Greece's Government Loses Support
All the relevant figures in the eurocracy have been meeting to discuss their differences over what to do next about Greece, even while in Greece itself, political support for the new austerity measures becomes more precarious by the day. It was never going to be politically easy for a nominally socialist party (Greece's ruling party PASOK) to keep its rank and file united behind a plan that will ultimately shrink government to a shadow of its former size while 'punishing' its natural supporters (i.e., the unions and all the idle hands lounging about in state-owned companies, for instance). In Greece the socialist dream that everybody can live at the expense of everybody else has been thoroughly shattered, but that doesn't keep people from hankering for more of the same. As a PASOK backbencher eager to ensure one's own political survival, one must surely ask oneself when enough is enough – and so PASOK's majority in the Greek parliament has now shrunk from six to four. Prime minister Papandreou already warned his party's members a week ago against voting down the new austerity measures, a sign that he fears a parliamentary revolt. “Greece's main private and public sector unions, GSEE and ADEDY, have called on workers and the elderly — whose pensions have been cut — to rally in central Athens. Until now dissent has been muted among the ruling Socialists. But Greeks have staged nightly protests for a fortnight in the capital's Syntagma Square to hurl abuse at the parliament building, with numbers hitting over 80,000 on Sunday. Many PASOK backbench members of parliament appear to be taking fright. Finance Minister George Papaconstantinou suffered a roasting when he presented the medium-term plan to senior party members at a meeting that lasted about 12 hours. Greece, which has a huge budget deficit but has been frozen out of debt markets for a year, seems to have no alternative but to depend on the EU and IMF and accept their demands. One PASOK lawmaker, Paris Koukoulopoulos, recognised that the minister's report on achievements so far had been sincere. "But what's important is that we have emptied the banks of deposits and filled the city squares with people," he said. Newspapers reported that Papandreou had ordered his finance minister to take the attacks on the chin and allow the backbenchers to vent their rage, in the hope that they will cool down eventually and vote for the plan. The government wants parliament to decide on the plan before the end of this month. Many PASOK lawmakers would risk losing their seats if early elections were held, meaning that they may have second thoughts about voting against it.” |
And yet, two more defections have just taken place. One deputy resigned, while another announced he would vote against the measures. This means PASOK now has only 154 votes out of 300 left. Meanwhile, the enraged masses on Athens' streets are attempting to cordon off parliament in order to sabotage the parliamentary debate and vote. According to Reuters:
“Greek protesters vowed on Tuesday to cordon off parliament to prevent deputies from debating new austerity measures, and unions said they would bring the country to a halt in a national strike on June 15. [it isn't at a halt already? ed.] Pressure is growing on Prime Minister George Papandreou's government, which is trying to muster support for a five-year plan that its international lenders say is crucial for them to extend more funding and enable Athens to avoid default. European Union leaders and the European Central Bank are also split over whether private bondholders should share the burden of a fresh bailout plan. Papandreou's Socialist party is due to submit its mid-term plan for discussion in parliament on Wednesday, with the goal of passing it later this month. But protesters staging daily demonstrations that have swelled to tens of thousands in Athens' Syntagma square in front of parliament said they would encircle the building. "Now that the government is putting the medium term austerity programme to vote, we (will) encircle the parliament, we (will) gather and we (will) stay at Syntagma," the self-named People's Assembly of Syntagma Square said in a statement. "Our first stop is the general strike of June 15th. We won't stop until they withdraw it." Public sector union ADEDY, representing half a million workers, said they would march on parliament during Wednesday's strike and join non-union demonstrators in peaceful protest. "The mid-term plan must not be voted. We want them to change their minds and throw the plan in the bin," ADEDY Secretary General Ilias Iliopoulos told Reuters.” |
What all of this illustrates is something we first mentioned about a year ago: the necessary reforms will turn out not to be politically doable. It is almost comical to see the eurocrats in acrimonious debate over how to proceed while the intended victim, err, bailout recipient, is apparently descending into chaos. One should note here that while one must have sympathy for ordinary Greeks suffering through an economic depression, the striking masses appear to have a very muddled perception of what they can possibly achieve. Here is what will not happen, regardless of their protests: there will be no more 'free money' from the State. Perhaps the hope is that Greece will simply revert to default mode, as has been the case for roughly half of the time it has existed as a modern nation state, then return to the drachma and devalue its way back to 'prosperity'. However, this would mean that all Greek savers and depositors would lose a large percentage of their wealth. It would also mean that the country would take one giant step closer to becoming relegated to third world status – as there is no 'prosperity' that can be bought with devaluation. We have to drag up Argentina again as a warning. At one time Argentina was the 5th wealthiest country on the planet in GDP per capita terms. Its governments have eventually turned the country into what is now a hyperinflation-prone and corrupt backwater – a road that was paved with devaluations and defaults, so perhaps avoiding a similar fate should be at least considered.
