The good news is that European financial ministers on Sunday have come up with a new solution for the Greek debt crisis.The bad news is that many in the financial community feel it is just another in a long line of misjudgments that will only delay the ultimate and more painful default of Greece.
A new breakthrough was reported Friday when German Chancellor Angela Merkel conceded on forcing those in the private market to extend maturities on Greek bonds they hold; a concept known as provisioning.
Provisioning has the upside of giving Greece more time to pay back its debt and keeping bondholders whole.
The downside is that the world’s rating agencies consider provisioning a form of default, triggering the very credit spiral that Europe was seeking to avoid. The European Central Bank, backed by France, has offered a “voluntary rollover” plan that would allow banks that currently hold Greek bonds to give them up in return for notes with a five-year maturity and a discounted interest rate.
But the notion that bond traders would essentially volunteer to take a loss on any investments seems almost comical to the industry.
“If you are a bank and you agree to this, you are … read my lips: a dead man walking,” said Lee Buchheit , a partner with the law firm Cleary Gottlieb Steen & Hamilton in New York at a bond traders meeting earlier this month. “If I were a bank manager that did that, I would make sure I have a very good D&O policy.”
Much is at stake for global banks in the Greek crisis. U.S. banks including JPMorgan Chase (JPM) and Bank of America (BAC) among others carry $32.7 billion in exposure to Greece, according to Nomura.
In spite of the new European “solution” to Greece’s debt and the billions in bank exposure, the country has proved to be a black hole of public finance. Letting the country default may not only be the best thing for the Hellenic state, but also for global finance.
Following are five reasons why Greece deserves default.
Greece Fudged Its Numbers
Greece’s public finances have been in chaos for nearly a century, but in 2001 the country sought economic redemption by joining the European Economic and Monetary Union (EU).
The only problem is that Greece didn’t actually qualify.
Greece received a “formal warning” from the European Commission after it was determined that the country had underreported its budget deficits for the three years leading up to EU inclusion, sometimes by comical amounts.
The European Central Bank (ECB) found in a 2004 report that Greece’s deficit in 1997 was actually 6.6% of its gross domestic product (GDP) — not 4% as was reported at the time. The report also showed that the country inflated the numbers for the following years as well.
That was somewhat of an important oversight, given that the EU put a 3% deficit cap on countries looking to join the euro.
It’s not as though Greece’s neighbours didn’t see this coming. In 1996, Greek finance minister George Alogoskoufis suddenly revised the country’s GDP by as much as 25% per quarter — for the previous six years — without much of an explanation.
The official Greek news agency quoted Alogoskoufis as explaining that the revisions showed his countrymen were “more rich than initially estimated.”
“We must never fear of the truth,” Alogoskoufis told the news agency.
That truth included some interesting revelations. The head of Greece’s National Statistics Service was quoted as saying that the country’s economic base had some surprising sources of productivity.
“The revised GDP will include some money from illegal activities, such as money from cigarette and drinks smuggling, prostitution and money laundering,” Manolis Kontopyrakis told the New York Times.
Greece Can Never, Ever Pay Back What it Owes
A country with debt is not necessarily a bad thing. But a country that has no prayer of ever paying back its debt is a sure loser.
A key indicator of long-term health, the country’s percentage of its debt relative to GDP is 148%, according to Eurostat.
How did they get there? Despite calls to live within its means, the Greek government has continually disappointed. Even today, government expenditures are up 3.6% year on year while revenues are down 9.1%, according to published reports.
According to Harvard economist Martin Feldstein, even if a default cut Greece’s debt from 148% of GDP to 60% overnight, it would still need to borrow immediately in order to function as a country. That’s because the country’s current annual budget deficit is 10% of GDP but it needs to be 3% of GDP.
Unless Greece makes drastic cuts, it would need to start borrowing again immediately after defaulting.
The Greeks Promised to Make Cuts, and Then Fudged Numbers Again
After agreeing to get their house in order after being caught getting creative with GDP numbers prior to joining the EU, Greece decided to cut the deficit, with a little help from Goldman Sachs (GS).
Goldman and Greece then created a deal to mask the “real” level of the country’s debt according to a report issued by Eurostat.
The report says that the Greek government and Goldman inked 13 separate “off-market cross-currency swaps” in 2001 that spread the debt over several years and artificially reduced the Greek deficit.
Although that EU had requested information on the swaps since 2001, the report states that the Greek government did not provide a full accounting until last year.
Goldman Sachs argues that everything was on the up and up, despite the damming report.
“The Greek government has stated (and we agree) that these transactions were consistent with the Eurostat principles governing their use and application at the time,” the Goldman Sachs statement says.
Dominique Strauss-Kahn Was a Greek Debt Enabler
Over the past year, Greece had been in negotiations with the International Monetary Fund to help it move past its debt crisis.
The only problem is that instead of cutting, the IMF and its former leader Dominique Strauss-Kahn (DSK) negotiated a deal that doomed the Hellenic state.
DSK and the IMF board came to the rescue last year after the rating agencies, including Standard & Poor’s, threatened to send to cut the bonds ratings. The IMF and the European Central Bank negotiated a $147 billion aid package.
“It is a multiyear program which begins with substantial upfront efforts to correct Greece’s grave fiscal imbalances, make the economy more competitive and –over time — restore growth and jobs,” Kahn said last year in a statement. “We believe these efforts, along with the government’s firm commitment to implement them, will get the economy back on track and restore market confidence.”
As each month, passed the IMF’s assessment of Greece became rosier.
“Our overall assessment is that the program has made a strong start,” a statement from the IMF’s first review mission to Greece in August 2010 said. “The end-June quantitative performance criteria have all been met, led by a vigorous implementation of the fiscal program, and important reforms are ahead of schedule.”
But by the end of the year, the writing was on the wall, and even the IMF realised Greece was turning into a lost cause.The IMF said in a February statement that “major reforms still need to be designed and implemented” in Greece.
Immediately after that, Athens rejected the criticism.
“The behaviour of EU, IMF and ECB officials was unacceptable. We asked nobody to interfere in domestic affairs,” government spokesman George Petalotis said in a statement reported by Bloomberg.
After that, Greece’s fortunes deteriorated until DSK was arrested in New York on rape charges — a day before a meeting on putting together another Greek bailout.
Bond Traders Already Think Greece Is Toast
Everyone in the capital markets knows it already: Greece will default.
The cost of insuring Greek debt against default has reached epic levels, similar to what was seen prior to the bankruptcy of Lehman Brothers in 2008.
Credit default swaps — derivatives that investors purchase to protect themselves against default losses — are trading hundreds of basis points higher over the past several weeks.
That’s because credit market experts, including the rating agencies, realise that no matter what bailout package is offered by Europe, Greece will end up defaulting in some way.
“In our view, Greece is increasingly likely to restructure its debt in a manner that, under the conditions of any package of additional funding provided by Greece’s official creditors, would result in one or more defaults under our criteria,” Standard & Poor’s said last week.
S&P added that the market “is already treating Greece’s CDS as a potential default” and that the CDS spreads agains Greek bonds are over 800 basis points wider than the country’s current credit rating.
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