Thursday, 22 March 2012

PSI Lessons to Investors

 As the Greek PSI is nearing completion it is important to draw some conclusions. The Greek debt tragedy went through many phases since its explosion in 2010 and it would be no surprise if there are more explosions in the future. So let us recap some of the more interesting points that became apparent the last two years.

Lesson 1. It is politics not economics.

Right from the start the Greek political leaders and Europe’s politicians sought a political solution rather than an economic/financial one. It is no secret that the Greek government and the Greek political establishment have the 3-i stuck to their forehead: ignorant, incompetent and irresponsible when it comes to financial prudence or management. The previous Greek PM was not joking when he naively asked why Greece cannot borrow at the same rates as Germany. After all, financial matters where of secondary importance in a family that produced 3 prime-ministers (Grandfather, father and son). It was therefore no surprise that Mr Papandreou (the Son, ex-PM) tried to completely politicize the Greek debt problem and avoid the hard facts.  

What perhaps was unexpected was the willingness of the rest or at least most of the rest of Europe to go along with these arguments. The Greek debt problem was right from the start a solvency problem. Despite this highly obvious observation, Europe chose to see it as a liquidity crisis. So, a first bailout was hastily put together of 110billion coupled with an austerity and economic reform program. I am one of the sad people who read the troika Memorandum of Understanding. It was a good economic fiction write up. Anyone with even a minimal knowledge of how the Greek economy functions (or better dis-functions) could tell you that you had better odds at winning the Euromillions jackpot(1 in 116million). The fundamental mistake Troika made is that they assumed that Greece is a state with the same European standards as the rest of Europe, and that they basically went ashtray in their budgets. They failed to see that Greece exhibited many of the characteristics of a failed state rather than a European state. Nevertheless, the first bailout was followed by second one and then a third one and I have no doubt that the counting will continue.

Lesson 2. L'État, c'est moi.

The conduct of the PSI restructuring is very instructive for the lessons learnt and very destructive for the future of the bond market. Let me explain. Greece needed to restructure its debt. This is no secret. However, European politicians thought that it can be done “voluntarily”. In other words, they believed that they had enough political power over bondholders to convince them to take losses. When they realised that this was not the case they resorted to the good old argument “L'État, c'est moi (I am the state).
Many may have heard the story on how they found a so-called loophole in the Greek law. Greek bonds did not have any Collective Action Clauses and Greece could retrofit these in order to facilitate the restructuring. That is pure and utter baloney. The so-called retrofitted CACs were just a sleight of hand.
Greece in effect exercised its prerogative not to pay the creditors and Europe gave its blessing. The law that they passed (4050/2012) suspended contract law and made it a “Public Interest” and with “mandatory provisions”. Plainly speaking they could have done this even if CACs did exist in the Greek law bonds. They basically unilaterally changed the Bond contract claiming it was in the Public interest. They engaged article 9 of EU 593/2008 in order to suspend European legislation. If this sounds like a legal coup it is because it is a legal coup.
In order to gain some legitimization and to push the blame away from them and into the banks they asked for bondholders to vote. The voting was similar to the one Pol Pot conducted in Cambodia. Greek institutional bondholders representing around 35% of the eligible bonds were either bribed (Banks through recapitalization sweeteners) or coerced (pension funds trustees were threatened). Adding to this, the so called IIF volunteers (arm twisted by their respective governments) and you very fast reach the threshold needed for Law 4050 to kick in. Resorting to Greek courts would be an adventure. Law 4050 supersedes any law that goes against it!! The face of authoritarianism and absolutism has shown its ugly face in Europe once more.  

Politicians played well this round. They advertised to their electors that they made the “bad” banks pay for the investment decisions they have made. What they failed to emphasize is that they were covering the losses with recapitalizations funded by taxpayers. They also ignored the numerous retail bondholders who did not participate in the so called discussions and in many cases were prohibited by law from receiving the Greek offering. Now these retail investors would get new Greek bonds secured by English law. Many are also secure that they will get their reduced capital back after they die since redemption is in 30y time. 

You may be forgiven for blaming this to the machinating Greeks, but remember the 3-i of Lesson 1. It was not the Greek government that came up with the idea and it was not the Greek government that sanctioned its implementation. It was a European and mainly Germany that pushed this abortion of a solution. The Greeks were just the puppets in the story. After all the debt load of Greece was only reduced by a very small margin. At the end of 2012 debt to GDP would only be 2-3% less than at the end of 2011!Here is what in essence happened:
·         Greek government got the European blessing to unilaterally change a bond contract and suspend any opposing law.
·         European governments bailed out the ECB few days before the exchange. They bailed out not just the SMP program but also all the National Central Banks who bought the Greek bond for INVESTMENT and not for monetary purposes!
·         Greek banks were promised to be recapitalised for the losses incurred. Greek funds were promised real estate to cover up the losses.
·         European banks were also promised preferential status if they were to participate in the restructuring.
·         Everyone else: Non-banks, pension funds, Insurances, non-European investors (American, Canadian, Chinese etc.), retail investors lost 78% of their money.
·         European politicians who stated time and time again that this was to be a voluntary restructuring were caught lying. Oops!! 

Lesson 3. Avoid Government bonds

When the credit crisis erupted most investors run to the safety of Government bonds. They dumped the Banks and sought safety in the Governments. In response the European governments placed under their protection the banking sector and their liabilities. This shifted the focus from the banks to the sovereigns and every state was scrutinised. Although Greece did not have a serious banking crisis it had a state unable to control its finances and a government not willing to deal with the problem. As the credit crunch migrated to the sovereign sector a solution had to be found. Europe pretends to be a democratic and accountable union but in actual fact the individual countries still have the power to ignore European laws and bent the rules to the detriment of those who trusted them. The moral of the story is simple: If you buy a Government bond which is under the jurisdiction of that Government expect NOT to be paid unless of course you are in the magic circle.

Thus unless you are a central bank or someone indifferent to the restructuring of a country’s debt, avoid government bonds. It is not just the fact that you are de-facto subordinated by the official sector (ECB and Government). You are better off with bank bonds or better still with a junk corporate bonds. In the last case you may have assets to attach in a bankruptcy and you may resort to the courts for justice. Yes, all countries do have legislation covering corporate debt and bankruptcy. It is only when it comes to themselves that they are tempted to act as renegades. As most European countries still issue the majority of their debt under their domestic laws the danger of changing or manipulating the law is real and growing.
Europe has shown that it has no problem behaving like a banana republic when it comes to restructuring government debt. The Greek debt restructuring is now the new paradigm in the sovereign debt restructuring arena. Anyone who claims otherwise is either a politician or blind.