S&P Says Greek Plan IS Default
Last week the French (banks and government) proposed a roll-over of Greek debt into new bonds, some with maturities as long as 30 years. By Thursday German lenders, insurers and government agreed to join the plan, which would cover debts falling due from now until the end of 2014. As France and Germany are by far the largest Greek creditors, the world heaved a big sigh of relief as a Greek default was going to be avoided, at least temporarily. Stock markets around the world staged huge rallies. Armageddon had been avoided again. The IMF welcomed the move to extend the resolution of the Greek debt crisis as a move that would allow for creation of conditions for sustained growth and employment. The default of debt coming due and the imposition of extreme austerity on Greece were feared would create a spiral into severe depression. In addition, the resulting stresses on the Eurozone financial system would have far reaching effects. From the BBC:
The French plan is designed to make Greece’s debtload more manageable in a way that would not be deemed a formal default.
If the deal is classified as a default by ratings agencies or credit derivatives traders, it could force European banks to recognise billions of euros in losses in Greek debts that they currently hold, putting their own solvency at risk.
It Is Default
But now Standard & Poors has thrown some sand in the gears that started turning just a few days ago. The credit rating agency has issued a statement that says the proposal is tantamount to a restructuring, such as would be accomplished by a formal default. In other words, the French proposal puts lipstick on a pig, but doesn’t change it anything else. The ugly duckling in this case will not grow up to be a swan – unless, of course, it is a black one.
According to the Financial Times:
French and German banks’ plan to roll over their holdings of Greek debt suffered a blow on Monday as Standard & Poor’s, the credit rating agency, said the move would amount to a default.
The proposal to provide up to €30bn ($43.6bn) in financing for Greece had been made conditional on rating agencies not downgrading Greece’s debt. But S&P said on Monday that any rollover would be a “distressed” transaction and thus lead to Greece’s rating being lowered to selective default.
The FT article goes on to say that officials in both France and Germany said that such a move had been anticipated and "should have no immediate impact on credit default swaps (CDS) markets." Such a statement flies in the face of the rapid and extreme degradation of Greece’s credit worthiness as seen in the following graph from Money and Markets:
CDS Webs and Insolvency
Further from the Financial Times article we find that officials said that the important thing was to avoid a credit event like the one that occurred after the Lehman default when the entire labyrinth of CDS inter-relationships was feared to be blowing up. To avoid such an event it will be necessary to "persuade the ECB (European Central Bank) to take affected bonds in exchange for providing liquidity to Greek banks," one official said.
The entire exercise appears to be one of confusing the boundaries between liquidity and solvency. It might be said that the plan is one that says "if we pretend the bonds have value then the bonds have value." This ignores the basic premise of GEI(Global Economic Intersection) contributor Michael Hudson: "Debts that can’t be paid, won’t be." Hudson is not taking this proposition lightly – it is the title of his next book due out in a few months. Prof. Hudson has further proposed that no deal can be binding on Greece without a national referendum such as was held recently in Iceland. There the voters soundly rejected assumption of debt by the taxpayers of that country to pay for a bailout of UK and Dutch investors.
New World Order
Brad Lewis has suggested that the workout (“bailout”) as being formulated is nothing more than a grab of Greek assets by northern Europe. Prof. Lewis asks if Greece is destined to become a colony.
Michael Pettis goes even further. Seven months ago he said that the current restructuring and default process would not end with Greece, but would extend to Portugal and Spain. Pettis likened what is going on in Europe to the U.S. civil war, this time being fought with financial weapons. He wrote, “Once the dust finally settles Europe will either be a unified country with fiscal sovereignty firmly established in Berlin or Brussels, or it will be fragmented with little chance of reunion.”
Elliott Morss has looked at the ascendancy of power by finance from a different viewpoint. He sees the fragmentation of national power under the onslaught of large NGOs (non-governmental organizations), multinational corporations and banks plus the explosion of new technology. It may not be governments as we have known them which are running the world of the future. It may be a strengthening of the new feudalism described by Derryl Hermanutz.
Risk of Capital
Whatever happened to capital risk? The only risk that appears to remain for creditors is that the debtors may end up refusing to endure slavery to preserve the lenders’ precious principal.
Whatever happened to restructuring when ability of creditors to pay could no longer be maintained? Has the world been reduced to a game of Monopoly where ultimately there will be only one winner and all others will be slaves? Dirk Bezemer wrote an excellent essay last year in which he recounted to the “clean slate” resolution of insolvency problems in ancient Babylon. In that case, sometimes as frequently as every seven years, overextended debts were cancelled, basic property rights of debtors were restored and creditors took a haircut. The haircut losses were simply a cost of doing business for capital. Of course, ancient Babylon may not have had the same principal of operation for capital that exists today – hundreds of times as much income for those who control the capital as for the rest of society. Ancient Babylon may not have had the Golden Rule: He who has the gold makes the rules.
Shylock
Andrew Butter has compared the current Greek situation to the Merchant of Venice. He points out that it was less than a century ago when the Weimar Republic had a debt that couldn’t be paid. That was resolved (after an episode of less than successful seizing of assets and bloodshed) with a restructuring of debt and currency that led to seven years, often referred to as the “Golden Era” of Germany. Unfortunately, a cornerstone of the German debt workout depended on American capital and that all collapsed with the New York stock market crash of 1929. We know what the ultimate result of this collapse was: Hitler, 1933.
