greece debt problems

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Greece: Our Debt, Your ProblemBy Paul Kedrosky · February 15, 2010 · ·

Good insider-y and cynical reading on Greece’s debt non-problem problem that has been making therounds, allegedly written by an anonymous in-country banker:

GGBs: Our debt, your problem.

If Greece defaults, it will be the biggest sovereign default in history. If Greece is bailed out, itwill be the biggest sovereign bailout in history. That’s what you get when there’s EUR 250billion at stake. The Russian and Argentinean defaults, both south of EUR 60 billion, were noteven a quarter as big. Thing is, as a Greek I’m as worried about the whole thing as a resident ofthe fictitious “South Sea” would have been when the South Sea bubble went bust. Here’s why:Debt is not dealt with very well by economic theory. Debts net out. For every lender there isnecessarily a borrower.

Total wealth is the dollar amount it takes to control every home, every corporation everyconsumer durable and every privately owned resource. No mention of debt here (though if youwant to get difficult, you will point out that to control a corporate you need to own both itsstock and its debt, but bear with me) Thing is, if you add a bit of debt, you untie a lot of agents’hands. If a 35 year old heart surgeon has access to the mortgage market he can move into abeautiful house before he collects his first ever paycheck, and he’s definitely good for themoney.

That pushes up home prices. So a bit of debt definitely pushes up total wealth. On the otherhand, recent experience indicates that a whole lot of debt leads to breakdowns. If we’ve all

Greece: Our Debt, Your Problem file:///Users/saumitre/other/read/articles/finance/Greece Our Deb...

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borrowed money to buy assets and for some reason they take a break from going up, marginalborrowers who count on selling appreciating assets to service interest on their debt will misstheir payments. Their liquidator will sell their assets. This will drive down asset prices, which inturn will trigger margin calls to more people and the vicious cycle can start that Irving Fischerdubbed debt deflation. 2008 looked a lot like that and most people believe it had a lot to do withoverindebtedness.

We also need to look at savings. If a country has a lot of savings, it can support a lot of debt.Japan has massive government debt, but equally massive private savings. Some countries, likeChina have massive savings and have to look abroad for investments. And some, like the USare the other way round. When it comes to debt, Greece is in a uniquely privileged situation.No, seriously! For starters, we Greeks are some of the world’s richest people.

On the official statistics alone, we are comfortably in the world’s top 40 for per capita GDP. Butthat’s peanuts. Lest we forget, that’s our declared income. Don’t quote me on this apocryphalstatistic, but I’m reliably informed that exactly six Greeks declared more than a million EUR inincome last time anybody counted. And exactly 85 declared more than half a million. So we’reprobably a bit better than top 40.

Either that, or this trading floor alone has more rich people than Greece. Hell, our new recruitsfor this season alone could probably do it. If you have any doubts about Greek wealth, checkout on Bloomberg the balance sheet of the National Bank of Greece, Eurobank, Alphabank andPiraeus bank, the top four. The four of them alone command EUR 164 billion in deposits!Slightly misleading, since they all have operations in the Balkans, but that’s almost one GDP,lying in deposits!!! More to the point, how many Greeks do you know who keep their money inGreece? That’s merely our spending money, it’s a small fraction of our savings and assets.Don’t even mention that a square meter costs less in Belgravia than in Psychico, Philothei orKifissia.

Bottom line, as long as Switzerland and Citibank are going concerns (for that is where we keepthe bulk of our savings), we’re loaded. Second, Greece scores well across all measures of debtbut one:

We have extremely low household debt / GDP ratio.

We have extremely low corporate debt/ GDP ratio.

We have extremely low bank debt/ GDP ratio.

We have a manageable total debt / GDP ratio. Half that of the UK or the US!

We only score poorly on sovereign debt / GDP ratio.

That’s it!

Greece is a country with rich, underlevereaged savers, underleveraged corporates and a healthybanking system whose government happens to have borrowed a hell of a lot of money. But theworld has grounds to be scared: with rates at 5% and government debt comfortably above 100%of GDP, servicing that debt costs 6% of GDP at the moment. GDP growth, in the meantime hasnot touched 6% nominal in a long, long time.


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So here’s the deal: No matter what happens, the debt is now at a level where its growth hasreached escape velocity. Even if Greece were to run zero deficit, ultimately we are heading todefault. We can default now or we can default later. Is that a big deal? Frankly, no. 75% of thedebt, probably more, is held externally. If JGBs fail to pay coupon, that’s a disaster for Japan,since 95% are held domestically. If GGBs fail to pay coupon, it’s far less catastrophic. For thedebt-deflation spiral to start, you need the debt to be internal.

