Commentary on the economic , geopolitical and simply fascinating things going on. Served occasionally with a side of snark.
Thursday, April 3, 2014
Yanis Varoufakis outlines how the Troika ( in particular the EU and ECB ) have assisted in the systemic looting of the taxpayer in both Ireland and Greece.... Yanis explains the Portuguese debt restructure petition and why he signed it .....Why has the Eurozone Bond Market stabilised - signs of light at the end of the tunnel or just an on rushing train ?
The Irish and the Greeks are, in many ways, very different people. And yet, caught up in the Euro Crisis, our fortunes have become too close for comfort. Recently, European authorities have devised a creative new method for damaging the people of Ireland and of Greece further. The new method involved imposed changes on the public financing of bank recapitalisations that shift even greater burdens on taxpayers and on the weaker members of our societies. This article examines the changes and answers the pertinent question: Why is Europe doing this?
When the Irish banks imploded, the European Central Bank famously leant on Dublin to bail them out. Thus the Irish government, without the consent of the Irish electorate, offered the bankrupt bankers so-called Promissory Notes which, as every Irishman and Irishwoman knows, bankrupted the nation, brought mass emigration back and condemned the majority to untold hardship.
The Promissory Notes specified regular payments by the Irish Treasury to the bearer of the notes. The payments were steep and to be paid in a few years, thus causing both the liquidity crisis of the public sector and the insolvency of the Irish state. The Irish Banks deposited the Promissory Notes as collateral with Ireland’s Central Bank, drawing liquidity in the process from the latter’s ELA (emergency liquidity assistance program) and repaying their (mostly German) bondholders.
After the change in government, the new Irish government bowed to the ECB’s pressure not to haircut or restructure these Promissory Notes. Instead, Dublin adopted the ‘model prisoner’ strategy: Do as we are told hoping for a reprieve, in the form of a restructuring of the Promissory Notes. For two years the Irish government has been petitioning Brussels and Frankfurt to elongate the Promissory Note repayment schedule. The ECB was adamant that there should be no loss of present value to the bearers of the Notes. It won the day. The Notes were, eventually, swapped for new interest-bearing Irish government bonds (in contrast to the Promissory Notes that had no interest compoment attached to them). Once Anglo-Irish Bank was liquidated, its assets (including promissory notes that Anglo-Irish had deposited with the Irish Central Bank as collateral for loans under the Irish ELA) were turned over to the Irish Central Bank, and so the latter ended up holding some of the fresh government bonds that were swapped for the Notes.
What seems to be happening now is that the ECB is pressurising the Central Bank of Ireland to reduce its assets by selling the government bonds it swapped for the Notes that it used to hold. Why? Because the ECB considers the ELA transactions to have been a form of government financing that it allowed during the crisis’ peak but which it now wants to roll back. But if the Irish Central Bank does sell these bonds to the private sector, this will strike another blow at the Irish taxpayer. Why? Because these bonds come with considerable coupons (i.e. interest) that will have to be repaid over a long period. Had the bonds been retained by the Irish Central Bank, the latter would be obliged to return these interest payments to the Irish Treasury (as profits from monetary operations). Now, it seems that hedge funds and assorted financial predators will take another chunk of Ireland’s diminished income. Moreover, a sale of bonds today will involve a haircut (as Irish government bonds are not trading at face value, despite having recovered significantly in recent months) that will, in due course, burden the Treasury further. And guess who will pay for this burden…
Following the haircut of Greece’s public debt held by the private sector (the so-called PSI) in the Spring of 2012, the Greek government was compelled to compensate the Greek banks. Indeed, the banks had just lost €38 billion from the PSI and they were bankrupt to all intents and purposes. So, Greece’s second bailout (that came along with the PSI) had set aside… €50 billion that the government would borrow from Europe’s ‘bailout’ fund (the EFSF-ESM) in order to recapitalise the banks. In effect, the bankrupt Greek state was forced by Europe to borrow from Europe on behalf of the bankrupt Greek bankers and ensure that the latter receive these capital injections without losing control of ‘their’ banks.
