Keeping Things Simple

The Malta Independent on Sunday



When simple things are purposely complicated it inevitably becomes a treacherous road leading to final disaster. Experience, since the financial crisis of 2008, is littered with examples of how obfuscation, complexity and useless complications of things that are basically simple, led to dysfunctional financial markets and the near collapse of the world financial systems.

In the good old days when bankers were bankers making a good living on a hard-earned reputation for honesty and integrity, before bankers turned into traders in search of a quick buck from trading, often against the interests of their own clients, things were simple. For every 100 units of assets, bankers had to have eight units of capital. Assets were assets and capital was capital. That simple!

Then greedy bankers started to persuade regulators that such simplicity was boring and inefficient. They argued that not all assets were equal and, given their risk management skills, assets had to be weighted according to their risk and the capital required should not be calculated on the basis of the gross value of the assets on their balance sheet, but on their risk adjusted value. Applying a low co-efficient of risk to a multitude of assets that were highly rated meant that bankers needed to keep much less capital than used to be the case when life was simple and an asset was an asset, pure and simple. The lower the capital that needs to be held for maintaining a given level of gross assets, the higher the efficiency of the capital and the profit return on such capital. Of course the counter-argument to this is that the lower the capital that needs to be held for maintaining a given level of gross assets, the more susceptible the bank would be to external or unexpected shocks (black swans as they are now technically referred to following N.N. Taleb’s famous book of the same name), with the prospect that while the profits in the good times are privatised the losses in the bad times are socialised through the forced intervention of the regulator to save the system from greedy and irresponsible bankers.

As if this were not enough, banks started playing around with capital by classifying as capital certain liabilities that were not capital at all. In the good old days capital was capital, i.e. paid up share capital and distributable ploughed back reserves. Banks persuaded regulators to include as capital, bonds on which they paid out interest irrespective of profitability purely because these bonds were subordinated to normal bonds. Counting bonds as capital reduces the true capital required and jacks up profitability in the good times but magnifies the risks in the bad times.

When crisis struck in 2008, it was like the proverbial tide that flows out to expose those that were swimming naked. Assets proved much riskier than the high rating allocated by rating agencies and much riskier than the adjusted value given by banks’ VAR (Value at Risk) models. On the other hand, subordinated bonds proved to be no risk capital at all (except in the case of Ireland) and regulators and governments had to work hard pumping liquidity and capital to ensure that banks remained liquid and solvent even when subordinated loans fell due for payment.

Many banks were found swimming naked with too little capital to sustain their bloated balance sheets. Regulators were also blinded by what banks and shadow banks could do beyond the cautious traditional role of taking deposits and lending a margin of them out to borrowers who could put that money to good use to grow their own household or business and in the process contribute to the general well-being of the general economy. Bankers started to dabble in strange products, among which Credit Default Swaps (CDS). What is a CDS and why should we care about them` CDS is a credit insurance, which anybody could buy and many banks can sell, that insures against default in payment by a third party, irrespective of whether or not the buyer of such insurance cover has an insurable interest. It is the financial equivalent of buying life insurance on the life of an unconnected third party, creating a hidden incentive to have the insured kick the bucket before his time so that policy holder can cash in the insurance money.

This practice in and of itself magnifies the risk of default as it creates large speculators who can benefit from default at the expense of the many who invested in good faith, believing in the promise of the borrowers to honour their repayment commitment. The reason why regulators would allow third parties without an insurable interest to buy a CDS to cover the risk of Greek default escapes me.

No wonder markets get rattled by all sorts of rumours meant to damage the ability of the insured to maintain financial solvency when the delicate situation requires silence or at least transparent dispassionate analysis. The same applies for short selling. Short selling is when investors sell an investment they do not own hoping to buy it back later at a lower price. Short sellers profit from a fall in the value of the investment they sell short and therefore have every incentive to denigrate the business or country they sell short. When things were simple, investors used to make money by buying investments they believe could grow over time but things have been allowed to get complicated enough for investors these days to have as much an incentive to profit from failure rather than share in success. My simple mind says if an investor does not like a particular investment he should avoid it, but I find such short selling hard to accept.

