Collective Action Clause, Ρῆτρες Συλλογικῆς Δράσης

Collective Action Clauses (CAC’s henceforth) or Majority Action Clause have a long and varied history. According to Buchheit & Gulati[1] they were first introduced in English law by Palmer (1879). Their introduction served and serves a very real purpose and need. That of facilitating the restructuring or the amendment the (T)erms & (C)onditions of a Bond by the majority of Noteholders and to avoid rogue or malevolent holders of bonds holding at ransom both the debtor and other creditors.  What are CAC’s (see Appendix for an example) and what purpose do they serve?  Let me start with an example of how it might work.

Suppose that ACME a company that manufactures futuristic technology gadgets finds itself in the position of having a severe cashflow problem as one of its major clients Mr W.E.Coyote has not paid in time. ACME is unable to pay its bond liabilities at the agreed time. Consider further that most bondholders believe, after careful analysis of ACME’s product range, that the main business is sound and given time and perhaps some reorganization of the company’s management and client focus ACME would thrive and pay in full its bond liabilities. All that it needs is to amend some of the T&C of the bond, perhaps extend the maturity or move some coupons in the future and ACME would survive. One bondholder, Mrs R.Runner for reasons of personal benefit or other, things differently. When ACME got into trouble Mrs Runner bought some of the bonds at discount with a view to either force ACME into liquidation or force a management change or simply to extract more money. Mrs Runner can do so since ACME bonds need the consent of 100% of Noteholders as there are no CAC’s that allow for the will of the majority to prevail. If on the other hand, ACME bonds included right from the start CAC’s specifying that a 75% majority is binding for all bondholders Mrs Runner would have needed at least 25% of the outstanding ACME bonds to see her sinister plans materialize.

Happy Birthday to Mithras

The date of December 25th probably originated with the ancient "birthday" of the son-god, Mithra, a pagan deity whose religious influence became widespread in the Roman Empire during the first few centuries A.D. Mithra was related to the Semitic sun-god, Shamash, and his worship spread throughout Asia to Europe where he was called Deus Sol Invictus Mithras. Rome was well-known for absorbing the pagan religions and rituals of its widespread empire. As such, Rome converted this pagan legacy to a celebration of the god, Saturn, and the rebirth of the sun god during the winter solstice period. The winter holiday became known as Saturnalia and began the week prior to December 25th. The festival was characterized by gift-giving, feasting, singing and downright debauchery, as the priests of Saturn carried wreaths of evergreen boughs in procession throughout the Roman temples.

Εγκαταλείψτε το PSI+

Άρθρο στην Ημερησία.

Η Ελληνική κυβέρνηση φαίνεται ότι έχει ήδη στείλει το γράμμα της στον Αϊ-Βασίλη. Θέλει PSI και τίποτα άλλο. Η αγορά όμως λέει κάτι διαφορετικό. Η αρχική συμφωνία του PSI προέβλεπε ένα «κούρεμα» της τάξεως του 21% στην καθαρή παρούσα αξία. Από την αρχή είχαμε τονίσει πως η συμφωνία δεν ήταν επωφελής για την Ελλάδα («Ημερησία», 30 Ιουλίου του 2011).

