Go Ahead, Make My Day
Greece has negotiated like the Clint Eastwood that spoke to an empty chair for 10 minutes. It is time to bring out the Dirty Harry. Point a magnum at the Troika and tell the “go ahead, make my day’!
Greece has been asking for money in some form or another for almost 3 years now. It begs and pleads. It is forced to do things to its people. Then it is back to begging and pleading. It is time to stop. The negotiations have been stupid. Not once has Greece come up with a credible alternative to more Troika money.
The Troika actually benefits as much, or more from supporting Greece and everyone would be better off if Greece was given real breathing room for a change. Since the Troika either doesn’t see it, or refuses to believe it, it is time to make the Troika see the error of the ways.
Defaulting Takes Planning
Defaulting, properly, is as much a process as anything else. You need to plan. You need to line up post default financing. You need a credible story of why investors should come to you post default. Sovereign defaults are particularly tricky since there are few rules to begin with, and enforcing those rules is tricky.
Different Offers for Different Classes of Debt
I see that Greece currently has about €290 billion of debt.
€20 billion is in Greek T-bills. These are sacrosanct. I don’t completely understand why, but I think it is best if they remain that way. Continue to pay them off and roll them. They are predominantly owned by Greek institutions so defaulting on these probably just creates additional problems anyways. The goal of the default is not to hurt others not yourself.
Of the “GGB” bonds, €63 billion are the PSI bonds. I think you commit to pay these bonds post default. The holders have in many cases are already taken massive losses, and with a 2% coupon and no maturity until 2013, there is no point crushing these holders further at this stage. Gain some good will with the “private sector” as you will need it down the road, and really, the financing is about as cheap as you will ever get. Defaulting on these bonds again is just adding insult to injury and doesn’t save much (the exact opposite of what the Troika is trying to tell you).
The other €50 billion of GGB bonds are owned primarily by the ECB through their poorly thought out SMP. That was Trichet’s baby, and was stupid, and it is time to deal with these bonds. Many have already been paid back at a big profit to the ECB and not a single interest payment has been missed. Off the ECB to exchange all bonds at cost (including disgorgement of all profits) to the PSI bonds. I’m guessing, average cost, when accounting for all interest, and the profits of bonds that were bought below par, but already paid back, takes the average price to about 70%. The average price might even be a little lower. This would knock at least €15 billion of debt out, would reduce the coupon on this debt from a little over 5% on average to 2%. An annual savings of over €1.5 billion, which is a lot of austerity and it isn’t like the ECB needs such high coupons. The alternative to the ECB is to fight them in court. Yes, the ECB would have to seize assets, end financing of Greek banks. I’m not sure what else it would do. But I can tell you, investors in Spain and Italy would not be excited to see this. The ECB aggressively attacking a country it used to “help”. Going after banks for their ELA lending and fighting with the Greek Central Bank. These are all things the ECB would need to do in default, and it would send a shockingly horrible message through the rest of Europe. Whether the ECB could avoid losses in the end is a question I don’t have the answer to. Would their efforts to avoid losses likely spark capital flight from Spain and Italy – hell yeah! Go ahead, sue me, and see what happens to your precious OMT.
There is about €75 billion of long dated EFSF loans. I cannot tell how much has been disbursed versus how much is a line of credit, but default on these. If there is any complete and total patsy in this European debt crisis drama, it is the EFSF. They were made to take losses. Default on them. Let Regling try and sue you. If the ECB is going to look bad suing you, the EFSF will look even worse, and I suspect, will be less competent at it. At this time I would remind Germany, France, and the Netherlands in particular, that their citizens will be on the hook for the EFSF losses. You really don’t get much by defaulting on the EFSF loans from a practical standpoint, but from making Germany and them look stupid to their own people, you get a lot. You are playing the contagion card with this threat. If citizens see actual losses at the EFSF, how much support will there really be for new and bigger programs from the ESM for Spain and Italy? EFSF losses will put the ESM in jeopardy which will put Spain and Italy on a crash course. On top of that, it always feels good to pick on the little guy. Fighting the ECB is going to be painful, so get some joy from watching the EFSF run around like a chicken with its head cut off and watch the fear of contagion hit the rest of the EU.
