdp ratio, has instead caused the debt burden to rise as spending cuts savage the real side of the economy. History shows that these large debt burdens are almost always resolved by either inflation or restructuring. And so instead of letting the suffering drag on, creditors should recognize that the full debt will not be repaid.

Second, higher equity requirements on Eurozone banks would make them better able to withstand a haircut if such debt problems arise again in the future. In addition, this would make the shareholders in the banks bear the burden of overly risky investment decisions, such as buying Greek debt at only a 1% yield premium relative to German debt. As such, it would have the additional effect of disallowing Greece access to excessive amounts of cheap credit in the future.

In effect, instead of focusing on moral hazard from borrowers, this proposal would resolve the pervasive incentives for lenders to buy government debt that they expect to be bailed out.

This approach is better than forcing the burden of adjustment exclusively on the borrowing country. Sovereigns face a diabolic loop in which economic weakness makes debt repayment more difficult, thereby creating a sovereign debt crisis that further damages economic growth. Pressing these countries to pay up when growth is weak threatens to send the situation out of control. Instead, banks should be responsible for appropriate funding structures that allow them to share in the burden of adjustment.

Moralizing is unproductive in a debt crisis. Instead of trying to punish Greece, the conversation should shift towards debt write-offs and higher equity requirements in an effort to restore current growth and establish a more rational risk division for the future.

Germany’s GDP Linked Debt

A recent proposal from the Greek finance minister includes a debt for equity swap, replacing some of the existing bonds with growth linked bonds that will only pay coupons if Greece grows. The stock market certainly liked it. After the news was announced the Athens stock market shot up 11% and the country’s bank stocks were up 18%..

But Germany’s experience with GDP linked debt should give Greece some caution about the potential political ramifications of GDP linked debt. I am referring to, of course, is Germany’s reparations burden after World War II. The German experience should serve as a reminder that if GDP linked debt is to work, it requires the good will of both creditors and debtors to encourage macroeconomic policies that help the debt get paid.

After World War I, the treaty of Versailles imposed an extremely harsh reparations payment on the German government. The numbers make the Greek situation of having to raise primary surpluses by a few percent look trivial. As noted in Barry Eichengreen’s classic “Golden Fetters”, the total reparations bill for Germany totaled 132 billion gold marks — over 4 times national income at that time. Around 50 billion of that burden was to be paid unconditionally, with initial payments around 10% of national income.

The other 80 billion was linked to the economic recovery of Germany. As such, around 60% of the new external debt burden was GDP linked.

This created a poisonous dynamic in German politics as officials knew that much of the fruits of their economic reforms would be sent abroad. As Barry Eichengreen writes:

“By linking reparations payments to the condition of the German economy, the Allies diminished the incentive for German policymakers to put their domestic house in order. Hyperinflation was only the most dramatic illustration. Politicians were not encouraged to implement painful programs designed to promote growth by the knowledge that the fruits of their labor would be transfered abroad.”

The German situation was not helped when the allied nations raised trade barriers in the wake of World War I. By definition, if Germany was to run a capital deficit and pay these reparations, then by definition it must also run a trade surplus. But since Allied nations were unwilling to allow dramatically greater German competition in what were already intensely competitive industries, the only alternative for Germany was to endure a severe internal devaluation in an effort to restore competitiveness and have funds to send abroad.

Now, I am not trying to draw an equivalence between German reparations payments — which were forced upon the country—and the Greek government’s debt—which was voluntarily accumulated. But I do want to use Germany’s interwar experience to sound out two potential concerns about GDP linked debt:

  1. It can have toxic effects on domestic politics. Politicians are unlikely to make sacrifices to shore up growth when a substantial part of the marginal benefit will be going to bondholders abroad.
  2. It’s useless without supportive policies from abroad. Even when more than half of the reparations bill was at stake, Allied nations were unwilling to ease trade conditions to ease the German reparations burden. In the current context, unless there’s support from the ECB to raise nominal GDP across the Eurozone, Greece’s debt burden will continue to be massive relative to the underlying nominal size of the economy.

Cross-listed on Medium

Victory of Leftists and the future of Greece

Jan 28th 2015

 syriza

(http://www.reuters.com/article/2015/01/25/us-greece-election-idUSKBN0KY00520150125)

Newspapers in the U.S. talk about the victory of the Leftists in Greece and the uncertainty it will bring into the whole Euro zone. What is the correlation between the Leftists’ victory and the certainty of the EU? And what kinds of impacts it will cause?

After the sub-prime mortgage incident, Greece has been through the harsh economic situation. The economic damage was so severe that ECB (European Central Bank) and IMF provided bail-out programs and helped the Greek government escape the deflationary shock in the market. But, these bail-out programs and credit lines are not free; the Greek government needs to repay its debt. The problem is that the tension between the New Greek party (Syriza) and other European countries. Yannis Behrakis from Reuter says, “European leaders have said Greece must respect the terms of its 240 billion euro bailout deal, but Tsipras campaigned on a promise to renegotiate the country’s huge debt, raising the possibility of a major conflict with euro zone partners.” Additionally, many Greek voters are upset about the Smaras’ government for consent to the terms of 240 billion euro bailout, including severe expense cuts and tax hikes.

