Monday, March 19, 2012

What's Next for Greece?

Jenny Lowe of the FT reports, What's next for Greece?:

Greece hung on by the skin of its teeth as it won a crucial debt swap on March 9, a deal that marks the largest restructuring of government debt in history.

In a statement after a conference call of eurozone finance ministers, Jean-Claude Juncker, president of the 17-nation Eurogroup, said “the necessary conditions are in place to launch the relevant national procedures required for the final approval” of the country’s new ¤130bn (£110bn) bailout.

Holders of 85.8 per cent of debt subject to Greek law and 69 per cent of its international debt holders agreed a debt swap. The figure was ahead of expectations for a participation rate of 75 per cent to 80 per cent, but still falls short of the 90 per cent target that would have allowed the swap to be completed on a voluntary basis.

Consequently, the Greek government has said it will activate collective action clauses on debt holdouts, which would lift the participation rate to 95.7 per cent. Payouts on Greek debt insurance have also been triggered.

Default

However, investors were left wondering what prompted the deal – as opposed to letting Greece default outright – and what it actually solved for Greece and the euro.

Under the terms of the deal, each bondholder will receive 15 per cent of their money back in a cash equivalent, and 31.5 per cent of the face value of their bonds in the form of a new 30 year Greek bond paying just 2 per cent at the outset, rising to 4.3 per cent over its lifetime if all goes well. The stated reduction in bondholder wealth is therefore 53.5 per cent.

However, John Redwood, chairman of Evercore Pan-Asset’s investment committee, argues that the new bonds are unlikely to be worth their par value.

“Early indications are that Greek debt will continue to change hands on very high yields, meaning if a bondholder wants to sell their new bonds they will have another large loss. They might lose three quarters of the par value on the new bonds, taking their full loss to roughly three quarters of the capital value at the issue price of their original bond.

“Individual investors of course may have lost a lot less, as they may have bought in at much lower prices, and will have received some income. The government is also offering sweeteners in the form of the promise of extra payments if the Greek economy grows well in the years ahead. These probably have little value today, though we all hope for the sake of Greece they do in due course become more valuable.”

Jason Gaywood, consultant at currency specialist HIFX, observes the authorities’ stated aim was to cut Greek government debt from 160 per cent to roughly 120 per cent by 2020. However, he questions whether this level of debt is sustainable.

“Whether this aim is achieved or not, only time will tell. However, 120 per cent of GDP is still a level of debt that may be described as unsustainable and with Greece in its fifth year of recession and facing extreme austerity for the foreseeable future, it is very difficult to see how Athens can steer a course back to prosperity from here.

“This debt swap and the recent flooding of EU banks with a trillion cheap euros smacks of a desperate face saving attempt by EU politicians to keep the increasingly Frankenstein-like eurozone patient alive. The irony of the Greek deal is that the haircut is likely to trigger insurance payments to some international bond holders. These payments will be levied against, among others, already embattled Spanish and Italian insurance companies who would not survive if it wasn’t for the aforementioned ECB bailout – this sounds remarkably like robbing Peter to pay Paul.

“Sadly, most commentators recognise that Greece is probably past saving within the euro. In order to survive, Athens needs to be cut free of its economic shackles, devalue its currency and gradually trade its way out of a hole.

“However, political leaders elsewhere in the eurozone who are facing domestic elections this year or perhaps head a weak coalition government are motivated more by short-term political well-being rather than the economic well-being of the EU as a whole.”

Insufficient

Rathbones’ chief investment officer Julian Chillingworth deems the latest attempt to bolster the failing economy insufficient to guarantee its place within the euro.

“The Greek outcome is the best the ECB could have hoped for, but it’s not enough to guarantee Greece’s membership of the euro,” he says. “We remain sceptical as to whether this will translate into a meaningful reduction in debt as Greece’s ability to implement its austerity package with conviction is still very questionable indeed.”

Mr Redwood agrees: “While the markets are treating this outcome with relief, it is scarcely good news. An advanced country and a member of the eurozone has failed to repay its debts. Markets still do not fully trust the new debt instruments the Greek state is issuing.

“The Greek economy, deep in recession, has just lost more potential spending power from private sector holders of these bonds. This follows hard on the heels of the extraordinary decision to cut the minimum wage by 22 per cent, the minimum wage for young people by 32 per cent, and some of the pensions in payment by 12 per cent.”

He explains that Greece is an extreme example of how a western economy locked into a single currency has to slash living standards to try to live within its means. After years of building up debt, the country faces the reality that no-one wants to lend to it on anything like normal terms.

