Yesterday’s election result in Greece was about the best that could have been realistically hoped for. And that might be the most depressing thing. Let’s recap: Greece is broke. Greece’s government needs loans to pay salaries and pensions, but only a lunatic would actually lend money to Greece. Greece ended up getting a series of loan agreements from the International Monetary Fund, the European Commission and the European Central Bank (popularly called the “troika.”) Greece’s government has signed a series of agreements popularly called “memorandums” in which Greece’s government promised to cut spending and raise taxes in order to balance the budget and pay back Greece’s debts. Greece also has to privatize government-owned companies and implement market reforms (opening restricted professions to competition, making it easier for employers to fire workers, lowering the minimum wage) in order to make the Greek economy more internationally competitive. The combination of Greece’s government no longer being able to float the economy by vast borrowing (Greece’s budget deficit was over 15% of GDP in 2009), tax increases, spending cuts, and unimplemented market reforms has led to five straight years of recession. Greece is looking at about a 22% decline in GDP by the end of the year and the unemployment rate is over 22% and rising fast. By way of comparison, our Great Recession saw a GDP decline of 5.4% and an unemployment rate that peaked at 10%.
Greek politics has polarized around parties that want to keep a modified version of the “memorandum” (maybe with some of the budget cut demands softened a little) and parties who want the loan agreement scrapped in the hopes that the “troika” would give Greece funds with no strings attached as a way to avoid a global financial meltdown. By far the most likely outcome of scrapping the memorandum would be the troika refusing to disburse future loan installments and Greece having to go to the drachma to pay out salaries and wages. But the lure of bluffing the troika in pursuit of free money had a certain plausibility.
The two main contenders in the last election were the nominally conservative and “pro-memorandum” New Democracy party and the radical-left SYRIZA. Greece’s Parliament has 300 seats and you need 151 seats to form a government. 250 of the seats are awarded more-or-less proportionally and the other 50 goes to whatever party finishes first in the popular vote. New Democracy finished first with just under 30% of the vote and 129 seats in Parliament. The nominally socialist but pro-memorandum PASOK party won 33 seats so that a New Democracy-PASOK coalition would have 162 seats. That means there are enough votes to prevent an immediate meltdown in the Eurozone. That’s a big deal.
There are other small mercies. New Democracy won by a margin of just over 2.5%. That isn’t a landslide, but it big enough that there won’t be a big “we wuz robbed” movement from SYRIZA supporters. It also matters that a possible New Democracy-PASOK government will have 162 rather than 151-152 members. The new government will still have some very unpopular spending cuts to make and market reforms and civil service cuts will be opposed by active and entrenched interests that don’t hesitate to take it to the street. If the coalition’s majority is very narrow, then every last eccentric, crook, and coward in either party’s parliamentary delegation will be able to hold the government hostage by threatening to vote against a given law or simply by quitting the party and joining the opposition. Now it is more likely that only a major falling out between the coalition’s party leaders will bring down the government. That is the good news. Here is the bad news:
1. Greece is still probably going to default and crash out of the Eurozone with who-knows-what results. Greece’s economy is too uncompetitive absent a major devaluation of the currency, but that is impossible since Greece doesn’t have its own currency right now . So Greece has to go the even more painful route of nominally driving down wages. Greece’s debt is too large given Greece’s sharply shrinking economy. Greece’s government and political culture are too broken. Greek society is too exhausted, divided and cynical from a five year depression (the term fits) that still hasn’t hit bottom. Greece can’t and won’t meet its obligations to its creditors.
That is the case against Greece being able to avoid default, and I’m almost convinced. Don’t get me wrong. There is a nonzero chance that Greece reforms enough and doesn’t default. It would mean Greece following through on its market reforms and privatizations + Greece reforming and downsizing its civil service + Greece maintaining a stable government despite public outcry + Greece fixing its tax collection system + the troika being willing to put off some Greece interest payments and then writing off some significant portion of Greece’s debt when Greece’s government finally consistently reaches a primary surplus. That is a lot of needles that need threading. A happy ending (and this “happy” ending involves a lot of pain along the way) is possible, but it isn’t the way to bet.
