from MacroScope:
The Law of Diminishing Greeks
The Law of Diminishing Returns states that a continuing push towards a given goal tends to decline in effectiveness after a certain amount of effort has been expended. If this weren't the case, Usain Bolt would be able to run the mile in less than 2-1/2 minutes.
From an economic standpoint, this law now seems to be fully in force in Greece. The latest jobs figures from the twice-bailed out euro zone country paint a bleak numerical picture of the impact of unrelenting austerity in ordinary Greeks, regardless of whether it was self-inflicted or not. To wit:
More than one in five Greeks is unemployed.
There are more young people without a job than with one.
The record 1.08 million people without work in January was a 47 percent tumble in a year.
Putting aside for the moment the question of what such a condition means for political dissent, there is now the issue of whether any of this austerity-fueled pain is actually helping the Greek economy.
Austerity mixed with the inability of euro-tied Greece to devalue its currency means Greece is now in its fifth year of recession. As for job-creating small and medium -sized businesses, the latest projections are that more than a net 130,000 of them will have shut down over two years by the time 2012 is over.
The biggest example of the Law of Diminishing returns, however, is the impact all this is having on what ails Greece in the first place -- its budget.
Unemployed people offer no revenue to the government in terms of income tax and far less in sales tax than they would if they were working.
A good deal for Greece, its creditors, and Europe
Amid all the doom and gloom about Greece in the last few weeks, it is easy to overlook an important piece of good news: the debt exchange offer published by Greece on Friday with endorsement by its main private and official creditors. If implemented, this would be a major achievement and an important step toward overcoming the euro zone crisis, almost regardless of what happens next.
Under the offer, bondholders would receive 15 percent of the face value of their bonds in the form of short-term European Financial Stability Facility (EFSF) bonds, plus a set of new Greek sovereign bonds maturing between 2023 and 2042, with a 31.5 percent face value.
This agreement is a very good deal for Greece. The combination of the cut in face values, lower coupons and (in most cases) longer maturity implies a debt reduction of about 60 percent in present value terms (evaluated at a 5 percent discount rate). Assuming high participation (about €200 billion in bonds), this translates into savings of about €120 billion, or 54 percent of Greece’s 2011 GDP. This is very large. By comparison, the Argentine exchange of January 2005, the previous high-water mark, generated present value of debt relief of only about 29 percent of GDP, because although the per-dollar debt reduction was higher, the volume exchanged was much smaller.
Private creditors are also getting a good deal. Although they are being hit hard, they could have done much worse. You will see claims that the “haircut” suffered by creditors is on the order of 75 percent. These are exaggerated, because they compare the present value of the new bonds with the face value of the old bonds. But in a pre-default debt exchange, creditors never have the right to full immediate repayment. They only have the right to keep their old bonds and expect them to be serviced.
A better way to determine the value of the new bonds is to compare them with the present value of the old bonds, assuming they both are subject to the same default risk. This leads to a haircut of about 65 percent — much less than what creditors would have lost in a disorderly default. And it does not reflect two additional benefits: “GDP warrants” that may deliver extra payments beginning in 2015, depending on the level of Greece’s GDP; and an effective upgrade in creditors’ rights compared with those of the old bonds. The new bonds will be issued under English law, making them harder to restructure again in the future, and their repayments will be linked to repayments to the EFSF.
Finally, the agreement is a good deal for Europe — not because it guarantees a good outcome, but because it takes some really bad outcomes off the table. The risks of the new EU-IMF package for Greece are well-known: It assumes a large and protracted reform effort in an economically depressed country where both politicians and the “troika” are deeply unpopular and social tensions are high and rising. And even if the debt exchange is successful, Greek debt will remain very high. Yet the proposed debt exchange and the program that underlies it differ fundamentally from previous instances of “kicking the can down the road.”
Take the worst-case scenario: Following the debt exchange, the program goes offtrack in just a few months, and Greece is cut off from any further borrowing. This would aggravate Greece’s economic downturn and force it into even more austerity to avoid running a primary deficit. But it would no longer lead to a catastrophe. Assuming high participation in the exchange, Greece would face almost no net debt repayments in 2012 and just €1.25 billion in interest payments on the new bonds in 2013. Hence, it would not need to default, let alone leave the euro. Furthermore, Greece would no longer represent a contagion threat, and with a recapitalized banking system, and little or no remaining government deficit, it could likely manage its crisis on its own — at least until large repayments to official creditors begin to fall due in 2014.
