Posts Tagged ‘bailout’


November 1, 2011

The Greek Prime Minister wants to hold a referendum on the new bailout deal to be signed with the Europeans. It appears that this was an unexpected move which has caused anger throughout the Eurozone (also here). The details are not yet available, but it seems that Greece will negotiate the rescue plan first, and then will put the proposal to a vote. The Greek people will decide if they agree or not.

To be honest, I thought that this was the best piece of news (for Greece) to come out recently. Negotiations thus far were a two-party game, which has now been forcibly turned into a three-part asymmetric game:

  1. The Greek Government who are on one side of the negotiating table,
  2. The EU, ECB, bankers, IMF, etc. who are on the other side of the negotiating table, and
  3. The Greek people who are voting on the outcome when negotiations are complete.

Now one has to only think: whose negotiating power increased immensely and whose negotiating power took a dive, when the third party entered the game. Yes, it is the Greek government who now drive the process.

Also, it is worth remembering that what Eurocrats fear most is democracy. The history of referenda on EU policies is not stellar, and I suspect that they really don’t want to lose this one. It will not surprise me if Greeks get away with an 80% uniform haircut including the ECB, and bank recapitalisation for free.

Unlike what Greek commentators keep repeating, Greeks have the option to say No: a standard EU policy is to keep having referenda until a Yes vote is won, giving more and more sweeteners in the process.

PS: All is not clear sailing though. A requirement is that the Greek government will maintain its slim majority until January, which is not certain. Another Greek MP resigned today, most probably because of the referendum proposal itself. The opposition leader does not want to hold a trump in his hands, and promises to stop the referendum at all costs.

The chance of Greece descending into a chaotic horde of witch hunters has gone up by another notch.

adverse efsf

October 24, 2011

There is a widespread view that the EU will attempt to lever up the EFSF capital to achieve an insurance capacity of EUR2-3tr, by turning it into the equity tranche of a sovereign CDO. Others put forward a TARP-like structure which will buy back bad sovereign debt.

A Special Purpose Vehicle (SPV) will be the financial entity that will implement this endeavour, where whatever is left of the initial EUR440bn EFSF money will serve as the capital. This is certaily a big number, which is bound to catch the headlines and trigger a stock market rally. But is there any meat on this bone?

How do you value that crap?

Although yet unknown, the bond buy-back structure will be probably similar to the TARP model which was implemented in the US to help banks offload their ‘misunderstood’ assets. The idea behind TARP was that the market for CDOs and other morgage backed instruments just dissappeared overnight. For that reason, if banks were to sell these assets they would receive very little, even though foreclosures at the time were not justifying such a severe price cut.

In order to implement the TARP, a price discovery mechanism was needed to gauge what a fair value would have been. An ‘inverse auction’ was put into place, where the holders of the assets posted the prices at which they were prepared to sell, and the lowest prices were filled first until capacity was reached. Therefore selling institutions had an incentive to post a low price to get rid of their assets, and losses were written down. To fill in the holes these sales punched in their capital, banks issued preferred shares that were bought by the same programme. A total of USD700bn were earmarked for this programme, of which about two-thirds were actually used.

How would that work in the context of the EFSF? Here Greek, Portugese and Irish bonds appear to be eligible at the moment, while Spanish and Italian bonds could become eligible in the future (if eligibility is defined as being bailed out). Banks that hold periphery bonds will post a selling price, and the cheapest ones would be filled first. One does not know yet the exact mechanics, but it is safe to assume that Greek bonds will be the first ones to go. Obviously, the current market price serves as a lower bound, but if enough banks try to get rid of the bonds, then the price might not be too far away.

The main driver behind the TARP was that households were not defaulting on their mortgages at a rate that would justify the market prices, and that if these ‘misunderstood’ securities were kept for a while then the market would resume and reasonable price levels would be restored. The current situation is markedly different: the problems facing Greece (and other periphery countries) are not due to the lack of liquidity but lack of solvency. The low price of Greek debt is not unreasonable if one considers the fundamentls, and is in fact supported by the implicit or expected haircuts described in the various PSIs. If these PSIs were gone, the price of Greek debt would be arguable even lower. Pumping liquidity in the secondary market would do little good to the banks involved, and no good to the Greek state.

