Concerns about Spain build whilst the French proposal for Greece benefits the banks most yet again

Today is something of a crunch day for Greece as this afternoon her parliament will vote on her latest austerity package. This comprises some 28 billion Euros of austerity over the next four years combined with 50 billion Euros of privatisations under what is called the mid-term fiscal programme. Has anybody noticed how the demands made of Greece are getting larger rather than smaller? Indeed if we think of the original aid package of 110 billion Euros which was supposed to solve the problem we now have proposed just over a year later a new aid package of 120 billion Euros! Not only is the second aid package larger than the first but if we add them together we have 230 billion Euros which is two-thirds of Greece’s total national debt! Some care is needed because there may be some double counting in the two aid packages but we will not need much more before all of Greece’s current national debt is matched by the bail out.

Christine Lagarde for the IMF

One of the architects of the somewhat bizarre and failing package I have described above was the French Finance Minister Christine Lagarde who was fond of describing it as a “shock and awe” effort. As the shock and awe inspired by it was at the incompetence and hubris displayed you might think that she would be debarred from any major finance job going forwards. Well apparently not as in a version of giving a junkie the keys to the pills and medicines cabinet Mademoiselle Lagarde is now head of the International Monetary Fund.

I see that as a sad development for Greece as one of the things that would genuinely improve her situation a restructuring of her debt has been labelled “unthinkable” by the new head of the IMF. So Greece can only expect more of the same failing policies and the level of moral hazard in the world nudges slightly higher as once again failure in a role is rewarded by promotion. I am reminded of the theory of the Peter Principle where “in a hierarchy every employee tends to rise to his level of incompetence”.

The French Proposal for Greek bonds: some more analysis

I wish to return to this subject as having read it several times some new points come to mind. You may not be surprised to read that a plan constructed by banks favours the banks as it places more obligations on the EU/ECB/IMF troika and means that Greece will have to pay a higher interest-rate than you might initially think. The idea of the programme favouring the banks is of course a familiar theme.

If we think of obligations on the troika we get this bit in the plan that the troika continues to “disburse funding” so it will be made to promise to keep funding Greece. The problem with that is that it clashes with the IMF/ECB mantra that disbursing such funding requires strong conditionality i.e Greece has to do certain things such as the austerity package discussed above in return for the funding. These two objectives plainly clash as under the new plan Greece will know she is getting the money.

The cost to Greece goes as follows she gets 70% of the money rolled over into longer maturities and 30% goes into the Special Purpose Vehicle but an interest-rate of 5.5% is guaranteed on all of it so the true rate is more like 7.8% if we compare it to the funding Greece receives. There is also a bonus element which can add an extra 2.5% if Greek GDP growth hits or exceed that amount and this is calculated independently for each year. So by the same logic the maximum rate of interest is 11.4%.

This will be badged as cheaper for Greece than current interest-rates which is true. What nobody seems to have pointed out yet is that Greece cannot afford such interest-rates and they leave her profoundly insolvent.

Let me now refine my point about the deal being good for banks. I do not mean that it will be good for their shareholders, borrowers or depositors as the pack of cards described above will fall down at some point. In my opinion it would be better for them to have some sort of resolution (restructuring) now which can be done in a rational manner rather than the likely panic atmosphere of a collapse of this plan. However if you are a bank director this plan will allow you to continue the charade that your Greek investments are viable and maybe even profitable and so the usual carousel of bonuses and large salaries can continue. In the worst case scenario you extend your highly paid tenure and in the best case you might even retire (on a large pension) before the deal founders. If we look at the UK experience even when a bank collapsed as a consequence of a Chief Executive’s grandiose expansionary plans he kept an enormous pension. So moral hazard is written here in capital letters.

In other words we have yet another liquidity based solution for a solvency problem ignoring the fact that liquidity is not the real problem.

Spain’s problems mount

One of the features of Spain’s finances is that she has a government system which is more devolved than may of her peers. This means that regional governments have more power over their spending and spend more than their peers around Europe. So Spain’s government does not have full control over her country’s fiscal policy as some of it is outside its control. This places an additional risk on its austerity plans which was added to yesterday  by this warning from Moody’s.

We expect several Spanish regions to exceed the 2011 deficit target of 1.3% of GDP.This was confirmed by Catalunya’s recent 2011 budget plan, which foresees a deficit that is twice the size of the target…………..If the regions do not implement new measures, we estimate that the overall regional deficit would deviate by an additional 0.75% of GDP from the initial target of 1.3%.

One of the issues here is the fact that the Spanish regions are responsible for much of the health care spending which is of course a major issue in many other countries too. If we look abroad we see the arguments over President Obama’s extension of state health care in the US and the u-turn performed in the UK by the coalition government over its planned reforms for the National Health Service. So it is a genuinely difficult issue and improvements are not easy to find.