Readers may well ask 'so what should be done'? Clearly the creditors will have to accept a haircut. Adding more debt atop the existing mountain of debt isn't going to solve anything. Austerity as such is a necessary and positive policy, but it needs to be accompanied by measures that support the revival of the economy. We want to quote Dr. Jim Walker of Asianomics on the subject, as he has put it very succinctly in a recent missive:
| “Adding more debt to a nation with contracting production activity and shrinking income flows is, to put it diplomatically, an invitation to an even deeper condition of debt distress down the road. If there was good reason to presume the new debt will spark production growth and expanding income flows in Greece, it might be a different story. Unfortunately, we have no reason to believe the new subsidized loans that are currently under discussion will have anything to do with jump starting private sector growth in Greece. Indeed, since the condition for a second round of subsidized lending to Greece was the acceptance by Prime Minister Papandreou of an additional 78 billion euros in fiscal cuts, with no discussion about how to make it easier for the private sector to mobilize the productive resources (such as meaningful deregulation or growth inducing tax policy changes) that will be freed up by further fiscal austerity, odds are nominal income flows in Greece will shrink at an even more disturbing pace.” |
Meaningful deregulation or growth-friendly tax policy changes both seem to be out of reach. The austerity packages after all not only prescribe spending cuts, but also tax increases. The latter are clearly a disincentive to private sector activity. Meanwhile, as a member of the EU, Greece has become a recipient of a great many subsidies, while at the same time being bound by the 100ds of thousands of regulations invented by the eurocracy in recent years (some 290,000 new regulations over the last decade alone). This is a typical welfare state type dependency, only at one remove from the citizen-State relationship. In this case it describes the nation state-to-supranational bureaucracy relationship. The problem with this is that it has become impossible for people to help themselves – the entrepreneurial spirit is simply crushed by this thicket of regulations. This is by no means a problem particular to Greece – but in Greece's case it is now a huge obstacle that stands in the way of recovery.
Eurocrats in Search of Compromise And the Problem with CDS
While the debate over how to 'bail in' bondholders without triggering a credit event goes on, the European Commission has circulated a paper detailing the likely costs of a default or rather, a 'soft rescheduling'.
As the FT reports:
"A German-inspired plan to reschedule Greek debt could force eurozone governments to provide up to an extra €20bn to avoid a meltdown of its financial sector, European finance ministers have been warned. A briefing paper circulated by the European Commission, and seen by the Financial Times, warned the extra money may be needed to recapitalise Greek banks following a proposed maturity extension of Greek government bonds, which would be classified by rating agencies as a “selective default”. A further cash reserve may be required for emergency Greek bank liquidity if the European Central Bank refuses to accept downgraded bonds as collateral. Ministers have been told all the Greek collateral – some €70bn – might have to be replaced. Opponents of Greek default, led by Europe’s central bankers, warned of the German debt exchange plan’s drawbacks. “If despite everything you try to reduce the debt and you provoke a risk of default, you’ll have to finance the entire Greek economy,” said Christian Noyer, Bank of France governor. “All in all, the costs seem to outweigh the benefits,” said Mario Draghi, incoming ECB president. The ministers, meeting in Brussels on Tuesday, are looking to involve private creditors in a new Greece rescue programme, to gain parliamentary support in countries such as Germany, the Netherlands and Finland without precipitating a disorderly default by Athens.” |
We have highlighted several of the aspects of the debt restructuring problem previously – specifically it seems almost impossible to organize private sector participation in a Greek debt restructuring that will not be regarded as a credit event by the rating agencies. This will then in turn create a big problem for the ECB, which is steadfastly holding on to the view that Greek government bonds could then no longer be accepted as collateral by the central bank (which is actually an odd position for it to take, considering the garbage that is already infesting its balance sheet in copious quantities at this time).