To allow the bankers to keep control of the banks, Greek Parliament had to legislate that if the bankers could show that they could raise 10% of the additional capital, the Greek state would put in the remaining 90% of required capital (money that the taxpayer would borrow from Europe) but have no control over the running of the banks. And as if that were not enough, the same piece of legislation specified that the privateers would receive (with their shares) something called ‘warrants’. Warrants are, essentially, options to buy more shares at the original low share price. Put differently, the state was not only allowing the bankers to remain in control of the banks they bankrupted, but committed itself to passing on whatever increase share prices achieved to the bankers. Tails the state lost, heads the bankers won. Simple!
Naturally, these insanely generous terms, especially the warrants, caused a whirlpool of speculative interest in the banks. Once Chancellor Merkel had impressed the markets that Greece would not be thrown out of the Eurozone, and therefore, that Greek banks would not be declared bankrupt (even if they are!), hedge funds began to recognise the great opportunity in purchasing Greek bank shares and targeting the lucrative ‘warrants’. (Click here for Mr John Paulson’s enthusiastic participation in this racket.)
This week, as part of a complex bill of ‘reforms’ that the government had to pass through Parliament in order to be granted another loan tranche of €9.2 billion (so as to repay part of its unpayable debts), a change in the bank re-capitalisation rules was slipped in in relative silence and in a manner that the vast majority of Parliamentarians failed to notice. The sub-clause allowed the government’s Financial Stability Fund (that owns the bank shares following their recapitalisation last year) to stay out of the new share issues that the banks are indulging in these days. It sounds benign. Only it is not!
By allowing for new shares to be issued at prices well below those that the Greek FSF (i.e. the Greek citizens) paid for the shares that recapitalised the banks last year, the shares that the FSF retains lost value while the FSF’s equity in the banks was diluted substantially. In short, the public was shortchanged, in ways that are not dissimilar to what transpired this week in Ireland.
The common thread between these fresh assaults on the Irish and the Greek people, is the European Central Bank; the truly guilty party here. In Ireland’s case, the ECB imposed further losses on the Irish by forcing Ireland’s Central Bank to sell (at a discount) government bonds that should be held to maturity so as to minimise the cost to the Irish people. In Greece’s case, the ECB allowed for (and, indeed, encouraged) a change in the rules of bank re-capitalisation that increase the effective transfer of wealth from the exhausted Greek public to the bankrupt and corrupt bankers (who, in turn, back Greece’s political and media establishment).
Why is the ECB doing this? There are two main reasons. One is ideological, fundamentalist, pig-headedness. The other is cynicism. The fundamentalist dimension has to do with a pathological fear of debt monetisation (in the case of the Irish Central Bank) and of public ownership of banks (in Greece’s case). Turning now to cynicism, the fact is that the ECB (following the so-called ‘banking union) knows that it will have (from next November) to evaluate the assets of these banks, in the full knowledge that: (a) they are bankrupt, and (b) the ECB cannot say that they are bankrupt as it lacks the capacity to recapitalise them (i.e. it is not like the Fed that can call the FDIC in). So, in order to allow itself room to pretend that the banks of Ireland and Greece are not insolvent, it is pressurizing Dublin and Athens to transfer additional wealth to the bankers. It is that simple…
Jorge Rodrigues, of Portuguese daily Expresso, asked me to explain why it is that I signed the petition of 74 economistscalling for an immediate debt restructuring of Portugal’s public debt, how this ‘call’ squares up with our Modest Proposal and what type of debt restructuring I had in mind. Click here for the interview as published in Expresso. My original answers in English follow… (See also this piece on lessons for Portugal from the Greek PSI – click here for the Portuguese published version)
Why did you decide to support the proposal for a debt restructuring in Portugal, announced before the end of the troika program?
There are two interpretations of the troika program.
Interpretation 1: It is a potentially successful fiscal consolidation agreement that will, upon completion, lead the member-state to a sustainable public debt and broad economic recovery.
Interpretation 2: It was, always, a cynical attempt to ‘extend and pretend’ so that non-Portuguese banks get the opportunity, and time, to unload their bad assets (i.e. Portuguese government bonds) onto the ‘official sector’ (mainly the Portuguese and European taxpayer) while (a) public debt rises and (b) national income suffers.
