Greek Negotiators “Shock” Their EU Counterparts

Over the weekend, conservative German newspaper FAZ (Frankfurter Allgemeine Zeitung) reported that euro-group negotiators were allegedly “shocked” by the lack of viable reform plans offered by Greece and the general attitude of the Greek delegate. As Reuters reports:

“Euro zone officials were shocked at Greece’s failure to outline plans for structural reforms at last week’s talks in Brussels, a German newspaper on Saturday cited participants as saying, adding the Greek representative behaved like a “taxi driver”. A meeting of deputy finance ministers on Thursday gave Athens a six working day deadline to present revised economic reform plans before euro zone finance ministers meet on April 24 to consider unlocking emergency funding to keep Greece afloat.

Euro zone sources told the Frankfurter Allgemeine Sonntagszeitung that they were disappointed and shocked at Athens’ lack of movement in its plans, and in particular its reluctance to talk about cutting civil servants’ pensions.

The mood between Greece’s leftist government and its euro zone partners, especially Germany, has deteriorated in the last few weeks, with personal recriminations flying between ministers and calls from Athens for Berlin to pay war reparations.

The paper said at last week’s meeting the Greek representative just asked where the money was “like a taxi driver”, according to sources, and insisted his country would soon be bankrupt.

The euro zone sources told the paper that Greece’s creditors do not believe this is the case and that it would be a domestic political issue if Athens is unable to fully pay salaries and pensions.

The paper also said that German Finance Minister Wolfgang Schaeuble, who has taken a tough line toward Greece in bailout talks, would have to get the Bundestag lower house of parliament to vote on any fundamental changes to the reform program.

This was immediately denied by the Greek ministry of finance, which issued a statement basically accusing the newspaper of making it all up:

“When the readers of FAZ read the minutes of the Euro Working Group meeting the newspaper will have difficulty justifying its headline and the content of its article,” the finance ministry said. “Such reports undermine the negotiation and Europe.”

However, we tend to believe that the FAZ probably relies on some inside source – that source may well be biased, but the report in our opinion correctly outlines the main problems between the Syriza-led government and the EU. One of those is that they keep talking past each other. Cutting civil servants’ pensions is a case in point: The Greek government has repeatedly insisted that this is something it simply refuses to do. It has even announced that it plans to roll back some of the public sector reforms already undertaken, by e.g. rehiring 10s of thousands of civil servants that have been fired by the previous government. Given the byzantine, ineffective and corrupt nature of Greece’s civil service, there can be little doubt that it would be better not to try to turn the clock back.

However, the main problem with such ideas is that they cannot possibly be financed by a bankrupt government. Obviously though, the extent to which the Greek government is insolvent depends greatly on whether or not its creditors are willing to voluntarily accept a haircut or some equivalent debt relief. While they may well realize that Greece’s public debt cannot ever be repaid, it is politically impossible for them to agree to a debt haircut. If they stopped continuing with the “extend and pretend” scheme, the losses would become an accounting reality, as the guarantees of euro-group members to the EFSF would be activated. A number of member states would rather not have to deal with this problem.

On the other hand, they can also not continue the existing scheme unless the Greek government agrees to most of the program’s conditions. Mr. Schaeuble found it already difficult to get Germany’s parliament to agree to a bailout extension without altering the basics of the bailout agreement. Other euro area governments are in the same boat – they all need their parliaments to give their placet. It is unthinkable that a materially altered program would be approved. And so the cart remains stuck in the mud.

10 year Greek government bond yields are at 11.30%, quite close to their recent highs – click to enlarge.

 

Greek 5 year government bond yields for comparison: these stand at a significantly higher level of 15.3%. This steep yield curve inversion is a sign that bond market participants remain extremely wary of Greece’s fiscal situation – click to enlarge.

 Close to the Edge …

Greece has just managed to repay a tranche of money it owed to the IMF, after at first indicating it might have to delay the payment. Last week the ECB has boosted ELA (emergency liquidity assistance) by another 1.2 billion euro to €73.2 bn. in total. This financing helps Greek banks to replace funding from deposits that keep flowing out. ELA approvals are reviewed weekly, and presumably this latest increase was given the nod so as not to jeopardize the ongoing negotiations. However, there is now a new “definitive” deadline for Greece to convince creditors to release more money – namely April 24. In the meantime, the Greek government seems to be running extremely low on funds.

Not only that, the distrust of creditors has by now increased so much that they want to wait for any reform proposals to be approved by the Greek parliament before releasing additional funds. One of the least compromising stances is taken by Finland’s government, which has recently mused publicly about the growing likelihood that Greece will be “pushed out” of the euro:

“From the Greek side there was a strong statement that liquidity is getting really bad and there was an appeal to release some type of liquidity support before the euro zone finance ministers’ meeting on April 24,” a euro zone aide said. “But no one knows how this could be done — there is no willingness to provide support before there is some progress in terms of the reform program,” the official said.