The same applies to measurement of the deficit of the public budget. In the good old days things were simple. A deficit was a deficit. In these complicated days, the deficit figure read out in the Budget never tells the true picture. You never know what expenditure is being passed through the Treasury Clearance Fund to be eventually brought back into the Consolidated Fund by spreading it over a number of years. You never know what expenditure is going on through SPV (Special Purpose Vehicles) created for a particular purpose (e.g. to execute the City Gate Piano Project), which borrows money commercially against the guarantee or letter of comfort from Central Government.

You never know how much unpaid bills are accumulating at the Treasury when line budgets are exhausted.

It would really help to solve problems and get out of the financial mess the world got itself into if we were return to the days when things were kept simple.

Should Maltese Tax Money Bail out Greece

The Malta Independent on Sunday



Before addressing this question, I have to reflect on two higher order questions related to the grim political and fiscal situation in Greece.

Does Greece want a bailout? Is a bailout the best solution for Greece? Without a bailout Greece will default on its debt obligations.? If Greece defaults it could be the European version of the Lehman debacle that will shake the entire European banking system.?

Many European banks, still operating with thin layers of capital following the financial crisis of 2008, will incur huge losses on their exposure to Greek borrowers (sovereign, banks or private sector). Many systemically important European banks will be wiped out unless instantly recapitalised by state injection of funds. It is very doubtful whether the shaky recovery from the bank solvency crisis following Lehman in 2008 can withstand another systemic shock induced by a Greek default. A slip back into recession or depression would seem a plausible outcome as governments no longer have capacity for fiscal stimulus without endangering their own sovereign solvency.

Some say that the systemic crash caused by a Greek default would make the 2008 financial crisis seem like a walk in the park.

Does Greece want a bailout?

Given that the alternative is a default, which would wipe out the Greek banking system and close its only lifeline for liquidity through the ECB, the Greek government seems prepared to do whatever it takes to qualify for a bailout. However, such a bailout comes with very tough conditionality, which will impose severe austerity measures on the Greek population. Such austerity would be comparable to the draconian conditions for reparation payments imposed by the Allies on Germany following its defeat in the First World War ended in 1918 by the Treaty of Versailles. The Greek government has no electoral mandate for such austerity and, judging by the social upheaval that has become a regular feature in the main squares of Athens where rioters and police face each other like Roman gladiators, the Greek government needs a broad mandate either by holding fresh elections or through the formation of national cross-party government.

Is a bailout the best solution for Greece?

This is a question that should be answered by the Greek electorate through the holding of early elections or a specific referendum. The electorate would have a choice of two options. Either go for the bailout and accept the strict austere conditionality like the Irish did and organise an internal devaluation (through cuts in wages, reduction in government expenditures through massive trimming of the bloated public sector, massive privatisation of state-owned inefficiently run economic activities, substantial improvement in tax enforcement, liberalisation of labour markets and softening of union rights, containment of social security abuse and extension of retirement age to North European standards), or exit the euro, revert to the old drachma, force conversion of all debt (sovereign and bank) back to Greek drachma at the same rate used when Greece had joined the euro, make a massive devaluation of the Greek drachma, re-introduce capital exchange controls, and force the temporary nationalisation of all Greek banks which will need to be recapitalised and sustained through enforced freezing of deposits.

It would be a re-run of Argentina 2001/2002. If the Greeks think that the second option would be more bearable than the first one they should think again. In case of the second option, Greece would be on its own, blocked out of international capital markets for a very time long until it rebuilds its credibility. The losses such a move would impose on European banks will cause a deep European recession just when Greece would need a healthy European economy to whom it would be able to export goods and services as it regains competitiveness through the devaluation route. Such rediscovered competitiveness would be quickly dissipated unless the Greek economy is restructured through the painful measures imposed by a EU or euro bailout.

If Greeks choose the euro exit and devaluation route as an alternative to the austerity measure of an EU bailout, they would be condemning themselves to a perpetual crisis.