Under the first interpretation, we should wait until the troika program is finished and, if some extra ‘measures’ need to be taken afterwards (like a small debt restructure), the time to introduce them will come later. However, under the second interpretation, the troika program will most certainly fail, especially given that it was never really designed to succeed. So, the reason why I signed the petition in favour of an immediate debt restructure is because I espouse the second interpretation and reject the view that the troika program ever had a chance to (or indeed that it was designed) succeed in its stated purpose. When a debt restructure is of the essence, the sooner it is implemented the better.
You have a different idea about the debt mutualisation regarding the Maastricht threshold for the Debt-to-GDP ratio, but you still supported the Manifesto. Why?
Our Modest Proposal for Resolving the Euro Crisis, which is what I think you are referring to as my ‘different idea’ (and which is co-authored with Stuart Holland and James Galbraith), did propose a different solution to the debt crisis to that of the troika; one that would have not necessitated any haircut had it been implemented (especially if it had been implemented in a timely fashion). In brief, we proposed, that the ECB (a) services each member-state’s Maastricht Compliant portion of maturing bonds, (b) issues its own ECB-bonds in order to finance this partial bond servicing, and (c) charges the member-states for the full servicing of these ECB bonds.
Such a limited debt conversion program would have ensured that no haircuts are necessary in the Eurozone – not for Greece, not for Portugal, not for any member-state. But it was not implemented. Instead, large loans were extended to our governments on condition of income-sapping austerity, the result being that our nations’ public debt is, now, even less sustainable than it was in 2011. Given this sorry development, and granted Europe’s unwillingness to implement our proposal, the only rational course of action by Portugal (indeed, the government’s moral duty to its people) is to effect a deep debt restructure immediately. To haircut the debt that Europe’s inane policies have allowed to get worse than ever.
Do you think Portugal needs a classical hair cut in the principal and not only changes in maturities and interests?
After three years of ‘extending and pretending’ the haircut has to be deep. A simple elongation of maturities (even if it pushes repayments into the distant future) plus a small reduction in interest rates will simply extend the crisis into the future. However, there are smart ways of effecting such a haircut that minimise the political cost in Berlin, and elsewhere, from conceding such a deep debt restructure. For example, the Portuguese government could issue new ‘bisque bonds’ or GDP-indexed bonds (i.e. bonds whose repayments, principal and interest, are automatically postponed if GDP growth is below a certain threshold) of the same face value as the size of Portugal’s public debt that is held by the ESM and the ECB and then use them to pay back the ESM and ECB ‘in full’. It would, essentially, translate into a haircut whose magnitude is inversely related to growth.
Is it necessary to implement not only a PSI in Portugal but also an OSI regarding ECB SMP portfolio and loans from European Funds (EFSF-ESM)?
Absolutely. Of the total €166 billion of Portugal’s public debt (as of December 2013), €91 billion, i.e. 54%, has already been transferred to the official sector. Domestic banks hold €31 billion of the remaining €63 billion. If the official sector is excluded from a haircut (i.e. if only a PSI happens), the Portuguese banks will take a major hit (if the haircut-PSI is to make a significant into overall pubic debt). But then the banks will need to be recapitalised and, since no genuine banking union is on the cards, they will be recapitalised by the… government (precisely as it happened in Greece), therefore pushing public debt right up again. It would be senseless to do this.
So, an OSI is even more important than a PSI at this stage (i.e. once the most debt was unloaded onto the official sector, following the ‘bailout’). Remember: The most important lesson from the Greek debt restructure of early 2012, which failed spectacularly to stabilise Greek public debt, was that: prolonging an unavoidable debt re-structure makes the problem worse, especially when a bailout is given in order to shift bad assets from the banks’ books to the taxpayers. Unless something like our Modest Proposal is implemented at a Eurozone level, an OSI is inevitable and the only serious question about it concerns when it will happen, how much suffering its delay will cause and, finally, how Brussels, Frankfurt and Berlin will ‘market’ it so as to minimise their political cost.