I bet the Trojans thought the same thing when the wily Greeks gave them a going away present in the form of a horse.
from Ian Bremmer:
Europe’s necessary creative destruction
By Ian Bremmer The opinions expressed are his own.
What we’re seeing in Europe -- in rising Italian borrowing costs and the felling of two prime ministers -- is the growing impatience of the markets for a resolution to the euro zone crisis. To put a finer point on it, the hive mind of the markets has decided it is not going to give Europe enough time to get its act together. The big institutions that drive the world’s economies are sitting on huge amounts of cash -- enough to solve many of these problems overnight. But they have lost confidence in the ability of the European political system to deliver solutions that will work.
In a G-Zero world, where there is no strong global leader to direct the course of events, no one is interested in taking a flier on helping the Europeans get out of their mess. As the abortive G-20 conference showed last week, there is no backstop for any country or institution that makes an error in today’s environment, whether it’s tiny MF Global or the Chinese sovereign debt fund. In the postwar era, the Marshall Plan was the very definition of global security -- it was a huge commitment by the U.S. to rebuild Europe into the economic force (and not incidentally, trading partner) that the world needed. Today, there is no Marshall plan for Europe, from within or without.
That’s the high-level view of the Europe situation. The question everyone wants answered is this: what happens next? Start with Greece: the best possible outcome for that country has happened with Papandreou’s resignation and the selection of economist Lucas Papademos as Prime Minister of an emergency government. Papademos is committed to remaining in the euro and accepting the terms of the Greek bailout package. Despite the roller coaster ride Papandreou took his country and the euro zone on, Greece has now moved closer to the Spanish and Portuguese models for avoiding the debt crisis drama. In Greece, a resolution is starting to be reached. It’s not the beginning of the end, but maybe this is the end of the beginning.
The same can’t be said for Italy as the situation changes by the day. The decisive Senate approval of a package of austerity measures (by a margin of 156 to 12) was one small step for Italy in the eyes of the markets— and a big step toward Silvio Berlusconi resigning his mandate. It’s a wonder that Berlusconi held on to power for so long; he burned up his political capital years ago with scandals of all stripes. His stepping down is good news for Italy in the long run, but the handover of power to likely frontrunner Mario Monti is a delicate process that will have to be handled with tremendous care. Unfortunately for Italy, political drama has insured it will face a higher and longer level of scrutiny.
Markets will continue to demand extensive and enforceable changes in spending levels throughout the peripheral states. When Italy and Greece look more like Spain and Portugal, the bond markets will treat them more like Spain and Portugal. But that alone won’t solve the problem: investors are going to demand to know what happens next time any euro zone periphery country is on the brink of collapse. Euro zone institutions and politics have to be reshaped to prevent this type of crisis from ever happening again. Until this risk is mitigated, lending costs will stay high for a long time to come.
Case in point: I talked with about 200 international financial executives at a conference two weeks ago. 92 percent thought a “Lehman event” could easily happen once again somewhere in the world. Because we all thought the economy had been getting better over the last few years, we took our eye off the ball when it came to shoring up the global financial system and making the necessary structural fixes. In the U.S., President Obama took up health care. A weak Dodd-Frank bill passed. In the global financial system, Basel III has gone nowhere. And so every time the markets are rattled, we stare down the financial abyss, again and again.
“Greece: the best possible outcome for that country has happened with Papandreou’s resignation and the selection of economist Lucas Papademos as Prime Minister”
How is more neo-liberalism and more debt a “solution” to anything.
Just like underwater mortgages in the US with no prospect or ever being payable, the time has come for massive write-offs and restructuring the banking system from TBTF to a regulated public utility model.
Enough neoliberal baloney.
from Edward Hadas:
What is the morality of debt?
Debt is a moral matter. While most economic activity is concerned with the “is” of how things are (investment, consumption and so forth), debts are always entwined with an “ought” – to repay. In discussing controversial debts--for example government borrowing in the euro zone and the U.S.--the moral question should be addressed directly: should these debts be paid off in full, or is some forgiveness justified?
