Managing A Greek Default?

Nikos ChrysolorasIan WishartMehul Srivastava of Bloomberg report,Tsipras Offers New Plan for Greece for Crunch EU Talks:
Greek Prime Minister Alexis Tsipras presented a new plan to stave off default before an emergency summit Monday that could decide his nation’s future in the euro.

The new offer “was a good basis for progress at tomorrow’s Euro summit,” European Commission spokesman Martin Selmayr, said in a Twitter posting. He also referred in German to the inception of the plan as “birth by forceps.” The euro strengthened in Asian trading.

Before the start of the summit in Brussels, Tsipras will meet with representatives of the countries’ main creditors. He’ll sit down with European Council head Donald Tusk before they’re joined by European Central Bank President Mario Draghi, International Monetary Fund Managing Director Christine Lagarde, EU Commission President Jean-Claude Juncker and Eurogroup head Jeroen Dijsselbloem, an e-mailed statement from the Greek prime minister’s office said.

With the clock running down on a June 30 deadline to make payments and work out a new aid deal after months of fruitless negotiations, Tsipras will have to convince the country’s creditors that he’s ready to compromise on election promises and avoid a default. With its finances in tatters and banks bleeding deposits at record pace, it’s unclear how long Greece can hold out without a fresh infusion of rescue loans.

In phone calls Sunday, Tsipras briefed German Chancellor Angela Merkel, French President Francois Hollande and Juncker on Greece’s proposal to unlock bailout funds, according to a separate statement from his office.
Greece Decides

“It’s not Merkel or others, but the Greek government itself that will decide if Greece stays in the euro zone,” Belgian Finance Minister Johan Van Overtveldt said in a tweeted message.

The euro gained in trading on Monday in Asia, adding 0.2 percent to $1.1378 at 12:30 in Sydney. Asian shares also advanced with the MSCI Asia Pacific Index adding 0.6 percent to 148.11.

Greece’s proposal is “for a mutually beneficial agreement, which will give a definitive solution, and not defer the problem,” according to a government statement. The government didn’t provide details on the plan, and the Greek government spokesman didn’t respond to phone calls and text messages seeking comment.

Tsipras’s anti-austerity coalition has rejected demands from creditors which would require Greece to slash pensions and hike sales taxes to qualify for an extension in aid. Instead, Tsipras has said that any solution should focus on the country’s unsustainable debt.
New Offer

The new plan includes elimination of early retirement options as of next year, an increase on tax surcharges that middle- and high-income earners pay, as well as a levy on companies with annual net income of more than 500,000 euros, a Greek government official said earlier Sunday. The official asked not to be named because the plans weren’t finalized and were subject to approval by the Greek cabinet that met on Sunday.

“This isn’t about the money, this is about the principles of economic reform,” Richard Jerram, the chief economist at the Bank of Singapore, said on Bloomberg Television. “It’s a question of are you prepared to do stuff that is going to have a sustainable effect on your economy or are you going to be permanently reliant on European support?”

While the German chancellor says she wants to keep the euro intact, Tsipras is probably overestimating her willingness to compromise, according to a person familiar with the government’s thinking.
Impact of Default

Merkel is expected to head into Monday’s summit with a chancellery estimate that the financial impact on Germany of a Greek default would be limited to 1 billion euros ($1.1 billion) a year, said the person, who asked not to be identified discussing government deliberations.

Euro-area finance ministers will meet at 12:30 p.m. to prepare the gathering of government leaders set to begin at 7 p.m. Earlier in the day, the ECB will hold a conference call to assess emergency funding for Greece’s banks as deposits continue to drop at dizzying rates.

Months of back-and-forth between Greece and its creditors have left the country’s banks living day to day on ECB funding. Failure to strike an agreement for unlocking emergency loans by June 30 -- when Greece’s euro area-backed bailout expires -- would risk leaving the country unable to service its debt.
Bank Withdrawals

Panicked depositors have withdrawn more than 30 billion euros since December. Without a deal, Greece faces the specter of capital controls and what U.S. Treasury Secretary Jacob J. Lew said would be a “terrible” economic decline.