2. Greece’s politicians are about the most selfish, vain, and short-sighted organisms to ever walk upright. Just last night, the leader of PASOK was saying that he would only join a coalition if SYRIZA joined too (and there is no chance on Earth that happens.) Almost nobody took PASOK’s leader seriously. Nobody should have. He was just trying to prove a point by making SYRIZA look unconstructive. That PASOK would choose last night to strike such a ridiculous pose is a bad sign for how long the coalition will hang together as the leaders of both coalition parties constantly put their own party’s short-term interests over the public interest.
It was amazing to see Antonis Samaras (the leader of New Democracy and almost certainly the next Greek Prime Minister) yesterday. In his “victory” speech he looked and sounded exhausted and broken. About the only clear winner from last night is President Obama. A Greece-instigated Euro crisis would severely damage his chances of reelection. It is now more likely (though not certain) that this crisis will occur after the November election. The rest of us gained much less. We have a faint chance that a global financial crisis will be averted. That is all the reassurance there is to be had.
June 18th, 2012 | 8:31 pm
Great stuff, Pete. Now if only you could explain the Egyptian situation!
June 18th, 2012 | 8:35 pm
Sorry, no can do. And thanks!
June 18th, 2012 | 9:29 pm
It’d be nice if there were any evidence that anyone has a plan for how Greece does not default in the end. Can-kicking is fine as a delaying tactic while things get shored up elsewhere, but can-kicking for the sake of can-kicking just makes things worse.
It’s like Shakespeare in Love:
Philip Henslowe: Mr. Fennyman, allow me to explain about the [EU]. The natural condition is one of insurmountable obstacles on the road to imminent disaster.
Hugh Fennyman: So what do we do?
Philip Henslowe: Nothing. Strangely enough, it all turns out well.
Hugh Fennyman: How?
Philip Henslowe: I don’t know. It’s a mystery.
Please tell me you have something more, EU wise men. Please tell me you’re not pinning your hopes on “it all turns out well.” This ain’t Hollywood. Sometimes everything ain’t “all’s well”…
June 19th, 2012 | 7:09 am
Brian, that’s the mode all right. It must turn out well because it ought to. Democratic peoples often act as if they have a strong belief in a God who will work everything out for them.
June 19th, 2012 | 9:11 am
Reading PowerLine this morning, Paul Mirengoff, looks at Max Boot in Commentary who is looking at the situation in Egypt and arguing that allowing democracy to work will work out best in the long run.
Which I bring up because of what Carl says about democratic peoples and God; doesn’t it depend on which god? Or in the case of Greece or any European nation, if God at all? I understand the impulse to think that way, but get caught lately in second thought, which is more along the lines of what Brian suggests.
God help us.
June 19th, 2012 | 9:25 am
Pete the Greek says it all in a stunning few and perfectly clear words. My own view is the Egyptian situation is even worse, but I don’t know if I can find an Egyptian blogger to flesh it out for us.
June 19th, 2012 | 9:31 am
Twenty four hours after the elections, bondholders are demanding higher interest rates on long term Eurobonds. This is how the game is played. Greece got a short reprieve; but, investors are beginning to play hard-ball. There will not be a repeat of last years’ compromise in which bondholders were forced to accept a 75% haircut in order to keep Greece afloat.
We will see shortly if the capital flight from the Euro continues. If and when the end does come (the Euro end, that is), it will happen quick.
June 19th, 2012 | 9:32 am
Carl: My understanding is that the EU has only gotten this far because Europe is actually strikingly undemocratic. And the “solution” that is proposed to the current problem is to make it even less so (i.e., to remove national sovereignty even more). Finally, to agree with Kate, I’ll say that if I thought that either the solons or masses of Europe had any faith in God at all, I wouldn’t be so worried.
June 19th, 2012 | 10:35 am
Great title, Peter; even better analysis.
June 19th, 2012 | 11:14 am
Typo alert: “Pete”, not “Peter”.
June 19th, 2012 | 12:18 pm
Peter, the pro-Arab-Spring yet anti-neo-cons and anti-Israel blog Arabist has good analysis. Their passion for Egyptian democracy causes them to know the details, which right now are nightmarishly fluid/complex, even if many will find their recommendations polly-annish, especially regarding the Muslim Brotherhood. But they are enough immersed in the stark reality of the choices that Egyptian liberals are presently facing to not be foolishly optimistic. A much worse situation than that faced by Greece.