Στην πραγματικότητα όμως, η λογική του PSI+ ήταν και είναι λανθασμένη. Για το λόγο αυτό εγκαταλείφθηκε από τους Ευρωπαίους. Είναι μυστήριο γιατί επιμένουν στην εφαρμογή του για την Ελλάδα. Ίσως γιατί δεν έχουν το χρόνο να ασχοληθούν μαζί μας και ίσως γιατί και η ελληνική κυβέρνηση δεν ασχολείται με το θέμα σοβαρά. Η καινούρια όμως συμφωνία κατόρθωσε να είναι δυσμενής και για την Ελλάδα αλλά και για τους ομολογιούχους.
Η αναδιάρθρωση χρέους είναι μία εξαιρετικά λεπτή διαδικασία έχοντας και την επιπρόσθετη εμπλοκή της δήθεν εθελοντικής διαδικασίας. Τα ομόλογα διαπραγματεύονται γύρω στο 25%-40% και πάρα πολλές ευρωπαϊκές τράπεζες τα έχουν ήδη εγγράψει κοντά σε αυτές τις τιμές έχοντας απορροφήσει μεγάλο μέρος της ζημιάς. Το PSI, τους καλεί να τα ανταλλάξουν με νέα, που θα έχουν περίπου την ίδια αξία με αυτήν που έχουν τιμολογήσει στο χαρτοφυλάκιό τους. Εάν όμως δεν συμμετάσχουν στο PSI, ενδέχεται να πάρουν 100 σε περίπτωση που αποφευχθεί η χρεοκοπία. Σε περίπτωση που η Ελλάδα χρεοκοπήσει και τυπικά, θα πάρουν πάλι κοντά στο 30% (υπόθεση). Άρα η λογική των τραπεζιτών, λέει ότι είναι καλύτερα εκτός PSI, παρά εντός, παρέα με την ΕΚΤ (45 δισ.).
Το PSI δεν είναι η καλύτερη λύση για την Ελλάδα στις σημερινές συνθήκες της αγοράς. Η αρχική ιδέα των Γερμανών ήταν η τιμωρία των ιδιωτών ομολογιούχων και η μείωση του χρέους. Η τιμωρία όμως των ομολογιούχων από την Ελλάδα δεν πρέπει να είναι ο στόχος και ούτε είναι προς όφελος της Ελλάδας. Η Ελλάδα πρέπει να ενδιαφέρεται μόνο για τρία πράγματα.
1) Επιτόκιο εξόδου. Δηλαδή η απόδοση με την οποία θα διαπραγματεύονται μετά την αναδιάρθρωση.
2) Πιστοληπτική αναβάθμιση μετά την αναδιάρθρωση.
3) Βιωσιμότητα του χρέους μετά την αναδιάρθρωση.
Δυστυχώς, το PSI με τη σημερινή του μορφή δεν πληροί τους τρεις αυτούς στόχους. Και τούτο, διότι οι ομολογιούχοι απαιτούν υψηλά τοκομερίδια καθιστώντας τη βιωσιμότητα και το επιτόκιο εξόδου προβληματικό. Η Ελλάδα θα χρειαστεί να δανειστεί ξανά για να πληρώσει τα νέα τοκομερίδια. Προσθέτοντας την αλλαγή σε αγγλικό δίκαιο και τις εγγυήσεις από το EFSF, τότε έχουμε ένα πραγματικό γόρδιο δεσμό. Το τραγελαφικό στην όλη υπόθεση είναι πως οι Ευρωπαίοι εμπιστεύονται και επιζητούν την προστασία του αγγλικού δικαίου αντί κάποιου άλλου. Μόνη εναλλακτική λύση η «εθελοντική» προσφορά επαναγοράς.
Υπάρχει όμως εναλλακτική λύση στο PSI. Πολύ απλά να δώσουμε 35% (περίπου) και να επαναγοράσουμε τα χρέος μας. Ούτως ή άλλως οι μόνοι που θα συμμετάσχουν στο PSI είναι όσοι πιεστούν από ευρωπαϊκές κυβερνήσεις. Αντί λοιπόν να ανταλλάξουμε τα παλιά με τα καινούρια ομόλογα κάνουμε «εθελοντική» προσφορά στο 35%. Τα προτερήματα αυτής της λύσης είναι:
Το χρέος μειώνεται στο 120% του ΑΕΠ από την πρώτη κιόλας μέρα. (15% αποχή από τη διαδικασία και με την ΕΚΤ να πάρει 70% της ονομαστικής).
Η Ελλάδα δεν πληρώνει τόκους και χρεολύσια για 10 χρόνια που είναι η περίοδος χάριτος των δανείων μας.
Η Ελλάδα δεν θα χρειαστεί να αποδεχθεί το αγγλικό δίκαιο στα ομόλογα. Μόνο στα διμερή δάνεια προς το EFSF (όπως και τώρα).
Οι ομολογιούχοι παίρνουν ρευστό, δεν θα έχουν άλλες ζημίες και ούτε οι τράπεζες θα είναι αναγκασμένες να κάνουν περαιτέρω προβλέψεις ή διαχείριση ρίσκου. «Τιμωρούνται» δε ακόμα πιο αυστηρά αλλά από την αγορά.
Η Ελλάδα καθαρίζει όλο το στοκ των ομολόγων της. Τα καινούρια ομόλογα θα μπορούν να έχουν ρήτρες συλλογικής δράσης και ό,τι άλλο θέλουμε.
Η Ελλάδα θα βελτιώσει κατά πολύ τη βιωσιμότητα του χρέους της αλλά και την πιστοληπτική της ικανότητα άμεσα.
Αγοράζοντας και καταστρέφοντας τα ομόλογα, απομακρύνεται ο κίνδυνος πιστωτικού γεγονότος από ενεργοποίηση των ρητρών που υπάρχει σε πολλά ομόλογα του ΟΣΕ αλλά και της ελληνικής δημοκρατίας.
Η Ελλάδα θα πάει σε επιλεκτική χρεοκοπία όπως και με το PSI για όσο καιρό ισχύει η προσφορά.
Θα ρωτήσετε όμως, πού θα βρούμε τα λεφτά για την υλοποίηση της εν λόγω λύσης. Χρειάζονται περί τα 105 δισ. ευρώ. Αν υπάρξει συμφωνία με τους κατόχους, τότε τα ομόλογα σε βάθος 12 μηνών θα μπορέσει να τα «σηκώσει» το EFSF.
Συμπέρασμα
Το PSI ήταν πάντα μια κακή επιλογή που προωθήθηκε από πολιτικούς. Η αγορά δίνει όμως πάντα καλύτερες λύσεις και αυτήν τη στιγμή λέει ξεκάθαρα μέσω των τιμών ότι η καλύτερη λύση είναι η προσφορά επαναγοράς και όχι η ανταλλαγή με νέα ελληνικά ομόλογα. Χρειάζονται άμεσα πρωτοβουλίες από την ελληνική πλευρά.