A few thousand anti-austerity demonstrators held a peaceful rally in front of the Greek parliament Sunday night, their second in the past week, just as Tsipras left for the airport. Holding placards with slogans such as “the people cannot be blackmailed” and “the country isn’t for sale,” the protesters gathered to hear labor union officials and leftist political organizers call on the government to resist extending the bailout program.

“Without a full default of the debt, it’s impossible for our country to recover over the next 50 years,” said Pavlos Antonopoulos, a member of the country’s public sector union.
On Monday, Dutch Finance Minister Jeroen Dijsselbloem, who chairs meetings on his euro-area counterparts, said the fresh set of proposals supplied by the Greek government are seen as a positive step but they haven't been fully assessed yet. Still, hopes for a last-minute deal was enough to lift global stocks and peripheral eurozone bonds.

As I stated in my last comment on preparing for Graccident, the two sides have taken such hard stances based on serious ideological differences that it's hard to see how any comprehensive deal will be reached. At best, I see some form of "extend and pretend" but all this does is kick the can down the road for this never ending Greek saga.

Meanwhile, over the weekend, I received some interesting feedback from my Greek contacts which I will share with you below. First, Sober Look put out an excellent comment on managing Greek default risk:
Many in Europe continue to believe in the permanence of the Eurosystem. The Bank of Greece is controlled by the ECB and its assets and liabilities will always be consolidated into the Eurosystem. By this argument, the collateral held by the Bank of Greece as part of the ECB's financing of Greek banks belongs to the Eurosystem. Therefore if the Greek banking system were to fail, at least the Eurozone's central banking system can keep the collateral.

Let's be clear: if Greece were to exit the currency union, the Bank of Greece and its assets would be immediately expropriated by the Greek government (making them part of the "new" Bank of Greece). Many in Europe are pointing out how such action would be illegal. There nothing "legal" about Grexit to begin with - the system was designed to have laws for "marriage" but no laws for "divorce". And with the Bank of Greece exiting so would go the collateral. To assume that the Bank of Greece is a permanent fixture of the Eurosystem is not prudent credit risk management. Therefore the Eurosystem's exposure to Greece should be added to the €323bn of other debt.

Having said that, Target2 debt owed by the Bank of Greece to the Eurosystem has no maturity and requires no immediate payments. Therefore a standalone Bank of Greece may choose to keep the liability outstanding in order to get access to the euro payment system. The Eurozone's political leadership may however demand a timely repayment of these balances, given the size of the exposure (click on image below).

This central-bank-to-central-bank exposure is now rising rapidly as the ECB approves a new limit increase for emergency funding (ELA) on a daily basis. This is what a run on the Greek banking system looks like (click on image below).

While some accounts are moving abroad and into other assets (including European bonds held in foreign accounts and even into bitcoin), much of the withdrawal activity is simply converting deposits into banknotes. Anecdotal evidence suggests that many in Greece are leaving a minimal amount at the bank to keep the account open and the rest is in cash stored under the kitchen tiles, etc. Greece is quickly becoming a cash economy. Capital controls could be the next logical move by the Greek government and the population and businesses are simply protecting themselves (click on image below).

Here is an example:
Bloomberg: - Dorothea Lambros stood outside an HSBC branch in central Athens on Friday afternoon, an envelope stuffed with cash in one hand and a 38,000 euro cashier’s check in the other.

She was a few minutes too late to make her deposit at the London-based bank. She was too scared to take her life-savings back to her Greek bank. She worried it wouldn’t survive the weekend.

“I don’t know what happens on Monday,” said Lambros, a 58-year-old government employee.
There is hope however for a less-than a disastrous outcome. These near-panic conditions could be sufficient to bring the nation's leftist government back to the negotiating table this weekend. However, time is fast running out as €1.6bn is due to the IMF in less than 10 days.

Moreover, there is a good possibility that Greece could default without leaving the currency union. With a strong support for the euro, Greeks could push for a referendum to form a more centrist government that would re-engage the creditor institutions. Here is a summary from Barclays Research (click on image below):

Much has been made of the ECB and its "nuclear option" to remove emergency liquidity assistance to Greek banks. Zero Hedge keeps posting articles warning of this nuclear option which even some of my contacts are worried about.

