Warren Mosler and Philip Pilkington: A Bad Haircut

By Warren Mosler, an investment manager and creator of the mortgage swap and the current Eurofutures swap contract and Philip Pilkington, a journalist and writer based in Dublin, Ireland

Are these haircuts on Greek debt really such a good idea? Or are they really just a stopgap that will make things all the worse in the long-run?

Sure, Mr. Market seems to think they’re fantastic. But then, Mr. Market has always been about as easy to please as a rather stupid dog: give him a car to chase and he’ll be happy – until his nose inevitably meets the bumper, of course. After all, these are the same markets that rally every time the Fed or the Bank of England announces more monetary voodoo ala QE.

As many of us have been saying time and again, the situation is simply not sustainable until the ECB takes up its proper role and backstops all the wayward debt. Until then, the whole thing will continue to resemble a man trying to lift a bucket by the handle while he stands on it. He might make a lot of noise and attract a lot of attention, but he’s not going to get anywhere.

There are any number of reasons that these haircuts will not work.

First up, there is still the implicit assumption that once the haircut is taken the Greek deficit can be brought under control. The recently leaked document from within the Eurostructure was sceptical of this, but even that document was overly optimistic as far as we can see. With the levels of unemployment that Greece continues to suffer – levels that will probably rise in the near future – those deficits are here to stay.

Then there’s the issue whether or not haircuts of 50% will be considered sufficiently voluntary. Not to mention the assumption that private sector funds will recapitalize the banks that lost capital on the write downs.

But the real elephant in the room – nay, it’s more like a mammoth – is the assumption that these haircuts will not cause other Eurozone countries bond yields to rise, thus requiring further intervention by the EFSF and, most likely, the ECB.

Think about this. You’re a private sector institution that has to ensure that you don’t take losses on crappy paper. You’ve now seen that the Eurocrats are willing to burn anyone who invests in the sovereign debt of any European country that experiences significant financial difficulties – difficulties which, it should be pointed out, are imposed on these countries by the Eurocrats. And you’re expected to continue to consider, for example, Italian debt to be relatively safe? What a lark!

The Eurocrats are essentially telling those who invest in the sovereign debt of European nations that they are expendable and open to taking massive losses should political whims lead the Eurocrats to further wreck the region’s economies and systems of government finance. Good marketing plan, folks! Keep it up; soon you’ll have scared all your customers away! Who knows, maybe it’s all a big Halloween prank!?

We can expect that the ratings agencies should catch up to this not so subtle point soon. Then the conditions for a perfect storm will be in place and yields will start to climb on the government bonds of various European countries. This will then require further bond buying from the EFSF and ECB.

This, of course, is probably the direction in which the whole thing is headed. But it’s going to take a long time to get there and it’s going to carry with it a whole lot of unnecessary pain for a whole lot of people.

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    1. Hugh

      The stock market was up today too. This always happens when one of these fake fixes is announced. The real place to look is where bond prices and spreads will be in a few weeks when reality begins to reassert itself.

    1. Mark P.

      Agreed. I disagree with Mosler and Pilkington. This current global regime of ever-expanding debt needs to be terminated.

      And as we’ve seen, if bondholders don’t suffer and banks are simply backstopped by the state(s), then the game of financialized capitalism will just be extended by the TPTB.

      In the U.S. since 2008, the consequences of that are clear: the ongoing — indeed, expanded — looting of all for the benefit of the financial overclass. So the Europeans are taking a notional step in the right direction — though it will be insufficient in the end — by not simply repeating the Paulson/Geithner strategy of handing money to the bankers.

      What we should have done and what the Europeans should do is put all insolvent financial institutions into receivership (or whatever European equivalents exist). Simultaneously, new lending institutions should be capitalized by governments to maintain necessary credit for the functioning of their real economies.

      This was what FDR did in the 1930s in the U.S., what economist Paul Romer and other recommended in 2008, and it would cost far less than what we’ve already spent feeding the maw of financialized capitalism.

      The simple truth is that that monster can never be fed sufficiently that it will not be back to take more and more again from the rest of us .

      1. bob

        “I disagree with Mosler and Pilkington. This current global regime of ever-expanding debt needs to be terminated.”

