Your Usual Table, Mr. Papagiorgio?

It would appear that European leaders are back at their usual table.

Speaking at the Bookings Institute before meeting with the US administration, Greek Prime Minister George Papandreou blamed “unprincipled speculators” and “ill-regulated” financial markets for pushing Greece to the brink of financial ruin and dragging down the euro.  Along the way he convinced France’s Nicholas Sarkozy, that another financial crisis is around the corner if the CDS market is not curtailed.  Sadly, we agree with the conclusion, but many European “leaders” are confusing cause and effect.  Keith McCullough, at Hedgeye, explained it best yesterday when he said, “markets don’t lie; politicians do . . . hearing politicians talk about markets is like watching a southern belle try to ice fish.”

So let’s set the record straight.  CDS trades are not the cause of Greece’s problems.  Profligate government spending is the 800 pound gorilla jumping up and down in the center of the Parthenon.  We wonder how Mr. Papandreou would respond if asked to imagine that the Greek public debt ratio was 50% instead of 135% and the Greek budget deficit was 5% or 6% (or even a surplus heaven forbid) rather than 12.8%.  Would insurance against a Greek default cost north of 300 bps and would Greek government interest rates be trading at elevated levels and rising in this unfathomable scenario?  We think not.

We’d like to briefly review our “principles” for the benefit of Greece’s PM.  We are a small family office in North Carolina, entrusted with protecting family wealth and growing it prudently for future generations.  We are also fortunate enough to do the same for a few other families that share the same objectives and same values.  Believe it or not, when we lend (i.e. invest) our money to businesses – and governments – we expect to get it back (and occasionally earn a respectable return over time).  We have a fiduciary obligation to look after the pool of capital entrusted to us and work hard to earn our investors a consistent rate of return.  As Papandreou and Company go cup in hand on their global PR tour blaming “unprincipled speculators” for their own fiscal recklessness, we ask how many of these so-called, evil investment managers have been bailed out with tax-payer dollars during this Global Recession.  And we’d encourage Mr. Papandreou to consider the following “principles” as Greek actions speak louder than words:

  • As early as 2001, just after Greece was admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, hidden from public view because it was treated as a currency trade rather than a loan.  This allowed Athens to meet Europe’s deficit rules while continuing to spend beyond its means.
  • Greece entered the monetary union with bigger deficits than permitted under the treaty that created the currency. Rather than raise taxes or reduce spending, the Greek government artificially reduced their deficits with derivatives.  Ironic how the same politicians are blaming derivatives for the problems they created.
  • Aeolos, a legal entity created in 2001, helped Greece reduce the debt on its balance sheet. As part of the deal, Greece got cash upfront in return for pledging future landing fees at the country’s airports. A similar deal in 2000 called Ariadne devoured the revenue that the government collected from its national lottery. Greece, however, classified those transactions as sales, not loans, despite doubts by many critics.
  • Then in 2002, accounting disclosure was required for many entities like Aeolos and Ariadne that did not appear on nations’ balance sheets, prompting governments to restate such deals as loans rather than sales.
  • After numerous downward budget revisions, the recently appointed “Committee on the Reliability Of Statistics” uncovered $40 billion of previously hidden debt.  Per Zero Hedge, “the findings indicate that the possibility of political interference is mainly associated with the close relationship of NSS with the Ministry of Finance and the inability of the General Accounting Office to work independently and responsibly.”

George, George, George.  We wonder exactly what  is “principled” about levering-up your country’s balance sheet to 135% debt to GDP, with a 12.8% deficit and them blaming others for your problems?  Take a look at the recent piece by GaveKal which clearly demonstrates that markets are, indeed, efficiently pricing the risk in government balance sheets.  There is nothing speculative about it.

The reality is that, politicians having failed at the task, financial markets have now become the best ally of the Euro’s founding fathers. Indeed, since the beginning of the year, sovereign spreads have been nearly perfectly aligned with the level of fiscal constraint imposed by the Maastricht Treaty to each country of the Eurozone. In other words, the market is doing the job that policymakers could not tackle.


The fiscal data presented on the table above helps us to understand the current structure of bond yields in the Eurozone. Working with publicly available official data rather than with potentially opaque in-house assumptions, we obtain a very good fit (97% correlation) between actual bond yields and a small number of key variables. Thus, for all of the complaints about market manipulation, it seems that the hierarchy of spreads over German Bunds has followed, since the beginning of this year, a pretty rational walk. Actual debt levels and short-term pressure on government accounts have systematically explained more than 85% of yield spreads. When a liquidity risk premium is applied, the explaining power of our model rises to above 95%.


While visiting US President Barack Obama this week, Papandreou urged that “Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system.”  We can almost visualize those cynical speculators letting it all roll.  Yet, we’d much rather invest for long-term returns, with a focus on capital preservation, than bet on the politicized strategy of piling debt, upon debt, upon debt.  Believe it or not, it appears that White House officials sent George packing, recommending that Greece focus on righting its economy and dealing with its own debt problems.  There is hope!