The related recapitalisation would be welcome though. Banks gain some immunity against sovereign default if the bonds are off their balance sheets. This also takes the burden to recapitalise the banking sector off the sovereign, but causes a moral hazard issue which invalidates the whole idea.

Survival of the fastest

As it stands the EUR440bn are not sufficient to provide a decent backstop. Already nearly half of the money has been spent, but let’s say that there is another EUR250bn left in the fund, and the liabilities of the larger periphery countries easily exceed that. An argument is to use the magic of leverage to turn these EUR250bn into EUR2tr or even more. I think that this argument is flawed, if one considers the incentives of the countries involved.

The size of the Greek default is constantly being debated in the financial press over the lat few weeks. The initial PSI of 21% has grown into a PSI+ of 50-60%, with some commentators advocating levels of 90-100%. There is a valid argument that the costs of recapitalising the Greek banking sector do not go away. Every Euro that a Greek bank loses through a haircut is a Euro that Greece has to borrow in order to recapitalise the bank. This means that the true impact of a 50% haircut might be actually less than the 21% that was originally proposed.

In the TARP world the default of a household was disconnected from the profit or loss that the MBS realised. But in the EFSF case this does not hold: if Portugal defaults then the Portugese state will need funds to recapitalise Portugese banks; if the EUR250bn have run dry because Greece and Ireland have already tapped the fund, then Portugal will be left exposed. It matters little that EUR2tr were insured, if the equity tranche is wiped out. The incentive for Portugal is to default before everyone else, just to make sure that her banks take advantage of the EFSF rescue funds.

The size of the default is now subject to adverse selection too. If Portugal need not worry about the impact of a default on her own banking system, then she might opt for a much larger haircut. As her banks are recapitalised externally, why not give them a helping hand?

Obviously moral hazard becomes an even more important issue for Spain and Italy, where the money involved would be stretched in the better of scenarios. If they want to have any chance of protecting their financial system, then they have to rush to the EFSF gates early in the day.

What this leverage will create, as the crisis deteriorates, is the equivalent of a good old bank run. A leveraged institution might not have enough capital, and everyone eligible rushes to get the most out of it. It also resembles the good old CDO: if CDOs underestimated tail dependence and systemic correlations, European politicians are making sure that a cluster of sovereign defaults will happen in the EU sooner rather than later.

As if there is not enough contagion as it is…

consequences of a euro break-up (ubs analysis)

September 6, 2011

UBS economists published today a research piece on a possible breakup of the Eurozone. They contrast feasible solutions like Greece leaving the currency union or Germany doing the same. They also explain why other alternatives (like expelling Greece) are not feasible.

They estimate that Greece leaving the Euro will incur a one-off cost of about EUR10,000 per person during the first year, and about EUR4,000 each year after that. There are obviously severe social costs that cannot be monetized. The one-off figure for the Germans (should they choose to leave instead) is somewhat lower at about EUR8,000.

Contrast that to the cost of bailing out Greece, Portugal and Ireland simultaneously, which is about EUR1,000 for each German taxpayer. It seems clear that the only viable solution at this stage is a default within the Eurozone, even though this could eventually take us to the same point in a few years’ time.

argentine illusions

August 24, 2011

The Greek stock market (the Athens Stock Exchange, or Ase) has now reached a 15-year low at 900 points, as the country marches towards formal default. For some time now, a number of commentators, politicians and various forum dwellers have started making comparisons with late 2001 Argentina. The general line is that the Buenos Aires (Merval) index was 200 points when the country defaulted, and reached 500 points within three months. This offered the patient (or intrepid) investor a 150% return before you could say ‘I-am-broke’.

This is an argument to support one of the following: either “if you happen to be in the stock market, and feel possibly creamed at the moment, don’t panic and make the mistake to sell”, or “if you are not holding stock this is the best time to get a bit adventourous and go long; after all, how much lower can the stocks go from here?”.