        “This was what FDR did in the 1930s in the U.S., what economist Paul Romer and other recommended in 2008, and it would cost far less than what we’ve already spent feeding the maw of financialized capitalism. ”

        How would you pay for that? Cash?

        Mosler and Pilkington agree with you, they are just pointing out the mechanism by which the victims are bled dry.

        1. Dan G

          “…until the ECB takes up its proper role and backstops all the wayward debt. Until then, the whole thing will continue to resemble a man trying to lift a bucket by the handle while he stands on it.”

          Create more and more currency to backstop investors/bankers.This is the modus operandi of the new capitlism with leverage squared to bail itself out from …derivaties-leveraged squared twice.
          The only answer is debt forgiveness, restucturing and jubilee, or it goes on forever. with the consequences inherent in income disparity of of protest, violence and war

      1. Sunny129

        50% haircuts, a CREDIT Non-EVENT?

        From ZERO HEDGE:
        (Reggie Middleton)

        an email I received from one of my
        many astute BoomBustBloggers.

        I’m a lawyer (and investor). There is no analysis by anyone on the internet about whether the announcement last night would in fact trigger CDS payout. Rather, everyone seems to be accepting the claim by ISDA that the decision would not trigger it. Because I can’t find any legalworth reading on the interne

        I decided to do my own research. In about 5 minutes I found a case inthe 2nd Circuit (USA) that explained to me what’s going on with thosecontracts. First of all, they are unregulated private contracts betweenprivate parties. In order to know whether a trigger occurred you have toread each individual contract. As a result, what the ISDA says aboutwhether a trigger occurred as to private contracts that are out there istotally meaningless.

  1. F. Beard

    The Eurocrats are essentially telling those who invest in the sovereign debt of European nations that they are expendable and open to taking massive losses should political whims lead the Eurocrats to further wreck the region’s economies and systems of government finance.

    Good! Governments should not borrow in the first place and those who lend to them get what they deserve when they are not repaid.

    1. Michael

      Yeah! Look at how awfully the US did when it borrowed money to destroy both Naziism and Japanese imperialism!

      “For every problem, there is a solution which is simple, clean, and wrong.”

      1. F. Beard

        Wow! Did I touch a sore spot? Having the government collect one’s usury (at gun point) is an old practice, isn’t it? Alexander Hamilton said that a national debt would bind the interests of the rich to the Nation.

        But protest in vain. The MMT folks assure us that government borrowing is unneeded for government spending.

        The game is up, rich parasites.

      2. F. Beard

        “For every problem, there is a solution which is simple, clean, and wrong.”

        I am an engineer. Solution are most often simple and clean.

        1. Moopheus

          I think a real engineer would know that’s only true on paper, and not with actual systems. Which can be complicated and require planning for failure (something economists seem unable to grasp).

          “Think about this. You’re a private sector institution that has to ensure that you don’t take losses on crappy paper.”

          Don’t want to take losses on crappy paper? Don’t buy crappy paper. Is Pilkington suggesting that the eurocrats should protect the bondholders from their losses?

          1. Kunst

            If your not an “real” engineer, don’t lecture those of us who are. Yes, the engineering mindset isn’t applicable to every situation, but when you don’t know what you;re talking about, talk about something else.

    2. Tortoise

      What happens when the wealthy demand and get their taxes reduced while the poor demand and get more handouts in exchange for their votes? The governments have found the easy way out: Borrow!
      Any bank that lends these governments money deserves to be taken to the cleaners. Let societies find other ways to rewrite the social contract.

  2. bmeisen

    “You’re a private sector institution that has to ensure that you don’t take losses on crappy paper.”

    Isn’t not buying it the best way to ensure not taking losses on crappy paper? Or is that old-fashioned? Or is it that they have to buy it so they can use it to satisfy capital requirements in order to continue leveraging irresponsibly, while simultaneously racking up fat fees by selling CDS to each other, going deeper and deeper into the shadows until there is no alternative to TBTF.