Newton's Notebook from Trinity College, Cambrige

I know that this is not a financial post but as a physicist who studied theory or gravity and Newton I found it very interesting (hat tip to Sotiris). It is Isaac Newton's Notebook from Trinity college, Cambridge. Notice the language!
You can see the rest in Cambridge Digital Library

Should Santa bring PSI to the Greeks?

Letter to Santa,

Dear Santa, I am the Greek government and I know that I have not been a very good child lately. I was placed on the naughty step many times this year for not behaving properly. Despite my parent’s good will and encouragement I did not manage to reduce significantly my addiction to the soviet style state, I did not brake relations with my good friends the unions, or increase my rather poor grades in housekeeping. I also failed to share some of my prized toys and possessions with other kids. I know, “If you do not share (sell) you do not play” but I really can’t. I realised that my finance minister behaved rather impolitely to your representative elves, but he has now learnt who is filling his dog bowl with goodies and realigned his allegiance accordingly.  He realised that our benevolent parents assign the top dog position. Although I cannot claim to have repented in full, I did change the Prime Minister as instructed by our well-meaning parents. I reluctantly formed a unity government consisting of some right wing xenophobic fascists, hysterical nationalists and utopian socialists. Although this is not the ideal, it is the absolute best, the crème de la crème, of the Greek political system. So, please, please, please can I have my PSI for Christmas? I promise to be good going forward.

Signed

Greek Government

Christopher Hitchens dies after long battle with cancer

Today is a very sad day for all who think that logic and rational thought should govern our lives. Christopher Hitchens perhaps the most outstanding polemicist for many generations died of lung cancer.

I am one of the lucky people who first met him through his toxic and sharp writings on Mother Teresa, Kissinger, and God. I also had the pleasure of meeting him in person. On hearing that I was Greek, he started speaking to me in Greek. I learned afterwards that his first wife was Greek Cypriot. His knowledge of global politics was unsurpassed and his ability to quote facts and stories legendary. As Richards Dawkins said of him "If you are invited into a debate with Hitchens, DECLINE". He recently locked swords with ex-PM Tony Blair. You can watch this debate for free for a limited amount of time (hat tip to Manos Markakis). He was a delight despite his illness.

He will be missed but not forgotten. In the future he will for sure be called as one of the leading lights of the new enlightenment. He did  plant many seeds. It is for us to help them grow.

My friend Leo Kolivakis paid tribute to Hitch. 

On Mother Teresa: "[Mother Teresa] was not a friend of the poor. She was a friend of poverty. She said that suffering was a gift from God. She spent her life opposing the only known cure for poverty, which is the empowerment of women and the emancipation of them from a livestock version of compulsory reproduction." 
On Bush: “[George W. Bush] is lucky to be governor of Texas. He is unusually incurious, abnormally unintelligent, amazingly inarticulate, fantastically uncultured, extraordinarily uneducated, and apparently quite proud of all these things.”

Obituary by Vanity Fair
"Farewell, great voice. Great voice of reason, of humanity, of humour. Great voice against cant, against hypocrisy, against obscurantism and pretension, against all tyrants including God. Farewell, great warrior. You were in a foxhole, Hitch, and you did not flinch. Farewell, great example to us all."

Obituary by Telegraph


“[O]wners of dogs will have noticed that, if you provide them with food and water and shelter and affection, they will think you are god. Whereas owners of cats are compelled to realise that, if you provide them with food and water and shelter and affection, they draw the conclusion that they are gods.”  

Reply to Prof. Varoufakis on the occasion of his blog post on the 10th December 2011.

Dear Prof. Varoufakis

Thank you very much for your swift and good natured reply. I am honoured that you took the time to read my critique and the respect you have given it.

Background

About a year ago Prof. Varoufakis and Prof. Holland presented a proposal to solve Europe’s debt crisis. Since then, the so-called Modest Proposal (MP henceforth) has undergone many revisions. The most updated version can be found in here. On the 5^th of December 2011 Andreas Koutras published a Critique of this proposal. Prof. Varoufakis answered these criticisms on the 10^th December 2011 in here. The current paper is the counter answer to Prof. Varoufakis.

 I share Prof. Varoufakis’ view that we need a totally open minded and rational debate about the causes and solutions to Europe’s problems. I would also like to add, that due to the seriousness of the issues, such a debate should be based on facts, evidence and logic rather than beliefs, convictions, political prejudices, groundless assertions or populist commentary. I am the first to admit, that unwittingly, I sometimes fall prey to their attractiveness. Christopher Hitchens, said “What can be asserted without proof can be dismissed without proof” when asked about the existence of God. If we apply this simple principle to every debate we would form a better society and a better future for all of us.

