The Mad Hatters Tea Party Mark Four Is Now Planned For Greece

This week has seen a new proposed deal for dealing with the debt problems of Greece. As there are genuine changes you could call this bailout version three or indeed four if you take the debt haircut (Private-Sector Initiative or PSI) as another. Indeed we can gain some perspective on this by considering the PSI itself.

The PSI or default

It was only in March that Greece adopted a 53.5% haircut or default on the approximately 206 billion Euros of privately held Greek government bonds. However the supposed gains turned out to be much less than you might think as I pointed out at the time. The sovereign-bank loop came into play as we saw that a 50 billion Euro bailout of Greece’s banks would be required due to their holdings of Greek government bonds. One or two bonds have had to be paid out in full. Also she had to provide “sweetners” to the deal of 35.5 billion Euros which meant that by the time everything was done you start to wonder how much was gained in practice. In the Mad Hatters Tea Party world of Euro area finance there were calculations made which suggested that Greece would be worse off and had suffered what might be called an anti-default.

The missing component was the fact that official holdings of Greek government debt were not subject to the haircut and the main player in this regard the European Central Bank set its face against ever doing so.

In spite of all this the troika claimed that such a move would put Greece on a path to reducing its national debt to 120% of its economic output as measured by Gross Domestic Product in 2020. Leaked forecasts in fact showed that not even they actually believed this!

This week’s version

This differed from the above as it added in these factors which the EuroGroup “would be prepared to consider.”

We start with an implict acknowledgement of the point that I made at the beginning of this saga that the debt is likely to be perpetual.

An extension of the maturities of the bilateral and EFSF loans by 15 years and a deferral of interest payments of Greece on EFSF loans by 10 years.

At this point the deal sounds rather like one of the televison advertisements of Ocean Finance. One friendly monthly repayment and all that. It lacks a statement that deferring debts means that the future burden is larger which is a very familiar theme for Greece and a major reason why things have got worse.

This comes with a sweetner that the interest on the debt may be cut.

A lowering by 100 bps of the interest rate charged to Greece on the loans provided in the context of the Greek Loan Facility…..A lowering by 10 bps of the guarantee fee costs paid by Greece on the EFSF loans

So a possible genuine reduction in Greece’s debt costs although there are two catches which I will explain in a moment.

Also the European Central Bank may finally contribute something from its holdings of Greek government debt.

A commitment by Member States to pass on to Greece’s segregated account, an amount equivalent to the income on the SMP portfolio accruing to their national central bank as from budget year 2013.

By SMP they mean the Securities Markets Programme the vehicle via which the ECB bought Greek government bonds in a failed attempt to boost that market.

Where might this go wrong?

Unfortunately this is rather a long list! Let us start with a condition for all this.

conditional upon a strong implementation by the country of the agreed reform measures in the programme period

So to get this Greece has to do what she has signally failed to do so far. One of the features of the troika system is the way that it appears to learn nothing from its experience.

If we consider the proposed interest-rate reduction we face the problem that quite a few Euro area countries will have to borrow at a higher interest-rate than the proposed rate for Greece. If we note that the loans are now for a longer time period we see that the situation has just got worse for them. For Spain and Italy this is a genuine problem and as they are 32% of the programme we see that it has a problem and this is before either of them join this group.

Member States under a full financial assistance programme are not required to participate in this scheme for the period in which they receive themselves financial assistance.

That way the unstable lifeboat I have discussed before sees the waves finally submerge it.

I note that the statement is careful to call the possible addition of money from the ECB’s holdings of Greek government debt as “income” unlike many commentators who have called it profits. There is an income stream from these bonds because they pay a higher interest rate than the cost of the money to the ECB which is currently officially 0.75%. However there is a very large catch here as the ECB started buying some of these bonds at 100 and bought at 90,80,70 and so on whereas even with the recent rallies they are worth more like 30. So there have been capital losses if you use market prices. Just to give an illustration of this Greece’s new (i.e post PSI) bond for 2023 closed last night at a price of 35 and her 2033 one closed at 27.5 according to the Financial Times.