Brian, I’m speaking of the Europeans as ideologically democratic. I fully agree with those who say the EU has a major democratic deficit. One aspect of Europeans being too ideologically democratic is believing in what Pierre Manent calls the “religion of humanity.” That concept is discussed in Manent’s A World Beyond Politics; Paul Seaton is right to recommend that book as an essential text for understanding what political philosophy can say about the fundamental political dynamics/facts of our time.
June 19th, 2012 | 4:40 pm
Pete, would it not be better for our Aegean friends to go ahead and collapse (and not take the Germans down with them), pay the price for their economic silliness, and begin to restore a true market economy in Greece. Much like we Americans stiff upper lipped it with our collapse and the lost of 40% or so of our wealth.
When a nation looses its moral ground there’s always going to be a price to pay, sooner or later.
Sadly, America’s economic misery is compounded by our failure to harshly punish those responsible both in gov’t and private business.
June 19th, 2012 | 6:58 pm
Thanks fellas.
Brian, I think there is a plan that Greece would balance its budget through tax increases and spending cuts (and produce a substantial primary surplus), institute labor market reforms and undergo an internal devaluation (basically produce large wage and benefit cuts to become more productive.) On paper this wasn’t crazy. The problem is that the Greek government sabotaged the implementation by spending the first two-plus years focusing on tax increases and pension cuts while avoiding cutting and reforming the civil service and slow walking the labor market reforms. This wasn’t incompetence. It was following political incentives. There is no guarantee that a better implementation would have produced a MUCH better result. The problem of sticky wages downward, the conflictual nature of Greek electoral politics, and the corrupt and clientist nature of the Greek political elite all make an internal devaluation that much harder (and it isn’t easy under ideal circumstances.) So Plan A is probably (but not certainly) politically unsustainable. So the Germans kick the can by alternating threats to block future loan installments and making vague offers to soften some of the bailout terms in return for better implementation.
“Pete, would it not be better for our Aegean friends to go ahead and collapse (and not take the Germans down with them), pay the price for their economic silliness, and begin to restore a true market economy in Greece.”
Bob, sure but the diabolical structure of the Euro doesn’t make it so easy. Once Greece goes to the drachma and defaults, then there will be a threat of a European and world banking crisis as investors wonder if Spain and Italy are next to turn Euro debts into debts in a new domestic currency that are worth half as much (or less) to the bondholder. If Greece defaults, it doesn’t matter to the rest of us what policies they then adopt. The rest of us are in just as much trouble if they adopt the economics of Reagan or Stalin.
June 19th, 2012 | 7:41 pm
Thanks Pete, but it sounds like the idea of the ‘euro’ wasn’t a very good one. Somewhere along the line everyone involved in these ‘bubbles’ is going to have to bite the bullet and seek to restore economic reality. It seems the earlier the better?
Never-the-less, I read your analysis with awe.
June 19th, 2012 | 8:45 pm
Boo!! (It is no fun, unless I disagree with everyone here). But I actually do!
Greece is “screwed” unless it adopts my policy solution(that of Warren Mosler actually) Essentially default indifferent, good as money bonds.
Because: “but only a lunatic would actually lend money to Greece.”
Not really, at 29% interest only a lunatic would borrow money. Figuring out the “sucker” in this game is not easy.
Lets put it this way if I could guarantee one 75% “haircut” on a greek 1000 Euro 10 year Bond I would buy one tommorow for 78 Euro. Sure at the end of 10 years I would only have 250 Euro instead of my 1000 Euro. (woe is me!) That is still a 12.2% return, post 1 75% “haircut”. If I suffer 2- 75% “haircut’s” I end a 10 year period with 62.5 Euro.
If Germany keeps with the strong Euro, tight money policy, it is almost guaranteed that the Euro provided it dodges political apocalypse(mainly “hype”), remains stronger and appreciates on the dollar.
So I could see starting with 78 Euro @ exchange rate $1.26= 1 Eu, = $98, and ending 10 years @ 62.5 Eu @ $2=1, and thus ending $125.
So I would be very suprised if the Euro is gone in 10 years. I don’t think Germany can keep up this tight money policy, I would have been suprised if you could get a Euro for $2. I don’t actually know what will happen in Europe over 10 years. I do believe that if Germany has its way Europe will have tight money, and that the US on a relative basis will have loose money. The “troika” unlike the Fed does not have a twin mandate of full employment and fighting inflation, the “troika” only fights inflation. So in this case American and English exceptionalism might actually be Keynesian!(it probably is) Which means a 1 Euro for around $2 sounds fair. (pure speculation)
If the Euro appreciates on the dollar, odds are you could lose money on the Greek bond denominated in Euro and gain in dollar terms (theoretically possible, and colorably probable)
JP makes it sound like Bond holders are loosing horribly. That is sort of like saying that Master Card and Visa are going to go broke because they lend to idiot consumers, who have the availability of bankrupcy, they do but it works out. They become high alpha, high beta plays.