So coming back to the original question, should Maltese tax money be used to bailout Greece?

I would say that Maltese tax money would have to be used to bailout Greece because in the process we would be bailing out the whole European financial system and the general EU economy which we need in good health to maintain our exports and our tourism. However the bailout must not be temporary patchwork, just kicking the can down the road till it explodes in the face of successor governments. The bailout must be a true solution that delivers a period of several years during which Greece will not need to have access to private capital markets.

Bailout loans:

•  are to be at normal market rates paid by Greece in the first 10 years of euro membership not at the current crisis rates. 
•  Substantial privatisation to re-energise and re-invigorate strategic sectors of the Greek economy which are currently extremely inefficient through public sector style of management which leads to a normal train worker earning €9000 a month remuneration package. Privatisation revenues will reduce the size of the bailout required. 
•  Acceptance of the austerity measures through a national government or the conduct of referendum or fresh elections whereby the government seeks a popular mandate for acceptance of the austerity package or for the stark alternative of exiting the euro. 
• It is inconceivable that if Greece were to default it could stay in the euro. 
• International supervision for prompt execution of the austerity package. 

 Anything short of this would be wasting our scarce resources on an errant nation that never absorbed the spirit of EU and euro membership and who should feel ashamed especially when comparing themselves to their neighbour Turkey. Fifteen years ago Turkey was the Greece of today and Greece was a respectable stable democracy with sound financial structures. Greece is now in a worse situation than Turkey was 15 years ago whilst Turkey has improved its economy so much that currently it can borrow on the capital markets at margins much finer than Portugal, Ireland and Spain and obviously much better than Greece would have to pay if it were possible for it to borrow on the markets, which obviously is not possible at present.

A final word of warning to those who had depicted our euro entry as an anchor of stability for our economy. The Greek financial tragedy and the Turkey success story proves that euro membership does not guarantee success and retaining control of one’s own sovereign currency and monetary policy is not an impediment to achieving financial stability. What matters is not being in or out of the euro. What matters is how prudently and how effectively politicians manage their economy. Greece, euro and all, has failed while Turkey, without the euro, has succeeded. We have to earn our living by safeguarding our external competitiveness and consistent hard work. Euro membership alone guarantees nothing if not an obligation to use our tax money to bail out errant peers.

The Church and Greece

The Malta Independent on Sunday



There is much in common between the present situation of the local Church and that of the Republic of Greece.

To start with, they are both in a desperate situation, working through a crisis of their own making. Yet, whilst fully deserving the pain caused by their arrogance and bad management, we cannot nonchalantly let them simmer in their own juice.

Our well-being depends on their successful recovery from the mess into which they have got themselves. Never in a month of Sundays did the Church authorities in Malta expect that a referendum about the introduction of divorce would get an outright majority approval at the first attempt. The Church knew that divorce would eventually be introduced through normal parliamentary procedures, when an increasingly liberal society demands it of its representatives.

Such measures which concern the rights of minorities should never be addressed through a referendum, but recourse to this odd instrument was organised in the near certainty that the popular decision would tie the hands of the elected representatives for many years to come. Convinced that in a popular electoral vote the majority that does not need recourse to divorce would trample on the rights of the minority with a comfortable margin, the Church and its PN allies organised a quick referendum in which, with the subtle assistance of the PN and Church tandem, the anti-divorce campaign was much better resourced than its adversaries, which only had the arguments in their favour.

As the campaign evolved and the pro-divorce campaign, especially through the excellent performance of its main representative Dr Deborah Schembri, started winning the arguments and people’s hearts and minds, the Church entered more directly in the campaign, with the threats of awaiting hell for those who voted for divorce becoming less veiled and more and more nuanced, to the point where the local Church’s second in command labelled pro-divorce Catholics as wolves in sheep clothing.

At no point in the campaign did the Church make the obvious distinction between the introduction of divorce in the civil statute, which for all intents and purposes is a civil right enjoyed by all other people of the world, and the actual act of divorce which in most circumstances is an act forbidden to those who want to continue to form part of an active Catholic community even at the level of partaking the Holy Sacraments.

