False dawn

As dawn broke on 21st February 2012, the leaders of the European Union announced that they had agreed terms for additional financial support to Greece to enable it to meet scheduled debt repayments on 20th March. European Union officials pronounced that "the European debt crisis is ended".  Light has dawned, the sun is shining and everything is rosy.

Except it isn't.  Not one commentor on the dawn deal thinks that it solves anything. As the BBC Breakfast reporter said, all it does is "buy time". Time for what? Time will solve nothing. Even with this deal and a VERY large amount of economic luck, Greece's debt is only forecast to reduce to 120% of GDP by 2020, which for a country as poor as Greece looks unsustainable. And that assumes that Greece is able to return to growth in 2013 despite the extra cuts imposed in this deal, which are almost certain to deepen recession further. And it also assumes that Greece somehow manages to maintain a primary surplus in excess of 4% from 2013 onwards. Neither assumption looks remotely believable. The IMF's worst case scenario (in its Debt Sustainability Report, leaked yesterday - timing impeccable, as always) is that Greece's debt in 2020 will be 160% of GDP, which is about the same as it is now and completely unsustainable. Zero Hedge, pessimistic as ever, commented that the IMF's "worst case" scenario looked decidedly upbeat and things could be much worse. Other commentors have joined in what is rapidly becoming a storm of criticism. This deal is yet another flavour of Eurofudge - and a particularly bitter one at that, because despite even more austerity and surrender of sovereignty being demanded of Greece, it does not appear remotely adequate.

Let's be clear what this deal is NOT.  It is not, in any sense, a rescue of Greece. Greece itself will receive very little of the additional lending provided under the terms of this bailout. The vast majority will go to foreign holders of Greek debt.  And the measures that Greece has had to agree to put in place to qualify for this "assistance" will push more people onto the breadline and drive the economy deeper into recession - if they can be imposed at all, which is looking increasingly unlikely. No, in no sense is this deal a bailout of Greece.

Contrary to popular belief, it isn't a bailout of private banks and financial institutions either. Private sector holders of Greek debt are being expected to take a reduction of 53% in the nominal value of their holdings and a total NPV loss (including interest payments) of 75%. By any standards that is a substantial loss. Yes, any prudent financial institution will have written down the value of its bond holdings to junk long since, so this haircut doesn't necessarily hurt their reported profits - in fact properly marked-to-market Greek bonds are probably worth even less than this haircut, so the debt restructuring might reduce their realised losses. But that is cold comfort. However you look at it, this deal leaves private sector investors taking heavy realised losses on their portfolios. And the "voluntary" description of this restructuring looks increasingly thin. The Institute of International Finance (IIF), which is the "private sector representative" that has agreed to this debt swap, actually only represents about 50% of private sector bondholders. The rest haven't been asked, but it is widely believed that hedge funds, at any rate, would prefer not to participate. Furthermore, even those bond holders represented by the IIF still have to agree to the deal. So the private sector could still scupper it. The Greek government is putting in place Collective Action Clauses (CACs) to force reluctant bond holders to participate in this deal.  I don't call that voluntary.  It remains to be seen whether the almost criminally useless ISDA agrees with me. Somehow I doubt it....even though it is hard to see that this is anything other than a structured default, so it should trigger a credit event.

It has been argued that the European Central Bank (ECB) and Eurozone National Central Banks are benefiting from this deal, because they are not taking a haircut. But since when has not losing your shirt been a "benefit"?  The ECB is taking steps to ensure that it doesn't get caught up in the debt swap and end up taking losses, and National Central Banks are expected to follow suit. So their investments are more-or-less secure. The private sector is understandably annoyed about the ECB's behaviour, since it means that their investments are effectively subordinated to the ECB and the ECB can rewrite the rules at any time to suit itself.  This may make it even more difficult to persuade private sector firms to participate in the haircut, which increases the likelihood of some form of coercion. I can't help wondering whether the ECB accepting some losses might have been a wiser course of action.

The only people who benefit from this deal are the politicians who have staked their careers on the survival of the Euro. That now includes the unelected "technocratic" Greek government, which now has a vested interest in preventing Euro breakup at any cost. But the benefit to politicians is starting to look doubtful as well.  National politicians in the Northern states of the Eurozone are finding Greek bailout hard to sell. The increasingly draconian measures demanded of Greece by politicians from Germany, the Netherlands and Finland are without doubt intended to sweeten the pill for their electorates. And in Greece, the population is tired of seemingly never-ending austerity and angry at both their own government and the Eurozone leadership. Memories of World War II are resurfacing in Greece and German leaders are being portrayed as Nazis. The benefits of the European Union - free trade, freedom of movement, support of certain industries and poorer areas, and above all peace - are quickly being forgotten, as the price paid by weaker and stronger countries alike for propping up the misbegotten Euro starts to look too high and old wounds are reopened.

