Diary of a Financier

Greece Should Sell Equity Stakes

In Economics on Wed 29 Jun 2011 at 08:55
  • Germany, France & ECB should inject liquidity to Greece via equity stakes with rights for future share purchases.
  • Greece really should choose a gutting default over indentured political servitude.
  • Greece is not a Lehman because of the lead-time, but Italy can very well be an AIG.
  • SPX should rally to 50DMA ~1315, so I’m long SPY. I do expect a morning profit-taking selloff.

Per my notes on StockTwits last week, I have to elaborate on my musing that Greece should sell equity stakes in itself. My tweets from Monday:

Albeit radical, I meant it. Greece will take whatever capital is rammed down its throat, just like the American banks on their 2008 deathbed. Also like the American banks, more loans will [obviously] exacerbate Greece’s debtload. The loans are a contingency of deeper austerity commitments too, which will bury GDP. All considered, Greece will have no prospect of trimming its 150% Debt/GDP to a more palatable 60%, which remains the EMU statutory maximum.

For a sovereign like the UK, austerity is a survivable emergency measure toward long-term deleveraging. (English austerity has received criticism for all the wrong, short-sighted reasons. The program’s failure stems from lack of vision and commitment, not from the exercise of austerity itself.) The UK is like a value stock with resilient cashflows. Greece is not. Greece can’t sacrifice any cashflow in the near-term, because it has P&I payments that it can’t even honor without austerity. France’s Nicholas Sarkovsky can rally his banks to guarantee a rollover of their Greek debt, but that really just delays the day of reckoning. I consider a private creditor workaround a credit event (i.e. default) and a CDS payout trigger, since the contractual terms of debtholders’ stake would be altered. Even if such a private alteration weren’t a credit event, it adds nasty duration risk to creditors’ exposure. What makes that duration nasty is Greece’s reputation as a “serial-defaulter.” Say Carmen Reinhart and Ken Rogoff in their 2008 book, This Time Is Different:

Greece’s default on debt reached an almost pandemic reoccurrence at the turn of the century… Greece has been in default roughly one out of every two years since it first gained independence in the nineteenth century.

In my SeekingAlpha days, I ran an article about the irony of lending to banks who were teetering in insolvency between the Bear Sterns and Lehman debacles. I empathize with policymakers, because they have their mandates to support the system. With that in mind, I suggested that the Fed & Treasury shouldn’t have burdened banks with interest coverage when the debtors didn’t even have working capital; rather, the government should have provided equity. Subsequently, regulators unveiled the nationalization of American banks via equity stakes. (Like I said, I empathized with the decision-makers, who had to do their jobs, but I never supported nationalizations. I’m afraid of zombie banks; they suck an economy’s blood to survive, but it’s a short-term solution whose venom turns the entire economy into a zombie long-term. I fear that in the Greek case as well.)

Remember Angela Merkel’s ‘I’ll never put taxpayer money toward bailing out another Eurozone state.’ She clung to a populist excuse that the EMU charter prohibits bailouts. But, political charters are mere toilet paper come times of crises. We’ve seen that in the emergency loans already provided Ireland & Greece, not to mention the carefully-crafted European Financial Stability Facility (EFSF).

Austerity will pass parliament and Greece will receive it’s emergency loans. If I’m Greece, I choose a gutting bankruptcy over indentured servitude. When the alternative is mortgaging future prosperity to cover interest payments on emergency loans, default is inevitable, perhaps desirable. The problem is that (unlike Iceland) relative to the size of the Greek economy, a large swath of the sovereign debt is held domestically by banks and pensions (hence the gutting). That’s just the socialized penance from widespread corruption among taxpayers & politicians. The default scenario is one side of the catch-22 here. The other side is a bailout, which risks Greek political enslavement to the Eurozone a la Ireland. As Sino-American creditor-debtor relations illustrate, the debtor holds more sway when murmurs of default arise. That’s Greece’s bargaining leverage. So I would advise them to project the attitude that default is favored, then negotiate an equity bailout from the EMU memberstates. Again, why mortgage your peoples’ futures to honor coupon payments on emergency loans to foreigners? Is that worth EMU membership? If Germany and France want to dictate terms of Greek governance, they can purchase the right via subordinated equity, which is also a natural progression toward political unification in Europe–a necessary tenant of the monetary union’s survival. If the Eurozone core is committed to Greek survival in the bloc, equity injection is the route. The ownership-stake will be illiquid and hard-to-value, but that’s never stopped Wall Street before. Greece can throw in some rights for the future purchase of shares as a sweetener. The shares will value with negative book value, but over time, Greece can sell assets and increase revenues to buyback the float.

To bring this entry to a close, I have to insist that if Greece were to collapse, it is not a Lehman, because most institutions (with the exception of Money Market Mutual Funds) have had the opportunity to trim/unwind exposure far in advance, although that has come at a price (specifically, a deep discount). German banks, for example, divested almost 50% of their Greek debt in 1q2011, despite a “pledge of solidarity” that they wouldn’t join the sellers’ chorus. Of course, there will still be a witchhunt for derivative counterparty-risk, and reorganization still won’t be folded & pressed. Global equity markets will wrinkle. But, Greece is still not Lehman. It won’t permanently overstarch the overnight, LIBOR, Repo and Swaps markets. That takes something like an AIG… or Silvio Berlusconi. Yes, if Goldman Sachs can structure Greek debt veiled within FX swaps, imagine what it can do for shameless Italian politicos. Spain & Portugal have very public economic handicaps, but I have to fear Italy, whose political process creeps in the shadows.

As we’re on the doorstep of the Greek austerity vote at 9am EST (inevitably an affirmation), I wish their people the best in a speedy recovery. I trust the system will be back on its feet in no time. I’m long the S&P 500 ETF (SPY) because it will rally magnanimously on the Greek austerity approval, to which I assign a 95%+ probability. (I ask myself why markets would rally so strongly on information they already know to be true with high conviction. Do markets perfectly disseminate and discount information? I think not.) I expect SPX to climb up to its 50DMA around 1315 in this cycle. I will weather the early morning profit-taking selloff too. Worst case, there’s a failsafe, a lender-of-last-resort, the US Fed, which readily opens credit lines to European and American institutions to promote liquidity. Kind of like a QE3, no?

–Romeo

PS- Kind of a rambling, disorganized post. I’ve been submitting entries from my iPhone WordPress App lately, and I have to say, I’m displeased with the functionality. Most recently, I lost the original draft of this entry when the App crashed. I though Apple products don’t crash? Ay.

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  1. So it starts: “US Fed Extends Dollar Swap Arrangement with ECB.” The facility was set to expire August 1, but the Fed extends to year end 2011.
    http://uk.reuters.com/article/2011/06/29/uk-usa-fed-ecb-swap-idUKTRE75S2MJ20110629

  2. […] « Before Greece Should Sell Equity Stakes Wednesday, 29 June 2011 AfterAnother Round of Layoffs!? Thursday, 30 June 2011 » […]

  3. […] out of its range and pulled SPX with it. I covered my short JJC for a thin profit, and I’m still riding SPY higher. (The hedge turned into a naked […]

  4. To followup on my “Equity Stakes” suggestion, I wanted to note that Greece followed this advice in the end: they added GDP Warrants to their bond swap terms.

  5. “…if Goldman Sachs can structure Greek debt veiled within FX swaps, imagine what it can do for shameless Italian politicos.”
    I was right. The answer: $3.4b net.
    http://www.bloomberg.com/news/2012-03-16/italy-said-to-pay-morgan-stanley-3-4-billion-to-exit-derivative.html

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