A Big, Fat Greek Swap?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

First, let me correct a mistake I made in my previous post on the Greek fiscal crisis and neoliberal oligarchy.
My stepfather wrote me from Brussels where he heard straight from the
Greek finance minister that military spending accounts for roughly 4%
of GDP, not 15% as was originally written in my previous post. I
verified this statement and it is correct: Greece directs approximately 4.3% of its GDP to military expenditures. I apologize for this mistake.

Greece continues to be the hot topic in financial circles. In his Contrarian Chronicles, Bill Fleckenstein asks A big, fat Greek bailout?, and concludes:

As
an aside, I think Greece itself is probably less of a problem than
California and some other U.S. states might be -- though for the
moment, the fact that we as a country have a printing press and no
rules governing its use is carrying the day.

Perversely,
when you've got a printing press running full throttle (as do the U.S.,
the United Kingdom and Japan), you can be as irresponsible as you want
to be and your credit will be fine. But try to enforce a little bit of
discipline, as the European Central Bank is attempting to do, and
things go kablooey. As such, the PIIGS' predicament continues to push
people toward the dollar.

Exactly how the situation sorts out
is not knowable at this juncture, due to the myriad permutations
involved. However, though it might be difficult to imagine that
Europe's disparate nationalities will be able to row in the same
direction, it seems unlikely that they won't. Consider how hard
everyone worked to put the system together in the first place. In any
case, whatever comes out of Europe on this score is sure to be a market
mover one way or the other, or maybe both. A bailout plan for Greece
was announced Friday, but the details were sparse.

Over at Project Syndicate, there were many excellent articles on Greece and the European Monetary Union. Nouriel Roubini writes on Teaching PIIGS to Fly and states:

Loan
guarantees from Germany and/or the EU are less desirable than an IMF
program, as it is very hard to design and credibly implement
conditionality in such guarantees. IMF support, on the other hand, is
paid out in tranches and is conditional on achieving various policy
targets over time.

The Greek authorities and the EU
had until recently denied the need for financing, owing to concern that
it would signal weakness and create a stigma. That was a grave mistake.
Fiscal adjustment and structural reform without financing is more
fragile and liable to fail without a war chest of liquidity to prevent
a run on public debt while the appropriate policies are implemented and
gradually gain credibility.

At
the same time, if Greece does not fully adjust its policies to restore
fiscal sustainability and competitiveness, a partial bailout by the EU
and the ECB will still be likely in order to avoid the risk of
contagion to the rest of the euro zone and the consequent threat to the
monetary union’s survival. A default by Greece, after all, could have
the same global systemic effects as the collapse of Lehman Brothers did
in 2008.

Sovereign spreads are already pricing the
risk of a domino effect from Greece to Spain, Portugal, and other
euro-zone members. The EU and the ECB are worried about the moral
hazard of any “bailout.” But that is precisely why a credible IMF
program that ties financial support to the progressive achievement of
fiscal and structural reform goals is the right way to teach Greece and
the other PIIGS how to fly.

Professor
Roubini is a smart guy but if he thinks German/EU loan guarantees are
less desirable than IMF financing and fiscal austerity, he is simply
nuts. Accepting IMF financing is effectively "the kiss of death" if
you're Greece.

Consider Ken Rogoff's comment, Can Greece Avoid the Lion?, where he writes:

A
debt crisis is not inevitable. But the government urgently needs to
implement credible fiscal adjustment, concentrating not only higher
taxation, but also on rolling back some of the incredible growth in
government spending – from 45% of GDP to 52% of GDP – that occurred
between 2007 and 2009. The government must avoid relying too much on
proposals for tax increases, which ultimately feed back on growth and
sustainability. It would be far preferable to balance tax increases
with some reversal of runaway government spending.

I
have Greek friends who say that Greece is not alone. And they are
right. Some countries are almost inevitably going to experience
bailouts and defaults. One of the more striking regularities that
Reinhart and I found is that after a wave of international banking
crises, a wave of sovereign defaults and restructurings often follows
within a few years.