€ 20 billion to 'prevent a meltdown of the financial sector' actually sounds fairly cheap. That would be a lot of bang for the buck, so to speak. Thus far 'averting financial system meltdowns' has always tended to come a lot pricier. Of course by throwing in another € 70 billion to replace the funding the Greek banks will then lose, one is talking about non-trivial amounts again. However, if there really is anyone willing to replace the ECB's funding of Greece's banks, they might just as well opt for bailing out the Greek government again. In other words, if all the different positions currently debated should turn out to be irreconcilable, the Greek banks may end up insolvent overnight (i.e., instead of merely being de facto insolvent as they already are, they would then be de iureinsolvent as well).
Alas, there is now an additional problem no-one has really thought about much yet. Ever since talk of the 'soft', respectively 'voluntary' debt restructuring has begun, the question over what happens with CDS on Greek debt has become fairly urgent for the holders of said CDS. After all these insurance contracts cost a fortune at present, as they are pricing in an over 70% default probability.
Let us say that a credit event is averted, but creditors still end up with the short stick in the form of a 'voluntary' restructuring. What then about CDS on the debt of other sovereigns? If these instruments are no longer reliable hedges against a sovereign default, then how will fiscally weak sovereigns continue to peddle their debt? In fact, it could well be envisaged in case of a 'non-default'-default that makes the value of such instruments suspect, that mayhem in the bond markets of other peripherals could ensue due to the lack of a reliable hedge. As the FT reports on this particular point:
“While the anti-CDS noise makes for good political theater, it’s drawn opposition from many financial professionals. Debt ratings agency Fitch and the European Central Bank (ECB) have both stated that any soft restructuring of the sovereign should be treated as a default. The potential for triggerless CDS would also have costly implications, not only for the investors who bought USD 5.6bn of net notional CDS protection written on Greece, but also for fellow EU member countries Portugal, Ireland, Italy and Spain that are exposed to contagion risk, traders told Debtwire. If the integrity of sovereign CDS is called into question as a concept, it would hurt those countries’ ability to raise new capital since investors would be less willing to jump into the fray without the ability to hedge their trades, they added. Greece itself last year reaped the benefits of sovereign CDS, as the hedging tool helped drum up demand for the EUR 40bn of bonds the country raised after December 2009 from fast money investors who used the new bonds as basis trades, analysts said. “Politicians might like to avoid a scenario in which CDS triggers, but contagion appears to be a more legitimate concern,” said Michael-Hampden Turner, a credit strategist at Citigroup in London. The lack of a solid hedge in the form CDS could set off a self-fulfilling negative dynamic in the bond markets, he added.” |
Oops.
As can be seen from this, there are a great many moving parts that could influence the eventual outcome of whatever decision is arrived at, and these outcomes all look rather unpalatable. It appears that regardless of whether or not the CDS are triggered, a certain degree of unpleasantness could result. Even if the total net notional amount of Greek debt insured by CDS is fairly small (isn't it funny how after four decades of unbridled monetary inflation we refer to several billions as 'small amounts'?), whatever happens will no doubt have an effect on the other fiscally weak sovereigns as well. One can not make any firm predictions of course and it is to be expected that most financial institutions have individually prepared themselves for a range of potential negative outcomes, but the problem is once again the system's interconnectedness. If for instance only a few large institutions were to become suspect because they have failed to adequately prepare themselves, there could be another 'freeze' in interbank markets (although it should be noted that these markets exhibit no concern as of yet). Even if no cross-defaults were to occur, yet another batch of large losses following on the heels of the 2008 crisis would further weaken an already shaky and somewhat suspect financial system. It should be noted that although the legal situation regarding what triggers CDS payments on sovereign debt is slightly murky, ISDA has a voting process in place that allows financial market participants to have a vote in determining when a credit event is deemed to have occurred – the question is whether such a determination would redound on the views adopted by rating agencies and ultimately the ECB.
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