The British riots

Many of my friends seem to be under the impression that the riots in the UK are some type of spontaneous expression of pent-up anger from a poor and disenfranchised youth that feels betrayed by society.

I fully agree that young people today are facing extremely serious challenges and that many are angry that their voices are not being heard. However, I think that trying to ascribe political meaning to what is clearly opportunistic crime is, frankly, naivety of the highest order.

Having lived in Greece for most of my life, I have seen my share of civil unrest and so I’d like to draw a few comparisons. When 15-year-old Alexandros Grigoropoulos was murdered by two policemen in December 2008, Athens experienced an explosion of anger that lasted several weeks. At the time I supported the daily protests against police brutality, being fully aware that the destruction and the (limited) looting that took place was a sad side-story, an unfortunate by-product caused by a criminal minority that took advantage of the situation and was completely out of tune with the zeitgeist. The fact that the protesters themselves turned against these criminals demonstrated this point.

In short, the Greek civil unrest was fundamentally politically motivated, and the destruction that accompanied it was a side-effect caused by a minority of opportunistic criminals. The same can of course be said for the inspirational uprising of the Middle Eastern youth who is self-defiantly standing up against armed tyrants.

Now compare that with what’s happening in Britain.

What I see here in London is blatantly not politically motivated. Out on the streets there is not a movement protesting about anything or indeed calling for any sort of reform. Looting and destruction is not simply a side-story; it seems to be the entire story. These people are not trying to get any message across, they are not addressing the problems young people face, and they are certainly not trying to make this country a better place.

As Professor Mike Hardy of the Institute of Community Cohesion neatly put it “the current troubles are almost entirely focussed not on a cause or a protest, but on greed and personal want – I haven’t got something and I can take it.”

Mugging and assaulting random by-standers is not rising up against the establishment. Destroying small businesses and people’s livelihoods is not a reaction against unemployment and economic hardship. Getting drunk and smashing stores to get a new DVD player and a new pair of trainers is not a sign of political disillusionment and excruciating poverty. This is all pure thuggery, organised and carried out by common criminals in an opportunistic copycat manner. As they themselves admit, this is destruction for the sake of destruction, the type of droog mentality coming straight out of Clockwork Orange.

I do not accept the argument that this is a direct result of poverty. I would be more inclined to believe that if the looters were mainly going after essential goods, not when they are stealing booze and plasma TVs. Besides, the UK is one of the wealthiest countries on earth, and comparatively speaking its welfare state is more than generous – I struggle to believe that all these people lack the essentials and have no choice but to steal.

More importantly, for each one of these criminals, there are thousands of other people who have endured much more gruelling poverty with honour and a strong sense of community.

My own grandparents have lived through the Nazi occupation of Athens; a time when famine claimed the lives of hundreds of thousands of people, and when council carts would go around the neighbourhood on a daily basis to collect the dead. Not only did they not feel any urge to destroy their own communities, they in fact shared what little food they had (mainly dried grapes from their garden) with their neighbours and vice-versa.

So perhaps these ‘desperate’ and ‘hopeless’ people with their £400 Blackberry smartphones can learn a lesson in personal dignity and social responsibility instead of wreaking havoc on their own neighbourhoods and stigmatising an entire generation. 

In the meantime, I hope my friends will reserve their sympathy for those people out there who are far worthier of it.

The times they are a-changin’

After 18 months of dithering, the Eurozone has finally come to terms with the fact that its piecemeal approach to the sovereign debt crisis has failed to stop the peripheral dominoes falling. As Spain and Italy started wobbling, European leaders finally realised that a comprehensive solution to the crisis could not be postponed any longer.

That long-awaited solution was agreed to on Thursday. It involves giving new powers to the European Financial Stability Facility (EFSF), along with providing debt relief (through bond swaps, debt repurchasing, lowered interest payments and prolonged maturities) and putting together a ‘Marshall plan’ for Greece, aiming to restructure its economy and lift it out of a deep recession.

Though a lot remains to be done, this agreement is a quantum leap for Europe. It is only the first step towards a necessary and inevitable fiscal integration, but it is still a clear sign that the right decisions have been made and that the tide is finally turning.

Selective default

Credit rating agencies had already indicated that they would consider any form of private sector participation as a temporary ‘selective default’. Indeed, Fitch has now explicitly stated it will soon downgrade Greece to that rating as a result of the new programme.

