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Wednesday, 15 June 2011

Letter from Dutch Finance Minister on Greece: Although it is not free of fear mongering, it gives a realistic image of the current options for the situation in Greece. Unfortunately, it chooses for the path of least resistance.

Greece has many structural problems:

  • the low GDP per capita of Greece;
  • the bad tax-payment ethics of the Greek population, where avoiding taxes is a national sport;
  • the corruption that is spread through all segments of population and government;
  • the poor state of the Greek industry, where shipping and tourism are virtually the only sources of income
All these factors make that the debt crisis in Greece already would be very hard to solve in a stable situation. And in the present unstable situation with interest rates soaring through the roof, it is even impossible to solve this crisis, regarding the current amount of debt. It hangs like a millstone around the neck of this tormented country and it chokes all attempts to reduce it.
The only thing that new debt – provided by the ECB and the European countries – supplies is time. Time to do… what? To send the problems farther into the future, hoping they will magically disappear?!

Everybody knows that the current situation in Greece is unsustainable:
  • The European leaders know this; 
  • The bank executives know this;
  • The financial markets know this. 
  • Also the curious and intelligent bunch of people that does not only listen to the official pundits and powers-that-be, but gathers information from the internet, radio and television, for instance via this blog, know this.
When even the rating agencies, like S&P’s, Moody’s and Fitch are front-running to lower the ratings for Greece, then you understand there is something seriously wrong with the sovereign debt in that country.

But the European leaders think that the general public doesn’t know or understands this and will believe their country’s leaders, when they ask to maintain the current status quo for Greece. Also the Dutch government (represented by Finance Minister Jan Kees de Jager), the Dutch national bank DNB and the ECB want to continue the chosen path of least resistance by supplying extra debt to Greece, enabling the country to roll-over other debt and to pay the bills.
Minister De Jager drew the options in a letter that he sent to the Second Chamber of Dutch Parliament (house of representatives). Although De Jager considers to involve the private sector in the Greek debt restructuring, he tosses this plan quickly out of the window in his conclusion, unfortunately. Therefore investment remains a poker game without losing cards, for the private sector, represented by the large banks, insurance companies and pension funds.
Here are some pertinent snips of the letter of Finance Minister Jan Kees de Jager  (translated by EL; link in Dutch) accompanied by my comments.
The Dutch cabinet is confronted with a difficult choice, due to the grave Greek financial-economic situation. As a result of inadequate economic policies over the last ten years, the Greek economy faces severe headwinds and the trust of the other Euro zone-member states is seriously damaged. 
Several options can be distinguished:
1. No more financial support for Greece
2. The Netherlands, together with the IMF and the European partners, keep providing financial support to Greece, but with a substantial contribution of the private sector 
3. The Euro-member states and the IMF provide all financial means that are necessary, as Greece cannot return to the financial markets mid-2012. 
Adjustment of the path of debt reduction is not an option. To make sure that Greece can resume following the original, ambitious path of debt reduction, the Troika (Europe, IMF and ECB) spoke with Greece about new, solid budgetary measures. 
There is an arrangement that the Greek government takes measures to the value of 2.9% of GDP. This will lead to a reduced Greek debt of 7.6% of GDP, in accordance with the strict target in the original program. Until 2016, measures are planned to the value of 11% GDP. With a stringent implementation of these measures, the Greek deficit will be 2.6% of GDP in 2014, according to IMF, the European Commission and the ECB.
The bold, red text looks and smells like wishful thinking, as it will be virtually impossible to make these kind of harsh cutbacks without the full cooperation of the Greek people.

And the cooperation of the Greek people leaves currently a lot to be desired: wealthy Greeks are stashing their savings in foreign banks, hoping that the tax authority can’t find them and everybody and their sister are protesting against anything.

Whether these protests are a justified outcry from poor Greeks or an attempt from ‘fat cat’ civil servants to maintain the current status quo, doesn’t matter. It is hard making harsh decisions, when your country seems on the brink of total chaos. Therefore I suspect that in practice, it will be impossible to meet these demands. This already becomes clear from the following part of the letter.
The arrears that arose in Greece during the reduction of the deficit are mainly caused by the Greek government not realizing the targets at the area of tax collection. There is a lot of attention for this subject in the package of additional measures. To enlarge the robustness of this programme, the measures to fight tax defraudation and fraud are not included in the forecasted results. There is a substantial risk that it takes more time before they measures will yield.
Translated to English: The Greek people pay too little taxes. Therefore we try to make the Greek pay more taxes, but we know in advance this might be extremely hard / almost impossible.
Besides that, it is clear that Greece should fix the arrears that arose on the subject of structural reforms, meant to reinforce the economic growing power of the country.
Translated again: It is one thing to plan measures to make the Greek economy more competitive, but it is another thing to implement these measures. It seems that the Greek government failed in doing so.
The situation in the finance industry remains worrisome. Greek banks have hardly access to the capital markets and are fully dependent on the liquidity of the ECB. In order to reinforce the financial sector, the capital demands for Greek banks will be further increased. In the utmost case, the stability fund for the Greek banking sector that was founded in the original programme, will be available as safety net.
Translated: the ECB and the stability fund are the lenders-of-last-resort for the Greek banks, when nobody else wants to lend money to the Greek banks.

At this moment the following three options are open.
Option 1. No more financial support for GreeceIn this option, there will be no new loans for Greece to fill up the financial void in the programme. Loans of the euro countries ask for unanimity. If The Netherlands (or one of the other countries) refuses, there will be no loan. Also the IMF won’t pay in that situation. That will lead to a disorderly default of the Greek government. Greece in a few weeks won’t be able anymore to meet its payment obligations. A bankruptcy of the Greek banks will follow soon afterwards.