This
correlation is hardly surprising, given the massive build-up in public
debts that countries typically experience after a banking crisis. We
have certainly seen that this time, with crisis countries’ debt already
having risen by more than 75% since 2007.

But,
whereas we are likely to see a wave of defaults and IMF programs this
time, too, fiscal meltdown does not have to hit every highly indebted
country. Indeed, what a country like
Greece should be doing is pulling out all the stops to stay clear of
the first and second wave of restructurings and IMF programs. If
it can, then perhaps watching other countries suffer will help convince
the local political elite to consent to adjustment. If not, Greece will
have less control over its adjustment and potentially experience far
greater trauma, perhaps eventually outright default.

There
is an old joke about two men who are trapped by a lion in the jungle
after a plane crash. When the first of them starts putting on his
sneakers, the other asks why. The first answers: “I am getting ready to
make a run for it.” But you cannot outrun a lion, says the other man,
to which the first replies: “I don’t have to outrun the lion. I just
have to outrun you.”

Greece has yet to
put on its sneakers, while other troubled countries, such as Ireland,
race ahead with massive fiscal adjustments. Greece’s new Socialist
government is hampered by campaign promises that suggested the money
was there to solve the problems, when in fact things turned out to be
far worse than anyone imagined. Unions and agricultural groups tie up
traffic with protests every other day, hinting at possible escalation.

Most
Greeks are taking whatever action they can to avoid the government’s
likely insatiable thirst for higher tax revenues, with wealthy
individuals shifting money abroad and ordinary people migrating to the
underground economy. Greece’s underground economy, estimated to be as
large as 30% of GDP, is already one of Europe’s biggest, and it is
growing by the day.

In the case of Argentina, a pair
of massive IMF loans in 2000 and 2001 ultimately only delayed the
inevitable harsh adjustment, and made the country’s ultimate default
even more traumatic. Like Argentina, Greece has a fixed exchange rate,
a long history of fiscal deficits, and an even longer history of
sovereign defaults. Nevertheless, Greece can avoid an Argentine-style
meltdown, but it needs to engage in far more determined adjustment. It
is time to put on the running shoes.

In his comment, Europe's Trojan Horse, Barry Eichengreen writes:

All
of this raises the obvious question: Was the real mistake creating the
euro in the first place? Since I was one of the few Americans to
advocate a single European currency, you would be justified in asking:
Am I having second thoughts?

My answer is no,
creating the euro was not a mistake, but it could still be a mistake in
the making. The Greek crisis shows that Europe is still only halfway
toward creating a viable monetary union. If it stays put, the next
crisis will make this one look like a walk in the park.

Completing
its monetary union requires Europe to create a proper emergency
financing mechanism. Currently, other member states can provide
assistance to Greece only by bending the rules, which prevent them from
lending except in response to natural disasters or circumstances beyond
a country’s control. This heightens uncertainty. When Europe’s leaders
do help, it makes the public and markets think that they are being
dishonest. If it is the Lisbon Treaty that creates these problems, then
the Lisbon Treaty should be changed.

Moreover,
assistance should come not just with conditions, but with temporary
control of the national budget by a committee of “special masters”
appointed by the European Union. Mere promises by the recipient,
history tells us, are not enough.

No doubt,
countries to which these measures are applied will express outrage.
Well, no one is forcing them to take the money. Worried about moral
hazard? Here’s your solution. Note also that this would also be a much
more effective disciplining mechanism than the defunct Stability and
Growth Pact.

You might well ask: how would
Californians feel if their state was forced to turn over its budget
temporarily to a special master appointed by President Barack Obama’s
administration? Actually, they would probably feel okay.

The
special master would not be a fellow Californian, but he would be a
fellow American. People would understand that he was acting in the
interest of the state as well as the country. They would also be
reassured by the fact that California sends representatives to
Washington, D.C., where the special master’s marching orders would be
issued.

Europeans don’t do these things because they
see themselves as Greeks and Germans first. They don’t interfere in the
“sovereign prerogatives” of other member states. Germany is especially
reluctant, given memories of its World War II conduct, not least in
Greece.