So the ECB actually has very large capital losses on these bonds which it assumes away by telling itself that all bonds will be repaid at maturity at par or 100.

This has a very serious consequence for Euro area taxpayers

Back on May 10th I explained how the ECB was getting par back for the bonds it had bought. In essence via the European Financial Stability Facility the bonds are being bought off them by you if you are a Euro area taxpayer. The detail from back then is here.

As with previous disbursements to Greece, the EFSF will transfer the €4.2 bn into a segregated account which will be used for debt service payments.

On the 18th of May there is a 3.4 billion Greek bond redemption. Who owns that? Er the ECB mostly and maybe virtually all of it although it has never actually declared its holdings. But the 40 billion Euros or so has to be somewhere and it did buy short-dated bonds. So we have come full circle as the ECB creates money and lends it to the EFSF so the EFSF can buy Greek bonds at par from the ECB!

So the use of a special purpose vehicle means that taxpayers are misled. From this there are two very serious consequences. One the Euro area and its taxpayers become ever more exposed to capital losses which would no doubt be presented as a “surprise”. Secondly as the bill ends up with Greece her debt burden continues to rise and the whole effort has a self-defeating component.

Greece debt buy-back plan

This is where the Mad Hatters Tea Party really gets into full swing. As I pointed out on Monday leaking such a plan has meant that prices have risen when such a plan works best the lower prices are. I think that everyone can understand that a buyer would wish to buy as cheaply as possible. So one more time Greece will get a larger bill than was necessary. Also there may not be that many bonds available to buy as so many have been bought already!

Comment

I have kept to this point a fundamental failure of the Euro area bailout plan. This is that they have provided more debt and not capital. As the Americans put it some “skin in the game” was always needed. In my opinion this was done to avoid the implication that losses probably would be made which in the passage of time have become a certainty. They have become a certainty partly because of the increased debt burden placed on Greece in a manner of which the Mad Hatter would be proud.

Also in the financial alchemy which desperately tries to find a version of mathematics which gets Greece down to a national debt to GDP ratio of 120% I see some familiar friends. For example economic growth next year and in subsequent years is always stellar. An equivalent weather forecast in the UK over this summer/autumn would have been to continually predict sunny rainfree days! Putting this another way back in 2010 the troika forecast that the Greek economy would grow by 1.2% in 2012 and instead it looks likely to shrink by around 7%.

Even with all that and a deferral of two years in many of the plans the future for Greece’s debt looks horrible and in the end there will have to be some capital applied presumably now by what is euphemistically called “debt forgiveness”. One of the saddest parts of this episode is that much less would have been required in 2010 and it would have meant that some of the economic pain inflicted on Greece since need not have happened.

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  • steveD

    Will the US shale Gas and Oil deposits, which may see the US become self sufficient with cheap energy, bale the world’s economies out in future?

  • Drf

    Hi Steve,

    I would suggest this is in fact doubtful, since what most people miss is the energy equation balance in extracting this gas and oil; it actually consumes more energy and resources (including water) altogether to extract and deliver these mineral resources than is available in net terms by then burning them as a fuel. In this it is a bit like the economic and resource fallacy of so-called present electrically-powered vehicles; the total energy employed in manufacturing these and their batteries, and then charging them, is greater than the total likely energy delivered at the road wheels over their anticipated life-cycle. Also the expected life of the batteries used in these is around 3 years only for general use and the cost (not considering the additional energy to manufacture the replacement lithium batteries) is generally about 3/4 of the cost of the complete vehicle on the road when new!

    Finding real improved-efficiency replacement technology for current utilizations requires much research and the very best skills in engineering, management, ecology and economics. If it were easy it would have been done already by half-whits.

  • Midge

    The Mad Hatters Tea Party.I was thinking more of Charles Dickens.Maybe Hard Times,Great Expectaions or the optimistic Mr Micawber.’ Eurodisneyland’ keeps on entertaining.Hollande may nationalize steel works,IAG staff on strike and Spanish banks to shed more staff.Bankia alone reported to be shedding 6,000.It’s sad but not much light at the end of this tunnel.