  3. sam

    There is an assumption here that those who sold CDS will actually be able to pay out. My, have we forgotten why AIG needed to be “rescued” by American tax payers. The collapse of CDS counter-parties would expose the true state of affairs, and the 50% haircut without any payment from CDS counter parties might the best option when compared to the possibility of some uncontained CDS counter-party chain reaction.

    1. Typing Monkey

      I’ve been a little to busy to look this deal over, but I think its safe to assume that at least some parties were buying CDS’ to hedge their long positions. If they lose on the haircut and can’t collect their CDS hedge, they will become insolvent and might crate the same chain reaction. This is just a gift to the CDS writers, who basically received premiums without having taken any risk.

      Do I care? Not really. Once a few more of these deals go through (if they can withstand the lawsuits, which I highly doubt), then perhaps the entire CDS market will disappear, which I view as a good thing. After all, who is going to buy “protection” when the seller (via the ISDA) gets to determine whether he pays out?

      BTW, how much of the remaining 50% belongs to the ECB, and how much goes to the private sector? I know the ECB gets seniority, but what is the effective “haircut” taken by the banks and pension funds?

      As for markets rallying on this news–I don’t get it. This didn’t even kick the can down the road…

  4. George Phillies

    On the other side, and this affects every Euro-region country with a deficit, the Europeans have just established that CDS protection of bonds is indubitably worthless. The Greeks cut 50%, and there is no payout. Furthermore, as the dominoes fall, one set of debts after the next will be defaulted.

    OK, you are the Ninth National Bank of Notionalville. If you own any bonds of Euro countries whose finances are shaky, such as France, why are you going to replace them as they are paid? Are you prepared to bite the bullet and take your losses now, before Portugal — from interest rates, the place in the worst shape after Greece — goes down for good? What does your D&O provider say?

  5. Curiositykilledmycat

    hmm, I think this is the shortest article I’ve ever read that was supposedly written by two different people.

  6. Eric

    it’s telling this sort of comment is coming from the USA. Why? Because with private investors, the USA means foreigners, and they indeed won’t so easily accept a haircut. Greek bonds are owned by European investors, they can sort out a deal between them and they did yesterday.

    1. F. Beard

      Because with private investors, the USA means foreigners, and they indeed won’t so easily accept a haircut. Eric

      No haircut is ever needed. The US Gov can always pay debt owed in a currency it can create at will.

      1. Eric

        so can the eurozone, but the eurozone can also solve it’s problems without debasing the currency, the USA has no choice than money printing.

        1. F. Beard

          US Government borrowing is absurd and unnecessary in the first place. It is a gift of a risk-free return to the rich and to banks. It goes back to Alexander Hamilton, who sought to bind the rich to the success of the fledging United States. It is fascist.

          1. F. Beard

            Well, yes it is fascist. Government borrowing is one of several privileges the banks receive from government in addition to a lender of last resort, deposit insurance, and legal tender laws for private debts. Government/business partnerships are the essence of fascism.

            Our money system is fascist.

          2. F. Beard

            Moreover, since the US Gov can create its own money without borrowing then it is obvious that any borrowing it engages in is a gift of a risk-free return – typically to the rich (who have idle money to lend) at the expense of the poor (who typically do not).

            US Gov borrowing is fascist.

  7. Dan Duncan

    C’mon…It took both of you to write this?

    I know I’m being a jerk…but that’s just funny.

    Seriously…what would have happened had only one of you decided to comment on this state of affairs?

    “Ah, yeah. Uh…I think the haircut sucks. Yeah, that’s it. It sucks.”

    I mean…There’s no research here–it’s just an opinion. Yet, it took two of you MMT geniuses to come up with this?

    Does either of you mean to tell me that you couldn’t have done this without the other?

    Maybe you thought putting your names together would bring this more gravitas?

    Too damn funny.

    Instead of the movie, “Jerry McGuire”, I’m thinking, just simply:

    “Warren Mosler”

    And here would be the climactic final scene:

    “Oh Philip. You complete me.”

    1. skippy

      Thanks Dan, that cleared up a lot, was so confused.

      Skippy…you used to at least have something to say, had some gravitas too it. now its just personalized distractions with out distinction. Viewing your opines creates the mental imagery, an old man lost of his intestinal control, sitting in his own filth, jabbering at the coffee pot, why his back side is sore.