While Frankfurt-Berlin-Brussels are in full spin mode on Portugal, pretending that the fiscal consolidation program was successful and the country is about to exit its bailout (a little like exiting the frying pan to land in the fire itself), the bitter reality is that Portugal’s public debt is out of control, its labour market in shambles, its real economy moribund. Against the grain of Europe’s shameless propagandists, 70 of us have signed a petition calling for an immediate debt restructure that might give Portugal a chance to escape its debt-deflationary spiral. Click here for a pdf of our letter/petition as published in a Portuguese newspaper.
In June 2012, at a time when central banks had pushed interest rates to almost zero, Italy had to borrow at 8% to re-finance its gargantuan $3 trillion debt. Spain was in even direr straits. With national income falling by 2% annually, these interest rates meant that the national debt mountain was rising by 10% every year. In one word, insolvency! This was the spectre hanging over major European nations in the summer of 2012, guaranteeing that the Eurozone was finished. Today, Italy’s and Spain’s interest rates have fallen to a more manageable 3% to 4% and national income has stabilised. There is even fast money that flows into the crippled European banks, even into the dismembered Greek stock exchange, seeking bargain-basement prices for certain woefully depressed shares. These observations can easily be mistaken for signs of light at the end of the tunnel. But ‘mistaken’ is the operative word.
Stabilised public finances, continuing economic and social disintegration
Europe’s apparent ‘stabilization’ can be pinned down to two factors. The first, and most crucial, was the ECB’s intervention in the summer of 2012. Moments before the Eurozone blew up, with devastating impact upon the rest of the world, the ECB stepped in with its nuclear option, also known as the OMT Phantom Program (OMT standing for Outright Monetary Transactions and ‘phantom’ because it has not been activated, so far): ECB President, Mr Mario Draghi, former Goldman Sachs and Bank of Italy golden boy, issued a stern warning to bond dealers the world over:
“Bet against Italy and Spain and I shall blast you out of the water. I shall print as many euros as I need in order to buy as many Spanish and Italian bonds as necessary to bury you in your filthy bets.”
Of course, these were not his chosen words. But they there the words that bonds dealers knew he meant to convey to them. They also knew that Mr Draghi had issued that threat contrary to his own charter. At that point they could have called his bluff. Instead, they chose to back off and stopped short-selling Eurozone government bonds (most likely because Chancellor Merkel had backed Mr Draghi, via Mr Asmussen). So far, bond markets seem happy to remain cowed by Super Mario’s bravado and not to test the OMT threat.
The second factor took longer to play out. It was a large transfer of wealth from the taxpayers to the banks and from the weaker citizens to the states’ coffers; a transfer that was predicated upon immense cuts in wages, salaries, public sector jobs, unheard of tax hikes and the effective demolition of social security. In words, austerity of a magnitude that put the patient into an induced coma. By 2012, the Eurozone was in a triple-dip recession which reduced projected growth and created deflationary expectations (which are currently being confirmed) that increased the attraction of high yielding bonds, especially under the aegis of Mr Draghi’s OMT pronouncement.
With these two moves, the tail-spinning Eurozone was forced into a temporarily stable rut. Most governments became a shadow of their former self while Europe turned a blind eye to the insolvency of the banks that continued to operate without really lending to anyone. As government spending shrunk, along with the services to their citizens, and taxes rose, speculative investors (e.g. hedge funds desperate for returns a smidgeon above the almost zero interest rates available elsewhere) suddenly decided to take another look at the possibility of unloading their idle cash onto Europe’s governments. After all, had Mr Draghi’s ECB not promised to keep these governments solvent?
Coupled with the German Chancellor’s belated statement, in the Fall of 2012, that even pathetic Greece would be kept within the fold, the ECB’s move and Europe’s induced coma turned the tide: Private money began to trickle back to Europe in the form of cheap loans to Europe’s governments and bets in their stock exchanges. A semblance of recovery had taken root. If not in the real economy at least in the domain of public finance and in the realm of speculative capital.
The appearance of an upturn was reinforced further by the simple fact that the European Commission and the national governments, having panicked at the political consequences of their austerity drive, stopped pushing for more of it. While they never dared admit it had been self-defeating, and did nothing to reverse austerity’s deleterious effects, they did give up on their initial plans to impose even deeper austerity in 2013.