There is a large chance that Greece will feel being forced to leave the Euro zone, to keep up the Greek banks, using its own central bank. As the exposure of the Dutch financial sector to Greece is limited, the direct losses will be limited too.
This scenario, however, leads to substantial losses for the ECB and thus for The Netherlands, via the profit hand over of the Dutch National Bank DNB. The DNB estimated these losses at about €4 bln. The risk of contagion is very large, as investors could lose confidence in the other PIIGS-countries in case of a default of Greece.
Contagion to Spain would form a serious threat for the financial stability of the euro zone, including the financial sector in The Netherlands.
The letter of Minister De Jager continues with many lines of doom and gloom that will come upon us in case of a Greek and Spanish default. In a second scenario within option 1, De Jager talks of a Greek return to the Drachme. It promises eventually to deliver the same amount of doom and gloom, according to De Jager. Besides that: from a practical point of view this scenario is virtually impossible, as the time it would take to reintroduce the Drachme is at least three years.

Summarized: when Greece defaults and the contagion spreads to Spain, the skies will fall on our heads and prosperity, as we know it, will end. This is a classical case of fear-mongering: we should continue throwing good money at bad money, or else…

In reality, the situation is the following: 
·    If the Greek don’t like to change their attitude and tax-payment ethics, we pay…
·    If the contagion spreads to Portugal, Spain and Ireland anyway, no matter what we do, we pay…
·    If the banks maintain paying out their bonuses and maintain getting into trouble, only to be helped by the European taxpayer, thus privatizing profits and socializing losses, we pay…

Reality is that these attempts to keep on saving Greece, Portugal, Ireland and Spain will cost us about the same amount of money and maybe even more. It is impossible to wear out the financial markets, if these smell blood. And do they smell blood, currently…

Option 2. There will be an additional programme for Greece, with private sector involvement.
In this option there is significant involvement of the private sector; for instance by making an agreement with the sector that existing private debt will be prolonged for a number of years. When as much maturing debt from private parties as possible will be prolonged, the Greek need for extra support from the euro countries will diminish. In this scenario Greece fully pays back its debt, preventing write-offs on Greek debt for banks, pension funds and insurers.
The most rigorous form of private sector involvement is a sturdy restructuring of existing debt, via debt remission. This reduces the amount of debt to be paid back by the Greek people and leads to a lower tax pressure in the future. There are some important side-notes:
  • Restructuring debt is no alternative for further financial support to Greece
  • Debt restructuring would cause large, immediate expenses for the ECB, the banks and the pension funds. Also the risk for contagion to the other PIIGS countries is substantial.
  • Restructuring debt doesn’t solve the financial problems for Greece. Even after the restructuring, there will be debt left that should be rolled-over.
  • Money that is borrowed in good trust, should be paid back in an orderly fashion.
For these reasons neither the member states of the euro zone, nor the EC and IMF are proponents of a scenario where debt is remitted. When The Netherlands would make its financial support dependent on a demand for restructuring of debt, this would therefore eventually result in a disorderly default (option 1).
These lines contain also some classical fear-mongering: we would like to restructure Greek debt, but if we do that hell breaks loose. Therefore we choose the path of least resistance on the expense of the Dutch and European tax payers, in order to postpone the inevitable.

Option 3. There will be an additional programme for Greece, financed by the Euro zone-member states and the IMF. This is the scenario where the private sector hardly contributes to this Greek programme. The risk for contagion is minimalized in this scenario. 
It means, however, that the amount of support of the euro countries is equal to the lacking private sector contribution. Private exposure will drop considerably, while public sector exposure rises.

There you have it: The path of least resistance: privatizing profits and socializing losses.

The rest of the letter is filled with the remarks that option 1 is the riskiest for the Dutch taxpayer and option 2 is also very risky, followed by the inevitable conclusion that we should choose option 3, under very strict conditions (yawn… - EL).

It might sound strange to my regular readers, but for me this is in itself a very good letter:
·    It draws a clear picture of the situation that we are in currently with Greece and
·    It shows the options that we currently have towards Greece.

Therefore it is even more disappointing that De Jager – arguably the best Minister in this cabinet – chooses the path of least resistance by again voting in favor of handing out large sums of money to Greece, without having even the faintest guarantee of getting it back in the future. The money will be given to the Greeks anyway, without ECB, Euro-countries and IMF having rock hard warranties for the necessary reforms in Greece.

The Greek government will also choose the path of least resistance and will delay those reforms, afraid as they are for their popularity and re-election. The population of Greece will protest against any reforms and in the end, nothing will change, until all money is spent.

In my opinion, option 1 (with a twist) is still the best choice: let the country officially default, thus forcing the Greek government to really reform the country. It is not hard to stop spending money, if you don’t have any left. Offer the Greek government financial and fiscal assistence, but make them clear that the tough decisions are theirs and not those of Europe. Don’t accept jawboning and chuckling by the Greek government.

And ask for a very substantial contribution from the private sector. The risk of contagion to the other PIIGS countries from acting like this is not more substantial than it already is: contagion is already a fact of life. The financial markets prove this every day, by increasing the interest amounts on Irish, Portuguese and Spanish sovereign bonds.

In my opinion the former is the quickest and most effective solution to fight the debt crisis. But unfortunately this is probably not the path that Europe, the ECB and IMF choose:

Todd Harrison of Minyanville (www.minyanville) would say that Europe is again choosing for administering drugs to a drug addict, instead of helping the addict to get rid of the drugs. And that is a truthful, but worrisome conclusion.

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