Unfortunately for the Spanish government Moodys concludes that.

Therefore, in the absence of credible commitments by the regions to take the steps needed to achieve sustainable improvements in their fiscal positions, we believe the central government will find it very hard to achieve its overall fiscal targets.

So in effect it has received a shot across the bows on a subject it will find hard to change. This has been exacerbated by the steady rise in Spanish government bond yields I have been recording as this raises the cost of both new finance and refinancing maturing debt which also weakens Spain’s fiscal position. This factor is compounded by the fact that over the next year or two Spain has a lot of funding to do.

Today optimism that the austerity vote in Greece will succeed has seen a reduction in peripheral bond yields which may well continue later if a yes vote is achieved. But we have seen such rallies have a shorter and shorter half life as time has gone on as hopes realise that rather than being based or reality realise they were based on a  mirage.

The Greek super league

From time to time I use football as a metaphor for wider themes and this week has seen something sadly symptomatic of Greece and which on first reading make you wonder if this is fiction or reality. The Greek football super league is mired in a corruption and match-fixing scandal that she was warned about several years ago by European authorities but did nothing about. Sounds familiar does it not? This goes right to the top as it appears that the President of the league and various club owners are implicated in a scandal and at the latest board meeting of the league some of the attendees were only there because they had been let out on bail!

So we have match-fixing,illegal betting and no doubt money laundering and tax evasion on a grand scale which has involved many matches. The problem with this sort of thing is that in addition to the above it erodes the credibility of  a game from which many including me derive much pleasure (and at times pain!). It is a great shame to see one of life’s pleasures corrupted in such a way and I would hate to see such events affecting the league I support. So my sympathies yet again go to the Greek people.

The Price of Oil

This has undertaken quite a rally since I discussed it on Monday and some of the inflationary pressure has returned as it has rallied to above US $ 109 for a barrel of Brent crude which is up some six dollars since I wrote that article. So the impact of the International Energy Agency’s release of 60 million barrels of oil seems to be reducing. However one of the features of these times is that the price of oil is very volatile and can spin on a sixpence so we will only be able to judge the full impact of the move by the IEA with some historical perspective.

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  • Jon Richards67

    Morning Sean, this article has confused the hell out of me now. Re the French proposal for Greek bonds. As of yesterday I thought that the funds from maturing Greek bonds (to the lender banks, eg Soc Gen) were going to be split: 50% in to new 30yr Greek bonds, 20% SPV and 30% cash which they take and do as they please. Re the interest rate paid, I thought it was 5.5% plus a variable amount up to 2.5% depending on Greek GDP growth. Where do you get the 7.8% from 5.5% from to make a total of 11.4%? 
    Looking at FT Alphaville today - it seems to concur.

    Either way whether it’s 8% or 11.4% the whole situation seems farcical anyway in that Greece will never be able to pay anything like these rates and will surely default anyway. Interesting post from Peston today re once Greece gets it’s primary deficit in order, it might as well tell the rest of the world to whistle for it’s money anyway -

  • Andy none

    Excellent insight. Your views on the IMF new MD’s no Re-structure’s, she is beholden to the French banking system (which placed her so highly in Frances political structure). So her views are shaped by a protective bias of French banking interests. Greece will do what all European democracies do when the people are ignored, they will bitch and complain and end up changing a few faces but not budge the underlying centralist political views and ultimate control. See any of the recent Euro referendums, they will just re-vote until they get the right answer. Greece is slightly different to its northern democracies in that its army is made up of the sons and daughters of its people and its primary loyalty is to its immediate family not the politicians, if push came to shove and the army sees their families struggling to survive then you will see the army move to support the people as the people (typically middle/working class) get squeezed ever more viciously. So, do not rule out the people breaking before the liquidity solution.

  • James


    Very interesting as usual. On the Greek bail-out, it seems to me (irreespective of the various ways of looking at the component parts of the package) that we are seeing a wonderful conjuring trick right in front of our eyes and I wanted to point out another potential flaw.

    We start with the fact that, although the bond markets (and, indeed, any sane person) do not value Greek debt at par, accounting convention dictates that these are really worth par. The banks look fine as a result of this charade.

    We then move on to the problem about the ghastly moment when the debts fall due. We cannot have a default, so the full 100% par has to be repaid. Greece cannot pay that, so we invent a way of rescheduling (voluntary, so that the ratings agencies don’t call it a credit event/default) the loans in the way you describe.