However, I don’t think that the Greek government can avoid its mandatory of repayment; many people also agree with the statement. Therefore, the interest rate, repayment amount or its period really matter in renegotiation. If the country tries to postpone the deadline too late or lower its interest rate too much, the tension between Greece and EU will be longer and harder. It will cause another bad shock in the Greek market. In addition, whether the renegotiation is successfully completed or not, other countries won’t be willing to trade the Greek bonds or currency. Why do people or countries avoid the Greek funds? It’s because renegotiation means that Greece doesn’t keep its agreement, losing its faith (or economic ability). Lower currency and bonds will make the Greek financial market suffer again.

Furthermore, Wall Street Journal argues “if negotiations to revive the bailout falter, Greece would be without an umbrella of protection. That program ensures that Greece’s government has access to a stream of cheap financing, and ensures Greek banks have access to cheap funding from the European Central Bank.” Even worse, Greece faces about 7 billion euro repayment which mature in July and August. But, the government doesn’t have the cash yet, and many economists worry that the failure of repayment finally leads to Greece’s exit from the Eurozone.

The future of the Greek government seems so harsh for the Greek and its government. “…Greece has undertaken broad economic overhauls and cutbacks that have helped mend its public finances and … deep recession. Those cutbacks have come at a cost: Some 25% of Greeks remain jobless, while a quarter of households live close to the poverty line” (WSJ). Consequently, Syriza needs to solve various conflicts in the nation and outside of the nation. Considering all situations, I think Greece still needs a lot of time to be recovered unless surprising economic booms (like internet boom) will occur.

Greece Will Not Leave the Eurozon

europe-debt-crisis-greece-ultimatum(http://guardianlv.com/2013/11/greek-economic-crisis-desperation-greeks-self-infecting-hiv/)

On Jan 26, 2015, Syriza won the election of the president of Greece. His won of the election means the antiausterity leftist will hold the power of this tumbledown country. There are many surmises that Syriza’s winning will impulse Greece leaving the Eurozone. Nevertheless, I cannot nod to those speculations.

All those speculations are based on the diffident belief about Greece’s recover from the essential crisis. Greece is suffered with a huge amount of debt and presents little potential ability to deal with it in a short time. For the announcement of the government’s deficit has been declared, the credit rating has fallen from A- to BBB+. The government deficit was 12.7% of Greece’s GDP in 2009 and this number has surpassed the assigned limit from the European Union significantly. (which was only 3%) After the election, one of the biggest creditors of the Greece—Germany presented a tough attitude about the relationship between Greece and European Union. The German government indicated Germany has been already prepared for Greece’s leaving from the EU. This kind of attitude is not ridiculous since Greece seems impossible to pay off the debt for Germany, in the coming dozen of years, at least.

However, what if Greece regain the credibility? Actually, from the election, we can discover that Greek people have had enough about the intensified monetary policy and they wish the new president can lead them jump out of the dark marsh. “Syriza surged to victory on Sunday by promising Greeks that it would reverse many of spending cuts and labor-market reforms that Athens’s creditors have demanded of it in return for aid. Mr. Tsipras also has also called for Greece’s creditors—a group that includes the European Central Bank, other European Union countries and the International Monetary Fund—to forgive about one-third of the country’s more than €300 billion ($338 billion) in debt”.(http://www.wsj.com/articles/ecb-board-member-says-greece-must-repay-debt-restructuring-talks-possible-1422261074) Granted that Syriza can keep his promise and be determined to implement relevant series of actions, we should conceive Greece can make a turn.

Moreover, the European Union will not hope to see Greece’s leaving from Eurozone definitely. If leaving the Eurozone is the consequence, then for other similar European countries like Spanish, Portugal, even Italy will all be disappointed. This means the Europe is facing another big division. No one is willing to see this terrible result. This can even bring a magnificent wave in the worldwide. The first step to recover Greece’s economy is to establish confidence for Greece’s government and people. “‘For all markets, if they gain control, all bets are off. We do not think it is possible for Greece to exit the EU. Or they could if they want to commit sovereign suicide,’ John De Clue, chief investment officer at the private client reserve at U.S. Bank Wealth Management, said.” (http://www.cnbc.com/id/102362865 ) Hoping this election can drill the fuel for Greece’s development.