Aristotle can help frame the argument. The philosopher condemned all lending at interest because money cannot create wealth by itself; a loan is just a way for the lender to take advantage of the borrower. Some proponents of Islamic finance make a similar argument, but it is not quite right. Capitalism has shown that loans can indeed produce wealth. If the lent funds are invested well, enabling the borrower to improve his lot and the world’s, then interest payments are the lender’s just reward for providing the fruitful funds.
But Aristotle’s moral logic remains relevant; his condemnation is appropriate for loans which do not share wealth justly between borrower and lender. Unfair loans should not be made, and where they have been, full repayment only compounds the original injustice.
Libertarians, believers in the right of individual to make their own decisions, have another contribution to the moral discussion. They point out that loans are freely agreed contracts which should be honoured. Both sides should understand the possible consequences of their free choices. Borrowers should repay, even if that requires making sacrifices, and creditors who make bad lending decisions should suffer losses.
In the euro zone, some libertarians (and most Germans) consider the borrowers’ obligations to be paramount. The governments of Greece and the other over-extended nations can and should repay all their agreed debts. The citizens just have to work harder and pay more taxes.
Other libertarians take the opposite moral line. Losses are the just punishment for the foolish creditors. And the Aristotelian logic may justify forgiveness. The lent money has mostly been spent unproductively, so the borrowers now have few gains to share with the lenders. The original loans turned out to be unjustly generous to the debtors, but the terms have become unjustly harsh.
Morals? There has been no display of morals, even an attempt at appearances of morals from: Congress, Wall Street Banks , Corporate “Citizens”, Big banks, Investment Banks. To expect the taxpayers, strapped, underemployed, to be morally motivated to repay these con artists who want all the gain while sharing none of the losses is beyond all gall.
Here’s morals-BoA offered my hubby a credit card, he had no income, he declined. BoA persisted in offering this credit, knowing hubby had no income. My credit is trashed-medical debt and divorce, matters not, I was not in consideration, nor could he add me to the account. I was the sole household income, and seriously making way in (finally) breaking even. BoA kept at it, hubby caved and BoA gave him $5000, Why? I was laid off shortly after that. Knowing my own credit could be further damaged, I did set up auto payments-and BoA chose to withdraw their payments, 3-5 days before the due date, and that due date began to fluctuate(my auto pay acct was also with BoA) causing a missed payment, and overdraft fees, as I had no idea the date had changed in a way that preceded my auto deposit of earnings. Nice moral behavior all around, no, I will not be paying anymore money to banks nor government, even if I somehow could-They mismanage on their end and want to convince me I mismanaged a loan I had no say in!?!
Keep paying if you want, or feel morally obligated to. The one’s you owe are relying on you for their excess to continue.
How Europe can stave off a crisis
By Gordon Brown The views expressed are his own.
It was said of European monarchs of a century ago that they learned nothing and forgot nothing. For three years, as a Greek debt problem has morphed into a full blown euro area crisis, European leaders have been behind the curve, consistently repeating the same mistake of doing too little too late. But when they meet on Sunday, the time for small measures is over. As the G20 found when it met in London at the height of the 2009 crisis, only a demonstration of policy intent that shows irresistible force will persuade the markets that leaders will do what it takes. An announcement on a new Greek package will not be enough. Nor will it be sufficient to recapitalize the banks. European leaders will have to announce a comprehensive — around 2 trillion euro — finance facility; set out a plan to fundamentally reform the euro; and work with the G20 to agree on a coordinated plan for growth.
For three years it has suited leaders across Europe to disguise Europe’s banking problems and, citing the blatant profligacy of Greece, they have defined the European problem as simply a public sector debt problem. And it has suited Europe’s leaders to call for austerity (and if that fails, more austerity) and forget how the inflexibility of the euro is itself dampening prospects for growth, keeping unemployment unacceptably high and weakening Europe’s competitive position in the world today. Indeed, Europe’s share of world output has now fallen to just 18 percent. And it is a measure of how it is losing out in the growth markets of the future that just 7.5 percent of Europe’s exports go to the emerging markets that are responsible for 70 percent of the world’s growth.