Andrew has asked: “Wouldn’t what worked in 1923 Germany taste better than a pound of Greek flesh?” He asks a very good question, which relates back all the questions raised by previous references. But history has taught us that the solution may not work if it depends on the performance of the American (or any other) stock market.
Restructure and Move On
All the contributors above have one thing in common: They are of the opinion that it is time to swallow the medicine, take haircuts (even a few that may remove entire heads) and restore a balance of power between creditors and debtors. Dirk Ehnts points out that this option is almost completely ignored in the media. He says that price adjustments are needed, not just for financial assets, but in the real economy as well. Until there is restructuring and a moving on, these adjustments are simply postponed. Steve Keen has presented much the same picture with very detailed analysis.
Get this over with already! What is being done is like supplying continuous transfusions to a patient who is losing massive amounts of blood and leaving the injury untreated. It is time to apply some disinfectant, treat with antibiotics, cut out any dead flesh, suture the wound and get on with healing. To do otherwise, the Armageddon that was avoided last week has simply been deferred.
This article was prompted by a news item at GEI News from which excerpts were taken for the beginning of this piece.
Added note: A reader has suggested that Greece is largely responsible for the current situation. Of course he is correct. Here is the response I sent to him:
A key element of this problem (and one that Andrew Butter developed well in his Merchant of Venice article) is that tax evasion and avoidance in Greece has been elevated to an art form. The difficulty arises when spending is predicated on tax collections that do not occur. That leads to financing (bonds) to bridge the gap, but the gap keeps widening , as you point out in your comment.
Greece did not need to get in this situation. They could have cut expenditures to match the actual tax receipts or they could have tightened their tax codes and enforcement. Greece did neither.
Related Articles
Euro Crisis: Key Facts and Predictions by Elliott Morss
The Rough Politics of European Adjustment by Michael Pettis
Fragmentation of Global Power by Elliott Morss
Will Europe Face Defaults? by Michael Pettis
End of the Shell Game? by Dirk Ehnts
Merchant of Venus Redux by Andrew Butter
U.S. and EU Debt Crises Compared by Andrew Butter
Will Greece be Colonized? by Dirk Ehnts
Greece: No Deal Without a National Referendum by Michael Hudson
EU: Politics Financialized, Economies Privatized by Michael Hudson
Bank Capital is Illusory by Raihan Zamil
It seems to me that everything I read (maybe selection bias???) gives very good examples of defaults that solved the problems post haste (Sweden, Argentina, Russia ?Iceland?).
So WHY is it that GOVERNMENTS seem to do everything in their power to support bond holders and banks and oppose defaults? Do they know something we don’t – the world financial system is just a big house of cards and it would collapse with a few defaults? Or are they just generals figthing the last war?
Are there any arguements or examples that country defaults do not work out?
Dan – – –
Actually The Great Depression is an example related to defaults that were not resolved well. In that era high private leverage was allowed to default, first with no government involvement in the bankruptcy (1930-32) and then with insufficient and hesitant (fitful) government involvement (1933-1939). Only with the massive stimulus of spending for WW II was a sufficient government role exercized to permanently reverse the contraction.
The Great Depression was the result of indirect sovereign default. Defaults occurred in the private sector that spiraled through the world economy because sovereigns “defaulted” on the opportunity to step in in an effective way.
In the modern era we have had massive assumption by sovereign entities of private debt to protect the interests of private leverage at the oligarchy level. Little has been done to unwind the excessive leverage, only to extend it. At the citizen level the unwinding is progressing as mortgage and credit defaults continue.
The financial house of cards is an apt analogy. Fractional reserve banking, where 90% to 95%+ of “money” is actually credit backed by “assets”, is a house of cards. As long as the assets are not distressed (the weather remains sunny), the glue holding the cards in place remains strong. However, when the weather turns stormy much of the glue is found to be water soluble and cards start falling out of place as demand for the assets (which is what supports their price) collapses.
The arguments that sovereign defaults do not work come from those who say that high leverage must be supported to realize continued economic growth. Sovereign debt is comprised of private creditors as well as other sovereigns. There is much logic to the argument that deflation can produce a destructive spiral that destroys wealth for both creditors and debtors. However, deflation is a great benefit for those who are neither creditor nor debtor.
Inflation, on the other hand, is very damaging to wealth not in the credit/debt world and to some creditors who have not advantageously positioned their interest arrangements. Debtors are greatly advantaged.
So, Dan, the answer to you question is that it is not whether sovereign defaults have been successfully completed. The answer is that the equitable distribution of losses from defaults throughout the economic universe has never been achieved, except possibly in ancient Babylon.
And, as long as any economic interest (be it finance, industrial, military or labor) has a superior political position, equitable resolution is a virtual impossibility.
Iceland looks like it is recovering well. It had one big advantage in that it could use its currency to take the strain of devaluation. Greece does not have that advantage. The reason that politicians do not want to allow defaults is that it would look bad on the party in power. Plus they have been exceptionally generous political donors. Since most political parties are always broke they are vulnerable to being corrupted by a big donation or three. The banks have effectively bought our governments. That is probably the biggest reason for their survival. Tony Blair when he left office became a director of JP Morgan. In fact most british PM’s have done the same. Look at politicians everywhere they do the same.
I do agree with the assessment that this is basically asset stripping by foreign banks. They should default and let moral hazard take its place. Yes it might be scary but all the governments have to do is protect the normal banking business and basically strip shareholders and bond holders of any rights to any branch network assets in a default. Then let the rest of the economy resume business.