In the abstract these democratic peoples who have a “faith in God” as Carl puts it, might be smarter than some of the comments here.
That is I think the current price might be more of a random walk than your rhetoric might suggest.
My policy solution would encourage banks to “lend” money to Greece.
Let banks pay Greek taxes using Greek bonds.
I am the only one with a plan, because essentially “default” does not matter if the asset is convertible into euro’s for the purpose of paying taxes.
At the very worst a greek bond would essentially become a financial instrument that is only good for paying taxes. “Default” would become a dinosaur of rhetoric(or at least more complicated legally/mechanically)
Banks in Greece make payments in Euro’s to the Greek government on a monthly basis. If functionally they could remove Euro’s from a client account and redeem bonds as payment, then this almost certainly changes the entire financing risk calculations.
Overnight, Greek Bonds go to 3% interest.
I am actually bullish on Greek Bonds,
I don’t think they are a safe investment. I do think Pete is most likely right(but he is so full of rhetoric that I have to disagree on principle).
But even a double 75% haircut over 10 years which might be the most likely outcome is not horrible, once you figure the tight money dividend. Slightly less likely is a single 75% haircut, which leaves you profitably in the 12+% annual return range.
Greece leaving the Euro is possible…But the most bullish thing that could happen would be for the Greek government to declare that the bond’s default language made it good as cash for the payment of greek taxes. In this case 78 Euro today becomes 1000 Euro in 10 years (if you are a bank), or at least 900 Euro if you are sort of bidding for a limited pool of greeks with tax bills. Think of owning Greek bonds as gift cards only redeemable at Greek government “restaurant”. If a bank is holding these gift cards, then when Greek’s who are customers need to pay taxes it can spend them directly for full value. But if a greek wants a discount on his taxes, say he owes 1000 Euro, why might he not be willing to pay 900 Euro on Ebay Europe for a greek bond? (hypothetical in any case, even non-greeks who would own bonds would do so thru an institution which would provide the liquidation service smoothly…it is not like any of you have a paper bond is it?) Depending on the transfer mechanisms for non-banks…It would I believe totally destroy the mechanics of this destructive usery death spiral.
In any case I think the reason the Apocalypse will come, and Pete doesn’t see a way out is that everyone sort of knows that a company (or a non-monetarily sovereign nation, being similar) cannot borrow 78 Euro and promise to pay 1000 Euro in 10 years.
So the cycle of Greek “debt crisis” will continue.
On the other hand I like Carl’s hypothetical democratic man, and Brian’s “Philip Henslowe” in a sort of random walk, que sera sera way.
The thing is, Brian in my opinion just doesn’t realize how rediculous his question is: “It’d be nice if there were any evidence that anyone has a plan for how Greece does not default in the end.”
If I put on my Philip Henslowe hat, this sounds like a man who laments that a team that is down 3 games in the world series is not an even bet with the team up 3 games. I mean if you want the German odds (the team up 3 games, you can get your 1.34% annual) If you want your Greek odds (the team down 3 games, you can get your 29% annual). Obviously the payout is higher the longer the odds, and it is too much like bitching that your trifecta of long shots never won a derby.
A 10 year 1000 Euro German bond with damn near 100% chance of being paid in full costs: 875 Euro vs. 78 Euro for the Greek bond.
I differ than Pete, in that I think there is a zero chance that any of the reforms he suggested change the math. The only possibility is a change to the legal architecture upon which the math is based…so a policy reform of a sort, but more narrowly focused upon exactly what “default” means in the first place.
Of course the reform I think “saves” Greece actually works as a super windfall for anyone who buys greek bonds now.
Politically I think SYRIZA could push/pull it off in a deal that saves its “base”, it would still need to modernize and making the reforms pete suggests might be good, but essentially unless it can get to where it can borrow at 3%, there is enough truth to the neo-keynesians (especially with regard to all economic variables denominated in a currency) that all this will cause is doom.
