June 5, 2011
David R. Kotok
There is not a single meal at the GIC gathering in Helsinki that does not include comments about Greece, and it is not because the fare features imported feta cheese. Sovereign debt in Europe is on everyone’s mind. Three of the seventeen members of the Euro system are in trouble; Greece is a basket case. There is universal agreement that Greece is now illiquid and insolvent. The latest compromise is another temporary bandage. Our American idiom “kicking the can down the road’ fits perfectly.
However, kicking the can does not fix the problem. All indications are that Greece is the one member of the euro system that cannot recover. Greek taxpayers are notorious cheats. The Greek economy is spiraling downward. Commercial and residential real estate prices continue to fall. Currently, the country is indebted in excess of 330 billion euros, increasing daily. At the same time, the GDP is 230 billion euros and falling. The economy of Greece is shrinking. The unemployment rate is well into the high teens and rising. This is not a formula for economic recovery.
The key issue for Greek debt is the banking system in Europe. The European Central Bank is responsible for the currency and is a funding source of the commercial banks. Those banks are under each country’s national banking system in the seventeen-member euro-zone. They do not have reserves for sovereign debt defaults. The ratings of Greek debt have now fallen to junk status. If Greece defaults, the banks then have to respond on that debt. When they respond, they will take losses, and the losses could erode or eliminate their capital. A banking-system collapse risks contagion in Europe.
It is this contagion risk that strikes fear into the heart of the European Central Bank. Fear prompts short-term solutions for this festering wound. However, a long-term solution of restructuring the debt could trigger clauses in credit default swap contracts, causing a massive dislocation in some financial institutions.
Could voluntary restructuring of debt occur? Perhaps, but only when the debt can be assembled in the hands of institutional holders. Then they may engage in a voluntary restructuring transaction and not trigger a default clause in a credit default swap contract. The whole issue is quite technical, and countless eyes watch intently as these events continue to unfold.
We are in Helsinki, Finland, to discuss the issue of sovereign debt: how to manage it and what to do about countries that get too much in debt and cannot service their debt or grow their way out of it.
Finland is a country that has been through financial crisis and corrected itself, imposing discipline and austerity. Finland avoided the last round of financial chaos. Along with its collaborative countries in the Baltic region, Finland didn’t have a Madoff, a Fannie Mae, a Lehman Brothers, or an AIG. This leads one to ask why. What were the disciplines in place? How did these countries in Northern Europe keep from getting buried? Why did the peripheral, southern countries like Greece not experience the same outcome?
The GIC meetings are delving into these questions with discussions that are equally cautious and fascinating. A number of central bankers are participating, discussing the differences in monetary policy among their countries. In private conversations this is explored in greater depth. Those conversations and round tables at the GIC are held under the Chatham House Rule, so takeaways are not attributable to the participants.
Through much exploration, discussion, and debate, we conclude that there is no conclusion. The character and discipline in financial systems, countries, and cultures are different around the world. It is clear there is something at work in Northern Europe that avoids difficulties, and there is something else at work in peripheral Southern Europe that has put several countries in jeopardy. Greece has become the poster child for such activity.
On a final note, Helsinki in June is a beautiful place to visit. Sunset is at 10:30 pm, and the sun rises at 4:00 am. During this time of year, the sky is darkened only between the hours of midnight and 2:00 am. The temperature is delightful, and the city’s squares and parks are decorated with white, pink, yellow, and red tulips and lilacs in full bloom. Adding to its natural beauty, the welcoming people of Finland make this to be a grand experience. This time will be valued, however short it may be, with Greece’s sword of Damocles hanging over the bankers’ heads.
David R. Kotok, Chairman and Chief Investment Officer