When I attended the first ever meeting of the euro group of leaders in October 2008 there was astonishment when I reported that Europe’s banks had bought half America’s subprime mortgages and there was incredulity when I said that European banks were far more at risk than U.S. banks because they were far more highly leveraged. Since 2008, as American banks have tackled their toxic assets, they have written off 4 percent of their loans and raised the equivalent of another 4 percent in new equity. But euro area banks have written off just 1 percent of their loans, and have raised their capital base by only 0.7 percent, leaving them highly vulnerable even before their exposure to sovereign debt has become a central issue. Their vulnerability is increased because they have always been far more dependent for their funding on the short term and confidence-dependent wholesale markets, and countries within the euro zone are able to do far less in the face of capital flight than, say, Britain.
Of course in 2008, governments could fund the rescue of indebted banks; in 2011, indebted governments are finding that more difficult. For they know that even after they recapitalize the banks, they have still to deal with the even bigger financial problem of funding the borrowing needs of the most at-risk countries: Greece, Ireland, Spain Portugal and Italy, which could cost as much as $2 trillion in the years to 2014.
It is thus clear that the 400 billion euro rescue fund, the European stability fund, is wholly inadequate to address this profound failure across the European financial system, and that without a mechanism for fiscal coordination the euro cannot easily survive. A few days ago, U.S. Treasury Secretary Tim Geithner said that “the critical imperative is to ensure that the governments and the financial systems under pressure have access to a more powerful financial backstop.”
I believe that only an impenetrable firewall will show the determination of European leaders to head off the crisis and save Europe from a new recession. I know of all the doubts about a new but temporary role for the ECB, but it is unlikely that any other organization has the resources for quick action. But the IMF should back them up, funding their contribution through loans from the oil states and China. It may now be impossible to avoid hundreds of billions in bank de-leveraging and liquidations, but a coordinated approach with the support of the international community could provide the breathing space for what matters — the reform of the euro.
at last some clear analysis…bvious, but yet clear and sophisticated…nevertheless problems of trust and adjustment work against co-ordination…we need a psycologival recognition in the west that the balance of power is rapidly shifting. such a recognition needs to be on all sides to develop the trust necessary….and there is the problem. If I was China, I would not trust.
Europe’s Lehman moment
By Jeffry A. Frieden The opinions expressed are his own.
Europe is in the midst of its variant of the great debt crisis that hit the United States in 2008. Fears abound that if things go wrong, the continent will face its own “Lehman moment” – a recurrence of the sheer panic that hit American and world markets after the collapse of Lehman Brothers in October 2008. How did Europe arrive at this dire strait? What are its options? What is likely to happen?
Europe is retracing steps Americans took a couple of years ago. Between 2001 and 2007 the United States went on a consumption spree, and financed it by borrowing trillions of dollars from abroad. Some of the money went to cover a Federal fiscal deficit that developed after the Bush tax cuts of 2001 and 2003; much of it went to fund a boom in the country’s housing market. Eventually the boom became a bubble and the bubble burst; when it did, it brought down the nation’s major financial institutions – and very nearly the rest of the world economy. The United States is now left to pick up the pieces in the aftermath of its own debt crisis.
Europe’s debtors went through much the same kind of borrowing cycle. For a decade, a group of countries on the edge of the Euro zone borrowed massively from Northern European banks and investors. In Spain, Portugal, and Ireland, most of the borrowed money flooded into the overheated housing market. “At the height of the building boom,” Menzie Chinn and I write in our new book, Lost Decades: The Making of America’s Debt Crisis and the Long Recovery:
One Spanish worker of every seven was employed in housing construction. Half a million new homes were being built every year—roughly equal to all the new homes in Italy, France, and Germany combined—in a country with about 16 million households. The amount of housing loans outstanding skyrocketed from $180 billion in 2000 to $860 billion in 2007. Over the ten years to 2007, housing prices tripled,second only to Ireland among developed countries; by then, the average house in Madrid cost an unheard-of $400,000. (pp. 49-50)
Greece was a different story. It borrowed, as we write, “mostly to finance a continual budget deficit and an American-style consumption boom.”