Well, if Europe
is serious about its monetary union, it will have to get over its past.
It needs not just closer economic ties, but also closer political ties.
Those running a strong emergency financing mechanism will have to be
strongly accountable. They will have to answer to a strong European
Parliament.

German Chancellor Angela Merkel’s
constituents hate bailouts, because they know that it is they who will
be doing the bailing. They oppose anything that smacks of European
political integration.

But Germany is not innocent
of responsibility for this crisis. It demanded an extraordinarily
independent and unaccountable central bank that is now running an
excessively tight monetary policy, aggravating the plight of the PIIGS
(Portugal, Ireland, Italy, Greece, and Spain). Germany’s enormous
current-account surplus aggravates their problems further. Germany has
also done too little in terms of fiscal stimulus to support the
European economy.

Germany
has benefited enormously from the creation of the euro. It should repay
the favor. It should push for the creation of an emergency lending
facility, and for political integration to make that feasible. It
should provide more fiscal support. And who better to press for a more
accountable European Central Bank?

The Greek crisis could be the Trojan horse that leads Europe toward deeper political integration. One can only hope.

Finally, the FT reports that the EU demands details on Greek swaps:

A
key focus for authorities, according to Mr Altafaj Tardio, would be
whether the currency swaps, a derivatives transaction, had been
calculated based on prevailing market rates.

Goldman Sachs, Morgan Stanley, Deutsche Bank
and other investment banks arranged complex transactions that enabled
the Greek government to raise cash for budget spending without having
to classify the proceeds as public debt.

One of the biggest of
such deals was a securitisation in 2001 in which Greece raised €2bn
backed by grants the finance ministry expected to receive from EU
structural funds.

Italy, Spain and
Portugal used similar forms of off-balance sheet accounting as they
sought to keep their budget deficits within the 3 per cent of gross
domestic product mandated by the eurozone.

The Commission said on
Monday that the Greek government failed to disclose information about
the currency swaps to a Eurostat team that visited Athens in September
2008 to monitor Greece’s debt management.

But
Greeks with knowledge of a 2002 currency swap and a series of
asset-backed securitisation deals – all carried out under the previous
Socialist government that held power between 2000 and 2004 – disputed
that contention.

“Eurostat knew all
about these deals, which were perfectly legal at that time. We didn’t
keep them secret,” said a former senior Greek finance ministry official.

George
Papaconstantinou, Greece’s finance minister, told a meeting of the
European Policy Centre think-tank: “The kind of derivatives contracts
that are being reported by some newspapers were, at the time, legal and
Greece was not the only country to use them. They have since been made
illegal, and Greece has not used them since.”

He added: “The
current government has neither mandated not considered any instrument
which is not compliant with Eurostat rules.”

A Eurostat
representative declined to say which transactions were subject to the
group’s request, or whether it was focusing on the work of specific
banks.

The focus on Wall Street, first detailed in a New York Times report,
came as the Commission on Monday moved to tighten control over member
states’ book-keeping. It approved proposals that would strengthen
Eurostat’s hand to audit governments’ finances and ensure they provided
accurate data. Those measures will now go to the European Council for
consideration.

Tyler Durden and Marla Singer over at Zero Hedge
have done a masterful job going over the interplay between the rating
agencies and the rating of the Goldman underwritten swap agreement
securitization SPV known better as Titlos PLC. It's an absolute must read analysis.

It
also makes me wonder whether Goldman called its preferential clients
(big global macro hedge funds) ahead of the debacle to warn them of the
upcoming triggers that would rattle the euro, Greece and the PIIGS's
sovereign debt markets. I am looking forward to seeing whether Spain's
probe into CDS/FX speculative trading uncovers any inappropriate trading. Stay tuned.

Comments

[Anonymous]

Most people argue that the Europeans will have to come up with a system that fosters greater unity.

It’s fine if that can actually be arranged, but I have my doubts that it can be.

