Is Greece signalling a return to old-time basics?

The latest developments surrounding the sovereign debt crisis in Greece might be signalling a forced return to time-tested economic truths as some European governments, led by Germany are resisting another bailout in which their taxpayers alone shoulder the cost, while the private institutions originally involved in overly risky loans go scot free yet again.

Euro zone finance ministers met last week Tuesday to discuss a fresh bailout for Greece after its credit rating was dropped by Standard & Poor to the lowest level in the word the previous day to CCC, which is only four notches above default.

At this meeting Germany demanded that private bondholders should contribute to a rescue. France on the other hand, because of the size of its major banks’ exposure to Greek bonds (€53 billion) and a warning by  Moody’s that it might drop the rating of these banks,is opposed to the German plan.

The EU and the IMF last year agreed to a €110 billion bailout to avert a Greek state bankruptcy in return for tough austerity measures and tax increases by the Greek government to curb massive budget deficits. In the face of mass public protests and because the austerity measures are hindering economic growth to generate the much needed tax revenues, the Athens governments has, however been making slower progress than expected.

A joint report on Greece’s progress by the European Commission, European Central Bank and International Monetary Fund revealed that a Greek insolvency within the coming 12 months could not be ruled out. That would mean that the IMF would not be able under its rules to transfer its share of the next tranche of the original bailout to the country, necessitating a new EU-bailout if Greece is to avoid a default.

Ironically there are fewer and fewer private creditors involved who can help finance a next round of a Greek bailout. While the previous plan did not succeed to rescuing  the Hellenic society from its troubles, it bought private investors time to bail  out. They sold Greek government bonds on a large scale amid fears of a default or exactly what Germany is proposing now, forcing them to take a so-called haircut on their investments.

By now it is mainly public institutions such as Germany’s state-owned regional banks, big French banks and the European Central Bank (ECB) who still hold Greek bonds. And, it is not only the French position on private investor participation that is influenced by this situation.

The ECB’s neutrality and independence might already have been compromised by the fact that like France it insists that any rollover of debt by private investors should be conducted on a voluntary basis, fearing that any move to force private creditors to participate might lead to rating agencies interpreting it as an effective or selective default, with ratings then going that way.

Concerns are growing that a restructuring of Greece’s debt could have a potentially disastrous knock-on effect on the European financial system and wider.

Quite apart from the principle of private creditors taking the knock for the risk they took in the hope of making a profit from credit they extended to Greece, if they take a haircut with a rollover, it would save Greece an estimated €44 billion on its financing gap estimated to be €144 over the next three years.

By the end of last week it emerged that Germany softened its position on aiding Greece as chancellor Germany's Angela Merkel and French president Nicolas Sarkozy reached agreement that private banks and investors would only be involved on a voluntary basis in the rescheduling of debt. This should pave the way for a new bailout deal at a meeting of EU finance ministers on July 11.

Will it work this time?

The big question however is, will it work this time round to get Greece out of its debt trap?

Former chairman of the American Federal Reserve Alan Greenspan said in an interview with Bloomberg the "chances of Greece not defaulting are very small". His comments came as Greece’s prime minister George Papandreou's failed to win support for more austerity measures to help address its debt problems.

He also warned that the US debt issue is becoming "horrendously dangerous" and that he doubts lawmakers have another year or two to solve it., adding that the US recovery is being hindered by apprehension among businesses over the long term outlook, and claimed there is nothing more for the Fed policymakers to do.

Neil Mackinnon, an economist at VTB Capital in London and a former Treasury official, told the Daily Telegraph: "The probability of a eurozone Lehman moment is increasing. The markets have moved from simply pricing in a high probability of a Greek debt default to looking at a scenario of it becoming disorderly and of contagion spreading to other economies like Portugal, like Ireland, and maybe Spain, Italy and Belgium."

Germany’s Die Welt in an opinion piece wrote: “… in light of the growing resistance in Greece to Athens' austerity measures, it is becoming ever clearer that the policies pursued by the EU will not lead to their goal. The EU cannot force shock therapy on the country. Besides, economists doubt whether a country as indebted as Greece will ever be able to become economically healthy again without a hard restructuring of part of its crushing debt. Europe's taxpayers aren't helping the Greeks as the self-named rescuers like to repeat like a mantra -- they are merely financing the servicing of their debt, and by doing so they are making it ever more expensive. It's a theatre of the absurd."

Fundamentals screwed-up some time ago

With direct reference to the situation in Greece the Süddeutsche Zeitung recently wrote:

"Fundamentally and for reasons of fairness, there is no reason to object to the idea that private investors waive some of their planned proceeds or at least extend the amount of time until they receive this money. Those who want to turn a profit must also be prepared to make a loss.”

Economic theory has for centuries held it that he who takes the risk is entitled to the profit and if thing do not workout you absorb the loss. If you have risked to much you might go bankrupt. This still holds true for most, unless you are a major bank or financial institution, for then you can count on a government bailout.

In an article for Information Clearinghouse Michael Hudson last week wrote: “Financial crashes were well understood for a hundred years after they became a normal financial phenomenon in the mid-19th century. Much like the buildup of plaque deposits in human veins and arteries, an accumulation of debt gained momentum exponentially until the economy crashed, wiping out bad debts – along with savings on the other side of the balance sheet.

“Physical property remained intact, although much was transferred from debtors to creditors. But clearing away the debt overhead from the economy’s circulatory system freed it to resume its upswing. That was the positive role of crashes: They minimised the cost of debt service, bringing prices and income back in line with actual “real” costs of production. Debt claims were replaced by equity ownership. Housing prices were lower – and more affordable, being brought back in line with their actual rental value. Goods and services no longer had to incorporate the debt charges that the financial upswing had built into the system.”

He argues that “gradually, as the financial system became more elastic, each business recovery started from a larger debt overhead relative to output. The United States emerged from World War II relatively debt free. Downturns occurred, crashes wiped out debts and savings, but each recovery since 1945 has taken place with a higher debt overhead.

“Bank loans and bonds have replaced stocks, as more stocks have been retired in leveraged buyouts (LBOs) and buyback plans (to keep stock prices high and thus give more munificent rewards to managers via the stock options they give themselves than are being issued to raise new equity capital.

“This time around the bad debts have not been wiped off the books. There have indeed been the usual bankruptcies – but the bad lenders and speculators are being saved from loss by the government intervening to issue Treasury bonds to pay them off out of future tax revenues or new money creation.”

He goes on to argue that “credit is seen as necessary; but what of credit derivatives, the financial sector’s arcane small print? How intrinsic are financial gambles on collateralised debt obligations (CDOs, weapons of mass financial destruction in Warren Buffett’s terminology) – not retail banking or even business banking and insurance, but financial bets on the economy’s zigzagging measures. Without casino capitalism, could industrial capitalism survive? Or had the superstructure become rotten and best left to free markets to wipe out in mutually offsetting bankruptcy claims?”