The Closed Debt Talks Time Loop

In terms of the Greek deb negotiations, every day seems like groundhog day: they're always 'close to an agreement', but somehow never seem to be getting there. Dimitris Kontogiannis at Ekathimerini expresses the optimistic view: Greece will continue to be able to blackmail the 'troika' into releasing more bailout money. Alas, yet another 'haircut' will be unavoidable anyway.


„The likely agreement between Greece and the troika on the terms of the new economic program and the level of private sector involvement (PSI) will significantly raise the cost of a Greek exit from the euro. However, it is likely not to be enough for Greece to avoid another major public debt restructuring down the road.

When this article was being written it was not clear whether Prime Minister Lucas Papademos and the three political leaders would reach an agreement with the representatives of the European Commission, the International Monetary Fund and the European Central Bank — collectively known as the troika — on the second economic program.

We have always assumed, however, that the stakes are too high for both sides to fail to reach a fair compromise, and therefore we will proceed on the assumption that there will be an agreement on the terms of the second bailout package and the PSI plan will be implemented.


In this light, we argue that the agreement acts as a barrier against a potential Greek exit from the eurozone because it shifts to a large extent the cost from the private sector to eurozone countries. Therefore, it should put to rest for quite some time talk of Greece’s euro exit in official circles, which was not the case before former Premier George Papandreou came up with the idea of a referendum on the agreement reached at the European Union summit last October.

It is noted that Greek government bonds in private hands accounted for more than 90 percent of total public debt in 2009. At the end of 2011, the percentage is estimated to have fallen to about 56-57 percent as official loans by eurozone countries and the IMF replaced expiring bonds and the ECB amassed some 40 to 60 billion euros of Greek bonds.“


(emphasis added)

There are quite a few assumptions here that may turn out to be incorrect. As far as we can tell, there are quite a few private sector holders of Greek bonds that are deeply unhappy with the demand that they accept an over 70% haircut and at the same time cast this process as 'voluntary' so that they won't receive payment on their CDS hedges. The Financial Times meanwhile argues that the failure of the political parties in Greece to come to an agreement regarding the most recent demands of the bailout lender 'troika' means that Greece has come a decisive step closer to default:


„After five hours of discussions, the three leaders of Greece’s national unity government had not accepted demands by international lenders for immediate deep spending cuts and labour market reforms as part of a new medium-term package.

Mr Papademos said the political leaders had agreed on some “basic issues”, including making spending cuts this year of 1.5 percentage points of gross domestic product, or about €3bn, according to a statement from his office.

George Karatzaferis, the head of the small rightwing Laos (People’s) party said as he left the prime minister’s office, that he expected the talks to continue on Monday. There was no immediate announcement by Mr Papademos.

It was clear however that the talks had reached a dangerous deadlock. “They’re asking for more recession than the country can take,” said Antonis Samaras, leader of the centre-right New Democracy party as he left the meeting.

The talks with the three leaders of a national unity government came after the government failed to persuade the so-called “troika”– representatives of the European Commission, European Central Bank and International Monetary Fund – to ease conditions for the rescue deal.

Patience with Greek politicians has evaporated among its creditors. During a conference call on Saturday, eurozone finance ministers bluntly told Athens to deliver on its promises and agree to reforms or face default next month“


(emphasis added)

We actually happen to think they mean it this time. If Greece can not come to an agreement that is politically palatable to its lenders, they will cut the flow of funds off. Hence the German idea that Greece's budget should be supervised by an external commissar as long as the bailout funds are flowing. How else is compliance going to be achieved? More on this further below.

Meanwhile, Athens has accepted the demand to shrink its ineffectual bureaucracy. 15,000 government workers are to be laid off.


Greece has agreed to lay off 15,000 public-sector workers by the end of 2012, a government minister said Monday, as international pressure mounts on Athens to accept austerity measures needed to secure major new debt agreements. The cuts will come by abolishing or cutting back a number of public-sector entities, Administrative Reform Minister Dimitris Reppas said in a statement.

The announcement late Monday signaled a concession after meetings between Greek Prime Minister Lucas Papademos and the country's political leaders over a reform program demanded by the country's creditors had been delayed for another day. Party leaders remain at odds over broad wage cuts, one of the most politically sensitive demands issued by Greece's creditors.

