Sunday, February 7, 2010

Greek drama

The dramatic events playing out in the press regarding Greek sovereign debt are almost guaranteed to manufacture a happy ending to the final act. But the real outcome will be when the curtains are closed.

It was just a matter of time before all of the global bailouts led sovereign nations to severe debt strains. Unlike the subprime crisis where there was disclosure and mark-to-market accounting for a little while, national fiscal conditions of the PIIGS (Portugal Ireland Italy Greece Spain) are ripe for off balance sheet manipulation. Look at how the US keeps Freddie and Fannie off the official debt tally even though they are now explicitly supported by the US taxpayer.

Moreover, when Iceland's banks were on the brink, the IMF swooped in and recapitalized the country. Who funds the IMF and influences their largesse? The same central bankers (US, Japan, UK, Germany, China) whose banking interests would suffer from any economic shock wave or market turmoil.

"Privately, American officials have said there is next to no chance that Greece will default on its debts. They said European officials were balancing a conviction that the International Monetary Fund should not be involved in solving Greece’s problems with their belief that political pressure was necessary for the Greek political leadership to cut spending and raise revenues."(1)

Greek change of heart? Not even an interesting subplot, Krugman noted that Greece has spent 50 of the last 200 years in default.

But since the issue of sovereign debtors needing forebearence will be a common theme this year, there is lots of interests in not seeming too lenient in the public. Otherwise everyone will want the same sweet deal. Another resolution will be a backdoor bailout by a willing party with an off balance sheet swap deal with funny accounting. If I were to write the script of the conclusion to the third act, it would be "You pay me $100B USD now and I pay you two payments of $75B USD of Yen over the next two years and your government buys only Toyotas for the next ten years." This has been done before.(2)

No matter what monologue of despair or dialogue of conflict plays out in the press, the final act will be a private arrangement where the main actors are major investment banks and quasi government investment vehicles. In fact, Goldman Sachs is at the tip of the spear making sure the conclusion of this drama is a happy one, at least in public. (3)

(1) "Group of 7 Vows to Keep Cash Flowing" New York Times, Feb 6, 2009, by Sewell Chan
(2) "Traders, Guns, and Money", written by Satyajit Das, p. 106-10
(3) "Is Greece’s Debt Trashing the Euro?" New York Times, Feb 6, 2009, by Landon Thomas Jr.

Feb 14, 2009 update

This article confirms my speculation was spot on.

"In Greece, the financial wizardry went even further. In what amounted to a garage sale on a national scale, Greek officials essentially mortgaged the country’s airports and highways to raise much-needed money.
Aeolos, a legal entity created in 2001, helped Greece reduce the debt on its balance sheet that year. As part of the deal, Greece got cash upfront in return for pledging future landing fees at the country’s airports. A similar deal in 2000 called Ariadne devoured the revenue that the government collected from its national lottery. Greece, however, classified those transactions as sales, not loans, despite doubts by many critics."

After this initial deception to get into the euro... there was even more deception to stay in the euro...

"The answer was no. But in 2002, accounting disclosure was required for many entities like Aeolos and Ariadne that did not appear on nations’ balance sheets, prompting governments to restate such deals as loans rather than sales.
Still, as recently as 2008, Eurostat, the European Union’s statistics agency, reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”
While such accounting gimmicks may be beneficial in the short run, over time they can prove disastrous.
George Alogoskoufis, who became Greece’s finance minister in a political party shift after the Goldman deal, criticized the transaction in the Parliament in 2005. The deal, Mr. Alogoskoufis argued, would saddle the government with big payments to Goldman until 2019.
Mr. Alogoskoufis, who stepped down a year ago, said in an e-mail message last week that Goldman later agreed to reconfigure the deal “to restore its good will with the republic.” He said the new design was better for Greece than the old one.
In 2005, Goldman sold the interest rate swap to the National Bank of Greece, the country’s largest bank, according to two people briefed on the transaction.
In 2008, Goldman helped the bank put the swap into a legal entity called Titlos. But the bank retained the bonds that Titlos issued, according to Dealogic, a financial research firm, for use as collateral to borrow even more from the European Central Bank.
Edward Manchester, a senior vice president at the Moody’s credit rating agency, said the deal would ultimately be a money-loser for Greece because of its long-term payment obligations.
Referring to the Titlos swap with the government of Greece, he said: “This swap is always going to be unprofitable for the Greek government.”"