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Monday, July 6, 2015

Tsipras wins Exclusivity Extension Over Creditors' Objections - Still Needs DIP Loan

Back on January 4, in my first post of the year, I wrote:

"If the ultra-left Syriza party wins control of Greece's government this month, I expect Greece will default, for three reasons.  One, the core reason for Syriza's existence is to repudiate the terms imposed by the "Troika" (EC, ECB, and IMF) as part of the 2011 bailout and restructuring, so it doesn't really have a politically viable alternative to default, although I expect there will be an elaborate show of offers and counteroffers between its leadership and the Troika before a default occurs.  Two, even after the massive haircut inflicted on private creditors back in 2011, Greece was left with an unserviceable debt load, so it was inevitable it would get to the point of defaulting eventually, and there is a lot to be said on both sides to get it over with sooner rather than later, as opposed to the surplus-generating nations in the EU throwing good money after bad.  Last, those nations have to be worried about emboldening copycat repudiations by ultra-left parties in larger nations, especially Podemos in Spain, where there will be national elections in December, so it makes sense to let Greece make an example of itself that, one hopes, causes Spanish voters to avoid following in its shoes.

"The counter-scenarios are that either (1) the bureaucrats in the Troika are not politically strong enough to take an action that effectively throws a member out of the EU, in part because they are bureaucrats to begin with and in part because France, Portugal, Italy and possibly Spain may want to see Greece treated liberally so they themselves can receive similar treatment.  In this view, the Troika will ultimately cave and kick the can down the road a ways ....   The second counter-scenario is that, once Syriza comes to power, they will, like many before them,  soften their rhetoric, face up to reality and settle for some easy loan terms if the Troika pushes back hard enough and a deal will get done.  These are very possible, but at the end of the day, I think that, much like the Kirchners in Argentina, Tsipras will choose to play to the crowd with a populist repudiation."

And that is essentially what has happened year-to-date.  A lot of posturing to try to position the other side of the table as the one responsible for the fault.  But ultimately, as Tip O'Neill once put it, "All politics is local".  

I was apparently in the minority with this prediction.  I haven't understood why so many pundits did not see how this would play out.  Tsipras and Syriza have played out the textbook Left - Populist political strategy, dating back to Hitler and recurring through Latin American history from Castro and others right up to the present with the Kirchners and Chavez/ Maduro, and perhaps other episodes elsewhere about which I am not as well-read, which consists of the 5 following steps:

1)  Take one indebted nation in economic crisis;

2)  Demonize its foreign lenders / investors, and often the business and financial elite of your own country;

3)  Wrap yourself in the most ancient traditions of your nation, positing the economic negotiation as an existential, good vs evil struggle;

4)  Promise consumption subsidies and welfare payments to the poorer half of the electorate, and heavy nationalization of the economy, to win their vote;

5) Take power and repudiate the debt.

It wasn't an  insight gained from my career in debt restructuring, but just a knowledge of politics and history.  Perhaps those who held a more optimistic view were just talking their book, like Wilbur Ross, or just too steeped in financial market norms to see what was coming.  But, notwithstanding Syriza's ethnic slur of equating modern Germany to WW2 Germany, it's been Tsipras who has tracked Hitler's rise to power, not Merkel. Germany in this drama is more analogous to the creditor nations of the US and France, and Greece more like the debtor Germany in the 1930's, a fact Macron, the French Economy Minister, has apparently recognized.  I don't imply Tsipras will be invading anybody or sending anyone to the gas chambers.  I just mean his political strategy and rhetoric track those Hitler employed when he campaigned in the early 1930s, and other Left-Populists have used since.  If you want another, more American example, think of Huey Long, or on the right wing, George Wallace standing in the doorway of the University of Alabama administration building, positioning himself as the man fighting for local traditions against external forces whom he demagogues. All politics is local.

That said, I thought it might be useful to draw on my restructuring experience to point out how many similarities there are between what has gone on between Greece and its creditors and a contentious, "free-fall" corporate debt restructuring  here in the US, because it's apparent a lot of the media covering this are not able to get a handle on what is going on.  That's why I stuffed the title of this post with chapter 11 buzzwords.  And from this I will draw out one important point: notwithstanding the talk in recent years about the need for a "sovereign bankruptcy regime", the Greek episode reveals why that won't be an adequate solution; remember, all politics is local

Greece right now is like an administratively insolvent chapter 11 debtor who is unable to pay, not only its pre-petition debt (here, pre-Syriza debt), but its day-to-day operating expenses. It has been depleting its cash and engaging in emergency liquidity conservation measures, such as raiding accounts dedicated to other purposes and just not paying vendors, and now even those have been exhausted.  

