The AIG-Style Scenario for Greece
I have relentlessly argued in these lines (obviously for way too long, given my apparent isolation!) against the way in which investors value Greek debt. The logical way for Europe to resolve the PIGS nation debt crisis would be to follow the example of the United States via the establishment of an AIG-style bail-out scenario.
The conditions at the origin of these crises are very similar, with a liquidity crisis transforming itself into a solvency crisis. AIG was confronted with huge losses stemming from the derivation positions held by its subsidiary, AIGFP, which threatened to exceed the value of its assets, themselves impacted by the Great Financial Crisis (GFC). Greece is no longer able to finance its primary deficit and, a fortiori, even less coupon and principal payments on its sovereign debt due to shock wave triggered by the GFC and its continuous decline in national competitiveness since its admission the European Monetary Union.
In the United States, the Fed and the Treasury teamed up to resolve the liquidity and then the solvency problems in the midst of incredible outrage at AIG's lack of risk controls and the huge bonuses racked up by its traders.
Greece must also contend with intense anger about the cooking of its national accounts, criticism of its social safety net, deemed overly generous, and an utterly ineffective tax system (characterised by rigidity and accusations of mass corruption).
In both cases, the initial bailouts were launched at punitive, if not downright usurious, interest rates, set so high that they guaranteed failure before they even got off the bailouts even got off the ground.
In both cases, cooler headers prevailed and lending terms were eased, both the unsustainably high interest rates, given that they were much higher than projected Greek economic growth, and maturity length.
However, what made it possible for the AIG rescue plan to move to the next stage of functional support was the U.S. Treasury's expropriation of private-sector shares in exchange for money, while the Fed collateralised part of its loans with AIG assets within its Maiden Lane transactions.
In the case of Greece, we are confronted with a major obstacle; while its European partners now acknowledge that Greek (like Ireland and Portugal) will not be able to return to debt markets in the medium term (and for many years to come, given the ESM's confiscatory nature for investors), it would appear impossible to offer public-sector creditors the same sort of guarantee, should the replace private-sector creditors.
The Treuhandstalt Solution
It would appear however that this difficulty is in the process of being overcome, with the proposal to create an independent privatisation agency, based on the German Treuhandstalt model.
Created in 1990, this purpose of this agency was to carry out the privatisation of the assets recovered from German reunification, i.e. 8,500 businesses employing 4 million people, 2.4 million hectares of farm and forest lands, enormous property assets and even a governmental pharmacy network!
One of its particular characteristics was that it governed by an "autonomous" board of directors, comprising representatives from the federal and regional governments, the Bundesbank, commercial banks, the biggest private-sector enterprises and two European businessmen.
The proposal today is to bring together in an equivalent ad hoc organisation all of Greece's assets mean for privatisation for two reasons:
- Guarantee the proper execution of these operations under creditor monitoring (IMF, ECB, EU) to avoid politically-inspired" delays and local nepotism that might dilute the value of these transactions.
- Use the assets managed by this agency as collateral for new loans granted by the European Union to meet the concerns of those hesitant to lend more funds to Greece out for fear of throwing more good money after bad.
I have always argued that the aid provided by wealthy eurozone countries to their distressed partners was an essential element in the civilisational adventure represented by European construction. Indeed, Europe represents the first time in history that various peoples have come together of their own free will (without recourse to arms) to build a union of peoples in an effort to avoid a repetition of the terrible events of the past. While we cannot know the answer, it is interesting to ponder what the world would look like today if such a union had taken form at the beginning of the twentieth century!
Moreover, these plans are in total conformity with the interests of the euro-zone's wealthy countries. Aside from Germany's impressive market share gains stemming from currency stability (the end of wild currency devaluations), although that is hardly the sole factor, the existence of a single currency has resulted in enormous productivity gains, thanks to the absence of friction costs on currency operations, better cross-border costs visibility and the creation of a big capital market and trans-national companies (economies of scale).
Although I have expressed many concerns about the euro's institutional architecture, highlighted by the ECB's seizure of euro currency policy and by that institution's noncompliance with its own mandate(*), the fact remains that a return to national currencies could only heighten the relative decline of eurozone countries in the context of an increasingly globalised economy dominated by trading blocs.
The Consequences of Failure
Let's not kid ourselves: a refusal to help Greece succeed in its drive for recovery would have incalculable consequences:
- What would stop Ireland and Portugal from following the Greek example and declaring default as measures imposed by creditors on their respective populations become unbearable?
- What would stop investors from (quite logically) repricing all the risks relating to the eurozone's implosion by sending the interest rate spreads of countries in the northern part of the eurozone to levels consistent with those existing prior to the euro's creation? The spread between France and Germany on 10-year debt totalled 200 basis points in January 1990, while that between Germany and Italy came to 600 basis point in 1995! I don't need to draw a picture of the consequences in terms of sovereign debt risk 0 if such a scenario were to come to come about.
- The the ECB considers that such a default would lead to a disaster scenario for the European financial system as a whole, as articulated by none other than Christian Noyer, and, for once, I tend to agree with them. After criticising the Bundesbank for its total ignorance of the dramatic situation of certain German banks in 2007-2008, I can only be satisfied with such an opinion.
We now have the tools needed to try to resolve part of the problem confronting the eurozone. The ball is now in the court of government leaders. Given the hesitation and backsliding of the past 16 months, it is easy to understand why Greek CDS attribute 70% probability of default.
"without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2." (Treaty article 105.1).
"The objectives of the Union (Article 2 of the Treaty on European Union) are a high level of employment and sustainable and non-inflationary growth)"
Disclosure: Long 20 years OAT and 30 years BTP Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2 Y and 10 Y bonds, Thaler's Corner.