The Greek Troika Deal

There’s an old banking proverb: “If you owe the bank thousands (a small amount), you have a problem. If you owe the bank millions (a large amount), the bank has a problem.

So who do you think is really worried about Greece not paying back its 360 billion euro debt; the newly elected Greek left-wing Syriza party or the lenders, consisting of the European Central Bank (ECB), the International Monetary Fund (IMF)Troika?

Obviously the Troika are rattled over the prospects of a Greek default. After all, a 360 billion euro default is no small issue. In fact, a Greek sovereign debt default would be catastrophic for the financial markets.

Assuming that negotiation breaks down with the Troika and Greece were to default on all or part of the 360 billion euros of loans, while that would be bad enough, the problem wouldn't end just there. As I explained previously, in an article entitled “Fire Back Stage”, sovereign debt is used as collateral to raise finance to make more loans (debts). Just like households pledge physical assets (a house as collateral against a bank loan), higher up the financial food chain, the commercial banks pledge intangible assets, such as sovereign debts, as collateral to raise finance on the secondary market.

But what happens when the holders of those intangible assets realise they have made loans on worthless Greek paper? Throw fractional reserve lending into the equation and you can see how the problem becomes magnified many times. Unlike Argentina's recent credit default, Greek debt hasn't been ring-fenced from the system. So a Greek credit default would have massive implications on the secondary market western financial system. If you are not technically minded then look at it this way, if the US sub-prime mortgage crisis created the financial crisis of 2008, what would happen when a western country defaults on its sovereign debts? It would make the last financial crisis of 2008 look like a picnic.

But that is unlikely to happen because the Troika and the newly elected Greek government want the same thing, for Greece to stay in the European Union.

Initially, in the early stage of negotiations both sides flex their muscles, then they end up making a compromise and reach an agreement midway.

The Greeks want to restore a “sense of rationality in the Greek debt program,” according to Greek Finance Minister Yanis Varoufakis who was a professor at the University of Athens.

So what happened when the Greek state became insolvent back in 2010?

“The ECB addressed the problem by unloading the largest loan in human history to the most insolvent of European states”, said Varoufakis.

These Troika loans were based “on conditions of austerity that by mathematical precision shrunk by a quarter Greece national income by which all new loans would have to be repaid,” he said.

Indeed the Greek “rescue package” were a Trojan horse. “A case of extend and pretend implemented at large to a whole nation.” “The Troika were in denial about a bankruptcy problem, instead they treat it as a liquidity problem and dumped more debt on an insolvent entity, deepening bankruptcy and extending it in the future,” said Varoufakis. “Our objective is to end this vicious cycle that has bad repercussion for Europe as a whole,” he added.

So what is the new Greek left-wing Syriza Government's objective?

To reach a “mutually beneficial compromise” that will render the Greek economy sustainable again and to stop eluding the Troika with unrealistic conditions to pay back the debts.

What are the important dates?

The end of February is a political arbitrary date that can be extended. The ECB bond that purchased in 2010 and 2011 expire in June, which gives Greece and the Troika four months breathing space. The parties are likely to come to a mutually acceptable agreement before the ECB bonds expiry date, until then there will be wrangling.

The Greeks will be looking for considerable write downs on the loans with the aim of getting the economy back to life again. They are going to need to find a way to package and sell this idea to the Federal Parliament in Berlin. Also, a development plan that will render the Greek economy sustainable. “Once the debt has been restructured Greece can breathe within the Eurozone again,” said Varoufakis.

What are the Greeks likely to put on the table?

There is talk about a debt swap linked to GDP performance. Whatever haircut proposed is likely to be proportional to GDP performance.

But if Greece could return to a healthy path of economic growth then a haircut may not be necessary.

This might be an acceptable solution since a deal would be done that would be in the interest of both parties, linked to the improved performance of the Greek economy.

“If they manage an investment plan that will lift economic performance that is fine and then we will be able to sell this to our own parliamentarians on the basis that Europe is becoming a partner in Greece's growth and not in Greece's misery which has been the case so far”, said Varoufakis.

The Greek Finance Minister Varoufakis is not a radical Marxist as mainstream likes to make out.

Varoufakis understands that it is a dynamic, innovative and enterprising economy that generates wealth and puts people back to work. He understands that employment based on a public sector that requires public funding won't get people back to work in the long term. “Young entrepreneurs face public enemy number one, which is the state in the form of taxation completely out of kilter and ability of these entrepreneurs to begin putting Greeks back to work, must be a priority.”

So after a few months of wrangling, the parties are likely to reach a mutually beneficial deal.

However, there is one wild card in all this, Russia. If the Russians could lure the Greeks away from the EU, offer them a better deal and get the Greeks to default on Troika, it would be a way of bazookering the western financial system. In financial warfare anything is possible.