The biggest losers from the failed Euro project are the people of Europe. The principles of democracy and self-determination are being sold down the river to maintain the illusion of unity and common purpose.  Across the board, measures are being put in place that undermine national democracy:

-  Greece must write into its own constitution a legal requirement to give higher priority to paying foreign creditors than to paying welfare and state pensions, and the money to pay these creditors must be placed in a so-called "escrow account" so that it can't be diverted to other purposes - in other words, Greece will no longer be able to default on its debts. Unless Greece manages to create a primary surplus within the next three months, which seems almost impossible, it will either have to default on its commitments to its own people or borrow yet more money to meet those obligations

- Hungary faces a funding freeze until it cuts its budget deficit - by means of austerity, of course.  The fact that its budget difficulties are at least partly caused by Eurozone banks reducing cross-border commitments in order to appease the Eurozone leaders, who insisted that they must not reduce Eurozone lending portfolios while they recapitalise, is apparently lost on the EU leadership

- Countries in "deficit reduction programmes" - currently Greece, Portugal and Ireland - are facing "surveillance" from Brussels to ensure they comply with the terms of these programmes. Under the terms of this deal Greece's surveillance is to be increased and Eurocrats are to take up residence in Athens, despite being deeply unpopular with the people

- Even countries that are not actually in "deficit reduction programmes" are now being monitored from Brussels to ensure they comply with the terms of the Stability and Growth Pact, and face sanctions and possibly fines if they fail to do so. That is most of the countries in the European Union, actually......

All of these are being imposed by unelected Brussels bureaucrats. Yes, in October 2011 EU national leaders agreed to the principle of these measures, but I wonder if they really appreciated the implications. No Europe-wide referendum has been held on any of this and the European Parliament has not been asked to approve these measures - in fact the European Parliament has been systematically sidelined and is so toothless now that Jack Straw today called for its abolition on the grounds of uselessness. The people of Europe have not agreed to any of this, and it is evident that many of them oppose the actions of the European leadership. Why should the governments of Germany and the Netherlands be able to dictate to national goverments in the rest of Europe how they should run their affairs? Why should unelected bureaucrats be tasked with "supervising" national governments? This is not democracy.

If the price of European union is abolition of democracy, then it is too high a price to pay. But I don't think  European union is being bought. On the contrary, the sacrifices demanded of ordinary people to preserve the single currency are a huge threat to European union. As externally-imposed austerity bites, not only in Greece but in other countries too, there is a real risk that Europe will fracture along historic lines and people will seek to settle old scores. The single currency is the biggest threat to European peace since the Second World War.

Like everyone else, I don't think this latest deal solves anything. I don't think it even buys much time. Even if private sector bondholders and national parliaments agree to the deal, and default on March 20th is avoided, it will only be a temporary respite. We will play this game all over again - for much higher stakes - in a few months' time. And waiting in the wings are other countries in debt distress. How long till Portugal needs bailing out? Its economy is already going into the same death spiral as Greece's, and for the same reason - harsh and inappropriate austerity measures. And then there is Spain.....at which point the wheels come off. Spain is much too big to bail out.

The dawn agreement is a false dawn, and the darkest hour is still to come. There is no solution to this crisis which can preserve the Euro in its present form. For the sake of all the people of Europe, Greece should default and leave the Euro now, before the "debt service primacy" requirement prevents it from doing so. And other countries should reassert their national sovereignty and their right to self-determination. Yes, there will be pain, and chaos, and huge cost. But surely it is worth it to preserve peace and democracy in Europe?


  1. You echo my fears with an uncanny accuracy. Thanks for an excellent article.

  2. This deal structure works so well for the EU's politicians!

    95% of what they are proposing to do is bailing out their own banks, to prevent embarrassment back home. Structuring it this way, they even get to source some of that cash from the IMF, which they would never have been able to justify otherwise. If anybody else now torpedoes the deal, or it falls apart under the weight of its own absurdity, they also get to blame the Greeks, or the hedge funds, or somebody else, and then they still get to keep the justification for bailing out their banks.

    Plus, we all know this will now just drag on, as the Greeks will have to come back 'cap in hand' again before long. So once again Merkel and Sarkozy will be able to pose as heroes, above the fray of local politics in Germany and France, and now they have the threat of similar treatment they can hold over the peripheral EU economies, pressuring them to vote on EU matters exactly the way they want.

    Really, from the their point of view, what's not to like?

    1. As I said in the post, I don't see how losses of 75% of Greek bondholdings NPV can in any way be regarded as a bailout. Eurozone commercial banks will take those losses just as much as hedge funds. The only banks that are not taking losses are central banks.

      This deal doesn't really suit anyone. It is born out of fear - fear that default and disintegration of the Euro would be worse. It is deeply unpopular not just in Greece but in the Northern economies, too, where politicians are having a hard time convincing their electorates that Greece should be bailed out at all.

      There is nothing to like, really, not even for Eurozone politicians.

  3. I think that if the Collective-Action Clause goes through, ISDA will declare a default, if only to stop everyone laughing at them.

    1. I wouldn't be too sure. They will be leaned on hard by European politicians, and quite possibly by American banks, too (who are probably most exposed to a credit event).

  4. Hi Francis

    I thought I would comment on one of my favourite topics the state of the ECB's balance sheet. In its fantasy world it has just exchanged its bonds for new ones valued at par or 100. So who pays?

    Meanwhile in the real world it has paid circa 80 for bonds which are worth 20. In my old line of work you used to get sacked for doing that!

    1. In the end EU taxpayers are on the hook if the ECB needs more capital. The bond swap at par or 100 is to protect itself from losses arising from CACs, so completely divorced from the real world anyway. And the LTRO is the largest sticking-plaster in the world, disguising as it does the mammoth credit crunch going on in the Eurozone. It's all various flavours of Eurofudge, designed to get round the restrictions in the Lisbon treaty and keep the ship afloat for a bit longer. When will they realise that tar and oakum can't stop a ship sinking when it's been holed below the water line?


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