With an alleged 216 billion held by foreigners (plus the recent 8) the contagion risks mainly lieoutside the border! Even the banks who are in the news for holding all those ECB-fundedGGB’s aren’t as long as US banks are long Treasuries, for example, though they wouldprobably have to be restructured. Basically, the economy is paying 5% or even 6% of GDP toservice a debt whose failure will hurt three or four times more abroad than it will in Greece. DoI look worried?

Supposing we default, what will be left is a AAA credit here. Give it five years and a line willform to our door to lend us more. It would not be fantastic for us to default, granted, because atthe moment we are in a virtual reality where a bunch of greedy foreigners lend us a fresh 5% ofGDP every year on top of what they were lending us the year before. If we default they won’tlend us again for a short while. During that period we will have to live within our means. Thatwill be a haircut. But it won’t be a catastrophe for Greece. Germany took a bigger GDP hit thanthat last year, for example, and so did the UK!

Indeed, I’m willing to bet Greeks continue to have good access to the international financialmarkets, and here’s why: as I’m writing this, Greek shipowners owe some EUR 100 billion tothe international banking system.

Even with the Baltic Dry somewhere in the dungeon, this debt is being honored and serviced.Greek companies will be just fine, basically. It’s the government that is the joke here, not thecountry! Nevertheless, a sovereign default by Greece will set off a cascade. Italy has tons moredebt than Greece and a much bigger proportion of it is held in Italy.

That won’t be a picnic. It gets worse than that, of course. People like to talk about PIGS, but thereal oink oinks of the past decade have resided in the protestant part of the world. The UnitedKingdom and the US have total debt of more than 400% of GDP. You can never grow your wayout of 400%, it’s as simple as that. And this concludes my first point: be careful what you wishfor here, because Greece is a rich country that will mainly hurt others if it defaults. Directly(through the default) and indirectly, via contagion.

A default will have both negatives for Greeks (less money to spend) and positives, which don’tconcern anybody here, so I will discuss them separately at the end of this piece.

This brings me to my second big idea here. When the Paulson / Bernanke / Geithner triumviratedecided to save the banks in September of 2008, who exactly was saved? Was it the Americaneconomy, as we are led to believe? What was the alternative? The establishment would have usbelieve that there was no alternative.

It was “hold your nose and save Wall Street” or a return to the dark ages. As Joseph Stiglitz,Willem Buiter and Paul Krugman were at pains to point out back then, an alternative existed:


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we could have done a GM/Chrysler on the banks. Expropriate the equity holders, pay 15 centson the dollar to the bondholders and nationalize. Had we gone down that route, there wouldhave been different winners and losers. Small business would have been a massive winner.

Rather than create zombie banks that are too busy pretending Ford is a great company (Fordowes banks 24 billion) and commercial real estate is about to turn a corner, they would carry onextending credit to small business. Sticking money into the zombies has had 100% the oppositeeffectof what was advertised. It has caused “extend and pretend” to the borrowers who are too big tofail and has throttled the little guy. Business was a loser.

The newspapers have us think that bankers were the winners. We did not do too poorly, but weare not the big winners. The big winners here are the baby boomers. That’s because they havetheir name against some 80% of the value in all pension funds and insurance policies.

And if the banks had gone down, that’s who holds their debt and much of their equity. Bottomline, had the banks gone down, no insurance product would be worth a penny more than thepaper it’s printed on. So basically, the 2008 bailout sacrificed business, i.e. our generation, butsaved our parents. The US bailout was intergenerational transfer, pure and simple. Now, ourparents did not have enough kids.

The past 10 years has been the story of their struggle to sell us their homes and their equities atthe price that will allow them to retire conveniently as they turn 65. They’ve thrown lowinterest rates at us to induce us to borrow against the homes they are selling us, but thatbackfired because low rates have pushed down their bond returns and their dividends. And theirstocks have not gone up in ten years. The final straw was going to be the decimation of theirinsurance contracts and pension plans, but Paulson, Bernanke and Geithner jumped in andsaved them.

Talk about the bankers is fashionable, but in the bigger scheme of things it was a side-show. It’spretty much the same with the Greek situation. Yes, we Greeks have been naughty. Yes, we areoverindebted. Yes, we live above our means. But, much like the evil bankers, this has nothingwhatsoever to do with Greece. That is my main thesis here. The Greek saga (for I refuse to seeit as a tragedy) is all about saving the French and German baby boomers’ retirement.

