Thursday, September 15, 2011

Greece crisis in Laymanomics

Had a discussion for long-ish stretch of time at home last evening on Greece and why this crisis is upon Europe (and by, extension the rest of the world). Just thought I would put it on the blog as well.

It all began with the start of the Euro project. When the single currency was launched, all countries could borrow in Euro terms, though the rate each country borrows at depends on that country's financial state. However, when the Euro was launched, the rates of almost all countries were within a small band. This really helped Greece, Portugal etc as they could now borrow at very low rates. This benefit was added on as one of the Euro project's success stories.

For a parallel, think of a group such as Tata. TCS can borrow whatever money it needs at less than 6% interest rate (TCS has cash reserves running into 100's of millions), whereas if Tatas started a new venture called Tata oil financing, they would be able to borrow only at rates of 10% or so. If the banks got a 'Tata' guarantee, then the loans to TCS and Tata Oil financing would be at closer levels. The Euro project gave all countries a Euro guarantee (Only it did not, we will see that)

Now, we all know what debt at low interest rates can do to people, imagine what it can do to countries. For second house and big car, read increased pensions and pet going-nowhere projects. Government spending increased and fiscal health deteriorated. Come 2008-crisis and everything froze for a little while. Anything freezes, the riskier assets are the first to clog up.

For our India parallel, imagine a bank run on ICICI. ICICI will do whatever to calm the markets, but one of the first things it will do internally is to say that stop lending to companies like Tata Oil.

Now, no country can run without debt-financing and even temporary freeze-ups can hurt perfectly well-run businesses and countries. So, the system did whatever it could to unclog stuff. Big blanket guarantees were promised. Huge recapitalization was done

In India RBI comes out and says depositors are protected, no matter what.

But suspicion that some countries are not that well-managed never went away and everyone started looking closer and closer at risk premia. Spreads started expanding. No longer would German debt and Greece debt be at the same cost. It was a stupid idea anyway and now with things looking sticky, markets had to revisit this.

ICICI and co told Tata group that group guarantees are well and fine, but will TCS shareholders cough up $500m if Tata Oil collapsed? Because they wont, we want to get paid 10% interest rates anyway. For good measure, we want to add a penalty clause that will increase the interest rates to 12% in case of missed/delayed payments.

When interest rates go up and EMI creeps up, families struggle to pay mortgages. Countries are no different. As it is the recession had hurt revenues, now with interest costs increasing finances started looking ugly.

Tata Oil had one rig failure and with interest rate reaching 12% things became tricky to handle. Interest payments went high and margins got squeezed

Greece got a soft loan from rest of Europe/ECB (read Germany). This was at a low interest rate, made plainly to help tide things along. This was for a short-term only, with the idea that once things recovered, Greece would be able to hold its own. In return, the Euro countries forced down a plan to improve Greece's fiscal state. Severe austerity measures were imposed. An already contracting economy's troubles were exacerbated.

ICICI realized that deliberately squeezing Tata Oil was going to help nobody, struck a deal with Tata Group, relaxed interest rate to 7% for 2 years, with an added guarantee from Tata Group (TCS shareholders were not spoken to even now). ICICI clamped down on top management pay, had an ICICI guy installed on the board of Tata Oil and slashed marketing budget. A company struggling for revenues had its marketing budget slashed - one can imagine what happens

Greece's recovery plan was based on three assumptions - 1) the austerity measures would be sufficient (some doubted this) 2) the austerity measures would be implemented well and accepted well (many doubted this) and 3) global economy would recover well (nobody really believed this)

ICICI got a promise from Tata group and assumed that Tata Oil would retain its best employees. Good employees have a knack of running away from a sinking ship and sharp clients are good enough to sense fleeing employees.

We are where we are. None of the three assumptions have held good. The world now wants blanket guarantees from Germany, a huge bazooka to bail out Greece and Greece to become good citizens and reform. Good luck with that. If this does not turn out well, the markets will go after Portugal and Ireland, we are told. If Germany wont bail out Greece, why should they bother with Portugal or Ireland.

Taking our parallel further, if TCS wont bailout Tata Oil, why should the bankers lend to Tata Real estate on group guarantee? Why indeed?

The most critical parallel here is the fact that as much as TCS is part of the Tata group, TCS is also listed. And the TCS shareholders have to have a say in any further guarantee-ing. Being part of the group was all well and good when this started. But 90% of TCS revenues come from outside, and everyone can sense that the group tag is a liability. Importantly, TCS shareholders can ask Tata group to take a hike.

Replace Tata group with Euro, TCS with German citizens and Tata Oil with Greece and our parallel becomes complete.

I am firmly with TCS shareholders on this. The German citizens should ask Greece to take a hike. This bail-out-or-we-will-all-be-in-bigger-trouble trick worked for the banks in 2008, Germany should not fall for it again.

1 comment:

  1. Totally echo your last sentence and sentiments.. Sick of this 'Bail me out or else I am gonna take you down with me...!'

    And apart from all this - How have you been? :)