Greece on decline

Today citizens of Greece are about to decide in a referendum whether to agree on conditions of yet another bail-out package and fend off looming full-blown bankruptcy or reject austerity measures that on one hand keep Greeks on their knees, but on the other prevent the country from falling off the edge of chaos. In the previous sentence I have mentioned a full-blown bankruptcy, by which I mean the government would be unable of meeting its basic obligations towards the citizens. If effecting payments of pension benefits and other allowances ceases and the whole public sector would grinds to a halt, Greece will plunge into total chaos. In fact, since a few days Greece is formally insolvent, but in economic terms it has been bankrupt for more than five years, though much work has been put in to cover it up.

Looking back in time, the Greek crisis has been in overdrive since April 2010. To make a good comparison, recall how much time has elapsed since the Smolensk plane crash. For such long period of time Greece functions only thanks to drip of money from creditors.

Two questions which ought to naturally come to mind are:

1) why has the ordeal lasted for half a decade and no one bothered to put Greece out of misery, while creditors of Greece patiently pump in more and more money to the effectively bankrupt country?

2) why over five years, despite generous aid from creditors, Greece has not managed to turn itself around?

You could mention political backdrop of the whole situation, willingness of key actors of the European politics to keep the eurozone together, since letting one country go would give others a free rein to walk away from the common currency. You could mention other reasons, such as fear of knock-on effect, etc., yet the story which deserves to be brought to your attention is about how the Greek debt changed hands. In 2010 and 2011 key creditors of Greece were German and French banks, through which Greek sovereign default would spill over onto the whole financial system of the EU. In the spring of 2012 Greece's bondholders agreed to lose 53.5% of face value of what they had lent to the Greek government (look at this, had Poland been written down 53.5% of its sovereign debt, its debt-to-GDP ratio would have stood well below 30% and Poland would have been one of the least indebted countries in the world). Thus most of the Greece’s debt was relieved and in the meantime transferred from the banking sector to the EBC and to the IMF. Private banks thus had to swallow some losses, yet recovered nearly 50% of what they had recklessly invested in Greek gilts and got rid of the junky securities.

Over five years of keeping head above water only thanks to continuously rolled over lending from international institutions, Greece has not gone ahead with structural reforms that would eradicate all the roots of their misery. Instead, it whiled away. It also has to be underlined austerity measures slowed economic growth in Greece and impaired the country’s ability to service debt. The cure has nearly killed the patient and made (lazy and economically illiterate) Greeks fed up with the fact their lenders have been dictating them what to do. The disgruntlement brought populists to power and after a few months of their rule, stance of Greece in negotiations with creditors has somewhat hardened.

The result of today’s referendum is anything but predictable. Greeks are strongly divided regarding the government’s refusal to further accept conditions set by lenders. The more rational part of society fears a scenario of banking sector’s collapse, which would mean loss of savings for those who have it and downfall of public finance system, which would mean public sector employees would not get their salaries and pensioners would not receive their benefits. I have no idea, what the other half think they will achieve by showing the middle finger to creditors and whether they realise how dire the consequences of being cut off from IMF’s and EBC’s money are.

Even assuming Greece is ousted from the Eurozone and all its debts are written off, the problems will not disappear. Greece would not be perceived credible by anyone (maybe except for Russia, which could lend to Greece to extend its sphere of influences), so no one would lend them (a liar) money. Greece would have make ends meet on its own, something the country accustomed to living beyond its means is not capable of. The situation is hence tragic enough that even pressing ‘reset’ button and letting Greece begin from scratch would not help.

Nevertheless, cognisant of consequences of Greece going insolvent, I do not commend of extending the misery of the country. Moreover, I believe far too much money has been injected into Greece, money that will never be recovered, therefore checking out and putting Greece out of misery in a controlled way would be the most reasonable solution.

What is going to happen tomorrow when results of the referendum unfold? If majority of voters back continuation of austerity program, the populist government will lose credibility and should step down. If majority of voters support showing the middle fingers to creditors, we will be watching history in the making.

Any lessons to learn?