  • forbin

    short answer – no

    cheap energy myth – its was the higher price of gas that made drilling the shale gas wells feasable in the first place. Currently the gas is a net sink – so why are they still producing? current high prices ( 90-100$ as opposed to 20-30$ ) of oil . the condensate and oil has kept a number of these wells profitable – not the gas. Dry wells are being capped. Long term the gas price is going to rise as the shale wells have a horrible decline rate – you have to keep driller ever more wells to keep production up – and hope for “wet” finds!! ( those with oil and condensate).

    As for shale oil or oil shale – well kerogen is in one ( shale oil) and thats NOT oil – needs to be processed to make it oil!

    All these fields were known about in the 70′s and its the current high price that make it worth while extracting them – so if the oil price drops I garantee these wells will shut ans gas prices will rise.

    Now to about conflicting energy independence with oil independence , don’t please. the USA could use its vast coal reserves , nuclear and Solar and get energy independence – but not oil /liquid fuels independence

    to do that you’d have to crash the US economy.

    Which to my mind is what the Europeans are doing to themselves……

    Forbin

    Popcorn ,yum!

  • MajorFrustration

    Lets stand back a moment. Are we dealing with the same organisation that for the eighteenth year has still failed to have its accounts signed off by EU Auditors.
    Come September 2013 the clouds will open.

  • forbin

    Hello Shaun,

    I agree this has always been the problem in the Euro zone , and here . The mistake of thinking debt is wealth.

    More debt is being offered all round to no avail because its more debt that got us here in the first place

    I would agree its sound to borrow if you can pay back the loan with interest and profit to your company/country via growth.

    Growth has not happened and our leaders have not yet explained why they have failed us.

    What you see in Greece fortells what will happen to the UK – we are heading there and all the bickering and shouting of the MPs will amount to nought

    The debt cannot be paid back – this is apparently not an issue so long as you can afford the interest repayments but you need growth – despite this mantra I see nothing at all that shows there is a plan to get growth!

    Question : what is the plan if we know growth is not going to happen – print the money ?

    Forbin,

    not long now – popcorn and a good fun show……

  • Rods

    Hi Shaun,

    The only thing of importance has been achieved by the Eurozone leader Merkel, which was to kick the can of a Greek default and German losses past the German elections in the Autumn of 2013. This is purely what this is about.

    What happens to the Greeks and their economy is irrelevant, how much it nose dives, how many more Greek businesses crash and burn or how many more Greeks commit suicide is all collateral damage, that the Greeks must pay for Merkel’s reelection. While Merkel and her partners in crime are eating the finest foods and quaffing £120 bottles of wine at their ‘deciding the fate of Greece summits’, many Greeks are standing patiently in the queue at their local soup kitchen. Eurozone economic convergence anybody?

    The is a very interesting breakdown of Greek debt in the DT Dept Crisis page today which shows that 62% of Greek debt is now owed to the EFSF, Eurozone Bi-Lateral loans, the ECB and the IMF. Taxpayer paid for Greek debt forgiveness anyone?

    Is it any surprise that the Germans and French are pushing so hard for the formation of an EU military HQ and Euro army. It is just a question of whether it is a re-run of 1936 or 1941 first! Popcorn is ready and waiting.

  • James

    Hi Shaun,
    It is so depressing seeing
    1. What is proposed
    2. How the papers report it.
    The fact is that what is going on is perfect for the politicians:
    1. It doesnt involve public sector cuts
    2. It doesnt need extra taxes
    3. The Germans don’t realise that they are sitting on losses already
    4. The system is obscure to the point of being Kafkaesque
    5. there are plenty of acronyms designed to fool the public
    6. the whole thing is kicked further into the future.
    7. The Euro gravy trains rolls on as agreeably as ever.
    What could be better?
    Why find a nasty solution when you can just fob off everything in a way that jounalists don’t get?