Prof. Varoufakis should be commended for his tireless zeal with which he has undertaken the European cause. I admire his energy and his ability to raise awareness about such important issues. Europe and Greece would be a better place if more people joined this debate and followed his example. Hopefully, this dialogue will show how urgent is the need to find a stable solution to the debt crisis. The EU is our home and it deserves another chance. 

EU Council Decisions. Moving Closer to Feudalism

Europe reminds me, of the famous pregnancy book, “What to Expect when you’re Expecting”.  The book describes eloquently many, if not all, the symptoms that Europe is undergoing; like waddling, drooling, vomiting, forgetfulness, fatigue, nausea, constipation, incontinence plus many others. How else can you describe the path that Europe has taken towards the birth of the new Europe? European Council meetings and Eurogroup or Ecofin gatherings are responsible for most of the credit spread basis points of Italy, Spain Greece and the rest than any hedge fund or trader. Their inability to diagnose the roots of the crisis is only second to their incompetence into finding a solution.  Lets look at latest decisions taken the past couple of days by the EU Council.

ORPHANIDES SAYS ABANDONING PSI IN GREECE MAY RESTORE MKT TRUST

 According to news reports the governor of the Bank of Cyprus and member of the ECB executive council spoke of abandoning PSI. Read the report here

*ORPHANIDES SAYS ABANDONING PSI IN GREECE MAY RESTORE MKT TRUST
2011-12-09 11:06:03.901 GMT

ECB adopts ELA practices, Stealth Quantitative Easing

ECB Decides that it is really a bad bank after all.

The ECB decided on Thursday to:

• Lower the Repo, Marginal and Deposit rate to by 25bp.
• Start a longer-term refinancing operation with a maturity of 36Months putable after 12m. 
• Reduce the reserve ratio from 2% to 1% (Banks would need 100blin less now to cover their regulatory requirements)
• Lowered the collateral rules for ABS (single A, Mortgages and SME’s) and allowing NCB to accept performing loans

Lets look at each of the decisions.

Abandon PSI+. Buyback Instead

This post is also mentioned in Greek (citypress Yannis Paleologos)
 
On the 26^th of October the European leaders pushed the head of the IIF to accept a 50% haircut on the nominal of the Greek bonds. This apparently was done in order to punish the banks that invested carelessly into Greek debt and to reduce the Greek debt burden. The noble aim was to reduce the Greek Debt/GDP to around 120% by 2020.

They also reiterated their resolve in keeping the whole PSI exercise on a voluntary basis. In this note we argue that the size of the haircut may have struck a death blow in the PSI and that now it would be better if Greece was to make a public offer to buy these bonds back at an average of 35% (say) rather than mess with the PSI conundrums.

A Critique on the Modest Proposal of Varoufakis & Holland

About a year ago Prof. Varoufakis and Prof. Holland presented a proposal to solve Europe’s debt crisis. Since then, the so-called Modest Proposal (MP henceforth) has undertaken many revisions. Their claim is that the MP can solve the continents debt woes without any fiscal transfers or treaty changes. The current flavour of their proposal can be found by clicking on the link Varoufakis and has been adopted by the Levy institute. Despite the publicity that the MP has commanded in the press and the relentless marketing efforts of its originators, the MP has not captured the market practitioner’s imagination or the banker’s acceptance. In this note, we analyse parts of the MP and argue that the non-adoption of the proposal may be due to flaws that many would call, detrimental and fatal to the proposal.

Greece could default on PSI negotiations

Back in July 2011 the so called Greek negotiating team made a rather fundamental error when negotiating the original PSI. They engaged into the talks apparently unprepared and with a rather amateurish team. The result was an agreement that was later abandoned and declared dead only to be replaced by another PSI that also seems to be dead too. The Greeks appeared to have made another mistake which only betrays severe incompetence in the matter. They signed a clause that allows countries (Finland) to ask for collateral from Greece as a prerequisite for their financial support. Why was it a mistake? Because there are Greek bonds in existence that specifically prohibit Greece from giving any security unless they do so for everybody. If they do not give this security to everybody, then it would be a breach of the bond's covenants and possibly an "Event of Default". The negotiating team could have said to the Finland team that they cannot possibly give these guarantees as this would be an event of Default, which is something to be avoided and the case would have been closed then and there. That would have been the case of course, if anyone had bothered to read the legal documents that the Hellenic Republic had already signed (see FT  alphaville).The fact that they did not object to it, shows that they had not done their homework going into a meeting that was to shape the country's future. Incidentally, for Bond aficionados the actual clause is called a "Negative Pledge". Let me give you an example from the Greek bond with ISIN XS0256563429.

Click to enlarge

   "So long as any Note remains outstanding, the Republic shall not create or permit to subsist any mortgage, pledge, lien or charge upon any of its present or future revenues, properties or assets to secure any External Indebtedness, unless the Notes shall also be secured by such mortgage, pledge, lien or charge equally and rateably with such External Indebtedness or by such other security as may be approved by an Extraordinary Resolution of the Noteholders (as described in Condition 10)."