Greek borrowing went beyond the sensible: at its peak, in one year Greece borrowed an amount equal to nearly 15 percent of GDP, so that more than one euro in seven spent locally was borrowed from abroad. By 2009, the country’s eleven million people owed more than $500 billion to foreigners, more than the foreign debts of Argentina, Brazil, and Mexico combined (with thirty times the number of people and ten times the economic output of Greece). (pp. 186-187)
For RussAbbott, the Spanish (and other non-Greek) fiscal deficits are very different from the Greek ones. They are the *result* of the crisis, not the cause. The Spanish government (like the Irish) went into substantial deficits as a result of the difficulties of the country’s financial system, and more generally due to the recession and the large increase in unemployment. This is one reason that the focus on large fiscal deficits is a little misplaced: the *origin* of the deficits varies greatly from country to country. There’s a big difference between running Greek-style deficits (and lying about them) in the runup to the crisis, on the one hand; and being forced into big deficits by the need to backstop the financial system and provide unemployment benefits, on the other.
from Ian Bremmer:
Slaughtering the PIIGS
By Ian Bremmer The opinions expressed are his own.
Nobody likes to be called PIIGS. For years, Europe’s so-called peripheral countries -- Portugal, Italy, Ireland, Greece and Spain -- have complained about this acronym, but the euro zone’s sovereign debt problems have only entrenched it further. Yet, it’s time to acknowledge that the PIIGS have a point. They don’t deserve to be lumped together. Their actions and their circumstances have sharply diverged over the past three years.
Some of the PIIGS, let’s call them peripherals, have accepted the need for painful austerity measures. Spain’s government beat its deficit reduction targets last year. That’s a result that should impress outsiders, including powerhouse Germany, where lawmakers have worked hard to persuade voters that profligate countries won’t be bailed out until they have proven they can mend their spendthrift ways. Protests against the belt-tightening have been limited and surprisingly peaceful given Spain 21% unemployment rate.
The conservative People’s Party, which has already pledged its commitment to both austerity and the euro zone, looks headed for a win in Spain’s November elections. That’s in part because Socialist Prime Minister Jose Luis Zapatero has pushed hard to implement so many of the plans called for by Germany and European institutions over the objections of his party’s political base, including a plan to amend Spain’s constitution to legally require both the central government and autonomous communities to meet deficit targets that go beyond the levels set by the EU.
Portugal is also making sacrifices, particularly on pensions, and its discipline has made a difference. Days ago, the IMF released another tranche of its bailout package for the country with a comment that Portugal’s strategy to bring its debt under control allows Portugal to “distinguish itself from other countries with a problem.” Its government has also made solid progress on reforming state-owned companies, collecting taxes, and stabilizing banks.
Germany deserves some credit here. Chancellor Angela Merkel has proven willing to drive a hard bargain for longer than many expected, but Spain and Portugal know that Germany will be there in the end and agreed to take their medicine anyway. Ireland has little in common with the rest of this group, because its need for a rescue package comes from a banking crisis, not a fiscal crisis or an economy that can’t compete. Italy is also a special case, given that the sheer size of its debt -- 1.9 trillion euros – represents a much greater long-term threat to the euro zone’s future.
Then there’s Greece, the only European country in full-on economic meltdown, where austerity measures don’t have broad support, and government and voters are sharply at odds over the country’s present and future. Greece isn’t about to leave the euro zone, but almost everything else is up for grabs. The Papandreou government is a spent political force, and its eventual demise, probably later this year, will leave a weak coalition government to try to manage public outrage and to kickstart an economy stuck in a ditch. Germany and the IMF can refuel the tank, but Greece is an automobile without an engine.
Congratulations Ian for your magnificent, yet concise, political approach to this severe menace to Europe.
This is not as simple as the awful acronym could eventually suggest. This is not the traditional schism between the beautiful south (plus Eire) and the opulent north.
This is a serious threat to european stability as a whole.
A narrow national perspective of this problem (with a central-north european realignment temptation)is so dangerous for the entire region that all should be done to avoid it.
Five ways to correct the Greek debt crisis
By Mohamed El-Erian This piece is the English version of the one that appeared in Handelsblatt. The opinions expressed are his own.
Not a day goes by without a flood of comments on Greece and its debt problems. They seem to come from everywhere. Some are later denied while others are left to stand, accompanied by a continuous string of worrisome data. In the process, even greater disorder is gaining hold of the country’s debt markets, with credit spreads exploding in an ever more alarming fashion.