He adds: “Other western countries are facing the need to rein in their debts and to adjust to their lack of competitiveness against the emerging market economies and Germany. Those not in the euro have been able to devalue their currencies, cutting living standards by the back door and altering the relative prices of imports and exports in a way which helps the local economy to adjust. Inside the euro all the adjustment has to take place by some combination of smarter working, job losses, wage cuts, and in extreme cases failing to repay debts.

“The Greek debt swap is seen as a success, but it is part of a much larger painful adjustment which is far from over. Portugal should be worrying, as they are still a long way from being able to return to the markets to finance themselves in the normal way.”

I'm getting tired of reading these articles because most people don't have a clue of what's next for Greece, including Greeks! All these economic pundits who think Greece should "break free from the economic shackles of the euro" are completely clueless and irresponsible in touting a return to the drachma. That is a guaranteed disaster which will send Greece back to the Dark Ages.

And yet the current mix of severe austerity isn't working either. Why? Because it's sheer lunacy to cut jobs, wages, pensions, health care in the midst of a depression and expect the country to grow its way out of debt. Austerity is a recipe for disaster in Greece and elsewhere which is why the bond market is pricing increasing risk of default in countries which impose harsh austerity measures.

On top of all this, successive Greek governments from both major parties have failed to cut the bloated public sector and keep pandering to unions to collect votes. Greek politicians are notorious liars. The country suffers from huge bureaucracy, rampant tax evasion, corruption at the highest levels, productivity gaps, inefficiencies, red tape smothering entrepreneurs, and now, at the worst possible time, a massive brain drain as smart, young Greeks migrate to find work elsewhere.

Where are they going? Europe's rising unemployment has led to a rise in the number of British and Irish skilled migrants applying to come to Australia which is also welcoming many Greeks too. Canada is also fast becoming the destination of choice for many Irish and British workers hit by the recession (some Greeks but Australia is warmer and have bigger Greek populations).

So what is next for Greece and Europe? Professor Yanis Varoufakis wrote a comment, Ringfencing Europe, where he states: "Europe is currently caught up in a false dilemma between current policies, which are contributing toward the eurozone’s disintegration, and a ‘federal move’ that cannot possibly unfold swiftly enough to arrest the Euro Crisis."

While I agree with the false dilemma, I have spoken to enough experts who have heavily criticized professor Varoufakis' Modest Proposal. One of these experts is Andreas Koutras who back in December, wrote a critique of the Modest Proposal of Varoufakis & Holland, and has yet to receive a succinct rebuttal to all the points he raised in that critique.

Andreas' latest comment talks about the auction for the Greek CDS which is taking place today. According to Andreas, things should go smoothly but there is always a risk of counterparty failure:

On Monday the auction for the Greek CDS is going to take place. According to the most recent data the Net volume is around 3billion so no-one should expect any surprises. In fact most probably it is going to be a non-event.

That is unless there is counterparty failure. Chances of this are again slim as the EBA stress test did not show anyone with significant or threatening size. So overall the auction should pass uneventfully. What is more interesting is the list of deliverables that has been published and the price that the auction is going to settle at.

Normally, in a credit event like a bankruptcy one should expect the auction to come very close to were the distressed bonds are trading. However, this is not the case here. The Hell.Republic trigger the CDS because of a restructuring event that destroyed all the Greek law bonds and replaced them with new ones. Thus one cannot easily predict or correlate his hedging with the real losses he has suffered. This of course is a much wider issue and one that is not going to be resolved any time soon.
All these technical issues on Greek bonds are unbelievably complicated. All I know is that if Greece doesn't get back on its feet by cutting waste and inefficiency and increasing private sector investment and jobs, the country will have a hard, if not impossible time, attracting foreign lenders.

But let me end on a somewhat optimistic note. I spoke to my uncle yesterday, one of the country's most successful manufacturers. While he acknowledges Greece is going through a very difficult time, he sees the light at the end of the tunnel and thinks Greece will eventually bounce back stronger from this crisis.

I agree and think now is the time for investors to take a hard look at private equity, real estate, and infrastructure opportunities in Greece. I will caution you, however, tread carefully of you'll get burned alive. If you are serious about investing in Greece, contact me (LKolivakis@gmail.com) and I will put you in touch with someone who worked there on a major infrastructure project and knows all too well the challenges of investing in Greece.

Below, Derek Halpenny, European head of currency research at Bank of Tokyo-Mitsubishi UFJ Ltd., talks about the European debt crisis and the outlook for currency markets. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday."

Also, delaying Greece’s debt restructuring by more than a year reduced banks’ potential losses as firms trimmed their holdings and most of the risk shifted to European taxpayers. Bloomberg's Erik Schatzker reports on Bloomberg Television's "Inside Track."