So simply by reading the Offerings of the bonds they could have avoided a lot of trouble and the subsequent structuring of a special vehicle to handle this guarantees. Absurdly enough  the Greek side seems to be repeating the mistake! (Τό δίς ἐξαμαρτεῖν οὐκ ἀνδρός σοφοῦ, "To commit the same sin twice is not a sign of a wise man.")

Greece negotiating directly the PSI could be an event of default. 

Click to enlarge

According to many press reports (Kathimerini) Greece has started direct negotiations with the bond holders in order to finalise the haircut and restructuring of their debt. If this is true, then just read the following "Events of Default" from the Greek bond with ISIN FR00489676.
"(l) Moratorium
A general moratorium is declared by the Guarantor in respect of its External Indebtedness or the Guarantor announces its inability to pay its External Indebtedness as it matures or the Guarantor otherwise commences negotiations with one or more of its respective creditors with a view to a general readjustment or rescheduling of its respective indebtedness."

The Guarantor in this case is the Hellenic Republic and the bond was issued by the Hellenic Railways. Interestingly, apart from the Greek lawyers (that may claim ignorance), the international one is a very well known firm, that should have spotted this gross mistake in the Offering.

One could have stretched the argument up until now by claiming that it was the IIF that was doing the negotiations and not Greece directly. This is like hiding behind a fig leaf. But if it is true that Greece is now directly negotiating the "voluntary" restructuring and haircut and it would leave very little room for latent interpretations. Ultimately, it would be up to the English courts to decide how to construe it.

One thing is certain, the market is scrutinizing Greece’s every move and Greece would better square up to it (see FT  alphaville). All one has to do, is to buy few thousands (minimum denomination is 1000) of this bond maturing on 13 September 2012 and go to an English court and declare that Greece has breached the covenants and has therefore defaulted. Apparently it is that easy. I wonder how long it would take before someone does this.

Gambler's Ruin. EU's Gambler's Fallacy.

Leonardo, the 6 year old son of a  colleague of mine when asked what kind of a Christmas present he wants answered "Dada I want a money printing machine so I don't have to ask you for money again". The kid's understanding of money creation is not far off from what most esteemed economists, politicians and journalists have. Many of us have pondered; if it so easy to print money to get out of a financial mess why doesn't everybody doing it? The USA is doing it to the tune of few trillions and Her Majesty's government engaged in quantitative easing (Fancy word for money printing). According to this idea the ECB can print two trillion Euros in order to buy all Greek and Italian debt and bob's your uncle. No more austerity measures, no more hardship or reliance to market forces.

In fact, this is exactly what the central banks of the most advanced countries are doing the past 10 years. They have been doing it in a number of ways not often seen as money printing. In fact the expression money printing is a misnomer as there is no real printing of currency notes in the traditional sense but just the practice of adding few more zeros on the accounts the commercial banks have with the central bank.

Gambler's Ruin

If you have done statistics and probability in college, you have probably come across the example known as Gambler's ruin. If on the other hand, you are a trader or a simple betting man or woman you would have experienced this mathematical concept first hand. Let me explain it with a simple bet:

G.Neous, a gambler, and his friend, John Doe, play a simple coin toss game. G.Neous declares Heads or Tails and a coin is flipped. G.Neous starts with a bet of £100. If he guesses correctly he has won £200, since there is a 50/50 chance in a fair coin toss. If he loses however, he doubles  his bet, in order to recoup his losses and make up some profit.  This strategy is perfect! G.Neous is assured of a profit. As we all intuitively know, at one point in time G.Neous would guess correctly and make a handsome profit.In mathematical language this is expressed by saying that the probability (expectation) of winning is 100%. So where is the catch? The problem is that even though you have 100% probability of success (at some future time) you do not know or have a limit on when this is going to happen. In other words, it can come after 10 coin tosses or after 1000 or even after 1 million coin tosses. This means that you must have infinite amounts of money in order to play this strategy and infinite amounts of time (for biological beings). In mathematical language this is called infinite variance or unbound variance. How many times did a gambler say, "if I only had more money to bet". He knows that eventually he must win, but he runs out of money before that winning bet comes.

This is analogous to what central banks have done the past 11 years. When the internet bubble burst the Fed first and the ECB later lowered their intervention rates. This made the price of money even cheaper. Effectively, they indirectly threw trillions of dollars and euros into the system in order to avoid the recession. This created a real estate bubble. When the real estate and mortgage bubble burst they printed even more money to stop the collapsing and the recession. In the process, they moved the problem from the banks to the sovereigns and now politicians are asking for even more money printing in order to save the peripheral countries. Where is the catch in this case? Well obviously central banks have infinite amounts of money because money are not mined in some far away land but are computer generated. If something has infinite supply then standard logic says that it must have zero value. And modern fiat money does have zero intrinsic value. Its only value comes from the confidence people have in it. If that confidence is lost then the system collapses.  The more you print the less confidence you have that it may be worth anything.  And this is exactly the risk we are running which is analogous to the gambler's ruin.