Is Euro Zone Cohesion at Risk?(Blog7)

The win out of the leftist party Syriza in the Greek election seems to intensify the disturbance of Eurozone’s break up. As described in a Jan, 25 WSJ’s article written by Simon Nixon: “Over the coming weeks, it must strike a deal with a new radical left-wing government in Greece that it will likely find even more unpalatable – or watch Greece leave the eurozone with potentially disastrous consequences for the whole currency bloc.” (http://www.wsj.com/articles/greek-election-tests-eurozone-cohesion-1422222267?tesla=y&mod=WSJ_hp_LEFTTopStories)

However, personally I think the situation is quite clear for Greece. Either quit the euro zone and start a new currency, or reach a compromise in terms of the fiscal austerity plan with ECB, EU and IMF, and keep its membership in the euro zone. ECB president Mario Draghi once said: “a monetary union of 19 sovereign countries can only work if the citizens of each member state believe that they are better off inside the euro zone than out.” It is just like in a game theory, and Greece’s leave is a threat. Whether the threat will works depends on whether it is a credible threat. And whether it could becomes a credible threat depends on who will be hit harder once Greece quit the euro zone.

From Greece’s prospect:

Once leaving the euro zone, it will faces at least following problems:

1.The new government has to issue new currency, which will require a lot of time and effort.

2. Due to Greece’ debt problem, the value of the new currency would be depreciate, which will causes a series consequences such as deposit flight and inflation in domestic, and losing credit for external.

There are also some goodness if Greece leave the euro zone. The first and the most important is that it can get rid of its fiscal austerity plan forced by EU and make its local financial and fiscal policies more flexible.

On the other hand, the advantage of staying in euro is that they can still get aid from its neighbors as well as all the membership advantages such as free trade and no currency exchange fee. While the disadvantages of the staying is that Greece will still have to be under the pressure and restrictions, as well as suffering the gloomy prospective of euro.

From Other EU countries’ prospect:

Though different countries hold different idea, but Greece’s leave is definitely a bed idea. First of all, the value of bond or asset they hold from Greece would shrink dramatically due to the depreciation. They would also lose the benefit of no-barrier Greece market. More importantly, the exit of Greece would lead a chaos on Euro Union which is seen as a backward of the Union.

And I am afraid that the only benefit other EU countries could get from Greece’s exit would be an increase in their “safe-haven asset” or hedge fund.

I could highly simplify the problem into the following game theory table:

Other EU    ,      Greece Stay Quit
Stay     (8,10)    (-1, 1)
Quit Highly impossible Highly impossible

And if Greece is rational enough, it will not take the Quit action since it will hit the Union and itself both though Union would be hit harder. By the way, the number in the above table would change depends on the compromise conditions the Union and Greece reach finally. As well as whether Greece is a crazy man if it want to spare no effort to hurt the Euro Union. But personally I don’t think Greece will take extreme move and leave the Euro zone.

 

Sources:

http://wallstreetcn.com/node/213554

Greece Leaving the EU Would Not Help QE

The Eurozone has certainly been getting a lot of attention the past few days. Numerous economists are now speculating what will happen to the Eurozone after the ECB’s announcement to implement Quantitative Easing. Brian Blackstone of the Wall Street Journal says the European Central Bannk will purchase 50,000,000 euros worth of bonds each month to help boost the economy. Needless to say, many economists have little optimism given the numerous failed attempts to stimulate the European economy. My fear is the QE will not effectively help larger problems that can emerge from within Greece.

Greek Elections will be held this upcoming Sunday, and signs are pointing that the Syriza Party will now emerge as the governing body. According to Yannis Palaiologos of the Wall Street Journal, Syriza’s policies are very left-winged and will raise the minimum wage, cut taxes for the poor, and rebirth collective bargaining in the industrial sector. The larger fear, however, is that the leaders will soon find no point in remaining inside the Union. Palaiologos explains:

“…There are enough people in Syriza who support the logic of “resistance” against Brussels and Berlin to make such a coalition a realistic possibility. If Greece’s new government does decide to go down that road, the country might well exit the eurozone.”

The coalition here is unification with the Anti-EU Greek Communist Party. If these two parties merge, the impact could be detrimental on the Euro. The editors of Bloomberg View claim, “Investors may be driven to short the bonds of Italy, Portugal or Spain — no matter how strong the economic or political arguments against their leaving the currency union — driving their borrowing costs to levels they can’t afford.” This clearly is not what economists want to hear on the brink of a QE plan.

My reasoning for worrying about Greece is perhaps the same as most people. Over the past few years, Greece has been notorious for upsetting member states for their high government deficits, which end up being the bourdon of stronger nations, such as Germany.

To further this cycle, Germany is also opposed to QE. In the article “No More Excuses for Draghi,” the editors of Bloomberg explain how Germany sees, “…QE as a ruse by which the richer members of the currency bloc will end up paying for the fiscal misadventures of their neighbors.” If this were the case, then Germany would be even more disheartened if Greece left. Essentially, it would be a big punch in the face after trying to help someone up after they fell.

Although QE is certainly a step forward in fixing the euro crisis, there certainly needs to be more unification to make things work. Being part of the EU, member-states must understand the risks and costs associated with the pact, even though the Great Recession was not anticipated to deplete the economy as badly as it did. Together, they must reach an understanding of how to bring themselves out of the recession as one governing body. As a result, Greece needs to hold themselves accountable and remain in the union, while Germany has to support it’s fellow member state through thick and thin. By not moving forward on a unified front, the EU will surely continue to plummet.