Firstly – a common currency does not prove to be a good idea if area where it functions is insufficiently economically uniform (do not confuse with integrated). The benefits of one currency do not make up for lack of flexibility offered by having a domestic currency.

Secondly – letting populists grow into power does not seem to be the way to heal the ailing country…

Europe is quivering, while Poland is holding strong.

It has been kind of nerve-racking week on financial markets. Last weekend abounded in political events that could affect the future of the eurozone – presidential election was held in France and Greeks elected members of their parliament.

The latter has drawn much more controversy than the former. The south-European nation has already had enough of severe austerity programme pursued by the previous government and this time backed mostly the parties that have opposed aggressive retrenchments, without which Greek government would have gone bankrupt long ago. Votes have been scattered among many parties, yet they have failed to form a coalition. Today leaders of victorious parties and the president are making a last-ditch attempt to bring together a government. Most observers hold the view the talks are doomed to bring no coveted results and new election will be called for June.

It is almost sure the same parties will win the election, only share of votes gleaned by each of them might differ. At the end of the day, populist politicians elected by irate Greeks will be trying to pull back from the spending cuts that on one hand reduce the pace in which Greek public debt increases, but on the other send the Greek economy into a deeper recession.

Greek bondholders have already agreed on a debt swap with a haircut of 53.5%, yet even such debt relief has not put the Greek government out of trouble. Its indebtedness is whopping and its capacity to pay it off in foreseeable future is highly questionable. Since the very inception of the Greek crisis, it has been clear that insolvency of Greece is just a matter of time. One of the rating agencies downgraded Greece’s rating to C, pointing out, rightly, the big write-down is in fact a form of controlled default. The full default, encompassing freezing almost all public spending is conceivable. This scenario can materialise if the new government backs out of austerity measures on which financial drip from the EU and the IMF is conditioned. If access to this money is cut off (such move is at creditors’ discretion), Greece will be unable to service its debts and maybe this is what many Greeks want. Probably they do not care they would bear a brunt of insolvency, since suffer anyway, so why not spite creditors? When I look at that uncivilised nation, I cannot believe those barbarians accustomed to living beyond their means claim to be heirs of cradle of democracy. No, these must not be the descendants of ancient Greeks.

So called ‘financial markets’ are totally aware Greece is even no longer on its knees; it is lying with its head buried in the sand and breathing through a pipe held by the EU and the IMF, consequently I dare to claim a full-blown bankruptcy would not trigger a sell-off similar to that witnessed in August 2011. There is no evidence for it, but at the end of last year I predicted an ‘earthquake’ on financial markets in the second quarter of 2012. I can concede my mistake if WIG20 does not fall below 2,000 points. Now it needs to go down by some 7% - 8% to hit that barrier so the this can done within a one-day solid tumble.

In France Mr Hollande deposed Mr Sarkozy from the presidential office. Markets’ reaction was anything but amiable. Many feared the new president would soon set out to follow out his leftist agenda, including increasing tax rate for the richest and imposing an extra tax on profitable companies which lay off workers to push up their earnings. I have never really liked Mr Sarkozy, his celebrity-like style of wielding power was not my kind and I will not cry after him. With time some elements of leftist agenda take my fancy. Marginal tax rate of 75% is an exaggeration which will rather cause the wealthiest people to migrate to the UK than help raise tax revenues, but to my proposal of tax system based on flat rate and high tax allowance I would add a higher tax bracket for individuals earning more than six times average salary. I also cannot resist liking for an additional tax on companies firing staff to boost profits. In the coming week my company is announce who will be laid off. At least they pledged to give very generous severance packages and some employees are coming forward to leave…

But wait, wait, who gave ‘financial markets’ power to punish people for the choices they are making? I know yields on government debt should be correlated with risk of its default, I know valuation of stocks depends on tax rate, but do not some price movements express markets’ displeasure? Who gave them authority to mete out punishments? Is this part of legacy of Thatcherism commendable?