So what is the bet that the central banks are taking when they print huge quantities of money. It is very simple. They bet that growth would kick in and inflation would lower the value of debt before people absolutely lose faith in the fiat currency they hold. As long as inflation is tamed then they can continue printing. Unfortunately, without realising they have engaged into the gambler's ruin strategy and suffer from the Gambler's Fallacy.


Gambler's Fallacy

Gambler's Fallacy is another great way that probabilities can fool you into thinking that you are a gambling genius. If for example, G.Neous plays the roulette and number 35 comes up 5 times in a row you may think that the probability of coming up again for the 6th time must be very very small. So you place your bet on everything else but 35. Or you may think that there is some hidden pattern and 35 would come up again for the 6th time. Wrong! Number 35 has exactly the same probability of coming up in a fair roulette (1 into 37 if there is only one zero in the roulette).
Policy makers have fallen into the gambler's fallacy trap. They believe that since inflation is mostly under control after two large doses of printing that would also be the case next time. They are running similar risks to our gambling friend G.Neous. Their thinking is not just wrong it is absolutely criminally dangerous. The more we print the closer we come to the abyss. Unfortunately as far as I know there is no direct measure or index  that captures the  faith on the fiat currency. Some people look at the price of gold or other physical assets in order to gauge it. My intuition tells me that if something appear to be too good to be true, then it is too good to be true.

Conclusion

There is growing evidence that policy makers on both sides of the Atlantic are committing the same mistakes our G.Neous gambler is making.They seem to engage the Gambler's ruin strategy as the best exit strategy out of the financial mess and their decision making process is based on a Gambler's fallacy. Let us hope (only thing we can do) that it works on this coin toss because there may be no more coin games later.  

European Tax incentives.

Taxes define the state

Historically, one of the key hallmarks of a successful state is the ability to impose and collect taxes. From ancient Egyptian times, to the Roman era and more recently to the Ottoman and American empires, tax collecting is not just a money raising activity but delimits the scope of the state’s power and its effectiveness. Sometimes it goes even further as a means of defining citizenship or nationhood. It comes therefore as no surprise that a sure sign of a failed society or a mismanaged state, is its inefficiency and negligence to collect taxes. Following this, the only way to claim that we have a united Europe is to have some form of united tax and tax collecting mechanisms that are accountable to the people of Europe. This has to be done in a democratic way and NOT some unelected officials. We have to adhere to the principle of "No Taxation Without Representation".


In this respect, the demands of the IMF on the Greek government to improve their tax collecting efficiency goes beyond a pure technocratic measure. It is akin to a call to rebuild a state and a society that lays in (Greek) ruins.

Greek tax incentives
Before attempting to provide explanations of the mechanisms that are responsible for this mess it is instructive to illuminate the mess Greece is in.

In essence, the Greek tax laws are very complicated. On average 5 tax laws are passed every year (17  in 2010) with tax officers unable to keep abreast of the most recent whims of their ministerial masters. While in the late 80’s tax arrears totaled €200mln in 2010 that figure is a staggering €33bln. The information technology revolution seems to have escaped the attention of the modern Greek state where paper filing is still king. Sporadic attempts to introduce computers only resulted in a proliferation of different systems and databases that do not communicate with each other. As a result the cost of collecting taxes is 2-3 times the European average. Corruption among tax officers is rife and has never been dealt with effectively. Tax evasion cases take on average 7-10years to be resolved in Greek courts by which time a tax amnesty is bound to happen. There is one tax amnesty almost every 3 years, which by amazing coincidence correlates highly with election time (Nov 2010, is the 10th since 1985, and more to come). Thus, one can argue that it is almost a state policy not to collect taxes.

In fact most economists would describe the Greeks as acting rationally within their own economic habitat. Volunteering to pay taxes is not a human trait. Some say it is a God given right to avoid paying taxes. 

Why Governments need to collect taxes. Incentives

On the surface, one is puzzled by the inability of the Greek government and the political establishment to raise tax revenue as this is the lifeblood of the state and the essential nutrition of the bureaucracy and the political elite. A clue is given by the exponential growth of tax arrears in the years 1995-2010. Governments have a big incentive to develop the economy and the tax collecting effectiveness, because, this is how they survive and exercise their power.
Against this incentive, a Government needs to balance the unpopularity of the taxes they are imposing and in modern democracies this costs votes. Thus a healthy equilibrium is reached and we have a functional state.