No effort whatsoever was made by the Church to explain to its followers that they would be sinning, possibly, by actually applying for divorce but certainly not by giving the minority that needs divorce a civil and responsible way out of their broken marriage.

The Church made the horrible error of contradiction by portraying the increasing problem of marital breakdown as a direct result of the introduction of divorce when, in fact, marriages are breaking down at an accelerating rate even though divorce is not yet on our statute book.

In the end, those who remained undecided until the last minute finally had to decide whether to back the Church’s evident contradictions or back members of their own household or near family who were suffering the personal experience of marital breakdown and who needed divorce as a route to a fresh start in life.

Greece is in a financial straight jacket. It entered the euro club by misrepresenting the true state of its finances and rather than using the 11 years since it has been a eurozone member to bring its public finances in line with its obligations and liberalising its economy to render it more flexible and competitive, Greece has contrarily used its euro membership credentials to borrow cheaply to continue financing its extravagance and its living beyond its means, and to defend the privileged rigidities inbuilt into its economy. In the process, many European banks built exposure on Greek sovereign debt, in the widely held assumption that no eurozone member would be allowed to default on its debts.

Today Greece is a financial nut case. By any measures, it is bankrupt. Government debt is now twice the 60 per cent GDP limit established by euro rules. The economy is contracting as imposed austerity measures are forcing the government to roll back its role in the economy without any compensating increase in investment in the private sector, which remains scared by the financial mess in which the country is enveloped.

Countries that find themselves in such situation normally have the option of imposing an instant cut in the standard of living in order to regain competiveness through the devaluation route. Greece does not have this option, unless it decides to exit the euro and default on its international debt – a move that would wipe out the Greek banking system, leaving the country in a financial mess bigger than the one it is in already.

It can stay within the eurozone and still default on its debt, but this would again wipe out the Greek banking system as it loses the life support of the ECB. Basically, the only route left is to hop from one bail-out to another organised by the remaining eurozone members (including Malta) to avoid a dirty default – which would rock the European banking system that is still recovering from the financial crisis of 2008 – and gain time until the Greek economy is restructured back into competitiveness and growth. In the meantime, the mass privatisation of economic entities still controlled by government needs to be urgently undertaken to lessen the quantum of the bailout required.

Ultimately, when the European banking system gets into better shape in the medium term, some sort of a managed debt reduction has to be organised, on a voluntary basis, to reduce the debt burden without triggering cross default commitments.

The tasks facing both the Church and Greece are of daunting proportions. In both cases silence, humility and hard work should be the main ingredients for embarking on the road to recovery. Both cases have an advantage in the fact that their recovery is in the interests of the many that have disciplined their arrogance and bad management and can expect much support in working their way back to health.

The Church will have to do better than issue an embargoed ‘apology’ at the end of voting which, between the lines, was celebrating a premature and – as it happened – non-existent victory and seek to retain the respect of those they perceived as vanquished but who ultimately proved to be the victors. The Church must accept that there is nothing tragic about the Maltese acquiring the right to divorce already enjoyed by most other Catholic countries and rather than continue to squander its energies and resources in defining everything in heaven or hell terms, it should apply its resources to guiding Catholics to better marriage preparation, to support better assistance to families, to be more effective in guidance to those who seek assistance when their marriage is passing through difficult times, to persuade Catholics that they should resort to annulment or divorce as a very last resort and ultimately to bring more transparency and compassion into the mechanism of marriage annulment.

Greek politicians should issue an all-party unconditional apology to the Greek people for having promised the unsustainable, for having squandered resources and for giving them the illusion of an easy life based on borrowed rather than earned money. They should then embark on a national programme to work their way out their financial troubles, not by organising street protests, which scare away investment, but by accepting reality and cutting back to the extent necessary to render their economy competitive, which would then attract investment and lead to economic growth – an indispensable and currently missing ingredient in the austerity package.

For our own sake, Europe needs a healthy and stable Greece, as much as Malta needs a messianic Church totally espoused to the true values of the Gospels.