Nevertheless, the effects of that downgrade will be minimal for two crucial reasons.

Firstly, because the European Central Bank has already agreed to provide liquidity to Greek banks under any circumstances, by continuing to accept Greek bonds as collateral no matter what’s their credit rating.

Secondly, because the International Swaps and Derivatives Association (ISDA) has stated today that, in its view, the new programme for Greece does not constitute a debt default. ISDA states there will be no ‘credit event’ as private sector participation will be voluntary.

This is a very important development. ISDA is the body that decides whether speculative tools like Credit Default Swaps (CDS) are triggered. It is ISDA who has the final say as to whether CDS holders can claim their insurance payments on Greek bonds.

So, ISDA’s decision is a slap in the face for all the speculators who have bet billions on a Greek default. What credit rating agencies say is meaningless if ISDA itself does not decree that Greece has defaulted on its debts.

As a result, all the vulture funds who have gambled billions on a Greek default will not be gaining a single penny. Their CDS contracts will not be triggered and their value is already collapsing rapidly – the price of a 5 year Greek CDS contract has dropped from above 3000 to 1675 basis points over the last 24 hours.

There is an interesting factoid concerning ISDA. The newly appointed co-chair of  its governance committee is Athanassios Diplas, a senior Deutsche Bank executive and a Greek national. While there is no evidence to suggest that there was any bias from the part of ISDA against speculators, I think this fact adds an element of fateful irony to what is quickly proving to be a European slam dunk.

What’s next for the Eurozone

The ongoing debt crisis in peripheral Europe appears to be a constant source of delight among Euroskeptics, who haven’t missed the opportunity to proclaim the imminent death of the single currency and the beginning of the end for the European Union.

While I do not doubt that the situation is extremely concerning, I think that these scenarios amount to little more than wishful thinking.

Firstly, despite the crisis, the fundamentals of the euro continue to be stronger than that of any other major currency. This is reflected in the fact that the euro is still trading near historical highs against both the dollar (EUR/USD: 1.40) and the pound (EUR/GBP: 0.88).

Secondly, it should be clear that no member-state would benefit by a potential Eurozone break-up. The European periphery would suffer an unprecedented decline in living standards, as FX markets would quickly reduce the newly introduced currencies to the status of Monopoly money. The stronger core, Germany in particular, would see the value of their new currencies rise sharply, thus losing competitiveness and jeopardising their export-led recoveries.

Furthermore, it is worth noting that the deficits of the periphery account to a large extent for the trade surpluses of the core. As a matter of fact, Eurozone members account for around half of Germany’s exports – one can only wonder what would happen to the German economy if its chief trading partners could no longer afford to buy its products. The reason why the euro was created in the first place was to facilitate trade by eliminating transaction costs and exchange rate risk; it would make no sense for an export-driven economy to abandon it for the sake of populism.

Let’s not even consider the effects that a chain of debt defaults would have on the European banking system, as well as the massive bank recapitalisations that would be necessary across the continent.

So, it is time for Europe to stop kicking the can down the road and come up with a permanent solution to the debt crisis before it engulfs Italy and Spain. Thankfully, there are a number of options available, which can and should be pursued in conjunction with the ongoing austerity and economic reform programmes.

These are the following:

1) Issuing eurobonds

Under this proposal, every member-state would be allowed to issue bonds that would be guaranteed by the Eurozone as a whole. In effect, this proposal would introduce a single Eurozone market for bonds, backed by all 17 members.

Not only is this possible, it is in fact precisely how American states like California have managed to stave off financial disaster – by relying on money being borrowed centrally with the guarantee of the US federal government.

If this solution is to be pursued in Europe (and there are growing signs that it will), then weaker economies would not need to be bailed out with taxpayer’s money, as they’d be able to tap capital markets by themselves. At the same time, Europe will have created one of the largest and most liquid bond markets in the world, rivalling that of the United States and allowing the euro to pose a serious challenge to the title of global reserve currency.

Clearly, strict rules would have to be attached in order to prevent issues of moral hazard. These rules may have to include constitutional limits on deficits and debts.