There is a risk that all this could serve to confuse rather than illuminate the key issues that should be on the radar screen of many, whether they are policymakers or normal citizens. I can think of five such issues.
First, there is a good reason why Europe’s current approach to Greece’s problems has not worked well. Indeed, many, including me, believe it will not work any better going forward. Meanwhile, the costs and risks are growing exponentially.
Despite a year of large sacrifices on the part of Greek society and exceptional financial support from neighbors, Greece is still very far from regaining economic and financial stability. Output continues to collapse, unemployment is rising, the budget deficit remains alarming, and the already excessive debt burden is increasing further.
As a result, the country is no closer to re-establishing normal access to the global financial markets. New investors prefer to wait on the sideline, thereby starving the country of fresh capital. Meanwhile, doubtful liabilities are increasingly being transferred from creditors, who knew they were taking risks in lending to Greece (rather, for example, than buy German debt at a lower interest rates), to Greek and European tax payers as well as to the balance sheets of public organizations.
Second, the time has come to urgently recalibrate the EU/ECB/IMF approach to solving Greek’s debt crisis. This must start with an open recognition that an insufficient number of the original key objectives of the Greek adjustment program have been realized and, going forward, even fewer stand any realistic chance of being realized under the current approach. As a result, the country will not be able to harvest gains from the courageous steps taken to improve the efficiency and functioning of the public sector. Indeed, it could be forced to reverse them.
Quote from the article: “In the case of Greece today, too much of the debt is being transferred from creditors to the public sector. As a result, too many tax payers and public institutions will end up taking the hit that many creditors should have taken.”
This is the primary problem of economies around the world as evidenced by Iceland, Ireland, Portugal, Spain and even America, but Greece’s problem is far greater.
Greece’s underlying fundamentals are so wretched that they have zero chance of achieving economic viability within the next ten years.
This epic drama can only end with loan forgiveness or default… and the end draws ever closer.
I’m astonished that the Eurozone and other investors have been willing to toss billions of Euros into Greece’s black hole of a deficit every time the bills come due.
Surely, most of those investors are sophisticated enough to know that Greece isn’t capable of generating enough income to actually repay all of that money. The risk of default is virtually 100%; it’s just a matter of when.
from MacroScope:
Europe’s over-achievers and their fall from grace
Ireland's fall from grace has been rapid and far worse than that of its counterparts, even Greece. But life in the euro zone has still been one of profound growth, as it has for most of the other peripheral economies.
Take a look first at the progress of PIGS (Portugal, Ireland, Greece and Spain) GDP since 2007 when the global financial crisis took hold. In straight comparisons (ie, rebased to the same point) Ireland is far and away the biggest loser. Portugal is basically where it was.
But now take the rebasing back to roughly the time that the euro zone came together. First, it shows that Ireland's fall is from a very high place. The decade has still been one of profound improvement in cumulative GDP even with the last few years' misery. But it is front loaded.
Perhaps most interesting, however, is what the second graph (courtesy Reuters' Scott Barber) says about the PIGS and the euro experiment. Despite major financial and market crises, Greece, Spain and Ireland have all seen their economies accumulate at a higher rate than the euro zone average. Only Portugal has been below average -- a perennial slow grower.
Could any of this outperformance have been attained outside the euro zone? Probably not. But the question now is whether the current troubles are going to wipe out everything that has been achieved.
from The Great Debate UK:
Not much stress, not much test
-Laurence Copeland is professor of finance at Cardiff University Business School. The opinions expressed are his own.-
Back in the 1950’s, when most women stayed at home while their menfolk went out to work, a favourite trick of life insurance salesmen was to walk into the prospect’s home at dinner time and ask the wife:
“Mrs Smith, have you ever thought what would happen if your husband keeled over and had a heart attack right now?”
Imagine the effect of this question on the poor guy sitting there eating his meat and two veg. It must often have been enough to make him choke on his roast potato there and then – maybe even die on the spot.
Not being in the business of selling life insurance, the European bank regulators were unwilling to take any chances with the client’s cardio-vascular system, so they have restricted themselves to asking the question:
“What would happen if the client had the flu and needed a couple of weeks off work?”