Incentives were altered in Europe. Moral hazard

This equilibrium of incentives was violated in Greece and in other peripheral countries, first in the 90‘s by the extension of European subsidies with no strings attached (a cost free cow to be milked) and secondly by the entry into the Euro system and the availability of borrowing at very low rates. Politicians did not have to make hard financial and political choices. They used the subsidies in order to get re-elected and the cheap borrowing to cover any shortcomings. Economic productivity was decimated as traditional industries fell prey to the rising globalization and was replaced by borrowing. GDP growth came from consumption which was fueled by even more cheap borrowing. Why bother with fixing the tax system when you can borrow at low rates with the implicit European guarantee? The spread of the Greek bonds to the Bund which now stands at roughly astronomical levels was at 30 basis point in 2002 and was close to 70-100 for most of the time. One can mitigate his unpopularity by yet one more tax amnesty. It is possible to delay dealing with hot potatoes until the opposition is in power and then to sabotage any attempts to fix things in order to get re-elected once more. Politicians became debt junkies.

Moral hazard and the disequilibrium of incentives is a very powerful force. It is like compound interest. It acts on a long timescale and it passes undetectable on a daily basis. Slowly, the voices of reason and common sense started fading away. Politicians who advocated restrain and prudence became political eccentricities and increasingly unelectable. Populism rose and an arms race of nepotism and exuberant political pledges took over.

The roots of what has happened in Greece are completely analogous to the situation in Arab states that discovered oil or to African states with mineral deposits. In all cases the shift of economic incentives for the ruling party/government acted as a retarding force for the economy and created dysfunctional and failed states. In the Arab world, oil supported totalitarian regimes and in Africa contributed to economic misery, civil wars and gun democracy. In Greece and in other EU countries the subsidies and cheap funding supported the profligate policies of hungry for re-election politicians.

The European bail out of Greece and of other peripheral states, is dealing with the symptoms of the crisis and not with the root causes. None of the moral hazards or the imbalances of political incentives is dealt with in a European level. Once the IMF finishes its work and leaves, the irresponsible behavior will resume in Greece and in other European member states. By that time a more coherent bail out package would exist and a transfer of creditworthiness can resume from the rich north to the south either through a European Bond (I do not mean  a proper Eurobond but the joined guarantee one) or some other mechanism.

 Conclusion

This is not what European citizens want. The current crisis is an opportunity to reset the core European foundations on a more concrete and moral footing ready to meet the challenges of the future. In this respect the current crisis could do us a great service only if we draw the right conclusions and act on them.We need a more democratically accountable Europe, one that citizens would be proud to be members of not just a union dictated by unelected officials. This is the time to address this democratic deficit. This is the time to address the Fiscal union. Failing this time is an option that should not be exercised.

Samaras sends letter. 6th Instalment

So finally, the leader of ND Mr. Samaras has sent a letter to the EU partners describing his support for the program. He did make some noise regarding modifications that need to be done, in the program all within the context and spirit of the program. Would that be enough to satisfy Troika and thus release the 8bil? We do not know. What is probably irritating to say the least, is that it appears that Mr Samaras did NOT negotiate the letter before sending it. In practice, these letters are sent and published after secret negotiations have taken place. In this instance, it seems that he acted unilaterally which is not just odd but grossly irresponsible given the gravity of the situation.

The truth is that this is a power game. Why would a personal signed guarantee make any difference once the Greek parliament approves the measures.Mr Samaras may not be the leader for all we know in 3 months. He might go the same way his university room-mate Mr Papandreou went. If his signature is worth 8bil then he should give 50 of those and wipe out the Greek debt. It is irrelevant what he or he does not sign in the same way that Mr Papandreou signed the MOU with Troika and did not keep his word. So, reality is that this is a badly scripted show of force by Troika and Samaras.

Instalment of 8bil
Greece needs this 8bil to pay not just the redemptions coming in December but also to pay salaries. This instalment was due in September, so it is very very late. In theory, December had the next tranche of 5bil.
So what if Greece does not receive the 8bln. Does this automatically signify default? Well, not exactly. The Greek state can borrow in theory the 8 billion from the Greek banks. You may ask where would the Greek banks find the 8billion? Well, they can turn around and give this as collateral to the Greek ELA (Emergency Liquidity assistance) which currently runs at 26billion. It does sound like a Ponzi scheme and it is, as the ELA is a liability of the Greek state, but hey the Irish are doing it to the tune of 75billion. Why not the Greeks. All that is needed is the unofficial (or official) nod from ECB.

Is Greece a failed state?

Let me explain the rather sensationalist title of this note. Most Greek citizens living in Greece, spend a disproportionate amount of their time dealing with the state. It is not uncommon to hear them talking in desperation about their failed public services, their failed political system and sometimes their failed state. When it comes to the every day dealings with the state their only consolation is the sunny weather and their eternal hope for change. As most of them say, proving that you are “not an elephant” is the norm rather than the exception.

Is this the sign of a failed state, or just normal moaning? What is a failed state? Can we measure somehow the degree of failure? Fortunately social scientists have done this, so we can apply their criteria and see how they fare.