Andreas Koutras of ITC Markets sent me this:
According to calculations the maximum amount of funding under the current collateral rules is around 93-95bln. This means that if capital controls are to be imposed there is a need for 5-10bln buffer which takes the limit before they close at around 85bln. Currently we are very close to this limit.
But as I've explained in all my recent comments on the Greek crisis, the ECB is not going to be the one that pulls the trigger first. It simply can't because a move like that will be interpreted as economic warfare from SYRIZA, giving them the ammunition to default on the country's debt.

And don't kid yourselves, nobody really wants Greece to default on its debt. Not the Greeks, not the Germans and not the French, but nobody is really willing to make huge compromises either, which is why this saga keeps dragging on and on.

Over the weekend, Theodore Economou, the former head of Cern's pension fund who is now CEO of Lombard Odier, shared these insights with me:
Thank you very much for sharing your thoughts via your blog, which I find a very useful near-real-time reference for the state-of-play in the Greek tragedy.

And it is a tragedy, because it is a fight of right agains right (and not of right against wrong, as in B-series movies).

Experience has taught me that predicting political developments is a near-impossible quest that one should approach with a good dose of humility.

What one can do however, is understand and analyse the motivations of the players, and derive some probabilities of potential future scenarios.

So what are the motivations of the players?

Let me suggest the following:

For the Greek government, the non-negotiable objective is to stay in power. This requires two things: (1) economic growth to restart soon and (2) a majority of the voters to congregate around Syriza. Restarting the economy implies that, barring a debt restructuring, today’s Greek leaders had decided long-ago that a default is only alternative. Getting popular support implies a common vision that transcends left/right political lines.

For the German government, the non-negotiable objective is not to sacrifice Germany’s option to get out of the Euro, at its election, if it ever sees fit to do so in Germany’s interest. This means Germany cannot accept any mutualization of periphery debts, or any ECB financing via Eurobonds, or any other measure that would start making the Euro irreversible.

Let’s now think about the implications of these motivations.

From day 1, the Greek government had made very clear what it needs: a package of debt restructuring, an investment program, and a series of targeted reforms.  Achieving that was plan (A).  Any package that would not include all three elements would not be accepted.  Plan (B), i.e., a short banking holiday, followed by the introduction of a new/parallel currency would be preferable.  If plan (B) was to come with a balanced budget (a Varoufakis pledge), targeted reforms (a stated Varoufakis aim), and some investment inflows, Greece would be back on a growth track.

The German government on the other hand, came into the negotiation with only one plan: force Greece to accept more austerity, and not recognise the losses on the EFSF/ECB direct and indirect (e.g., via ELA) loans to Greece. The problem is that if this plan failed, Germany had no alternative. It was then caught between a rock and a hard place.

Which is exactly where Germany is today.

If Germany accepts a debt restructuring, the German taxpayer will be stuck with some EUR100Bn in debt write-offs (estimates vary but they are of this order of magnitude). This is politically unsustainable for the German leadership. In addition, any federalisation of these losses would go some way to making the Euro irreversible, which is a German red line.

On the other hand, a Greek default, if accompanied by a return to growth, will inevitably put in motion a mechanism where the rest of the periphery will be asking why it has to continue to accept depressionary policies, and why it could not « pull off a Grexit ». This is anathema to Germany because the German banking system cannot sustain a default by, for instance, Spain or Italy. This situation would create a major incentive for Germany to exit the Euro quickly after Greece does so.

It is not by chance that yesterday’s Die Welt, the standard bearer of the German establishment, carried a page one opinion piece questioning the Euro’s senseless construct, and thanking the Greeks (!) for having opened the German people’s eyes.

I therefore agree with Leo, that whatever happens on Monday, we are only at the start of a longer process.

Let me add a few more twists, to indicate just how complicated it is to predict where this will pan out.