Meanwhile, the EC gave its strongest warning yet on Monday to Greece's political leaders to accept the latest austerity measures and complete talks with private creditors on debt restructuring, saying the country already has missed important deadlines.“


(epmphasis added)

Greece has missed important deadlines? You don't say. It should be noted here that there is actually no choice either way. If creditors were to cut off funds to Greece, the government would be forced to announce even bigger layoffs. It would no longer be able to pay.

Apparently the Greek coalition members are now also close to agreeing to a 20% minimum wage cut – an important step in liberalizing the labor market and getting unemployment down. However, popular resistance to these measures keeps growing and yet another general strike looms as a result.


Greece's two major umbrella unions said they will hold a 24-hour nationwide general strike Tuesday—the latest in a series of strikes called to protest successive waves of austerity measures Greece has taken over the past two years.

Apart from the popular reaction on the streets, the measures are likely to face resistance among lawmakers, many of whom have already balked at voting for new cutbacks. Earlier Monday, two Socialist lawmakers signaled they would vote against the reforms—although it is unlikely that a revolt by deputies will imperil the government's super majority in Parliament. The three parties who make up the coalition control 252 seats in the 300-member Parliament.”


(emphasis added)

The popular resistance is understandable, but it should be clear that there simply is no more money for the State to distribute. While a default would not alter this situation, it would at least send a message to lenders: throwing good money after bad is not a good idea. It would also produce a clean slate and make it easier for the government to implement the necessary reform measures. No-one could force it to keep spending money it simply doesn't have.


The History of Externally Imposed Budget Supervision In Europe

The German idea to plant a EU commissar in Athens as the new budget supervisor whose decisions could not be overruled by the government has produced a mighty political backlash. Practically the entire eurocracy ex Germany was up in arms over the idea (notable exceptions were of course other creditor countries. You can bet that e.g. the Netherlands are firmly in favor of the idea).

However, this method is actually a well-worn tradition in German lands. Back when there was still a Holy Roman Emperor and Germany was a jumble of small city-states and tiny self-governed territories (if only we could bring this arrangement back!), it was a matter of routine policy. If one of the countless princes, counts or dukes proved unable to run a budget and drove his territory's government into insolvency, the emperor in Vienna would send out his fiscal commissars and they would take over the finances of the territory concerned. The powers accorded to these imperial finance commissars were of a breadth today's EU commissioners can only dream of.

Only the debt commissioner could arrange for further credit. No expenses could be made without his approval. If there were too many castles in the territory concerned, some of them were sold off. As the Austrian paper 'Die Presse' reports, there was for instance the case of the profligate Duke Ernst Friedrich III of Sachsen-Hildburghausen, who was put under the tutelage of the Kaiser's debt commissioners in 1769. Many civil lawsuits for unpaid debts were pending against the overly generous duke and his Great-uncle Prince Joseph-Friedrich pushed for the intercession. Incidentally he was made chief of the debt-commission that took over the administration of Sachsen-Hildburghausen.

Contrary to what one might expect, the citizens of the state were actually quite happy with the arrangement. The 'loss of sovereignty' didn't bother them much – what bothered them was that someone would eventually have to pay for the duke's financial extravagance. And that someone were of course the territory's taxpayers.

The emperor's debt commissars didn't exactly treat debtors with kid gloves. In Sachsen-Weimar-Eisenach, they took away peoples' windows and doors in the middle of the winter to force them to pay the taxes they still owed.  Greece's countless tax cheats don't have much to fear by comparison.

The citizens of the German states that were under the supervision of the  imperial debt commissions didn't object to this harsh treatment of debtors – in the end, fixing the finances of the territories concerned was regarded as a highly desirable goal, as tax payers didn't want to chafe under high taxes for many years to finance the fiscal mismanagement of their rulers. The commissions as a rule remained in place until the financial situation was considered fully rehabilitated. Fearing a further loss of prestige, the rulers of the territories usually kept to the agreements that were struck before the commissions left.

