Unless you’ve been living under a rock, you know that Greece is in a bit of a pickle. You’ve probably seen videos of riots, read headlines of an on-again-off-again Greek bailout, maybe even spent a few minutes contemplating how the situation in Greece may affect you. If you haven’t, I don’t blame you.
I, myself, have spent way too much time reading news about the Greek bailout, reading analysis of news about the Greek bailout, and analyzing that analysis of the Greek bailout, in an attempt to figure out what it all means for the global economy. I’ve been meaning to weigh-in, but with contradictory news coming out seemingly hourly, I’ve been hesitant. Now with a bailout deal officially agreed upon (for the time being) it’s time to present Liberty Insight’s take on the Greek bailout.
Liberty Insight reads and summarizes all this crap so you don’t have to. So, without further ado, here’s everything you need to know about the Greek bailout. (Technocrats love using acronyms so I’ll try to spell them out as they are introduced.)
Now that the Greek bailout deal is done we’re in the clear, right? Well, not exactly. Before we breathe a collective sigh of relief, we should keep three things in mind. The situation is in constant flux with lots of moving parts and is by no means a done deal. There is no “solving” the Greek debt problem; only postponing the inevitable and destroying the rule of law in the process. Greece is simply the first domino; a precursor of what’s coming to the rest of the western world.
For years, Greece has run budget deficits due to a large number of public sector employees, generous social programs, and over-promised pension plans. The rest of the western world has done the same, but Greece has been at it longer and harder than most, running up a huge debt compared to the size of their economy.
After the global financial crisis, Greek debt soared and it became increasingly clear that Greece would not be able to pay back its debts. Most economists agree that once a country’s debt exceeds 80%-100% of its GDP, it is damn near impossible to pay it back. By 2010, Greek debt had exceeded 120% of GDP and interest rates rose sharply putting Greece on the fast track to default.
To avoid a Greek default, the Eurozone countries and International Monetary Fund (IMF) agreed to bail out Greece with a 110 billion euro ($146B) 5% loan. In exchange for the bailout, Greece agreed to implement austerity measures such as reduced government spending and higher taxes to reduce the budget deficit.
The bailout, we were told, would buy time for Greece to reduce its deficit to a manageable level so it could pay back its debts as the economy recovered. The plan was doomed from the start. The Greek economy, so dependent on government spending shrank, and unemployment rose. Tax evasion was rampant. The Greek government struggled to make cuts under protests from its citizens.
In short, Greece fell short on every promise to its European lenders, and its debt to GDP has now risen above 160% of GDP with interest rates on its 10 year bonds above 30%.
Now, Greece faces a large bond redemption on March 20, 2012 for 14.5B euros and has no money to pay and no ability to borrow. Without a new bailout finalized within the next few days, Greece will default on its debt.
It is painfully obvious that Greece can never pay back its debt. Total outstanding Greek debt is roughly 350 billion euros ($460B) and Greece is running annual budget deficits, and can not print it’s own money to monetize the debt (as the U.S. is doing). That leaves Greece with basically two options; both are horrible.
Option 1. Officially default on its debt, leave the European Monetary Union (EMU) and reinstate its own currency, the drachma, which would instantly be devalued to match the production of the Greek economy.
Option 2. Strike a deal with Europe and bond holders to remain in the euro and receive a new bailout loan, which would “renegotiate” the payment on existing bonds to reduce the debt to a “manageable” trajectory, in exchange for severe austerity measures.
As of today, the bailout deal has been agreed to, although it’s far from a done deal as I describe below.
The New Bailout Deal
The German people are sick and tired of throwing good money down the bailout rathole. The Greek people are not so fond of international bankers and governments telling them what kind of “austerity” they must endure. The Greek economy is tiny compared to the rest of Europe and the entire Greek debt is less than what the ECB just injected into the economy in December. Why then is the Troika– the three headed committee of the European Commission, The European Central Bank (ECB), and the IMF– so intent on bailing out Greece and keeping them in the Euro? And why would Greece accept a deal that would condemn its people to misery for the next decade?
The real reason is because the bankers are running the show and want to maintain the status quo at all costs. They have a cash cow of debt slaves throughout the world and won’t let a few fire throwing Greek protestors upset the apple cart. The politicians main goal is to keep power, and they are either a) in the pockets of the international bankers, including the newly appointed (i.e. unelected) technocrats (i.e. former bankers) Louis Papdemos in Greece and Mario Monti in Italy, or b) terrified into submission at the thought of “systemic crisis” if Greece is allowed to default and leave the euro.
So, with that said, here are the main points of the deal.
- A few weeks ago, the ECB changed the rules (I swear they are just making shit up) to swap their Greek debt with new debt that has special status and is not subject to any write-downs.
- Private owners of Greek debt would “voluntarily” agree to take a 53.5% principal write down on their bonds and then swap them for new bonds with lower interest rates. If less than roughly 70% of bondholders agree to the “voluntary” deal, a Collective Action Clause (CAC) would kick in to apply the haircut to all private bondholders. The write-downs would knock 107B euros off the current debt.