2) Debt repurchasing

Peripheral bonds are currently being traded at prices that are significantly below their nominal values. To take an example, a Greek bond with a nominal value of 100m would now be traded on the secondary market for around 70m. This is because risk has been priced in – the current holders of these bonds do not expect to get all their money back, so they are willing to settle for less.

Taking advantage of this discrepancy, the Eurozone could help troubled members to repurchase their debts from the secondary market at current market prices. This would save tens of billions in the process. Taking the above example, Greece could be lent 70m which it would use to repurchase its 100m bond, thus reducing its overall debt obligation by 30%.

To make matters easier, it is estimated that the European Central Bank (ECB) has already purchased around 100bn worth of Greek government bonds from the secondary market since the beginning of the crisis. So, Greece could simply be asked to pay back exactly as much money as the ECB invested to buy these bonds. The remaining amount would be written off in an accounting process called mark-to-market, thus significantly reducing the Greek national debt. The same idea could be applied to help Ireland and Portugal.

Debt repurchasing should not constitute a debt default, as the holders of these bonds have already sold off these assets voluntarily.

3) Quantitative easing

If all else fails, the ECB can always resort to the nuclear option of monetary policy – monetizing debts by printing money like there’s no tomorrow.

Since 2008, the US Federal Reserve has already overseen two rounds of quantitative easing that have involved 2 trillion dollars being created out of thin air – something which has of course contributed to the depreciation of the dollar. Similarly, during the financial crisis, the Bank of England printed £200bn to prevent a financial meltdown.

I don’t believe that Europe will choose this option, as it would seriously damage the credibility of the euro and the ECB, much like the credibility of the dollar has suffered serious blows.

I am, however, increasingly convinced that any viable solution to the debt crisis would have to involve a combination of austerity, structural reforms, debt repurchasing and Eurobonds.

Debt/equity swaps

The Greek government will soon start implementing an extensive privatisation programme, aiming to raise up to €50bn by 2015 in order to pay down part of the country’s €340bn national debt.

This programme has been roundly criticised by analysts for being overambitious – and it’s not particularly difficult to see why.  The list of saleable assets is long, but time is short, investor appetite and market conditions are at levels reminiscent of the Great Depression, public opposition is overwhelming, and the privatisation process will be organised by the famously incompetent and incurably populist Greek politicians. For these reasons, it seems more than likely that the programme will fail to meet its targets by a significant margin.

Nevertheless, I believe there is a simple idea that can mitigate these risks and ensure the success and even expansion of the privatisation programme.

The idea takes the form of debt/equity swaps. Under this proposal, Greek banks and pension funds, who currently hold €70bn of Greek government debt, would be offered the choice to swap the government bonds they hold in exchange for saleable state assets. The government can then write off these debts, as there is obviously no point in paying back itself.

If enacted, this proposal would have the following positive consequences:

1) The privatisation programme will be completed quickly and successfully, reducing the national debt by up to €70bn, i.e. by 20%.

2) The state-owned companies to be privatised and the other assets to be sold will stay in Greek hands. Considering the alternatives, I believe this would be much easier to swallow by most citizens.

3) Most importantly, Greek banks and pension funds would no longer be exposed to Greek government debt. This means that, in the event of default, the Greek banking system would survive intact. Without any toxic bonds on their balance sheets, Greek banks could quickly regain access to capital markets, and would no longer be dependent on the liquidity provided by the European Central Bank. The banks and pension funds would of course have the option to sell the assets they’ve acquired in order to gain additional liquidity.

4) With cleaned-up banks, with successful privatisations, and with debt levels falling, the Athens Stock Exchange is likely to shoot up, making it much more advantageous to sell other state assets to willing foreign investors.

5) Voluntary debt/equity swaps do not qualify as credit events and as such this idea would not constitute a debt default and would not trigger Credit Default Swaps. It could, however, quickly manage to reduce the national debt by up to 20 percentage points. This would save Greece approximately €3bn per year in interest rates, thus significantly lowering the deficit as well, and killing two proverbial birds with one simple financial instrument.

If you can think of any reason why this proposal would or should not work, please feel free to point it out. Personally I struggle to think of any flaws in it.

All that’s necessary is to explain the situation to the Greek people and agree the plan with the opposition, which has no real reason to disagree.

As for those who would oppose all forms of privatisation on ideological grounds, let me say that on matters of national survival political ideology should always come a very distant second.

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