  • DaveS

    Answer : yes

  • DaveS

    Yes, yes, yes……

    I could bang on about EROEI but why spoil the popcorn

    (Edit – apologies Drf did it for me)

  • forbin

    hey DaveS , thought you’d say MORE printing ! ;-)

  • forbin

    Hey James,

    perhaps they need to employ the Ministry of Cuts

    youtoob aleert – http://www.youtube.com/watch?v=KQs7Xctu3AU&feature=related

    ( this is trouble when you remember the 70′s ;-) )

    Forbin

  • http://twitter.com/notayesmansecon Shaun Richards

    Hi steveD and welcome to my part of the blogosphere

    I can see that you have replies already on this so I will merely add that the UK Energy Secretary is plainly not keen if the article linked too below is any guide.

    http://www.guardian.co.uk/environment/2012/nov/28/shale-gas-era-cheap?CMP=twt_fd

  • http://twitter.com/notayesmansecon Shaun Richards

    Hi Midge

    We did get some details on the Spanish bank bailout from the Euro area today with the main four nationalised banks commiting to shedding a quarter of their staff and half their branches. So more unemployment.
    Also the 37 billion provided to the FROB by the Euro area for this purpose will rise and rise…..

  • http://twitter.com/notayesmansecon Shaun Richards

    Hi Major
    It is extraordinary that this can persist is what is supposed to be a democratic state is it not? EU Parliamentarians should be ashamed of themselves for allowing this to persist.

  • http://twitter.com/notayesmansecon Shaun Richards

    Hi Rods
    As time goes by that 62% will continue to rise. In the short-term the debt buyback will raise it but as we progress forwards in time it will also rise as they continue to be the only available source of funding for Greece. So debt forgiveness or OSI in one form or another is unavoidable now.

  • http://twitter.com/notayesmansecon Shaun Richards

    Thanks for the reminder of this. As energy policy has been discussed I did spot the “night storage solar panels” quip…….

  • Drf

    Hi Forbin,

    That is evidently why (he says) Max Keiser has now moved to London, since he wants to watch the show in the City! Whether he has any popcorn whilst he watches I do not know though!

  • Roger

    Not only is Drf right on the money with this analysis but the ‘dirty’ energy of shale oil and gas plus coal will increase carbon emissions and hasten the increase in global temperatures to unliveable levels,

  • Rods

    Hi Shaun,

    You don’t get much can kicking with a summit anymore do you.

    Here is a new term for your financial lexicon “a one off in very special circumstances”. The Greek hair cut on private debt was, we were told “a one off in very special circumstances”, now the holders of the untouchable 62% want them to take another haircut of €20bn to try and make the Greek debt more sustainable. Oh dear, they must be nearly bald! The IIF are quite rightly are jumping up and down on this.

    Looks like, the German population has just woken up to the fact that the 62% (sorry 55% as 7% is from the IMF) is going to have to take a hair cut and the German tax payer is going to get a big bill. It will serve Merkel right if she falls on her sword while trying to manipulate the situation for her own election ends.

    But what is also becoming more apparent is that the Greek Government will take the money and not fulfill their part of the deal with market reforms etc, which has also been widely predicted.

    Better dust off your Greek Christmas plan as I think it maybe required!

  • Anonymous

    I’m afraid you are right about reforms. They are politically unacceptable in most of the southern countries. OK, they pose as reformers, but in truth, not a lot is happening. Money for nothing and chicks for free, again.

  • Anonymous

    Being pragmatic, if Spain doesn’t sort out its hugely overstaffed banking sector now, it will miss the one opportunity to get the funds to do it, though of course they are loans. The payoffs will be rather substantial. I gather the total number is about 10,000 employees, the number being so large because of recent mergers.

  • Anonymous

    You know, Forbin, the problem is actually rather worse than it seems. The last government (not the first to do this) actually spent the growth that we are not getting now. That was rather stupid of them, or at least imprudent. We really have to get economic growth to pay off the debts we incurred in the last 15 years, debts which I note are still fast increasing. In the past we have got into this hole and used inflation as a means of getting out again, that is, reduced the real value of debts and financial assets. That looks like being the way out this time, too. I wonder when foreign lenders will decide that they have had enough of this trick.

  • RealFinney

    Hi Shaun, if they would only start calculating everything in hexadecimal then the 120% target becomes easy!