    Now comes the trick. They are given 30-year instruments at a high interest rate and:
    1. Banks continue to value this at par for 30 years (by when, as you say, they will all be drawing pensions);
    2. The bond markets are free to value these at whatever they think fit.

    The flaw, it seems to me is that those horrid bond dealers may value the 30-year debt paying 5,8 or 11 % interest at rather a lot below par, thus exposing the farce. However, the deal will be done by this stage, the banks will look solvent and the pattern will be repeated.

    Either the politicians understand that the 70% rollover is worth less than par or they don’t and either case is pretty unpalatable.

    I would comment about Lagarde, but the filters on the blog would probably crash. Perhaps Gordon Brown would have been a worse choice, but otherwise they would have done better to pick a passing pedestrian for the job.

  • Anonymous

    Hi Jon

    As the Greek vote is delayed let me use the time to reply. The banks have one position but Greece only gets 70% of the money and passes on 30% to the SPV.Thus for the banks to get 5.5% means that Greece has to pay 5.5/0.7 or around 7.8% on the amount oof funding that she receives…

    The document is vague on this and one or two other points but otherwise the numbers do not work. This also reminds me of the Irish bail out where there was debate over the numbers which I discussed recently as one of those unsure was the Irish Finance Minister.

    Is that a change of view for Robert Peston? It certainly seems to put him in conflict with one of his colleagues Stephanie Flanders so it will be interesting to see how the BBC view settles down.

  • James

    I followed the link and I was very amused to see one blogger reports that there is the follwoing on Ebay:
    Wanted one tin can for street footbal. delivery Athens.

  • Anonymous

    There is a silver lining in Lagarde’s appointment. When the inevitable default occurs her “no default” mantra will look as ridiculous as Brown’s “No more boom and bust”.

    A 70% rollover cannot pay the maturing bonds and continue to finance a 13% deficit, the balance is provided by Northern European taxpayers. Stefan Homburg says this cannot continue indefinitely.,1518,770673,00.html

  • Anonymous

    Hello Shaun. I have just spent a month in Spain, reading the economic sections of papers every day. You are quite right about the  Autonomous Communities, but I think things are worse than they appear. First, the AC’s do not publish their full accounts. That is rather disconcerting. Second, some of them have recently changed hands, from PSOE to PP. As usual you have to discount the wilder rumours, but several articles I saw referred to the billions of Euros in unpaid invoices that Aznar found ‘in the drawers’ when he took over years ago, and the probability that the same has happened again. Some of the big community health services are paying on 300+ day terms, and that is big money. When the dust has settled after the recent elections, I think we will find out a little more of the truth about Spanish debt. I would not be surprised to see it grow by another €100bn or more, and that’s without going into the savings banks’ provisions for doubtful construction debts, or rather the apparent lack of them.

    One thing that struck me was an article in El Pais about 3 weeks ago that said that the government confirmed that 24% of the economy is ‘submerged’. It wasn’t clear that meant one third or one quarter, but either way (a) the Spanish government is hardly going to exaggerate the percentage and (b) it has enormous implications for the calculation of EU subsidies and contributions. Put simply, Spain is substantially understating the size of its economy.

    As is widely know, Spain is a place (like Greece, though not quite so bad) where paying taxes is partly voluntary. Employees, as everywhere, have to pay their taxes when they work normally. But if you do casual work,  as many still do, there’s no tax. And VAT is often partly negotiable, especially on services from small businesses. I guess that grew worse when the rate went from 16 to 18% last year.

    I wonder if this matter is understood in the corridors of Brussels, where they decide who pays how much to the EU based on things like VAT take. Obviously the UK also has a ‘submerged’ sector, but I don’t imagine it is quite so large… yet. A proper assessment of the real wealth of the southern European countries might result in a significant reduction in our contributions. That would be wholly appropriate if in fact they are richer than they represent.

  • Ian_jones

    Notice that Gilts fell today and commodities rose. Investors expecting more QE and responding to it in a rational way. No doubt the ECB will be forced to bail the whole situation out with QE but calling it something else……

  • Anonymous

    yea and the Mexico candidate would have done the work otherwise?

    bunch of frustrateds !

  • Sovjohn

    I should probably note this – You know, I feel you, Shaun, are much better than Peston & Flanders (whose blogs I do read as well), combined :)

    I sincerely hope you develop into a top-brass consultant in the UK Government or elsewhere, they surely could use a bit of “common sense”.

    Other than that – The “implementation law” that is due to be voted in Athens tomorrow is more horrid than the mid-term law passed today. The SPV that is created for the sale of state assets basically has ultimate authority on a number of things, from forcing the Greek state to pay compensations to affected parties, to forcing policy decisions (including, say, prices) to organizations it has under its “umbrella”.