Meanwhile on Wednesday the central bank of Poland raised its benchmark interest rate by 25 basis points, to 4.75%. While many European economies are threatened with recession, for Poland inflation above central bank’s target of 2.50% +/- 1.00 p.p., is a bigger problem than economic slowdown (projected GDP growth in 2012 is ca. 3%, 1.3 percentage points lower that actual GDP growth in 2011). Again I’m proud Poland’s monetary authorities have proved a forward-looking wisdom. Given the fragility of economic conditions with our trade partners, it is not clear whether the hike was just a one-off move, or a beginning of the second part of monetary tightening cycle initiated in January 2011. For sure higher rates mean good news for savers who keep their money in banks and slightly worse for all borrowers.

Depositors can cheer up even more, as Polish banks have begun to adjust their funding structure to Basel III requirements, taking effect on 1 January 2013. In practice this means many banks will have to match maturities of their assets (what they lent to households and enterprises) and liabilities (what they owe depositors or creditors). For many banks this might be a bit of a problem, as they finance long-term assets (i.e. 30Y mortgages) with short-term liabilities (i.e. up to 1Y time deposits). This means banks will be competing to garner long-term deposits from the market by bidding higher interest rates and will have to cut down on long-term lending, which essentially are mortgage loans. This means excellent news for the housing market. Property prices in Warsaw have fallen off the peak in early 2008 by some 15% in nominal terms (30% in real terms) and the market is stuck in a standstill. Banks, in order to comply with supervisor’s regulations, have curbed mortgage lending, creditworthiness criteria have been tightened, and buyers have finally noticed property prices are still steep, especially when compared to earnings. So the market may be heading only in one direction. The process of adjustment will take a few months, as sellers are unwilling to take on board that their hapless assets’ (for which many of them paid over the odds) intrinsic values are much lower than asking prices and buyers refuse to pay so much, or their mortgage applications are turned down, so few transactions are finalised. This also proves mortgage availability is the key driver of price trends on property market. May the adjustment run well and property prices should decrease by some 20% within two years – the substantial decline which began in 2011 will continue (transaction price of 1 sqm in Warsaw dropped by 11% year-on-year in April 2012), but fundamental factors point the pace of decline should speed up! Great news!

Shame on you if you fool me once...

…but shame on me if you fool me twice. Sometimes sayings that refer to ordinary life apply to politics and economy as well.

Have you ever wondered how many times have Greeks double-crossed their breadwinners from the EU? Greece joined the European Economic Community in 1981. I have to plead I know little about the backstage of entrance to European Communities at that time, but from what I remember at that time a country which applied for a membership did not have to meet any quantitative criteria. From that point being a member of EEC has helped Greece make a big stride, yet not in terms of development, but in terms of standard of living.

Things have changed after the Maastricht Treaty was signed and took effect. It laid foundation for single currency area and set requirements a country which wanted to join it had to meet. Two of them referred to soundness of public finances – each applicant had to keep general government deficit below 3% of GDP and the whole public debt could not account for more than 60% of GDP. These are figures, and whenever statistics are in use, room for tampering can be found. Here’s the rub – when calculating the public debt a country was allowed to legally subtract some of its liabilities. The main method of concealing some of debts was using complex financial instruments, mainly cross-currency swaps that allowed the Greek government to issue bonds in other currencies at “arranged rates” and with deferred maturity. The operation that helped Greeks dupe the EU was brought off in liaison with Goldman Sachs (the bank that rules the world, there is more than just a grain of truth in this assertion). Thus in official statistics the debt was curbed, in fact it morphed into time bomb that would blow up Greece’s public finances in a few years.

For many years Greek sovereign bonds were treated as safe investment. When banking crisis in 2008 reached its zenith, many banks in Europe, including Dexia lost millions on toxic US mortgage-market-related assets, but then received capital injections. This money was parked in safe havens. One of them were Greek bonds. Collapse of Greece’s public finances came to the light in September 2009. From then on, Greece has faced insolvency many times. For the first time it received a bailout package in May 2010. Over 100 billion Euros let the country avoid bankruptcy then, but this was just the first injection of never-ending drip of money. To borrow money on preferential terms from the EU and the IMF, Greece had to implement painful austerity measures. Greeks, pampered by overgrown welfare system, went to the streets to protest against dreadful retrenchment programme. The country repeatedly came to a standstill, strikes exacerbated economic contraction and debt-to-GDP ratio soared.

