Sunday, 30 May 2010


It is time, dear readers, for Greece’s creditors to take a haircut. They’ve had a good run but it’s just not going to work anymore. They made a bad bet on us as on many other risks and now it’s time to take the consequences.

In late 2009, Greece had a small window of opportunity in which to signal in a credible manner that there was more political capital to be made from reducing our liabilities than from increasing them. Similarly we needed to demonstrate that there was more political capital to be made from paying our creditors than from defaulting. I am convinced that this window of opportunity started to close in December and then slammed shut in January, when Joseph MUPPET Stiglitz supposedly came to our aid and our political elite gave up trying to convince the people that we are going to have to change voluntarily.

One after another, our politicians, our journos, and of course our people, came out in favour of a mild adjustment, or none at all. They cried “speculator” until they were hoarse. Our state banks even shamelessly played the CDS market ourselves, making money out of our own profligacy. Commentators threw tantrums, made absurd demands and blamed everyone except themselves (and their respective main constituents) for the state of our country.

Well it’s all over now – for a simple reason. We’ve left things to escalate for so long, let confidence sink so far and borrowing costs rise by so much that the math doesn’t work anymore.

Greece’s real GDP has never in the past 10 years grown faster than 4.8% per annum (see here).

Government revenues have never been more than 43% of GDP and Government spending has never been less than 43.2% of GDP. Expenditures excluding interest on public sector debt have never been lower than 38.8% of GDP (see here).

 The above suggests that we could not, over the past 10 years, ever have run a deficit of less than 0.2% of GDP, let alone a surplus. In actual fact, however, we’ve never run a budget deficit smaller than -2.9% of GDP (see here).

Finally, the informal economy has never been less than 22.6% of GDP (see here) in the past 10 years.

Now, I will assume that everything works out for us within the three years from 2010-03. We bring expenditure and the informal economy to their 10-year minima, and revenues to their 10-year maximum. I am using the IMF’s projections for real GDP growth the GDP deflator (basically the price segment of value added). I assume that the GDP deflator will tail off after 2015, while GDP growth will work out to the IMF’s projections and then gradually converge to our GDP growth maximum of 4.8%.

Under my rather rosy but at least realistic projections, debt servicing costs of anything over 9.25% would mean that our mountain of debt would never fall below current levels and eventually rise to infinity. If the market handed us that kind of interest rate, they would be handing us a death sentence. Unfortunately this came to pass as our 2-yr yields climbed above 20% in early May, courtesy of our army of subsidy-junkies, extortionists and murderers and the idiots who shelter them; hence the EU/IMF bailout. 

So far, so rubbish.

But now we have a different problem – the one at the heart of the Credit Crunch, the Great Recession, and in fact every episode of such in the past half century. In a world of fiat money, all money is debt and no monetary value is truly real. It exists only as long as it’s backed up by a web of implicit guarantees – in practice right up to the people with the biggest and best balance sheet. Hence the pressure on Germany, and potentially on the US, to guarantee everyone’s debt.  

So while have established our guarantors as the markets have demanded, the markets are still unsure they are good for the money. Why? Because if we go under, European sovereigns will have to bail out their own banks, to whom we owed north of EUR70bn last time I checked. They will also automatically become more likely to have to bail out our fellow PIIGS, with which we also have a web of liabilities. The IMF itself doesn’t have enough money by any stretch of the imagination to bail out the PIIGS – Greece is a bit of a stretch actually. So the guarantee is weak and our debt is looking decidedly blurry.

Now we can drag this sorry mess out forever, give up sovereignty over our own country and feed the delusions of Eurocrats for another couple of years before everything comes crashing down. Or we could bite the bullet, prepare for a seriously no-frills existence, and renegotiate our debt.

Is debt restructuring or indeed default a new thing? Historically it most certainly isn’t. Nor is it outside the realms of our recent experience. We have already tried restructuring our hospitals’ debts to suppliers in the past and done so again in May. Many state employees, even some that foreigners are likely to meet, are left unpaid for some time as a matter of course. The state also owes money to its pension funds. In the private sector, any of these things would be called “defaulting”. It is only out of respect for the sensibilities of a sovereign state that people do not call us bankrupt.

Perhaps more importantly, debt markets are pricing a 75% probability of Greek default by July 2015 into the price of insuring our bonds. Our creditors are already taking the damage to their share prices and those who are forced to mark-to-market will eventually take actual losses. The damage is already done.

Finally, it is fair to say our people want a default, as long as it doesn't hit pensions and benefits. That can be arranged.

What we need is an orderly wind-down; a cloak-and-daggers summit of creditors like the one held for Hungary should map our liabilities and the effects of different levels of default on them. Each creditor should come clean on the full extent of their individual exposure and write down an agreed percentage of the debt. Instead of financing us, the IMF will agree support for those banks over-exposed to our debt.

Now let’s see if anyone will bite the bullet and say it.

UPDATE: People have finally cought on to the fact that the restructuring of Greek hospital debt is tantamount to default. H/T To Nick Shay for pointing out this story. 


