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When a Bond Is Not a Bond

When a Bond Is Not a Bond

What I’ve found over the course of my career is that the closer people get to an issue, the worse their predictive power is. The forest-for-the-trees phenomenon. Like all the economists who do nothing but watch the Fed, every piece of data, every speech. Their track record in predicting interest rate moves is worse than everyone else’s!

I deliberately try to be dumb about things.

Some of my friends and clients know a lot about the Greek negotiations. There is a lot to know. I try to keep it simple:

  1. The Greeks are communists
  2. Everyone is incentivized to get a deal done, unless
  3. The Greeks overplay their hand

There. Now I know everything there is to know about Greece. At the time of this writing, there was no deal in place, but it was starting to look promising.

Promising Isn’t the Word

People are starting to figure out that Greece is probably better off just defaulting and going back to the drachma. Painful, yes, but better than this perpetual bailout purgatory where everyone loses. Greece doesn’t make the necessary reforms, and Europe just keeps throwing good money after bad.

Which leads me to the point of this essay—if Europe bails out Greece once again, will they ever realistically pay it back?

Of course not. Everyone knows this.

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Then it’s not really debt, right? It’s just aid. It’s a gift.

I think it’s time that people start being honest about what is going on here. This isn’t a rescue package, with covenants. It’s an aid package. If Europe wants to pay for Greece to pay all its civil servants (and its surprisingly large military), then fine. As we are starting to see, they’re less willing to do so when Varoufakis acts like a punk.

What does the profession of economics say about aid?

I’m not sure, actually. Though it seems that (in my experience) giving aid to countries stunts their growth. Five years of free trade is doing more for Africa than 50 years of aid ever did. I have some theories about charity in general, mainly that most of it has real externalities. So if you keep giving money to Greece, it’s only going to become dependent on… you get the picture. I am starting to sound like George Will.

What we do know is that if the Greek government issues more 10-year bonds—it will never pay them off. And it can’t refinance. So who would buy such a bond? It will default eventually, right?

That is the interesting question.

You see, as long as Europe (Germany) is willing to shovel cash into the money pit and call it debt, not aid, they will keep Greece afloat, and Greece never defaults, and nobody ever has to realize losses on Greek bonds, on which the recovery rate will surely be zero.

They are putting the pretend in “extend and pretend.” You pretend that Greece can pay it back, so if you’re a bank, you can keep the bonds marked at par on your balance sheet. So the accounting value (par) is different from the market value (60 or whatever), which is different from the economic value (zero).

Everything finds economic value eventually.

In my career, I’ve never seen anything like this. Sure, I’ve seen companies refinance that shouldn’t have been able to refinance, but that pales in comparison to this. It’s not debt. It’s aid.

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My guess is there are geopolitical concerns at play here too. I saw a headline the other day about Washington being concerned that Greece was going to end up in Moscow’s orbit. Too late! They are communists.

I will go a step further and say that in 10 years’ time, Greece will be a less pleasant place to visit. I am beating around the bush. I think it will be a very unfree place.

Please Help

Saw an article on Quartz recently about peer-to-peer lending. Apparently people have done some quant magic on it and determined that the actual words in the loan application can determine whether you default or not. Seriously.

So these words…

Payday loan
Give me a chance
Please help
I promise
Will not
Will allow

… indicate that you’re a deadbeat.

And these words…

Excellent credit
Lower interest
Student Loan

… indicate that you’re good for the money.

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Pretty cool, huh? Someone is going to make a lot of money on this. We’re talking about hundreds of basis points of edge.

So, back to Greece.

Which words are they using?

“Marxism” wasn’t mentioned in the article, but I’d wager it belongs in list number one.

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June 30, 2015, 3:47 p.m.

“So if you keep giving money to Greece, it’s only going to become dependent on…” Going to become? Dude they became a long time ago. Since independence in 1822 countries have been giving money to Greece because it is “important” (in geopolitical terms). The Brits wrote the checks for well over 100 years (and still Greece defaulted on its sovereign debt five times in that period). The Americans took over the task after World War II then handed the ball off to Europe when Greece joined the EU. Greece is past ‘being dependent upon’, they have moved on, in their mind, to being ‘entitled to’ OPM (other people’s money).
By the by I think your step further is in the right direction. If Tsipras and the former college professor and self proclaimed Marxist-libertarian (whatever that means) Varoufakis had intended to cut a deal from the outset it would have been done. It wasn’t, they have another agenda.

Kelly Jones
June 25, 2015, 12:22 p.m.

I like the approach of not getting too bogged down in the details, just looking at the obvious big picture, Jared.  I just think that your politics, though, are getting in the way of you seeing the complete big picture, which is that it’s not just the “Marxists” that are getting aid.  Some people talk about Greece as though they are the most obvious deadbeats in the world, and I agree with you that the $ from the EU is just aid, and should be called that.  It’s not going to be paid back.

But, it’s time for those commenting on Greece to drop the smugness and get real:  the 50 trillion added in QE and >global< aggregate debt since 2008 is “aid”, too, not debt that will ever be paid back in anything like its original value.  And it’s not aid to a poor economy that needs it, but much worse, aid primarily to wealthy people who don’t need it, so they can pretend and extend their economic control, their “trickle down” theories, and keep their corrupt trashy investments from crashing to their real market value to humanity, which is really not that much, given that they’re overloaded with more flexy straws extracting Vig than a Mafia split.  That’s the main reason a Greek deal has a prayer of going through – the bankers/politicians that wanted it in the first place still want it, so they can move their chalets further from the blast zones before reality hits.

Everyone should know by now, exactly what happened in Greece – we just never hear it talked about much:  The losses of German and French bankers, shareholders and bondholders, who should have taken the loss for their downright stupid investments there, were cynically transferred to EU taxpayers, so the taxpayer/voters could argue over who is screwing who while the bankers continue to enjoy their villas and their power lunches.  Yes, you are starting to sound like George Will, though he, you, me and many others likely agree with the “punk” Greek finance minister Varoufakis, who opposed the original EU bail outs of Greece in 2010 and 2012 for the reasons I just gave:

It’s time that some politicians,  bankers, and other select parasites of the financial services industry who produce nothing of value be called out for what they are when appropriate.  Many have the arrogance to look down their noses at Greece, (or “sub-prime” borrowers or student loan deadbeats in the US) when, as a group, it was they themselves that set up the corrupt, unproductive deals to begin with, phonied the paperwork, and like the deadbeats they are, live off the QE/exponential debt “aid” they’re now shoving down the throats of taxpayers worldwide to maintain their position.  Too many are feathering their nests for a soft landing when the absurd financial world they’ve corrupted and gutted finally crashes, all the while congratulating themselves about how smart they are, and how morally inferior everyone else is.
June 25, 2015, 10:33 a.m.

I love the way you think, Jared. I look forward to ... and always read the 10th man immediately.

Maybe you’ve written a book ... I’ll have to look.

The 10th Man - Jared Dillian

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