And what of Sachsen-Hildburghausen? The duke had really done a number on the territory's fiscal situation. The imperial debt commission had to remain in charge until 1826 – a time at which the Holy Roman Empire actually no longer existed.

So you see, the idea to install a budget supervisor from outside has tradition in Germany. The notion didn't just drop from the sky. The Germans were probably a bit surprised that it provoked so much resistance.



Bankrupt Duke Ernst-Friedrich III of Sachsen-Hildburghausen:

Put under the tutelage of a debt commissioner in 1769.

(Painting by Johann Valentin Tischbein, 1765)


Installing a Budget Commissar Through the Backdoor

Alas, the idea has not rolled over and died just because it is being resisted. The new Greek Bailout program comes with a twist that so to speak replaces the budget supervisor with a hard-and-fast rule.

As the FT reports:


European officials are insisting that any new bail-out programme for Greece earmark funds specifically to pay off remaining holders of Greek debt, giving lenders the freedom to withhold aid to Athens without risking a messy default that could reignite panic in financial markets.

Under a new Franco-German plan that senior European officials said was likely to be included in a new Greek rescue, eurozone officials would create an escrow account to accept new bail-out funding instead of paying it all directly to Athens, as in the past.

The new fund would then ensure bondholders were paid off while additional cash to run the Greek government could still be withheld if Athens did not live up to tough new reform demands.


A senior French official said the Franco-German plan, which has backing from the European Commission in Brussels as well as several other eurozone countries, was a way of “removing the Damocles sword of default” while keeping pressure on Athens to reform.

The idea of prioritising debt payments was included in a controversial German proposal circulated to eurozone finance ministry officials last month, which also called for a “budget commissioner” with veto authority over Greek spending decisions.

Eurozone officials said they believed the escrow account would give European Union and International Monetary Fund lenders strong control over Greece’s use of bail-out funds without stripping Athens of its budgetary sovereignty. “This is a better idea than the proposal of a debt commissar,” said the senior French official. “It is more acceptable.”


(emphasis added)

So in other words, the very things the budget commissioner would have done will now be done automatically. This is also a reminder of what the bailout is really all about: it is not really meant to 'help Greece'. It is meant to help Greece's creditors to get their money back. While the Greek government has all but defaulted anyway, there looms the much bigger issue of cross-border claims on private sector entities in Greece. A hard default followed by an exit from the euro area would likely impair the great bulk of these credit claims. Thus small Greece continues to harbor the potential for creating a major financial crisis.


Greece's public debt to GDP ratio compared to the euro area average from 1999 to 2010. Not once has this ratio been within the limits imposed by the Maastricht treaty. How was it possible for Greece to ever accede to the euro under these circumstances? – click chart for better resolution.


Greece's one year note yield closes at an absurd new all time high of 504% in Tuesday's trading, after hitting over 527% intraday – click chart for better resolution.






Charts by: Bloomberg, Eurostat



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4 Responses to “Greek Debt Negotiations – The Farce Drags On”

  • worldend666:

    It’s worth noting the proposed new minimum wage is around 600 euro a month. Just across the border in Bulgaria the minimum wage is 150 euro. Should Greece default what would be the difference between Greece and Bulgaria? Other than the fact Bulgaria has 10% income tax and one of the lowest debts to GSP in europe of course.

  • anto:

    What happens to the CDSs written on the old Greek bonds (assuming they aren’t triggered)? Will they be transferred to cover the brand-new bonds, or are they just worthless?

    Also, I keep hearing that the new, swapped bonds will be 30year bonds at around 3.6 yield. Does this mean that all Greek bonds, regardless of their maturity, will be converted into 30years? That sounds ridiculous, but I haven’t heard anything at all about any of the bonds being swapped for anything but 30yrs.

  • Andyc:

    “Wow a 527% return in one year, whats not to like!!”

    Jon Corzine

    I wonder what the total in purely speculative CDS purchases on all this sovereign debt amounts to and which parties are potentially on the hook for it?

    I realize such knowledge would be considered top secret information so do not divulge……

    : )

  • I wonder if it would help to put that last chart in front of the US Congress and the President? Bernanke has surely been looking at it lately. Maybe he should push the Funds rate to 5% in 6 months to give them a demonstration?

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