  1. many congrats on your posts...keep up the good work

  2. @Anonymous: Many thanks for your kind words!

  3. Andreas Eriksson2 June 2010 at 11:28

    I agree with Anon, you write really well. One question though:

    "Finally, it is fair to say our people want a default, as long as it doesn't hit pensions and benefits. That can be arranged."

    ..and the net effect on (greek) pensions and benefits would be?

  4. @Andreas: Many thanks. I see your concern. In fact, I would add to it. The IMF is a super-senior creditor: they need to get paid before ANYBODY gets a penny, including our funds. I hope our EU partners are not, but I'll have to look that up.

    To answer your question, our pension funds, simply put, would have to write down their exposure to our debt, currently valued at EUR29bn. At a 30% haircut, that would be about £8.7bn. Now, this works out to a big load of trouble, but consider the fact that the funds themselves lose about 2%-3% returns on their EUR30bn of assets due to allocation restrictions annually.

    Removing our ridiculous restrictions on funds' asset allocations could balance out the loss within 14 - 20 years.

    This still leaves a substantial hole in the system. We would have to balance that out in some way if we want to avoid civil unrest. Already, we're reviewing pensions contributions, retirement age limits and pension fund payouts, which would also plug some of the shortfall.

    But even that is not quite enough. The way I would tackle the rest would be through anti-avoidance reforms. For instance:

    1. Currently employers are allowed to settle pensions contributions lapses at ridiculous discounts. That could be stopped.

    2. Deregulating part of the labour market could help bring new money into the national insurance / pensions system. For instance, remember that according to our tertiary private sector union, GSEE, 173,000 Greeks have a second job paid cash-in-hand - almost all could be actual employees if not for the cost of our employment regulations. Let's assume they each make EUR200 a month. A conservative estimate. Even a small percentage contribution out of EUR415m per year works out to a tidy net present value.

    Finally, we could try substituting some of the pension funds' share of the creditors' haircut with a gradual phasing out of the government's obligation to stump up the difference if there is a shortfall between payouts and contributions. This will effectively remove a substantial share of the government's actual liabilities without changing the current cash position of the funds.

    That's a start, but as you rightly point out, we will need to think this through really well.

  5. I think we discussed this - I have always believed that default was the only way - if you are interested i direct you to Mazower, M., Greece and the Interwar Economic Crisis (Oxford: Clarendon Press, 1991) To indicate that the recovery and social turbulence was greatly aided by a default in 1929.

  6. I'm sure we must have discussed something. I didn't always believe in a bailout or a default - if we'd moved fast and not needed either I would have been happier, but there's nothing we can do about that now.

    Tell you what though. For me the equation works like this:

    Speed of fiscal adjustment:

    no bailout < bailout but no default < default

    Degree of fiscal discretion/sovereignty:

    no bailout < bailout but no default < default

    This means there's a tradeoff here. Your preference for a default suggests you believe the added fiscal discretion could offset the increased speed of fiscal adjustment - may yet prove right.

    How to make that happen is the policy challenge facing us now. More posts on that now.

  7. Its quite simple - deflation is counter productive when you need more money NOW - the rate of return of taxation drops. With default, the deficit will have to be reduced, and one has the defered interest payments as a social parachute.
    It could be the least painfull option.

  8. It's a fair point Alex, but I have a host of objections which have kept me from supporting default earlier:

    A default is a heavy option because it means that only the very brave or reckless will lend us any money. This means the entire fiscal adjustment will have to happen virtually overnight, a Mad Max scenario which would test the limits of my libertarian convictions.

    To answer your point more directly, if the point were simple liquidity, then we are liquid enough as it is - provided the EU/IMF overdraft becomes permanent, which will be politically painful for everyone involved and will require us to give up nearly all control over fiscal policy to our creditors.

    If on the other hand we wanted to be solvent in the long run, which was my concern, then - for a while - a default would mean nothing if we couldn't reduce our structural deficit.

    Worse, there is a huge risk that a Greek default would trigger a systemic collapse (especially now that much of Eastern Europe is buckling as well).

    In such a scenario, the EU and the IMF will simply not *have* enough money to extent our loan facility and we'll all go down together. Unless the IMF prints some handy SDR and simply taxes the entire world through inflation in order to bail out Europe.

    Now of course we've run out of options so the whole discussion is purely academic. I do hope, however, that we don't mess up the entire global economy on our way out.


Please remember that I am not notified of any comments and will not respond via comments.

Try to keep your criticism constructive and if you don't like something, do tell me how to fix it. If I use any of your suggestions, you will be duly credited.

Although I'm happy to entertain criticism of myself in the comments section, I will not tolerate hate speech. You will be given a written warning and after that I will delete further offending comments.

I will also delete any comments that are clearly randomly generated by third parties for their own promotion.

Occasionally, your comments may land in the spam box, which may cause them to appear with a slight delay as I have to approve them myself.

Thanks in advance for your kind words... and your trolling, if you are so inclined.