- Based on Troika projections, even with the bailout Greece’s debt to GDP would rise to 177% before falling back to a “manageable” 120% by the year 2020.
- Greece must pay all bondholders before they spend any money to run their government. They must also promise to make severe budget cuts and raise revenue through increased taxes and selling public property (probably to banks at firesale prices).
Let’s examine these points in more detail to see the whole can of worms that has been unleashed.
1. The ECB has unilaterally rewritten Greek debt agreements.
This is perfectly described by Mark Grant via Zerohedge:
The ECB, on its own and without judicial or parliamentary review, has swapped their Greek debt for new Greek debt that is not subject to any “collective action clause.” They did this unilaterally and without the consent of any other sovereign debt bond owners of Greek debt. They did this without objection of any nation in Europe. They have retroactively changed the indenture, the contract made by Greece with all of the buyers of their bonds, when the debt was issued…
Having then done this; the implications must now be considered utilizing the clear light of unadulterated reason. The issue now is no longer a one-off Greek issue but a full on ECB issue. We know now that the ECB can retroactively change the rules, change an indenture, so that if the ECB can do this with Greece then it can certainly do it with any sovereign debt in Europe. If they can exempt themselves from a “collective action clause” then they can exempt themselves from any clause, in any sovereign indenture, for any European country. The fact that they are now clearly senior to any other bond holder, or more aptly put, that any private bond owner is now subordinated to the ECB is one consideration but hardly the most important one…
The “Rule of Law” has been abrogated and tossed aside in the name of political contrivance
2. Private bondholders agree to a “voluntary” 53.5% haircut.
This raises a few questions…
First of all, why would anyone buy Greek bonds in the first place if default was likely?
Because the new bonds had a high interest rate and history has shown that governments tend to get bailed out. Plus investors could buy Credit Default Swaps (CDSs) to protect themselves in case of default. CDSs are a bit like insurance that in the event that Greece defaulted, the CDSs would mitigate any loss on the bonds.
Won’t a 107B euro write-down be devastating for the banks and other investors that own Greek debt?
It certainly won’t help. That’s one reason the ECB injected 489B euros into the banks in December and will add another estimated 400B-500B on Wednesday through their LTRO mechanism (the ECBs new favorite version of money printing which allows banks to put up worthless collateral to borrow at 1% for three years).
Why would private bondholders agree to a 53.5% reduction in the value of their bonds?
Because if Greece defaults, as they inevitably would without a bailout, private bondholders would get squat. The 53.5% was determined by the “experts” to be the number which would allow Greece to claw back to solvency. (Actually, when you factor in the modified interest rates it is more like a 70% haircut, but let’s not nitpick.)
Did all bond holders agree to lose 70%?
The deal was hashed out between the Troika, Greece and representatives of the largest private bond holders such as hedge funds, mutual funds and investment banks speaking on behalf of investors. However, investors still have a few days to choose not to take the haircut.
What if they decide not to agree to the haircut?
If a small number of investors don’t agree to the haircut they will likely get paid in full. However, if less than 70% or so of bondholders agree to the “voluntary” deal, then a newly (and retroactively) passed collective action clause (CAC) allows Greece to force the haircut on bondholders.
Why is the word “voluntary” in quotes?
They call it a voluntary agreement (despite all evidence to the contrary) because forcing the haircut might be considered a “credit event” and the CDSs would be triggered. The owners of CDSs would get paid but the issuers of CDSs would take big losses.
Wouldn’t bondholders want their CDSs to pay out and thus not agree to the deal?
You would think that the bondholders who bought CDSs would want to get paid. But there may be other considerations. Perhaps the fine print of the CAC is a worse deal for bond holders. Perhaps many CDS owners have other investments that would react poorly to a credit event. Perhaps there’s some arm twisting by central banks who hold the purse strings. All I know is that it’s complicated and interconnected.
So who sells the CDSs to Greek bondholders?
Mostly a few really big banks. CDSs can be bought by anyone who wants to bet that Greece will default, not just bondholders. The banks collect nice premiums on the $70B of notional value of CDSs, but will lose big if they are triggered.
Who determines if the CDSs get triggered?
The International Swaps and Derivatives Association (ISDA)
Who runs the ISDA?
The small group of big banks that wrote all the CDSs.
Oh, my! So wouldn’t the ISDA do everything in their power to just not trigger the CDSs?
Yes and no. They definitely don’t want to pay out the CDSs, so they are trying to pretend it’s voluntary so they can keep up the charade that CDSs are real insurance. However, these banks issue CDSs on other countries like Italy, Portugal and Spain, as well as corporate bonds. If investors get the sense that the CDSs are a sham they won’t buy CDSs and demand less bonds at much higher interest rates, which would accelerate the debt crisis in the other countries.
This sounds a lot like the 2008 financial crisis. Didn’t they learn their lesson about systemic risk, excessive leverage, CDSs from Lehman, AIG, etc.?