I think Syriza could pull it off because geo-politically such a deal would be best for Big French banks like Credit Agricole. Of course this is not the French plan, the French plan is less transparently in the interest of France, and big holders of Greek Debt.
This is actually the Warren Mosler plan.
But basically under the French plan, or even the Pete Spilankos plan which might be good, the plan does not really change the Greek risk calculation/thus the bond price. All these plans simply bake Greek default into the price(random walk), and hope to negotiate favorable “haircuts” that keep Greece in the Euro, and the Eurozone. The plan is essentially that Greece will default on favorable terms. For sophisticated parties, this is a tactical gold mine.
The plan is more or less eternal “negotiation” and “arbitration”, and the faith that it will all turn out alright is more or less akin to the idea that labor negotiations with a union will turn out alright (similar also in terms of rhetoric?).
June 20th, 2012 | 8:11 am
Once Greece goes to the drachma and defaults, then there will be a threat of a European and world banking crisis as investors wonder if Spain and Italy are next to turn Euro debts into debts in a new domestic currency that are worth half as much (or less) to the bondholder. If Greece defaults, it doesn’t matter to the rest of us what policies they then
1. They are already wondering;
2. Adopting a new currency does not re-denominate anyone’s existing debt. What it does is re-price a country’s exports and imports and allow the deficit in the balance of payments to dissipate.
3. The last time I checked, the major bank holding companies in this country had only a modest proportion of their assets (5-6%) in the debt issues of Eurozone governments or Eurozone banks. (The notable exception was the parent of Metropolitan Life). Dangers to our banking system would have to be through some occult transmission belt having to do with trades in swaps and derivatives.
4. If I am understanding correctly, the one financial concern undone in 2008 by trading in swaps and derivatives was AIG, which ‘warehoused’ the risk rather than buying and selling credit protection the way others did.
5. Europe’s banks tend to be a) very large and b) quite thinly capitalized. They are in serious trouble. Outside of Europe, not so much.
June 20th, 2012 | 8:47 am
John, “Lets put it this way if I could guarantee one 75% “haircut” on a greek 1000 Euro 10 year Bond I would buy one tommorow for 78 Euro.” If someone emails you an offer of such a deal, know that you are being scammed. If Greece were to ever float sucha bond issue (78 Euro upfront and 1000 Euro in ten years) they would be laughed at.
“JP makes it sound like Bond holders are loosing horribly.” Private Greek bondholders bought bonds at less than 7% interest and got a 74% haircut. That’s losing pretty horribly. that means that future bonds sales (if and when they happen) are going to price in a higher default rate.
I don’t know why you think Greece is any more likely to pay 4% or more of GDP to pay for its backward looking debt in bonds redeemable for Greek taxes rather than as payment to Greek bondholders in the troika. The Greek government still has to cut spending or raise taxes by the same amount either way (I suppose they could scam out of it by passing a special “bond tax” oh holders of the instrument you describe – that would just be another way to default.)
AD, “Dangers to our banking system would have to be through some occult transmission belt having to do with trades in swaps and derivatives.” Yup.
June 20th, 2012 | 11:50 am
Pete, do you recall the credit default swaps auction on the Lehman Brothers bonds? Nouriel Roubini’s site was saying that $100-150 bn would have to change hands even after the Depository Trust and Clearance Corporation issued a public estimate that $6 bn would have to change hands when everything was netted out. AIG’s Financial Products Unit sold $400 bn worth of credit protection on mortgage backed securities, full stop. Other people were both buyers and sellers, so did not require $182 bn in capital courtesy the Federal Reserve. (And if I am not mistaken, MF Global’s demise was a consequence of bond purchases, not swaps and derivatives trading).
June 20th, 2012 | 1:08 pm
AD, my sense is that Roubini overstated the depth of the 2008 fiancial crisis as it was happening, but his recent commentary (Lehman Bros. comparisons aside) indicates that he thinks the US would come out okay from a European financial crisis as long as the US put itself on the path of getting its own house in order.
As far as I can tell, MF Global got in trouble from borrowing money to engage in (more complicated than I can fully understand) European bond purchases and of course using customer segregated account funds to keep the game going in the hopes that the bet on the bonds would become profitable.) That was as much sense as I could make out of the Trustees Report.
If a Euro financial crisis comes (and I hope it doesn’t), I’ll be quite happy if the effects are limited to those that come from a European economic slowdown. If that is where your analysis is headed, I hope you’re right.
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