I don’t see what’s so wrong with a Darwinian approach… make it easy to expel member countries who need bailouts. Most “experts” will disagree with this view, but I think it would result in a stronger Euro (i.e., the currency itself, if not the European Union)

[Anonymous]

Amen--Bring on the tough love!! They have colluded with Goldman, lied, cheated and misrepresented their financial health greatly, and they should pay the price!

Wish we could take the same attitude with the criminal corporations that run America!

[carbonmutant]

The Greeks have to bring the budget deficit down to 3% from 12% by March 16.

That's the definition of Martial Law.

[steve from virginia]

Of Greece will get bailed, so will the rest of the insolvents. There is no choice, the real issue is whether the bailouts will be timely.

Not now, the bailouts are too late ...

>>>>>>>>>>>

Professor Roubini is a smart guy but if he thinks German/EU loan guarantees are less desirable than IMF financing and fiscal austerity, he is simply nuts. Accepting IMF financing is effectively "the kiss of death" if you're Greece.

<<<<<<<<<<<<

It's not the kiss of death if you are Germany which would rather have the Greek, Spanish, Irish and Italian albatrosses hanging around the IMF's neck. Let Bernanke et Cie. support the insolvents, they've had a lot of practice.

At bottom is productivity which is dependent on oil prices but since the economists and pundits don't talk about oil prices there is no need to consider their effects on cliff diving European productivity.

Is there?

[Leo Kolivakis]

Germans were the architects of the euro. Read Eichengreen's comment above. He is absolutely right that Germany benefited from the union and they should support it.

[Anonymous]

Pythagoras ( a Greek no less) and my HS geometry teacher would be proud of that graphic with all of the squares, rectangles and triangles in it. Brings back the Pythagorean Theorum and taunts of proofs like: Angle-Side-Angle and Side-Angle-Side.

[williambanzai7]

http://4.bp.blogspot.com/_wkgIzuqJM0w/S3rXwvKBfeI/AAAAAAAACgA/W0ytuWBuXf...

[Leo Kolivakis]

LOL, love that pic...thanks.

[Anonymous]

O.T.
Heads up to you, Leo.
Flaherty just announced that your Canadian housing bubble is gonna blow!
Remember when Bernanke said "there is no bubble sub-prime is contained"
Flaherty just said "There is no evidence of a housing bubble, but we're taking prudent steps today to prevent one," That's Fed speak for KA-BOOM!

Read more: http://www.cbc.ca/money/story/2010/02/16/mortgage-flaherty.html#ixzz0fid...

[Leo Kolivakis]

Minister Flaherty (or his deputies) and others in Ottawa regularly read my blog. He must have seen my Friday comment on the Canada Moral Hazard Corp.:

http://pensionpulse.blogspot.com/2010/02/canada-moral-hazard-corporation.html

Cheers,

Leo

[Anonymous]

So Germany is the only European Nation Fiscally strong enough to support the rest of Europe? Surely this will spread to the rest of Europe, look at the U.S. where most states are financially under water. Spend, spend, spend.Don't worry about tomorrow, someone else will pay your debts. This is the attitude of the people and its governments. The U.S of A is still doling out Sub Prime loans in the form of FHA mortgages. This is already evident as the new loans are going into default. What ever happened to guns or butter, economics 101. Tax the middle class workers to death to give to the Rich and Lazy. Use the bailout to make the rich richer,encourage sloth and ineptitude. Its really a shame when most of the new jobs created deal with foreclosure, bancruptcy Law Offices, Credit default agencies.

[spekulatn]

Nicely done, Leo.

[Anonymous]

Greece SHOULD be given the heave ho! And yes, it would be a clear signal to the expanding Euro zone regarding the 'rules of the road'...
Greece is about the economic size of Chicago to give one a sense of scale here. If I were Germany, I'd say: "Adios" (Ok, it would be in German, lol). It's not like Greece would be missed in the scheme of the Eurozone...

[Leo Kolivakis]

A buddy of mine who works for an international company in Athens shared these thoughts with me (I don't necessarily agree with his dire prediction or his characterization of the situation):

For several months now, I have been warning my colleagues that Greece's membership in the EU is fragile at best. The reality is that Greece has basically pissed away billions of EU subsidies and has very little to show for it. You know that the Greeks have become open "apateones" (criminals) over the last few years and the German and French have had enough.