It is very similar to the financial crisis and they learned the lesson that governments and central banks will be there with bailouts and money printing to save the bad actors until the entire system implodes.
3. The bailout plan will get Greece back to a “manageable” 120% debt to GDP by 2020.
This is how you know that this whole thing is a joke and doomed to failure. These technocrat jackasses have no clue what’s going to happen next month, much less 2020. And since when is 120% debt to GDP manageable considering no country has ever recovered from 100% debt to GDP save Great Britain during the high growth industrial revolution? Before the ink is even dry the IMF is now recalculating the expected 2020 debt to GDP to be 129%.
In Q4 2011 the Greek GDP declined 7% from the previous year and unemployment shot up another 2% in the last couple months to 20%. The streets are literally on fire. After a few years of compounding deficits Greece will be right back where they started, but with an even worse debt situation.
4. The stipulations of the bailout confirm without a doubt that this is a bailout for the BANKS and not the Greek people.
The rules of the bailout say that the money must first be used to pay back creditors (aka the banks) while the Greek people get austerity and liquidation of public assets. In fact 87% of the bailout money goes right back to the banks holding prior debt, while 13% goes to the Greek economy. The icing on the cake in my eyes, was a fine print clause that, according to the New York Times, would allow creditors to seize Greece’s 100 tons in gold reserves if needed.
The bankers have been following this script for years in developing countries through the IMF and World Bank. Step one: loan corrupt governments money they can’t possibly pay back. Step two: when they collapse, buy up their assets for pennies on the dollar or take their real wealth as collateral for more loans they can’t pay back which are used to pay back the original loans.
Greece is simply the first instance of this happening to a modern, developed economy.
Option 2: Greece Defaults
Greece will default at some point regardless of the deal. The proposed bailout plan may buy them a few years, but the end result will be a bigger default.
The Greek people have caught on to the fact that this deal makes them debt slaves to the bankers and will siphon any remaining wealth out of Greece. Greece is scheduled to have elections in April and the opposition party who opposes the bailout looks destined to win. (As a funny aside, one of the requirements of the bailout deal is that all parties running for election in Greece need to pledge that they will not reneg on the deal if elected. This was probably put in place after one of the Greek leaders publicly said he’d just agree to the deal and then not implement the austerity.)
Greece got a preview of what can happen when you give the middle finger to the bankers and refuse their “help” in the example of Iceland. Iceland had a huge, unpayable debt to bankers so the people said “we’re not going to pay.” Their currency crashed, the people went through tough austerity, and after a few years the economy is growing again. Ironically, after their default, it is easier for Iceland to borrow at lower rates since they don’t have a big debt overhang.
That’s not to say things will go as smoothly for Greece as Iceland. The problems are quite different. Greece will still have a bloated government with massive pension liabilities and an inefficient economy regardless of the currency. The drachma will be massively devalued and Greek people will find things like food, gas, real-estate, vacations, etc. extremely expensive. The Greek government would be able to print up its own money to pay for its overspending, risking a complete collapse of the drachma.
In other words, they will need to undergo even more severe austerity than if they stay in the european monetary union. But at least they will be working for themselves and not the international bankers.
What About Contagion?
As I stated, Greece is merely the first domino in a chain sovereign debt crises. European leaders like Angela Merkel and Nicolas Sarkozy are rightly terrified of contagion in a completely interlocked, over-leveraged and over-indebted global economy. There will be contagion whether the deal goes through or not.
If Greece defaults, banks all across Europe will get decimated. Interest rates in the other PIIGS countries, Portugal, Italy, Ireland and Spain will continue to rise, hastening their own debt crises and further harming global bank balance sheets, including U.S. banks. (To get an idea of the magnitude of the problem check out this Awesome Infographic.)
If the CDSs are triggered it could spark a whole new liquidity crisis. The “net value” of the CDSs is only $1.2 billion so the bankers claim it’s not a problem because Peter owes Paul, and John owes Peter, and Paul owes John so it will basically cancel itself out except for $1.2B. But that’s assuming Peter can get his money in time to pay Pau before Paul goes bankrupt and starts a daisy chain of defaults, bankruptcies and bailouts like we saw with AIG in 2008.
The European Union is scrambling to set up and fund a new bailout (err, stability) fund called the European Financial Stability Facility (EFSF) to calm investors’ fear of default and thus keep interest rates from soaring. But the Germans are reluctant to keep piling money into this and the rest of Europe and the IMF doesn’t have the cash, so it’s hardly a done deal.
If Greece does get the bailout, the other PIIGS countries will want similar write-offs for their unpayable debts. Students in Spain are already protesting in the streets against Spain’s self imposed austerity measures. Greece was tiny and could be bailed out. Spain and Italy are another matter entirely. They can’t be bailed out without massive money printing.
The bailout and EFSF might also temporarily take the focus off of Europe and put it back on the U.S. and Japan, who have their own massive debt problems. But that’s another story…