    People are generally disappointed at the stance of the MPs, but in general, the fact that not one of them can get out on the street without being abused / having yoghurt thrown at them / et al, should show something.

    Myself, I’m very, very curious to see HOW will several MPs ask for a popular vote in the next elections (which supposedly are on ’13, but I believe ’12 at the latest – they may even come this very autumn…)

    I don’t know. I would be afraid to do that, were I them. They have very high odds of being beaten up and brutalized…badly, instead of “securing votes”…

    And a final sidenote – I had sent that to the Guardian correspondent for his live blog yesterday – it gives you a view of things in the labor market here…

    “I’m a member of the so-called “lost generation”. And by that, I don’t
    mean that I am unemployed, or starving, yet things are quite hard for
    youths right now. Myself, I am paying off a bank loan used for studying,
    and some bills – but I begun working as a graduate in fall 2008,
    exactly when the “financial crisis” begun to show its ugly head

    It’s very hard to bargain for something better than what you have –
    even in cases where your manager wholeheartedly might recommend a pay
    raise for top performance, the CFO might just as well stall it, since
    “the company doesn’t have any money”. The norm, in many private sector
    companies, including the one I work in, is to get paid with delays. One
    month unpaid is considered “lucky”, two months is “common”, three+ is
    becoming more and more commonplace.

    In other occasions, companies may approve a 500 EUR advance to the
    whole of their staff, and owe the rest – under the reasoning that people
    will be able to eat / buy groceries at the very least, but no nothing
    more of course. The market lacks liquidity. Everyone lacks liquidity,
    even investors and shareholders, while we’re at it. When suppliers
    tighten credit and demand immediate payment, this cash flow issue will
    hurt the employee in many cases, as if the supplier doesn’t get paid,
    the company doesn’t sell and is doomed.

    As to what should the government do? They should vote for the
    mid-term plan, but only marginally, and noting the public discontent on
    the street. This will appease the creditors, however it will have them
    thinking that they can’t ignore the elephant in the room for much
    longer: Greece needs growth, not choking, if they are to get their money
    back. The sooner they guarantee / establish growth, the sooner they’ll
    see GDP rising, debt-to-GDP falling, and everything going as it should.
    Reducing GDP brutally within a couple of years will not work, it never
    has in any similar schemes.

    The politicians must clearly illustrate a long-term plan out of the
    crisis, and cut down on their own benefits as well – Being a politician
    should only mean you’re a well paid state employee, not a guy with
    minimum yearly income of about 90-100k EUR in a country where the
    majority of the tax base is in below 40k.”

    Today, after I sent this, my company announced to us that our next monthly salary payment will take place approx. 1.5 month after its original date, bringing us to 2.5 months “behind schedule” until that takes place, and back to “only 1 month” if it goes OK. Jolly good, n’est ce pas?

  • Anonymous

    Hi James
    Just the one? I guess it is a consequence of more of an interest in green issues that cans are lighter these days and fly further although modern economics/politics must have made some real advances in light weight cans…

  • Anonymous

    Hi SovJohn
    Thanks for the compliment and the update. One bit in particular struck me (and I would imagines others reading it).

    “In other occasions, companies may approve a 500 EUR advance to the whole of their staff, and owe the rest – under the reasoning that peoplewill be able to eat / buy groceries at the very least, but no nothing more of course”

    How often is this sort of thing occuring?

  • Sovjohn

    Either this, or the delayed payments, or both, is fairly commonplace. Things tend to be worse outside Greater Athens / Attica, the more rural, the less “by the book” employment you’ll find (if any).

    For instance, the company I work in, faces cashflow problems and is in a deep restructuring program to “brave the crisis” which includes across the board cost cutting, many redundancies, et al. However, June was not a good month cashflow-wise for the company, so it basically dictated an advance to all employees, and the remainder will be paid in mid July. The “end of June / early July” salary is pushed to “late July”.

    It’s by no means an isolated incident – There are horror stories around involving people getting advances, or nothing at all, for 4-6 or more months, while being officially “employed”. Also, remember that unemployment does not include “freelancing professions”, and there is a method of disguising employment under “contracted work”, where the “contractor” is an individual, registered as a company, and getting paid without the employer paying for any insurance / benefits. The individual has to pay for his insurance / healthcare / pension funds himself, in such a case…

    Tread carefully, I don’t believe the full extent of how ed up things are in Greece’s labor market have reached the outside world. Yes, it is rigid as a market, with somewhat high severance pay being mandatory and all, but it certainly does have many loopholes…

  • Anonymous

    Delayed wages are common in Bulgaria too. If the business does not have the money, then the boss has little choice. Finding an honest politician is easier than getting a bank loan