Broadly speaking there are three main indicator categories:  

•   Social

• Economic                       

•   Political

Social

In this category we have 

• Mounting demographic pressures 
•  Movements of refugees or internally displaced persons. 
• Legacy of vengeance seeking or group paranoia
• Chronic and sustained human flight

Greece does not have a demographic pressure or a population explosion. Quite the opposite it is a country with a declining birth rate. Thus there are no social pressures deriving from high density or limited food or resource supply. However, Greece is a hub for illegal human trafficking and does suffer from high influx of economic and political refugees without having the necessary infrastructure to deal with the issue. Moreover, there is a growing resentment and aggression towards these immigrants mainly stemming from the state’s failure to deal with the situation and the racist views of many Greeks.

Although Greece on paper is a very homogeneous country with more than 90% of citizens declaring themselves to be Greek orthodox (religion), Greek speaking (Language), Hellenes (Ethnicity), there are very deep divisions along political lines and affiliations. These deep divisions have caused in the past a civil war, a military junta and endless years of persecution for many. The recent financial crisis is partly caused by these divisive politics and the legacy of vengeance that exists in the main political parties. Greece is a highly divided country and this division along with the partisan politics is a major obstacle to the development of democratic institutions and of democratic political heritage. Greece may have been the cradle of democracy but as with most good things it was “for export only”. Finally, Greece is a regular supplier of brain drain professionals and intellectuals. There have been at least three major mass immigrations by Greeks in the 20^th century and we are currently witnessing the 1^st of the 21^st century.

Economic

In this category we have:  

•  Uneven development 

• Sharp or severe economic decline 

Greece does not have a uniform economic development. According to surveys close to 30% of the population lives close or under the poverty line. The past 30 years, the years Greece has been an EU member, saw the creation of a class of oligarchs that control the construction and the media industry and have an undue influence in the political life.Needles to say that the second criterion of sharp economic decline is currently in full swing. The total decline of the GDP might top the 20% from its peak in the years ahead. And this is an estimation that assumes Greece would not exit the Eurozone or the EU. 
Political
In this category we have: 

1. Criminalization of the state.  Corruption in the Greek state and in particular in the public sector is rife. Greece is 78^th in the transparency and corruption index, the lowest in Europe. Many call the ruling elite a kleptocracy and there is evident resistance to transparency and accountability.There is widespread loss of popular confidence in state institutions and processes. 
2. Progressive deterioration of public services: The Greek state’s responsibility to protect citizens from violence (including terrorism) and to provide essential services, such as health and education, are rapidly declining. The inefficient and bureaucratic state of soviet proportions is mostly to blame. Many believe, rightly or wrongly, that the state serves the ruling political elite or political families. 
3. Widespread violation of human rights: There is no significant violation of human rights in Greece when it comes to citizens. The situation apparently is different for illegal immigrants and refugees. 
4. Security apparatus as ‘state within a state’: Greece does not have a state within a state apparatus. Accusations do fly in from time to time but mostly for political expediency. 
5.  Rise of factionalised elites: Greece has had for many years’ two main political factions. The “patriots” or nationalist right and the “democrats” or left. They have fought not just an ideological war but also a real one. The problem is that even new politicians use this polarization in order to get elected, thus perpetuating the populist divisive politics. 
6. Intervention of other states or external factors: Currently, there are no foreign interventions or military actions. However, geographically Greece is located in an area that has seen many conflicts as recently as mid 90’s (Yugoslavia) and has open issues with more than one of its neighbours. 

Conclusion

Although many of the defining characteristics of a failed state are present in Greece, it would be imprudent to classify Greece as a failed state. The main problem is however, the increasing trend and intensity of some of these characteristics that point to a very dangerous path and future ahead. If Greece decides to abandon the Euro then it is highly possible that even more of the abovementioned characteristics of a failed state would be fulfilled, making Greece the first a truly failed European state of the 21^st century.

Eurobonds. Democratic Deficit

For a Greek translation click:
Αρθρο στο News247

The idea of the Eurobond as a Deus ex Machine saviour of Europe is not new. Various European leaders in distress like Mr Papandreou and others coined the idea of a single Eurobond that is going to solve all present and future problems. The problem is that everyone has a different idea of what a Eurobond is and how it would achieve saving Europe.

So let me describe what a bond is in my simple mind. It is a senior unsecured (most often) obligation (legal contract) of a legal entity that has the financial means to service the interest rate payment and repay the principle according to the schedule and covenants of the bond. Furthermore, the prospectus of the bond describes the way this legal entity is going to generate the cash that is going to repay interest plus principle. Sometimes, this description is very vague but nevertheless it should be there, otherwise how a prospective buyer would gauge the risk and assess the ability of the entity to repay him. In addition, as Bonds or debt is senior to the equity owners of the entity, the stockholders, have to vote or (democratically) approve the taking on of debt.

In the case of an independent sovereign like most European countries would like to think of themselves this means:

1.     Legal entity is the Sovereign

2.     Sovereign has taxing powers over its subjects and companies in order raise cash to repay the debt.

3.     The equity holders in this case are the voters who democratically elect the government (Board of directors) to tax them and raise the cash to repay the debt. This is one of the most fundamental principles of our western liberal democratic system. NO TAXATION WITHOUT REPRESENTATION.