    2. Mitt

      Prof. Duncan,

      Are you ever going to release a book of your really long comments on Naked Capitalism or something? You’ve got the art of smug dismissal without having addressed a single thing written in the post down to a science. Impressive!

    3. wunsacon

      I just drove home from a bar after hanging out with some 20-something frat boys. They’re short a drinking buddy and I think they would enjoy your company.

  8. Jim Haygood

    From the Telegraph:

    Greek opposition parties to the Left and Right united to condemn the eurozone deal amid mounting social conflict.

    Antonis Samaras, the conservative opposition leader, said: “We are not closer to the solution but are faced with nine years of collapse and poverty.

    Dimitris Papadimoulis, a Left-wing MP, said new EU powers in the agreement to impose austerity measures on Greece had a conflict of interest. “Those who monitor us do not have our interests in mind,” he said. “Their priority is that we pay back our loans.”


    Mr. Samaras is exactly right. A window-sticker 50% haircut (but actually half that, owing to the implacable usury of the official sector) leaves Greek debt north of 100% of GDP for the next decade, until it redefaults.

    There’s no upside for Greeks. They might as well just torch the place, and find work elsewhere in the EU.

    We’ve regressed 92 years to the Versailles Treaty, but with Greece taking the banksters’ whipping-boy role of Germany this time round: ‘Le Grec paiera!’

    The solution, of course, is to restructure both Greece and Europe’s TBTF banks. Instead of recapitalizing banks at taxpayer expense to reward their gross incompetence at analyzing credit risk, zero out their shareholders and amputate the bondholders as necessary. Accountability!

    By contrast, ECB backing of impaired debt just rapes the public with an inflation tax to coddle swinish banksters. Its advocates could justly be styled with the hokey old Forbes magazine slogan: CAPITALIST TOOL!

  9. wunsacon

    Warren, Philip,

    What should the Eurocrats have done instead?

    >> The Eurocrats are essentially telling those who invest in the sovereign debt of European nations that they are expendable and open to taking massive losses

    If Eurocrats bought the bonds at 100% (like Bernanke), would that have kept bond prices high and interest rates low?

    But, if they were to buy the bonds at 100%, wouldn’t that require more money printing — double the printing required to buy at 50% off. And wouldn’t that in turn cause some other problems? (E.g., weaker Euro relative to the dollar -> higher food/oil prices in Euros.)

    So, what should the Eurocrats have done instead (other than not get into this mess)?

    1. Philip Pilkington

      As we said, the ECB should backstop the bonds. Just like the Fed does in the US. As Greenspan says, in the US t-bills are 100% safe because the Fed always stands ready to print more money to pay it off. That’s why yields are so low. Same deal in Japan.

      This isn’t inflationary (again, see: Japan) — and inflation-warrior Trichet has recently come out and said this publicly. This is simply how an integrated fiscal union is supposed to be structured.

      The French and a few others are beginning to realise this. It’s just that the Germans are holding out. Why? Politics, politics, politics…

      But it’s moving this way, I think.

        1. Philip Pilkington

          No problem-o.

          My reading — although I can’t vouch for Warren here — is that all that talk about leveraging the EFSF through the ECB was actually a roundabout way of doing this. Pointless, operationally speaking as the ECB still ultimately forks over the money, but it seemed to me like a political maneuver.

          Marshall told me that opinion among the Eurocrats are moving in this direction. And stories like this one indicate that he’s right:


          Of course, this makes the situation in Greece and the other countries even more tragic. Why? Because then it should all be seen as a piece of theater being staged for the pleasure of certain Eurocrats and voters.

    1. Pat

      There may be something going on behind the scenes that we haven’t been told about, a side deal for the bondholders.
      There was a news article or two about the Greeks setting up collateral for the benefit of creditors. The Greeks would put a lot of nationally-owned real estate into one or two holding companies and then assigning shares in these companies to creditors (i.e. bondholders). The Greeks could redeem the shares at any time by paying back the creditors.
      So the way it might work is this: the Greeks put real estate into holding companies and give shares to EFSF in exchange for debt forgiveness or for buying future Greek bonds; the EFSF then assigns their shares to future bond buyers, thus in effect giving future bond buyers real collateral.