In short, Europe’s bond markets have stabilised due to the combination of the ECB’s OMT announcement, the rise of deflationary expectations due to the austerity-induced recession, the cancellation of further austerity post-2012 and, lastly, the decision to keep Greece in the Eurozone.
Capital inflows into bond markets and the changing behaviour of bond dealers
While it is clear that Mr Draghi’s OMT threat worked because the bond markets did not test it, it is unclear why the bond markets showed no interest in testing it. Their deflationary expectations (which increased their attraction to government bonds) played an important role, as did the common belief that the ECB would not allow the Periphery to default again (after Greece’s PSI). Still, there is a lacuna of explanation as to the radical absence of any bond dealer interest in challenging Mr Draghi. I shall argue below that this lacuna disappears if we take a broader look at the global bond markets.
Morningstar, the US based investment research group, reported recently that, since 2009, $700 billion additional funds were placed into US bond funds by US investors alone. This wall of money, which exceeded even the influx of capital in the dot.com bubble economy in the late 1990s, has, since then, appreciated (as bond prices picked up) to almost $2 trillion. In parallel to these developments in the United States, and perhaps because of them, another $1.2 trillion rushed into bond funds outside the US, especially in 2012. (To put this into perspective, during the same period, only $132 billion net went into the world’s stock markets.) Much of that money moved toward the Eurozone following Mr Draghi’s OMT announcement.
A recent research paper from the Chicago Booth Business School asks poignant questions about this footloose $3.2 trillion that is slushing around the US and European bond markets. Its conclusion is that we should expect a great deal more volatility and herd behaviour of these bond funds than before. “Investing agents are averse to being the last one into a trade [that] can potentially set off a race among investors to join a sell-off in a race to avoid being left behind,” the paper suggests. Is this not a problem with all fund managers? No, according to the Chicago Business School researchers who argue that bond fund managers have become more fickle than equity dealers. “Delegated investors such as fund managers are concerned with relative performance compared to their peers because it affects their asset-gathering capabilities…”
Analysing how bond funds reacted to the news that the Fed was about to ‘taper’, the Chicago paper surmises that bond fund managers are faster to hit the ‘sell’ button than banks (that used to hold a larger portion of bonds) ever were. One reason for their jerkiness is that hedge funds have been upset, of recent, by the failure of strategies that used to re-pay them handsomely. Funds used to take it for granted that interest rates and exchange rates followed some predictable patterns depending on the trends of global capitalism. Since 2011 these patterns have shattered and the hedge funds have suffered. Their reaction to the collapse of their modelling ‘certainties’ was that they fell back on simple strategies, such as heading, herd-like, toward high yielding (in real terms) Spanish, Italian, even Portuguese and Irish debt – ready to assume that, while these Eurozone countries are to all intents and purposes insolvent, their bonds are the best of a bad bunch of investment choices.
Michael Hintze, chief executive and founder of European hedge funds CQS, was reported by the Financial Times to have argued that desperate central bank policies (such as the ECB’s) have actually increased market risk. They did this by causing too much money to flow into the same assets, essentially ‘rigging the market’. When this happens, a small flight from a certain asset class can lead to catastrophic declines. In the Eurozone’s case, where the ‘asset class’, and ‘rigged market’, in question concerns none other than the bonds of fiscally stressed sovereigns, the abrupt declines will take Europe back to its pre-June 2012 situation. Only that, when this happens, Europe’s real economies will be even more fragile and the ECB decisively neutered (especially after the recent decision by the German Constitutional Court to admonish OMT and refer it to the European Court of Justice).
Peripheral bond debt-toGDP ratios are, today, much higher than they were in June 2012 while nominal national income is, more or less, the same and lacks any genuine growth potential. So, why have the bond yields of the Periphery’s member-states fallen so much since then?
My answer, in brief, was: They declined because of: (i) the ECB’s OMT announcement, (ii) the rise of deflationary expectations due to the austerity-induced recession, (iii) the cancellation of further austerity post-2012, (iii) the decision to keep Greece in the Eurozone, and (iv) a large inflow of capital into the bond markets that has taken a form which makes a large, sudden outflow very likely. Taken together, these six causes point to a disturbing prediction: Europe has not stabilised. While its bond markets have calmed down, the Euro Crisis is taking a breather before it returns with a vengeance.