Sleepy fund managers and insurers in the north of Europe decided that they did not wantcurrency risk and they did not much fancy credit risk. Sovereign risk denominated in EUR wasjust the ticket for them to deliver on their promises. So the decision was made to lend money tothe Greek government. Tons of money. Leaving out wars, more than any country has ever paidback that escaped default. Greece had no need for this money and indeed put it to horrible use.But Greece is not the protagonist here.

This is a domestic issue for France and Germany! The governments of France and Germanyhave a choice here. They can side with the baby boomer generation, tax its progeny and funnelthe money to Greece. Or they can refuse and have the baby boomers reap what they’ve sown.But the bottom line here is that if the money had not come to Greece it would have gone toItaly, Spain or Portugal. It wouldn’t have gone to Bunds and OATs, because they did not yieldenough for these wide fund managers’ taste.


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The goings on in America, where nobody is thankful for having been “saved” and where theeconomy is suffering the result of a misguided, short-term decision may push the French andGerman government to say “the Greeks don’t deserve a bailout” and allow their insurancebehemoths to take the hit. But I would not bet on it. My money is that the baby boomers prevailagain! Make sure you’ve covered GGB shorts by the end of the week!!! I, for one, hope we’reallowed to default, and here’s why: Once upon a time, Greece was a model small democracy.An extremely frugal government ran tight budgets and provided an extremely basic safety net,and truly threadbare services for a very low cost: Tax collected was minimal.

While tax rates may have been high, collection was virtually nil. A small oligarchy was the onlysource of capital and had the acumen, education and experience to deploy it as the countrydeveloped. Old families controlled the steel, cement, foodstuffs and construction companies thatrebuilt Greece after the war. As recently as 1980, debt/GDP was at 30% and it would have beenmuch lower were it not for the high costs of defense. When Greece joined the EU in 1980, allthat changed. It was party time. Money that was sent to build the Greek infrastructure wasfunneled pretty much directly into the pockets of the oligarchy as well as the new Socialistoligarchy that emerged.

This was not chump change. It was 6% of GDP for 30 years. With the exception of farmers,who did extremely well off of the Common Agricultural Policy, the rest of the money wentpretty much straight to Swiss bank accounts. As an example, Greece has paid 250% over list forF16′s and Mirage fighters and has spent EUR 750 million for an airport that was built by thesame company that originally bid EUR 220 million for the project. No prizes for guessing whathappened there. Once the addiction to easy money set in, the government of Greece wastransformed from a lean provider of defense, basic health, basic education, a basic road networkand extremely basic pensions to an auctioneer of projects to the oligarchy.

The families who control business in Greece used a system of bribes the government was happyto accept and set up a newspaper each to deliver threats its members would rather not. Sticksand carrots, and lots of Euros. And once the system was established, there was no need to stickto the money that was coming from the EU. ERM entry cost our politicians the printing press,but thanks to low EUR rates, the government could now service previously unthinkableamounts of debt with impunity. A residual part of that money may have ended up in usefulprojects, but the bulk ended up in the pockets of the twenty families who run Greek business.

A big chunk of that money, in turn, has been invested by these families in bringing to Greeceevery foreign franchise from Starbucks and Pizza Hut to IKEA and Stanley Kaplan, drivingexisting companies out of business in the process. In summary, EU funds have done to Greecewhat oil did to Nigeria, while low EUR rates have allowed the government of Greece to be ableto service a debt of 100% of GDP, most of which has gone straight to the pockets of theoligarchy. Man on the street, with the exception of the farmers, has not benefited one jot. Thisdoes not make all Greeks poor. Shipowners do very well, and a natural resource called the sunis very helpful to our 165,000 hoteliers. Man on the street never saw the benefit of the 250billion the government has borrowed. Ergo, support for austerity now that the bill has come iszero. You won’t see anybody accept an Irish solution in Greece.

The notion that Brussels will dictate to Greece terms on public sector wages and impose a May


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deadline are, frankly, comical. The government may like the idea, but the entire population willprobably go on strike. Needless to say, Greece can pay. If the government chooses to freezesavings accounts it can pay the whole kahuna in one go. But the Greek people will refuse totake any hardship. This is a matter between some French and German baby-boomers, theirgovernment, and twenty Greek families who will happily take more. I hope we default and thecountry is freed from the curse of free money that befell it in 1980. Once our politicians have nomore money to disburse to the oligarchs, we can start to be proud Europeans.

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