Athens submitted a 26-page list of planned reforms last week but euro zone officials said they lacked key details and proper assessments of the financial implications. The officials said trust was so low that ministers would want to see legislation going through the Greek parliament, not just promises, before they released more funds. Varoufakis accused the euro zone of inflicting toxic medicine on his country, and starving it of cash.

A secret memorandum drafted by the finance ministry of Finland, one of the most hardline creditor countries, raised the prospect of Greece effectively being pushed out of the euro zone if fails to meet obligations under its 240 billion euro bailout program.

The newspaper Helsingin Sanomat quoted the memo, dated March 27, as saying Helsinki must be prepared for the possibility that Greece would run out of cash before the end of June. That could lead to a situation where “by silent approval of the other euro zone countries a process is started which in effect results in Greece being expelled from the euro”, it said. The finance ministry was not available for comment.”

In early January, when it appeared increasingly likely that Syriza would win the then upcoming election, we described the situation that was likely to develop after the change in government as a “Mexican Stand-off”. Everything that has happened since then seems continue to confirm this initial assessment. The Greek government likely wants to get bailed out and retain euro area membership. The euro continues to be supported by the drachma-wary population while dealing with the crisis that would follow in the wake of a default would be a major headache, to put it mildly.

All the euro area countries on this list ex Greece are guaranteeing a slice of the Greek bailout. In the event of a Greek default, their public debts would jump closer toward the point of no return  – click to enlarge.

The EU/”troika” in turn surely wants to continue to bail out Greece, for analogous reasons (the list above shows why taking the loss would be rather inconvenient for many EU countries). However, both Syriza and the “troika” have drawn lines in the sand that seem to make an agreement all but impossible – especially one that can be struck in time. This makes the relatively sanguine mood in financial markets all the more odd. We reiterate that we don’t believe a Greek default and exit is “priced in” at this stage – it rather appears that the opposite is the case, i.e., a benign outcome (the continuation of extend & pretend) has been priced in.

Greek Stocks

The only securities markets that remain under pressure in Europe in the context of the stand-off between Greece and its creditors are those of Greece itself. This has created an interesting situation, as Greek stocks are now among the cheapest in the world (only Russian stocks seem to be even cheaper). It is hard to tell for sure whether re-denomination risk, a possible banking system crisis and the potential for defaults on euro-denominated foreign debt are all fully reflected in stock prices already, but that seems unlikely. One should probably avoid making a hero play in this case.

A long term chart of the Athens General Index (weekly) shows how far Greek stocks have fallen since their bubble peak  – click to enlarge.

Nevertheless, this is a market worth watching based on general contrarian investment principles. It may be worth contemplating a move after the situation has been resolved – almost regardless of the type of resolution. It would obviously be easier to bet on a big cyclical rebound in Greek stocks if Greece and its creditors were to come to an agreement. However, even in the event of a default, a low that reflects all the negatives should be established fairly quickly (in this case there would likely be one more major wave of selling before the low is put in, as especially bank stocks would likely be decimated further).

Always keep in mind in this context that the best time to buy is usually when the news backdrop is utterly bleak and every news headline is screaming “sell” (the Russian ruble is a recent case in point: Russian stocks have rallied by 18% in USD terms in Q1). Luckily there is a US listed ETF available (symbol “GREK”) that mirrors the Greek stock market fairly well. Every contrarian investor should put this ETF on a watch list. It doesn’t matter how terrible a crisis seems to be, a crisis almost always equals opportunity (there have been historical exceptions, such as when a number of countries adopted communism).

The Russian crisis of 1998 is quite instructive in this context, as it entailed a government default, a systemic banking crisis and a period of hyper-inflation in the country. In retrospect, one of the best trades was to buy Soviet era government bonds, which were given away for practically nothing at the time – no-one expected them to ever go beyond the status of mildly interesting wallpaper again (a more accurate description would have been “potential 10,000-bagger”, as Russia paid back every cent of Soviet era debt by 2006).

GREK, a US listed ETF of Greek stocks, weekly. Currently it is approaching the 2012 low again  – click to enlarge.

Conclusion

The back and forth between Greece and the EU looks increasingly like an exercise in futility. A Greek default and exit from the euro area would almost certainly find financial markets unprepared, and both bond and stock markets (especially in the euro area) would likely suffer more than just a wobble. Greek stocks on the other hand are very cheap already, and could well become almost absurdly cheap should a default and a currency re-denomination materialize. If an agreement between Greece and its creditors can be struck after all, it is a good bet that the Greek stock market would rise very strongly almost regardless of what happens in other markets. This is an opportunity in the making, and there is no need to bet on a specific outcome beforehand, as there should be enough time to make a decision once the fog clears.

Greek finance minister Varoufakis. Syriza’s election promises remain at odds with the troika’s demands and creditor goodwill seems to have evaporated.

Photo credit: Mike Theiler / Reuters

The Chinese ideogram for crisis: danger and opportunity