Last week the French (banks and government) proposed a roll-over of Greek debt into new bonds, some with maturities as long as 30 years. By Thursday, German lenders, insurers and the government agreed to join the plan, which would cover debts falling due from now until the end of 2014. As France and Germany are by far the largest Greek creditors, the world heaved a big sigh of relief, as a Greek default was going to be avoided, at least temporarily. Stock markets around the world staged huge rallies. Armageddon had been avoided again.
The IMF welcomed the move to extend the resolution of the Greek debt crisis as a move that would allow for creation of conditions for sustained growth and employment. It was feared that he default of debt coming due and the imposition of extreme austerity on Greece would create a spiral into severe depression. In addition, the resulting stresses on the Eurozone financial system would have far reaching effects. From the BBC:
The French plan is designed to make Greece's debtload more manageable in a way that would not be deemed a formal default. If the deal is classified as a default by ratings agencies or credit derivatives traders, it could force European banks to recognise billions of euros in losses in Greek debts that they currently hold, putting their own solvency at risk.
It Is Default
But now Standard & Poors has thrown some sand in the gears that started turning just a few days ago. The credit rating agency has issued a statement that says the proposal is tantamount to a restructuring, such as would be accomplished by a formal default. In other words, the French proposal puts lipstick on a pig, but it doesn’t change it anything else. The ugly duckling in this case will not grow up to be a swan - unless, of course, it is a black one.
According to the Financial Times:
French and German banks’ plan to roll over their holdings of Greek debt suffered a blow on Monday as Standard & Poor’s, the credit rating agency, said the move would amount to a default.
The proposal to provide up to €30bn ($43.6bn) in financing for Greece had been made conditional on rating agencies not downgrading Greece’s debt. But S&P said on Monday that any rollover would be a “distressed” transaction and thus lead to Greece’s rating being lowered to selective default.
The FT article goes on to say that officials in both France and Germany said that such a move had been anticipated and "should have no immediate impact on credit default swaps (CDS) markets." Such a statement flies in the face of the rapid and extreme degradation of Greece's credit worthiness as seen in the following graph from Money and Markets:
CDS Webs and Insolvency
Further from the Financial Times article we find that officials said that the important thing was to avoid a credit event like the one that occurred after the Lehman default, when the entire labyrinth of CDS inter-relationships was feared to be blowing up. To avoid such an event, it will be necessary to "persuade the ECB (European Central Bank) to take affected bonds in exchange for providing liquidity to Greek banks," one official said.
The entire exercise appears to be one of confusing the boundaries between liquidity and solvency. It might be said that the plan is one that says "if we pretend the bonds have value then the bonds have value." This ignores the basic premise of GEI (Global Economic Intersection) contributor Michael Hudson: "Debts that can't be paid, won't be." Hudson is not taking this proposition lightly - it is the title of his next book due out in a few months. Prof. Hudson has further proposed that no deal can be binding on Greece without a national referendum such as was held recently in Iceland. There the voters soundly rejected assumption of debt by the taxpayers of that country to pay for a bailout of UK and Dutch investors.
New World Order
Brad Lewis has suggested that the workout (“bailout”) as being formulated is nothing more than a grab of Greek assets by northern Europe. Prof. Lewis asks if Greece is destined to become a colony.
Michael Pettis goes even further. Seven months ago, he said that the current restructuring and default process would not end with Greece, but would extend to Portugal and Spain. Pettis likened what is going on in Europe to the U.S. civil war, this time being fought with financial weapons. He wrote:
Once the dust finally settles Europe will either be a unified country with fiscal sovereignty firmly established in Berlin or Brussels, or it will be fragmented with little chance of reunion.
Elliott Morss has looked at the ascendancy of power by finance from a different viewpoint. He sees the fragmentation of national power under the onslaught of large NGOs (non-governmental organizations), multinational corporations and banks plus the explosion of new technology. It may not be governments as we have known them which are running the world of the future. It may be a strengthening of the new feudalism described by Derryl Hermanutz.
Risk of Capital
Whatever happened to capital risk? The only risk that appears to remain for creditors is that the debtors may end up refusing to endure slavery to preserve the lenders’ precious principal.
Whatever happened to restructuring when ability of creditors to pay could no longer be maintained? Has the world been reduced to a game of Monopoly where ultimately there will be only one winner, and all others will be slaves? Dirk Bezemer wrote an excellent essay last year in which he recounted to the “clean slate” resolution of insolvency problems in ancient Babylon. In that case, sometimes as frequently as every seven years, overextended debts were cancelled, basic property rights of debtors were restored and creditors took a haircut. The haircut losses were simply a cost of doing business for capital. Of course, ancient Babylon may not have had the same principal of operation for capital that exists today – hundreds of times as much income for those who control the capital as for the rest of society. Ancient Babylon may not have had the Golden Rule: He who has the gold makes the rules.
Andrew Butter has compared the current Greek situation to the Merchant of Venice. He points out that it was less than a century ago when the Weimar Republic had a debt that couldn’t be paid. That was resolved (after an episode of less than successful seizing of assets and bloodshed) with a restructuring of debt and currency that led to seven good years, often referred to as the “Golden Era” of Germany. Unfortunately, a cornerstone of the German debt workout depended on American capital, and that all collapsed with the New York stock market crash of 1929. We know what the ultimate result of this collapse was: Hitler, 1933.
Andrew has asked: “Wouldn’t what worked in 1923 Germany taste better than a pound of Greek flesh?” He asks a very good question, which relates back all the questions raised by previous references. But history has taught us that the solution may not work if it depends on the performance of the American (or any other) stock market.
Restructure and Move On
All the commentators and analysts above have one thing in common; they are of the opinion that it is time to swallow the medicine, take haircuts (even a few that may remove entire heads) and restore a balance of power between creditors and debtors. Dirk Ehnts points out that this option is almost completely ignored in the media. He says that price adjustments are needed, not just for financial assets, but in the real economy as well. Until there is restructuring and a moving on, these adjustments are simply postponed. Steve Keen has presented much the same picture with very detailed analysis.
Get this over with already! What is being done is like supplying continuous transfusions to a patient who is losing massive amounts of blood and leaving the injury untreated. It is time to apply some disinfectant, treat with antibiotics, cut out any dead flesh, suture the wound and get on with healing. To do otherwise, the Armageddon that was avoided last week has simply been deferred.
This article was prompted by a news item at GEI News from which excerpts were taken for the beginning of this piece.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.