Both messages, if taken at face value, would contribute to slowing down the rapid market decline. I can see that trying to prop up a collapsing stock market or forecasting happy days in the near future serves the punters’ own agendas, but they are misleading the public.

Since many middle class Greek families are “entrapped” in the falling market, pundits aligning with the ruling Pasok party are quick to claim that there is hope for a quick rebound. Supporters of the opposition, after placing the blame on the current governments amateur approach to the problem, want to put themselves in a position to reap any potential future benefits. A significant number of (probably badly burnt) investors roam unregulated investment fora spreading the same lines, presumably believing that they are looking after their own interests.

But notwithstanding ones intentions, they are blatantly wrong. Greece might be similar to Argentina, but only to the extent that they both found themselves committed to an exchange rate peg that they find hard to support. Pundits are confusing real and nominal returns, or returns denominated in hard or soft currencies. And while small investors might argue that they were ignorant, politicians and commentators should know better.

Merval, Merval$ and the Ase

Merval (in ARS), Merval$ (in USD) and Ase (in EUR) indexes

In the chart above I put forward the Merval index from 2000 to 2005 (in blue). I rebase the index to 100 in November 2001, which is when the final leg of the crisis begun to unfold. This makes it easier to assess the performance as we approach or move away from the crisis. Merval is denominated in Argentinian Pesos (ARS), the local currency. I also chart the Merval$ (in red), which is the same index denominated in USD and rebased at the same point. Before the end of 2001 there a one-to-one fixed exchange rate between the ARS and the USD; for that reason the two charts overlap in the former part of the chart. This peg broke in November 2001, and the ARS rapidly lost three quarters of its value in the next few months; therefore, following the default, the Merval index produced divergent nominal returns for investors in ARS or USD.

It is true that the Merval rebounded in nominal terms, and more than doubled after the country defaulted and the peg to the USD was broken. But investors received cashflows in a worthless currency that was had lost 75% of its purchasing power; the 150% increase is irrelevant. Denominated in USD, the Merval index has a different story to tell: even after Argentina formally defaulted, the market carried on sliding at the same pace, and bottomed out after it had lost another 50% within the next six months. It then took a further year to return to the level it was when the currency peg was broken.

But how does that relate to Greece? I also collected nearly two years’ worth of the Ase index, and rebased them to the same point (as if we are sitting in November 2001) to make some comparisons. For a start, the decline in the two markets looks surprisingly similar, given that they are ten years apart: both have lost two-thirds of their value over the same length of time. For all practical purposes Greece is essentially pegged to the Euro, in the same way Argentina was up to the breaking point. The decision to be made (by Merkozy perhaps?) is whether this peg is to be maintained.

The Argentinian experience suggests a path for both eventualities: Staying within the Eurozone implies that the Ase investor is still a Euro investor, and the USD-based index indicates a further drop by 50% before recovery begins. This means that one should brace themselves for a ride down to 500 points. Leaving Euro for a New Drachma (or some dual currency setup) can cause the index to rebound, if it is denominated in this new heavily devaluated currency. Then the gains are illusional, as the ARS-based index gains were.

Obviously things are much more complex in practice, and the path of Argentina is not going to be followed exactly by every country that defaults. One should hope so, given that Argentina experienced a 10% contraction during 2002 (the year after default was declared), inflation which topped at more than 10% per month, and more than 50% of the population below the poverty line. Argentina only recently re-entered the capital markets; the abundance of agricultural commodities she produces and rising commodity prices kept her at a surplus through the years following default. This was a relief that Greece does not seem to possess. But it gives an indication of where things can go from here, and a message to the punters to keep their mouth shut.

it’s in your hands

April 9, 2010

You can do your bit to help this decent, hardworking but misunderstood nation by donating at least £5 here. No amount is too small, every penny is important. You showed your charity to the people of Haiti, now the proud Greek civil servant is asking for a helping hand.

Before you leave remember to browse through the comments left by distinguished donors like Angela Merkel, Jean-Claude Trichet, Gordon Brown and many others.