First, it is important to understand that a resolution of the Greek banking system is, in my view, one of the publicly unstated aims of Tsipras and Varoufakis. The perspective of a banking holiday and bank restructuring does not scare them. On the contrary, it would help them achieve what they see as their mission: reform Greece to liberate the creativity and potential of its people.


In the eyes of Syriza’s leadership, the pyramid of Greek corruption has at its base the bank owners (a single-digit number of families, real or political — as in the case of ETE) who have obtained from the government a right to print money.  Then comes the public works/media complex which, financed by this banking system, supports the traditional political parties (via various mechanisms to channel the money flowing through it in ways that support reelection of traditional party politicians).  For Syriza, any reform of Greece cannot succeed without getting rid of this « macro corruption » first.  Only then comes the fight against « micro corruption » at the level of doctors, pharmacists, corrupt civil servants, small tax evaders, farmers, etc.

(Varoufakis actually actively sought from early on the support of the EU to resolve the Greek banking system. But his cries for help fell fell on deaf ears.)

So, the Greek government has virtually no incentive to blink Varoufakis writes as much today in the FAZ.

One could argue that the Greek people have now amassed a war chest of 100+bn Euros outside the EZ banking system.  Following a EZ exit, and a devaluation in the order of 20% (i.e, by the accumulated differential of Greek vs. German productivity since 2001 when the Euro was introduced), this money will flow back and drive an unprecedented investment-led boom.  Once rid of the banking/public works/media complex, and with some targeted reforms, the benefits of growth would be widely spread out, to the benefit of Syriza.

At the same time, the anti-austerity fight — having now been defined as a fight for the right to sovereignty — has congregated voters of left and right around Tsipras, transcending the traditional left/right divide.

On the other hand, as concerns the Eurozone, its politicians always have preferred to push problems out to another day. This give them a strong incentive to prefer a Grexit over the — immediate — political cost at home of being seen as voluntarily agreeing to a de-facto write-off of Greek debt.

Therefore, the scenario of a Grexit has a material probability at this stage.

But it’s not that simple.

Adding to the complexity is the very strong US pressure on Germany to yield to basic economic logic, take its losses, and proceed with a restructuring.  This week’s strongly worded article by Jeffrey Sachs is the clearest sign yet that the US establishment does not want to risk the upheaval that would follow a Grexit, including a possible war with Turkey. The US also cannot afford a war in the Aegean, because of the wider instability in the area, and Russia’s ambitions.  It will therefore try to block Turkey’s appetite to start a war.

Very smartly, only a few weeks ago, Greece reached out to NATO with an offer for a major base on Karpathos island   If Greece felt betrayed by NATO following an attack by Turkey, who says it would not offer it to Russia?  The US cannot — ever — afford this.

Historically, Germany has always stood in line when it came to US strategic interests. Will it be the case this time?

This is another twist that supports Leo’s point that it’s not over yet.

But as the tragedy unfolds, I would argue that understanding the true motivations of the parties is the only way to make sense of developments and avoid being drowned by the often uninformed — and some times biased — noise coming from so many sides.
I thank Theodore Economou for sharing these extremely wise insights on just how complex these debt talks are and why this isn't over, not by a long shot. And I agree with those who think as long as this drags on, it will reinforce deflationary headwinds in the eurozone.

One of my friends who was part of that email distribution list shared these comments after reading the above:
A few points to consider: 
  • Would the EU find away to seize Greek private assets held in EU banks?
  • What impact will the brain drain and poor demographics have on Greece? And for how long?
  • Greek institutions still require reform (granted banking and media and the power they hold may as per Theodore's comments) but the rest of the public institutions would also need to.
  • I think the key point is that this has become political and ideological for Germany and Greece, an economic solution is easy... What we are witnessing is Germany's emergence as a world power...and the blueprint for Europe by Germany. If Greece leaves the EZ they will also lose a seat at the table of Europe.
  • We all agree it is tragic and painful to watch unravel but it has given Greece the opportunity to reset itself and to undertake measures that may help it in the long run, the question is are those in power the right individuals to achieve this? Are the Greek people willing to? And who will help? (Europe ,US, Russia, China all with strings attached).
Another friend of mine echoed those thoughts:
Is Syriza the right party to lead Greece after a EZ exit? Can Greece survive a prolonged period of Syriza rule if they do make a deal?

