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Peter Tchir
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Peter started TF Market Advisors in 2011 as a platform to trade and provide market information. The trading strategies are macro, but the direction and value decisions are based on insights into the credit markets. The firm’s commentary has been gaining respect and Peter has become a recognized... More
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  • What could you do with $20 Billion? 3 comments
    Jun 30, 2011 7:54 AM
    I woke up this morning wondering what you could do with $20 billion. It’s not something I will ever have to worry about for real, but certain ideas kept popping into my head. For starters you could call Forbes and have them update their list of richest people in the world with you as #25. That would be cool. You could buy any of the 340 companies in the S&P 500 with a market cap less than $20 billion. If you were feeling altruistic, you could go on E-Bay and buy 7 lunches with Warren Buffett or you could just give $3 to every person in the world. Maybe you could combine these two things and fulfill the childhood dream to be the person to “buy the world a coke and teach it to sing in perfect harmony”. World harmony might be too much to ask, but you can stop the world from collapsing by lending $20 billion to Greece, or so it seems.
    It is hard to define how much money Greece is getting. Is it the next tranche of IMF money? Is it the amount of cuts the Greek government agreed to take? Is it future promises of money from the Troika? It’s hard to tell, but $20 billion seems to be about the amount that is being provided to get us through another 3 months. 
    I have argued that Greece should be allowed to default and that governments could deal with the repercussions after the fact. The default would cause problems, but these wouldn’t be insurmountable, and support could then be directed more accurately to where it is needed after a default. This direct approach to dealing with the consequences has to be better than the current approach of indirectly supporting the Greek lenders. Governments continue to help Greece avoid default because they are too scared of the consequences. This just means that only a portion of the bailout money winds up where it is needed the most. Letting Greece default would reveal the weakest links. It would be painful, would cause stock markets to sell off, but then the governments can deal with the problem institutions, decide which ones are salvageable and which ones need to die. Ideally, the prudent risk takers would actually be rewarded, maybe even the people would get on board and the governments could institute policies their citizens approve of.
    Lehman 2.0 and Contagion
    Unfortunately, any mention of a Greek default brings out screams of contagion, Lehman 2.0, economic disaster. The shouts of panic from this crowd drown out any realistic discussion. Fighting with this group is like tilting at windmills. Any progress made at addressing specific concerns about which bank has what exposure, what banks aren’t properly reserved, etc., is eventually crushed when the economic doomsayers play the derivative card. The derivative card beats all else. Even rational investors seem to get caught up in wildly pessimistic arguments over counterparty exposure and the dangers of CDS. You can point people at the DTCC data and they will point to a blog that used BIS data incorrectly. If somehow you can convince someone the derivative issue is overblown, they eventually revert back to generic claims of Lehman 2.0, contagion, and you just don’t know what you are talking about. I lose enough of these types of arguments with my 7 year old that I’ve learned to take a different tack.
    Let’s assume the Lehman 2.0 and contagion crowd are correct. Is it realistic to assume that $3 per person is enough to save the world’s entire economic model? If so, sign me up, I will contribute my $3. But the GDP of the U.S. $14.5 trillion (it is easy to remember since it is the same as the amount of U.S. debt outstanding). The GDP of the European Union is $16 trillion. Add in another $10 trillion for China and Japan and you have GDP of $40 trillion. The doomsayers are telling us that $20 billion is all that it takes to save a $40 trillion system? We have a $40 trillion global economy that hinges on getting $20 billion to Greece so they don’t default. Even if it requires a $100 billion to save $40 trillion, that is still a great bang for the buck. That sounds too good to be true, and it is. Either the problems that would arise from a Greek default are being massively overstated by the crowd that wants to believe it would drag down the entire financial system, or this new round of money is just the tip of the ice-berg. If our economic system is so fragile that a Greek default would bring it down, there must be lots of other weak links that will require more money. Exactly right says the contagion crowd, bailing out Greece stops the contagion from spreading to the other PIIGS.
    Stops the contagion from spreading? With Portuguese 10 year yields at 10.8% and Irish 10 year yields at 11.5% it seems a little late to stop the contagion. Unfortunately, bailing out Greece doesn’t fix the problems in Ireland or Portugal. Tolstoy wrote “every unhappy family is unhappy in its own way.” Well Ireland and Portugal each have problems that are unique to them, and their problem isn’t that they lent too much money to Greece. If Ireland was a big lender to Greece, then sure, stopping Greece from defaulting would help Ireland. The problem with the contagion argument is that it is misplaced. Preventing a Greek default doesn’t help the debt of other weak sovereigns, but it does help the banks that lent to Greece.