They told us that they told them to lend

April 1, 2009

James Hamilton in a brilliant post discusses the recent expansion of the monetary base.

As it stands, the Fed has bought an array of securities from the banks, of a varying degree of toxicity. They did not go to the bank headquarters with a truckload of money, they, sort of, wrote a check or an IOU.

Every bank is required to keep some reserves with the central bank. In that way they force banks to keep some of their assets in cash form, thereby reducing the risk of banks over-leveraging themselves (or at least that was the principle). In order to buy these dodgy assets, the Fed did not actually pay for them, they just extended the reserves of the corresponding banks, without the banks putting any money themselves.

To make things more concrete, say that Pitibank is required to keep USD50 with the Fed as reserve. Also, say that the Fed decided to buy from them a bunch of mortgages (of face value USD300), but which they agree to buy at USD200. These are “toxic” because if the bank sold them in the market, then at the moment they cannot find a buyer that will pay more than USD30.

The Fed gets these mortgages from Pitibank, and instead of paying in cash, they just increase Pitibank’s reserve to USD250. It is essentially the same thing, since Pitibank can draw from these reserves if they want to (down to the requirement of USD50). The Fed will then essentially “print” money to give Pitibank when asked.

What politicians are telling us, is that they want banks to start lending again. This essentially means that they want Pitibank to ask for these reserves and lend the money to individuals, small businesses and each other.

But banks don’t appear to be doing that. They prefer to let the money in their reserves with the Fed. Why do they do that? Are they keeping good money idle? Well not really, because the Fed has decided to actually pay interest on these reserves. This increases the opportunity cost of lending the money to you and me, and acts as a dis-incentive for Pitibank.

Does that make sense? Well, no matter what the politicians are saying, central banks are having nightmares of all that money reaching the consumers and sparking inflation. As J Hamilton points out, doubling the monetary base will eventually translate into 100% inflation: all prices will double.

It seems to me that with that interest rate on the reserves, the Fed is trying to control how fast this huge amount of money reaches the real economy. And they don’t seem to be very keen for this to happen.

Closing in

March 30, 2009
Sir Fred Goodwin

A clever poster of Sir Fred Goodwin, the ex-boss of the Royal Bank of Scotland (RBS) who resigned just before the bank posted a loss of £24bn for 2008, the largest ever loss in UK corporate history. Sir Fred left RBS with an annual pension of about £700,000.

In 2004 he was knighted for his services to banking.

For the non-UK readers, the targeting benefit thieves motif is used by Government’s Department of Works and Pensions for their campaign. Apparently benefit fraud costs the UK taxpayer £800m in 2008. RBS lost 30 times this amount during the same period.

(picture posted here)

bailing out greece

January 14, 2009

Standard and Poor’s today downgraded Greece to A-, which was largely expected. Although Greece is a member of the Eurozone, S&P see the increasing deficit as a problem. And arguably, a bigger problem is that although Greece has experienced some remarkable growth in the last few years, the deficit issue was not adequately addressed by the government. In fact Greece has one of the highest public debt to GDP ratio in the world, and topping that with one of the worst current account deficits does not really help.

The folks at the have a very interesting recent presentation which touches on the matter. On p.11 there is a discussion on who would bail out Greece in case of troubles (either deserved or undeserved). As I understand it, their point is that no institution will be interested or capable of rescuing the Greek economy. They also see some cracks appearing in the <<weakest link>> of the Euro area.

And Greece will need to go to the global credit markets for EUR50bn+. Only yesterday they raised a mere EUR2.5bn, amidst higher spreads, which are now about 250bps (2.5%) above the German yield. Now they will have to raise 20 times that amount.

Should we expect spreads shooting up and Greece defaulting on the existing debt as a result of its inability to roll over? A speculative attack on Greek bonds? A test for the euro?

An IMF document discusses the Greek economy. Overall Greece is exposed to south-eastern Europe and the Balkans, which is not surprising. What surprised me is what a crap job Greek banks do within Greece, with such a high percentage of non-performing loans recorded in a boom period. I can only guess the quality of the loans that they have given in Albania, Romania and Serbia…