February 22, 2012
Illusion of Greek bailout is Europe's dirty little secretPosted in Irish Independent · 183 comments ·
Sigmund Freud once noted that: “Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.”
Europe and the EU are soon to go through one of those ‘collisions with reality’. The reality of the latest deal in Greece is that it drives the Greeks deeper into the mire and as the economy there contracts yet more, the wheels of this deal will fall off.
Before we go into what the deal means for us, let’s examine the latest illusion. Last year the illusion was that ‘austerity creates growth’. The 6pc contraction in the Greek economy in the final quarter put paid to that canard. As does our rising insolvency and mortgage arrears data here.
The latest illusion that the EU has now come up with is that ’120′ is the new ’60′. A debt/GDP ratio of 120pc is now regarded as sustainable. A few weeks ago during agreement of the fiscal compact, a debt ratio of 60pc was regarded as the sustainable target. Now we know — well, for Greece at least — 120pc is the new 60pc.
One has to wonder is the new target set at 120pc of GDP because that’s where Italy and Belgium are right now and to suggest that this was anything other that a good outcome for Greece might shine the light on these other outliers?
Whatever the reason, what is interesting for Ireland is that private bondholders took a 53pc haircut on their holdings. They have been burnt. It is estimated that the ECB owns up to â‚¬55bn of these Greek bonds, which it bought at a discount. Obviously because it didn’t buy these bonds at face value, the loss the ECB will take will be less than 50pc but it is interesting in itself.
For Ireland, this means that we will get a deal on bank debt most definitely. It might take time because the last thing the ECB wants is a queue of ‘me too’ demands from Ireland and Portugal. But it is clear that our hand has been strengthened, if we decide to play it.
But just in case you think this is a victory for the citizen, let’s examine in a bit more detail how it works. There will be no default. Greece will be given a â‚¬130bn loan. With that loan it will pay out â‚¬100bn to bondholders, who will have seen their bonds fall 53pc in value. After the penal interest Greece has paid on these bonds already, we still see an insolvent country paying bondholders 50pc of face value when they should be getting nothing.
So Greece gets â‚¬100bn written off, but borrows â‚¬130bn in order to achieve this, so it is still borrowing more making its overall debt not better but worse in absolute terms.
Now it needs to grow to bring these figures down and that is going to be impossible. So we are going to be back to square one in a few years except for one crucial thing.
After all this is done, private creditors to Greece will have been paid by European public money stumped up by the taxpayers of other European countries. The banks have been bailed out again. Without help they would have got nothing. They now get 50pc of their worthless holdings and the subsidy comes from the taxpayer.
The illusion of a great deal was exemplified by Jean-Claude Juncker, the chair of the meetings of eurozone finance ministers, who said that the Greek debt deal “will preserve the financial stability of Greece”.
It will do no such thing. And Mr Juncker knows it.
According to Bill Bonner at the wonderful www.dailyreckoning.com: “A 10-page ‘strictly confidential’ report on the country’s debt projections prepared for eurozone leaders warns that the principles of the new deal will (a) cause debt levels to rise by further weakening the Greek economy and (b) scare off future bond market funding.”
The report also reveals that Greek debt could still be at 160pc of GDP by 2020 and that it could require another â‚¬245bn in bailout funding.
It concluded: “Prolonged financial support on appropriate terms by the official sector may be necessary.”
So let’s go back to Freud. Why would Europe’s financial and political elites insist the deal is sound when they know it’s not? The reason goes back to the dirty little secret. The ‘bailout’ of Greece is really a bailout of eurozone banks.
But they can’t say that, so they maintain the illusion of success because, as Freud said, “it saves us pain” and obviously the collision has been postponed for a little while more.
As this column has said many times before, you don’t make a balance sheet with too much debt better by adding more debt; you fix it with less debt.
Greece is not making progress on this basis. All it is doing is incurring new debt to retire old debt .
Contrast this with Iceland. In the same week as the eyes of the EU were focused on Greece, Iceland — a country which in 2008 suffered a monumental crash — is now recovering strongly.
It has done exactly what economic mainstream thinking would advise. It dropped its currency by over 40pc to make itself more competitive and mainly to choke off unnecessary imports. It defaulted on its bank debt by simply telling the creditors that there was no cash and they could take equity in the banks if they wanted.
So it devalued and defaulted and, far from the markets punishing Iceland, the markets rewarded them. Iceland is now borrowing again, the economy is growing, inflation has fallen and there has been large-scale mortgage debt relief. Crucially, unemployment is now at 6pc and falling. And it is running at 6pc of GDP budget deficit, borrowing from abroad and at home to do so. Who says people won’t lend? Of course they will, because the debt default means that the balance sheet is fixed.
The Icelanders took control of the situation and did things their way. They were rewarded. They didn’t try to be ‘best in class’, but laid out things as they were to the creditors. The markets moved on. They would do the same here.
Make no mistake, the way mortgage arrears are rising here and the way companies are going to the wall due to their debt burden, huge debt deals will have to be done here.
It’s just a matter of when, not if. Greece shows us how not to do things. When it comes to debt, Iceland gives us a roadmap.