      If this collateral was available, some adventurous speculators might buy future Greek bonds, especially if the underlying holdings were undervalued or valuable to the Greeks for some reason. The speculators could then just wait for the Greek government to squirm under popular pressure to buy them back.
      I would buy Greek bonds if they were backed by the Parthenon and Delphi, wouldn’t you?

      According to “Der Spiegel” the Greek government owns real estate, businesses and other assets worth a total of about €300 billion. So there’s plenty of potential collateral.

      1. Typing Monkey

        And once the debt holders get the land, they can discover that they are getting taxed on it at a rate arbitrarily set by the Greek government.

        Do you still want the Parthenon if you have to pay, say, $1tr a year in taxes on it?

      2. psychohistorian

        I personally think that a society that thinks its a good idea to sell off national and world heritage sites to appease the global inherited rich is beyond stupid.

        Please folks,

        Laugh the global inherited rich out of control of our society and into rooms at the Hague. We need to prosecute these people that have made our would the non-sharing, non-compassionate and dysfunctional competitive incentives.

        I abhor the thought of future generations of our would being Rentier slaves to these anti-humanistic sociopaths that worship power and control over meaningful life.

        It is time to change our world for the better and away from the class system that has brought us to the edge of virtual slavery again.

  10. Kunst

    Bottom line, as long as these countries continue to run deficits, their debt will continue to increase and they will remain at the mercy of the bond market. If you don’t need new additional borrowing, you only have your outstanding debt to worry about Worst case, you can forcibly extend it, as long as you don’t have to borrow new money. None of the European countries have a balanced budget nor are likely to any time soon. This problem isn’t over.

  11. Typing Monkey

    Another dumb question…What is stopping all the other countries from demanding the right to give those holding their debt a 50% voluntary haircut as well?

    1. Typing Monkey

      The more I think about this “agreement”, the less sense both it and the market reaction makes.

      1. Let’s say I bought a whole bunch of these CDSs. I want to collect. What stops me from buying some Greek debt and just refusing to accept the haircut? Either I get paid my bonds in full, or else I get to declare an event, no?

      2. Why are financials rallying? BNP and SocGen (for example) now have to write down this debt, which they so far haven’t done.

      3. Why is any of the market rallying? This “deal” isn’t even completed yet–to succeed in even the half-assed way that it hopes to, the damned thing has to get funded. Even if it gets funded, Greece has to agree to it. If Greece agrees to it, its debt to gdp is still well above 120% for at least another decade (assuming a miracle occurs and all goes well). And it still doesn’t resolve the problems with other countries (Portugal/spain/etc)

      Either I’m missing something, or I should start to seriously consider increasing my short positions…

      1. Typing Monkey

        And again, what happens to all those who bought a CDS on Greece? Why is everybody so sure that getting a haircut and not being able to collect on a hedge will not cause a major institution’s insolvency (and judging by the financial rally today, that seems to be the assumption)

        I’m really in the dark here…

      2. Typing Monkey

        As for China:

        1. What will it expect in exchange for helping out Euroland (if it actually goes through with it)?

        2. If China is buying crappy Euro paper, what does this mean for all those crappy US paper purchases (esp. given a Chinese slowdown)? Is the Fed going to buy even more of its government’s paper, or are yields going to go up?

        Again, the 300+ DOW gain today seems really, really bizarre…

        1. psychohistorian

          It makes for good press and if you have all those trillions sitting around you can make the market do backflips with a double twist before lunch. Market fundamentals have been a joke for quite some time now.

          Its all kabuki to snare those faith based types that think they can beat the system….it is not new.

          I get pissed at alll the “private” and public pension funds that are going to lose their collective ass in the coming crash……methinks it was planned that way….even further reason to end the class structure we have.

  12. Ransome

    The banks are selling Greece to China. The Chinese will need to learn how to eat olives and cook with olive oil. No haircuts. Greece will become Hong Kong West, China’s window on Europe. The Chinese will run the economy and balance the budget.

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