    The real contagion risk is with the banks. There are banks that lent too much to Greece, some that lent to much to Ireland, and some that took on too much Portuguese debt, and sadly, some that took on too much exposure to all three. That is the real contagion that people are trying to prevent. That these banks will take losses on sovereign bonds is the real fear. Avoiding default on Greece doesn’t decrease the likelihood of Ireland or Portugal defaulting, but it reduces the pressure on banks. The PIIGS really aren’t linked to each other, and solving the debt problem of one won’t help the others. It is the banks that are linked. Banks may be able to withstand one country defaulting (though the Lehman 2.0 crowd would tell you they can’t), but the banking system would struggle if they all default. The problem is at the bank level. All these bailouts are once again to support the banks and the interconnectivity of the banks. 
    If we ever want to get off the bailout bandwagon, we need to make banks raise equity capital and increase the average maturity of their debt outstanding. Why wait until 2015 to make banks raise additional capital? Why wait until then to add a capital surcharge to large financial institutions? We shouldn’t wait. Make the banks raise more equity now and contagion risk drops down and is paid for by bank investors, not the general public. If banks funded themselves with a higher percentage of long term debt, contagion risk would also decrease. It is the short term debt rollover needs that expose banks (and countries) to default. Why not ensure that banks and governments issue a greater proportion of longer term debt? The primary reason for not forcing immediate equity capital increases and debt maturity extension is that it would reduce the profitability of banks. Bank profitability should be sacrificed now so that governments can worry less about any individual default, and focus on long term solutions that benefit the entire economic framework, rather than wasting so much time, energy, and money, to avoid even the hint of contagion amongst the banks. That is a trade off that should be made.
    Would forcing banks to raise equity now and to issue more, longer dated bonds hurt the availability of credit? I am sure we would hear lots of arguments that it would, but since the corporate bond market has been robust I doubt large corporations would notice it. I concede it’s possible that forcing banks to do this could impact credit availability for small and mid size companies, but even in that market, I suspect there are enough regional banks and entrepreneurs, and bond investors to pick up any slack. I believe that any short term risks of a slowdown in availability of credit, and even the long term effects on bank profitability are more than offset by the ability to shift government resources away from propping up one bad debt situation after another. It is over 4 years since the first Bear Stearns Credit Hedge Funds blew up and government intervention in the debt and housing markets started in earnest. With the latest rounds of Greek bailout talks ongoing, and Irish and Portuguese ones sure to come, it is time to take the hard medicine. Force banks to dilute existing shareholders, reduce earnings by urging longer term borrowing by banks, and then let the chips fall as they may. There will be winners and losers, and some short term pain, but it is the only way to start clearly building the future. As a final aside, in spite of all the talk about how Lehman should never have occurred, I find it interesting that few big U.S. banks are viewed as being in trouble – maybe Lehman was a necessary shock to get bank balance sheets to a healthier level. The jobs lost since Lehman, haven’t come back, but that probably has more to do with people willing to work for a few $’s a day elsewhere in the world than the fact that we had the courage to let Lehman fail.
    Themes: Macro View
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Comments (3)
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  • PSU Investor
    , contributor
    Comments (61) | Send Message
     
    I appreciate the long term view that you have. You should think about running for some governmental finance position. It might benefit society very marginally, but when your older the value might be more transparent. Opportunity cost might also be high. Thanks for the post
    2 Jul 2011, 07:02 PM Reply Like
  • CBReynolds
    , contributor
    Comments (83) | Send Message
     
    Peter,
    Do you get the feeling that a Greek default is inevitable at some point in time and that any rollover plan (bailout) will just delay this outcome? Or is Greece actually salvageable?
    3 Jul 2011, 07:56 PM Reply Like
  • Peter Tchir
    , contributor
    Comments (1260) | Send Message
     
    Author’s reply » I think default or restructuring with significant haircuts is inevitable. I just don't see them getting the benefits from austerity and it seems like they will lose the political will internally to keep cutting, when it seems more and more that all is for the banks.

     

    Juncker I believe made a comment today about how constrained Greece will be. He is playing to the people of Germany who lent Greece the money.

     

    I truly think they would be best served to default. They can do asset sales after the default.
    3 Jul 2011, 10:19 PM Reply Like
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