In most European countries the crisis was sparked by excessive expansion of deregulated banking industry, mainly consisting in reckless mortgage lending. In Greece banking sector stayed relatively healthy. The overgrown welfare state and lack of competitiveness of Greek economy were the nails used to close the coffin of Greece. Many privileges, despite social unrest, can be scrapped, but structural changes are will not be easily brought in, given the mentality of Greek society. Big grey economy and widespread claimant stance (postawa roszczeniowa) will be a stumble block. Greece must not only cut ridiculous expenses, but also take steps to boost its tax revenue base. Tax evasion must finally be severely punished, wages must finally be linked to efficiency. It sounds simply, but Greece has to get to grips with bigger challenges. In needs to carry out structural reforms to make its products and services sellable on global markets. It would be easier if they could be sold at lower prices, but as long as Greece is a member of the Eurozone, devaluation of currency does not come into play.

Solidarity is a glue that stick together the European Union. Poland is also a big beneficiary of this. As a poorer country we receive lots of money to modernise the country. A big leap being made in infrastructure development can be put down the inflow of EU funds, but life is not only about taking, but also about giving. One country should not sponge on other, as Greece has done. And if other countries bail one country out, it should not come up with ideas such as the one to call a referendum whether to accept another tranche of bailout package, subject to another dose of painful reforms.

Someone finally should bite the bullet and pull the plug on Greece. I would simply let it go bust, let banks write down or write off value of Greek bonds (most creditors of Greece are capable to absorb such losses, although it would be a blow to their shareholders). I would even let it start from scratch. But even in such scenario, I seriously doubt if Greeks would learn from their mistakes. They would rather be taught that if creditors let them get away with not meeting their obligations, that they can carry on living off other countries’ backs.

The Euro, as a currency, as well as the Eurozone, are political, not economic undertakings and for that reason no one will have the courage to kick out Greece from the eurozone. Admitting one’s defeat is a bitter pill to swallow, but in my view, this painful solution would in long-term turn out to be best, and less costly than pumping next billions into a bankrupt country.

It’s all Greek to me

“Goldman, Greece, those will be never ending stories”, a friend of mine told me today. “They’ll be pulling the markets up and down and all we have to do is to anticipate those moves and get the most out of them” – he envisaged a nice scenario.

The Goldman case might be a tip of the iceberg. It may drag on and on, the bank might hire excellent lawyers and prove it just bent the law. In the coming weeks I do not predict this case might trigger a bigger correction on the markets, but if regulators and politicians decided to accuse other banks or restrict proprietary trading, the momentum of bull market would be up in the air.

Now the latter. Greece has been facing problems for months on, the deterioration has recently grown apace, but when I saw yields on 2Y Greek bonds had soared to 17%, spread between 10Y German and Greek bonds had exceeded 700 basis points I asked myself if my eyes were deceiving me or if the editor of the hapless news item had made a typing error. But after checking a few other web pages and making sure that S&P agency categorised Greek debt as “junk” and downgraded Portugal’s rating. It’s kind of astonishing to see a Eurozone country rated as issuer of junk bonds.

Stocks tumbled across the Europe, in France CAC 40 index plummeted by impressive 3.82%, trading on Warsaw stock exchange closed ay 16:30 what means nothing else but that tomorrow it will open be far below today close.

What next? Will we be facing the second wave of crisis or will the concerted action of other countries head off the worst scenario? German and French institutions hold a large chunk of Greek debts, so they have a vested interest in coming with aid. As for me, Greece will sooner or later default on its debts, quite probably in mid-May when it will have to roll over much of it. The best idea would be let Greeks leave the Eurozone and let it face the music. Insolvency is just a matter of time, so should other countries chip in to prolong Greek agony? For months things haven’t looked as dangerously as they’re doing now.