The creditors have been unhappy with the debtor's business plan, which fails to generate any cash flow for debt service, and after months of negotiations, have lost confidence in management.  They hoped that the management would be replaced, but management instead sought an exclusivity extension.  The creditors objected, stating that the existing management was incompetent, as proven by the fact that revenue has gone down precipitously since management took over, and yet management refuses to take steps to bring costs in line with the reduced revenue. Similarly, management has declined to sell assets (i.e., privatize) to generate cash to fund operating losses. Nevertheless, the judge hearing the exclusivity extension, (i.e., Greek people) had a pro-debtor bias and granted the management the sought-after extension.  As we know, such orders are non-appealable.  

Having won this procedural victory, management still confronts the same substantive problem:  no money.  It is an iron law of life on this planet.  You cannot indefinitely consume more than you produce, unless you steal from someone else.  If you borrow in one year to fund consumption, thereafter you must include the resulting debt service in your expenses, and you either have to reduce consumption, reduce investment, liquidate assets (like privatizing ports or pumping out your oil reserves) or produce more than the year before.  If a nation borrows to fund investment, and invests wisely, it may be able to generate additional returns that service the debt.  But borrowing to fund consumption is by definition unsustainable over the long-term. Which is why Greece is where it is.

So the debtor needs a DIP loan.  To do that, it has to produce, yet again, a business plan and cash flow projections.  First, it has to show it will change its way of doing business to begin to generate positive cash flow. These are called "structural reforms" in sovereign debt parlance.  Second, it has to project the cash flow that will result from those changes, using assumptions the creditors find reasonable.  Third, it has to show how much of that cash flow it will allocate to service the DIP loan and as much of the pre-petition debt as is feasible.  For example, the creditors want to reduce the amount of cash flow that is being siphoned off to maintain the status quo of unproductive sectors of the economy, like nonworking people who are still able to work.  

Will Syriza do this? It is strictly a matter of political will. The most hopeful scenario is that, with this big electoral victory, Tsipras now has the political capital to cut the final deal.  The creditors can give him some more concessions, particularly writing down the debt which is unsustainable anyway, and in return he can accept more of their reforms, and they go on harmoniously, each side saying they got something more than when negotiations broke off.  In this context, the resignation of Varoufakis, the embarrassment he appointed as Finance Minister, is a hopeful sign. And all politics is local - now that his local status is solidified, Tsipras can face up to the reality of the larger problem.

I just don't know if Tsipras is that rational.  So far, he seems to be as mercurial as any national leader in history, one day purporting to make concessions and the next rhetorically destroying the environment for reasonable negotiations.  It's like he studies Richard Nixon's strategy in negotiating with Ho Chi Minh. 

The other concern is that, to the extent the rest of the EU in any way is seen to ratify Tsipras's strategy and tactics, that strategy will be re-enacted in the other low-productivity EU nations -- like Spain, particularly, where Podemos has already won many local elections recently and is consistently #1 or #2 in the polls for their November elections for national office.  But Italy and Portugal and even Ireland won't be far behind.  Once the norm of debt repayment breaks down, there isn't any logical stopping point.   So the creditors have to weigh the prospect of a rolling wave of debt repudiation cresting higher and higher if they work things out with an ultra-left Greece. 

If the negotiations of a consensual, going - concern reorganization doesn't work out, then we will see the sovereign equivalent of a chapter 7. The banking system and the government coffers will literally run out of euros in the next few days. Not just banks, but stores, businesses, government offices, will all shut their doors, as happens in a 7.  Yes, some parts of the country will continue to operate but massive amounts of GDP will cease to occur.  I don't think they can create a new currency fast enough to avoid this problem.  

And behind all this,there is the threat of further military incursions by Russia into places like the Baltic nations, which calls for as united a Europe as can be achieved.   

Angela Merkel has to be the George Washington, Abraham Lincoln and Alexander Hamilton of Europe, all at once, and all this month. She has her work cut out for her.