Then there is another €75 billion of EU or IMF loans. Once again it is hard to tell whether exactly how much is from the IMF rather than the EU or whether it has all been dispersed. Let’s be conservative and assume it is all disbursed and all from the IMF. I view that as conservative since dealing with the IMF is more delicate than the EU. With the IMF you are dealing with American and Chinese money. The IMF is supported by lots of other countries, but it is the involvement of America and China that is key since you cannot afford to upset them too much. By the time you are this far along, you are breaking so many bonds with Europe that the relationship will take years before it is functional again, so you will need America and China in the aftermath. A moderate 2 year extension is about all you can hope for here. Maybe a coupon reduction, but it looks like some of the loans have had their coupon reduced already, so even here there might not be much you can do. You may want to threaten a little more aggressively, depending on how your “DIP” financing goes.
Post Default Financing
Defaulting solves many of your problems. If you go with the program outlined above, your debt drops by a reasonable amount, and most importantly the near term interest and debt redemption payments drop to very low levels. You will likely have legal battles and also will still have shortfalls, so you need a partner. A strong post default partner is essential and there are 3 choices.
The first choice is the IMF. This is their traditional role. They are designed to help countries in trouble. The Greek program is so messed up and compromised so many IMF guidelines since day 1 that I don’t know that new IMF funding is really achievable. You have to approach them. You have to demand that they fulfill their duty. You can even threaten them on their existing loans. It is tricky and you might need to cut a side deal with either America or China, but you have to gently remind the IMF that their existing loans could be defaulted on so it is in their interest to be helpful. To restructure their existing program in a modest way and to add some additional lines.
Another choice is America. Go straight to the top here. Go to Bernanke and tell him what is happening and that it is in his best interest to step in and help Greece. Ask Ben to take on the ECB’s role in Greece. If there is any man in America who has money and is afraid of contagion and not using that money, it is Ben. I have no idea if this will be successful, but at the very least he is likely to promise swap lines to the new central bank of Greece. Given the reasonable debt burden Greece would have post default he might even find ways to funnel some money in your direction. It would be important to inform him of your stance with the IMF and see what he can do there.
Finally, and far more interesting, is China. Time and again China has declared that they want to “invest” in Europe. They want hard assets. They want to own companies and things. Time and again Europe asks China to lend them money. Those are NOT the same thing. Europe as a whole is happy to have China as a lender, but not as a deeply ingrained business partner. China, doesn’t want to just lend, they want some control. Greece, while preferring not to be in bed with China, may have no choice now. Ask China for loans, but give them priority access to things like, umm, the port that China wants. Give China priority on “privatizations”. While real investors might be scared to buy into Greek privatizations given the risk of the rules being changed, I somehow think China is less concerned about being double crossed. Double crossing China seems only slightly less dumb than stealing from the mob. Working with China isn’t a match made in heaven, but it isn’t bad. It will also test the resolve of the EU. Are they really prepared to let China get that much influence in the Mediterranean? This is the most interesting part of the negotiations. It is helpful not only because the money China would pledge means the whole default package would have some credibility, but the source of the money would incentivize Europe to act.
Crossing the River Styx
I wanted to go with the “die is cast” or crossing the Rubicon, but let’s go with the river Styx, as more appropriate for Greece and Dirty Harry is more at home in the rivers of Hades anyways.
This plan or idea is probably half crazy. It clearly isn’t that well thought out, but begging for money with no credible alternative is just stupid. It is time for Greece to get serious and fight back. Greece, really can drive the situation and needs to play on European fears of contagion rather than letting Europe play on Greek fears.
Still Mildly Bullish
I remain mildly bullish in part because so many of the debt situations, whether in Greece, Spain, Italy, or the U.S., all look the same. For all the tough talk and rhetoric, no one in power seems willing to let the bad alternative happen. Deep down they might want to. It may even be the right thing to do, but the politicians and central bankers are too scared, and just like the last feisty thug in the Dirty Harry movie, they won’t take the risk.
I wish investment doesn’t rely so much on such stupid drama, but it does. At least for now it does. I will wait for real signs that crisis won’t be averted before getting bearish. None of the current talk, in spite of sounding negative, indicates to me that nothing will happen.
It would be nice to see at least one rally sustained through the day and even see a pop on the close. Yesterday was disappointing from that respect, though it appears the market reacted badly to problems with the EU budget. The EU should not be confused with an actual country, or anything actually important. Other than organizing summits and creating some very cushy jobs for some connected people, I don’t see what the EU really does. If any place could use some austerity it is that quasi government in Brussels. So I personally am not worried about the EU government budget. The budgets of individual countries, that I’m worried about, but they are all in the lying stage, rather than being caught in a lie stage, so time for that to play out.