What will creditors do after a default?

If you have a background in sovereign lending (which I do), the pattern of events and behaviours after an IMF intervention are very predictable. Greece has been no exception.

My view is that staying in the EZ will continue to be painful for about a decade.

Exiting the EZ will be an order of magnitude worse in the short term (3-7 years) and may be better after that assuming that the capital markets forgive and start lending to the country. It may take substantially longer for this to unfold if things get messy.
In other words, whether it stays or leaves the eurozone, Greece faces a very tough decade ahead and perhaps worse depending on how the politics of this plays out.

Another friend of mine sent me this after reading on Greece's pension paradox:
In this entire dialogue about pensions is missed a more profound reality about Greece.

The pensions didn't create the Greek crisis. The corruption of the private sector created the Greek crisis

For example - doctors and pharmacists routinely prescribed phantom insurance that they used to profit - heck Greece spent more than 10x on drugs than Belgium did. And most of these drugs went to German companies

Greeks in Greece know this.

Cutting pensions feels like once again the people who profited from the corruption don't suffer and the poor do.

Cutting pensions doesn't solve the money pit that mostly went to the rich and to the connected and to European companies
He's absolutely right, on so many levels austerity measures have unfairly targeted the poor and weak while leaving the rich and powerful Greek scumbags who profited the most during the "fat years"  largely go unpunished.

But there was plenty of corruption in Greece's public sector too and there is no denying the pensions that were routinely handed out (to buy votes) were outrageously generous, something another friend reminded us of:
The pensions have been ridiculously generous. A dentist friend was in private practice, and also worked at IKA. She started working at age 24, and was promised an IKA pension at 50!!!! No political affiliation here or anything, just what was promised. About 10 years back that pension was clawed back, and then rewarded again at 55.

This is a pension to a health professional already earning in the 99th percentile of Greek households. This friend is very well educated, and generally a modern thinker. However, you should have heard the sense of entitlement kicking in and the negative commentary on the government that reneged on a promise…

The problem right now is because of the current state of affairs (no GDP, no business, no work), pensions have become the only source of income to Greeks. So, hello new sacred cow.
Indeed, public pensions are the sacred cow and it's not just a Greek problem. In my next comment I'll be discussing how Illinois and other U.S states are headed the way of Greece.

By the way, Greek Reporter notes that Greek public sector pensioners hit almost half a million in 2014, which is no doubt fueled by the crisis, exacerbating Greece's pension paradox. While there were deep cuts to public pensions there are individuals who worked at state enterprises who are still collecting outrageously high  pensions after retiring early.

I hope you enjoy all my comments, including the ones on Greece which provide you with a lot of food for thought on this debt crisis. I still maintain creditors will blink first but there is no doubt in my mind Tsipras and Varoufakis will concede something to get some form of additional debt relief. How this all plays out in volatile Greek politics remains to be seen.

Below, PBS Newshour reports on whether Greece can be saved from economic collapse. There is a lot of scaremongering in the media and popular blogs like Zero Hedge and Naked Capitalism but I ignore a lot of these sites because they simply don't appreciate the complexity of these negotiations.

Also, while Greece's economy minister Giorgos Stathakis has told the BBC that he believes Greece's new proposals to balance the government's books have broken the deadlock with its creditors, it remains to be seen later today. No matter what deal is agreed on, Greece faces a long and arduous road ahead and the sooner it reforms its economy, the better off Greeks will be.

Lastly, I went to my mom's last night and stayed up very late watching the Voice of Greece with her. It was the grand finale featuring four talented singers including a blind contestant, Nektarios Mallas, a gifted singer with unbelievable talent. He didn't win the title but he won the hearts and minds of all Greeks, including mine. Below, his duet with Greek singer, Melina Aslanidou.

I also embedded the duet of Greek superstars Despina Vandi and Antonis Remos who sang together for the first time in over 20 years. It was truly beautiful and even though we focus on all the negative economic news, Greeks will keep singing and dancing no matter what happens in these latest eurozone crunch talks.