My prediction is that Greece will be asked to leave monetary union by the end of this year. In return, their loans from the EU will be forgiven and any private lenders will be left to deal with a large pile of "leftover" debt.

The message to the rest of the PIIGS will be clear - if you fuck-up, you will be gone!

Also see this Yahoo Tech Ticker interview:

Relax, Greece Will Be Bailed Out. And So Will The Rest Of The PIIGS.

Posted Feb 16, 2010 10:05am EST by Henry Blodget For the past couple of weeks, the global markets have lurched between a state of bliss that bankrupt Greece will be bailed out to a state of panic that it won't.

According to our guest Dan McCrum, a columnist for the Financial Times, the latter fears are overblown.

Of course Greece will be bailed out, McCrum says.  The bailout won't be called a bailout (because people don't like bailouts), but it will be a bailout.

And what about the other troubled European countries in the group known as the "PIIGS"? (Portugal, Ireland, Italy, Greece, and Spain.). If Greece gets bailed out, won't these countries immediately come begging with their own hands out?

Yes, says McCrum.  And they'll get bailed out, too.  Basically, German citizens will have to pick up the tab for their less-productive Euro brethren.

One thing that won't happen, McCrum says, is that the EU will fall apart.  This project (the EU) has been too long in the making, and Europe isn't going to give it up over a few annoying bailouts.

And, the silver lining:  A weaker euro currency will be met with applause by Europe's exporting nations. 

[ptuomov]

"Germany has benefited enormously from the creation of the euro. It should repay the favor."

This doesn't make any sense.  Germany had a stable currency, the Deutsche Mark.  They did a favor to Southern Europe, at a cost, letting them ride DEM's coattails in Euro. 

[Brak82]

i guess the strong DM would have slowed down Germanys enormous growth in Exports over the last decade.

[Anonymous]

The special master would not be a fellow Californian, but he would be a fellow American. People would understand that he was acting in the interest of the state as well as the country. They would also be reassured by the fact that California sends representatives to Washington, D.C., where the special master’s marching orders would be issued.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
This guy is an idiot! A California CZAR LOL!! What California needs is a Katrina! Before Katrina the teachers union had a strangle hold on N.O. Now no more teachers union. Private schools were allowed to come in and build. Children are finally getting an education instead of an indoctrination.

Greece is a classic example of what happens when liberal control freaks are allowed to take over. It's never pretty, always turns ugly and has a nasty ending.

Lehman was the first domino in an economic cleansing cycle that were it not wrongly stopped with bailouts. Goldman Sachs, Morgan Stanley, Deutsche Bank and other investment banks would be history. We would be well on our way to a meaningful recovery. Do a little research compare the 1920 depression to the one in 1929.

[A Nanny Moose]

We are certainly overdue for a nice quake here in CA.

You have any supporting links about the NO union situation/privatization, post-Katrina? Seems everybody must cut back except the unions at this point...they are in for a rude awakening when the revenue streams that pay their salaries are falling in value.

[hedgeless_horseman]

"IMF support, on the other hand, is paid out in tranches and is conditional on achieving various policy targets over time."

Here is a preview of the collateral left over for the IMF after the PIIGS have done business with the Giant Squid:

http://media-cdn.tripadvisor.com/media/photo-s/01/23/cf/f8/meat-market.jpg

[DRju]

This has the potential to spread... Get the lowdown here:

http://www.marketwatch.com/story/time-for-fed-to-....

[Anonymous]

The treaty of the union is clear lend,swaps interest rates,currencies at your own peril.
Same as for Lehman,lend.swap CDOs at your own peril.
Should the IMF be adding Greece on his agenda?why not if it can improve the situation.
It looks like the Pigs are outside the Pigpen

[Nout Wellink]

The derivatives market is over $ 600 trillion and unregulated. Of course there are trillions of losses hidden over there, waiting to get discovered. Greece is hopefully the story that will fuel the attention at derivatives.