It remains my contention that Greece can dramatically upgrade its new securities simply by putting a provision in the default section that states that in the case of default the bearer, on demand, can use the securities at maturity value plus accrued interest to pay Greek government taxes. This makes the debt ‘money good’ for as long as there is a Greek government that levies taxes.

This would allow Greece to fund itself a low interest rates. It would also be an example for the rest of the euro zone and thereby ease the funding pressures on the entire region.

However, it would also introduce a new ‘moral hazard’ issue as this newly found funding freedom, if abused, could be highly inflationary and further weaken the euro.

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12 Responses

  1. Yeah, the Germans won’t like that at all! But its a great example of sovereign credit economics (which I think is more descriptive than “public purpose economics”, but obviously your mileage may vary). :o)

    I wonder though, does the ‘payment of taxes’ language even have to go on the security itself or couldn’t it just be added to the Greek revenue code? That way, already issued Greek debt would likewise increase in value (assuming the revenue code amendment chose to apply this to existing as well as future securities).

    There was a California Assembly bill last year that did just that for its IOUs:
    a state agency shall accept from a person or entity a registered warrant or other similar evidence of indebtedness issued by the Controller that is endorsed by that payee, at full face value, for the payment of any obligations owed by that payee to that state agency.

  2. It passed the General Assembly unanimously last September. Its still in committee on the Senate side.

    The hole in California’s hull is the same as for the entire US economy, healthcare spending. If the federal government provided universal coverage itself, that would wipe $13 billion from the state’s $20 billion budget deficit. And if Uncle Sam continued to send its 50% Medicaid cost share payment but as a general revenue sharing grant, California would be dealing with a $6 billion surplus.

  3. It would help to divert borrowing towards domestic private savings if it is used to repay taxes. I have proposed this idea to Greek officials as part of my plan to shift borrowing domestically. I do not see the advantage for foreigners or I do not understand the point!

    1. Panayotis,

      advantage for foreigners, ie. GS, will be in the market for Greek government bonds 🙂

  4. the securities would only be used to pay taxes in the event of default.

    this enhances the credit quality functionally to AAA which means they can sell new securities and not default, so the securities would most likely never actually be used to pay taxes. What has dramatically increased is the desire to hold Greek securities.

    Greece still does have tax revenue, and would still spend euro from both tax revenue and securities sales.

    The ‘signal’ that the desire to hold the new ‘AAA’ securities is saturated would again be rising interest rates. But the rates would be going up based on technicals rather than credit concerns.

    Also, if the ratings agencies recognize the credit enhancing aspect of the new default provisions, the Greek securities would be seen to permanently good collateral at the ECB.

    Yes, this does reintroduce the moral hazard issue but that was perceived to have been there from inception, and the stability and growth pact formed to deal with it, which most say has been too restrictive if anything, and not too lax.

    This does work, and I’d expect any investment banker who sees this and gets it done send me my usual 25% of value added, thanks!

  5. Warren,

    my idea was for domestic taxpayers that combine securities with a tax repayment option with a lower yield. these securities are conditioned for repatriation of capital that is the product of non reported income for tax evasion purposes. Its a way to induce these funds to return home although they could be used by those that want to tie savings with future tax liabilities. I do not see why it is limited only to the default provisions. Also where is the moral hazard in this?

  6. my proposal is to just keep it simple and simply add that clause to the default provisions. the only thing that changes is greece can issue/sell more debt at reasonable interest rates.

    they are still subject to the stability and growth pact for fiscal discipline.

    the moral hazard is that once they realize they can issue a lot more debt at lower rates, and all the other euro nations see they can do same, they elect to ignore the growth and stability pact and run up their deficits further, driving down the euro and driving up prices.

    however, that seems unlikely they would do that.

  7. Warren,

    Sorry to disagree with you here, but I think that such an announcement/revision would have little positive impact on the market value of Greek bonds, and it could have a large negative one because it might be taken as evidence that the Greek government is seriously considering default.

    First, there is probably already an assumption in the market, at least among Greek taxpayers, that defaulted bonds could be used as an offset against Greek taxes. The problem is that they couldn’t be used as an offset against German or French taxes!

    Second, the fundamental problem is that the Greek government does not have enough assets or taxing power to maintain the value of its IOUs. If the IOUs are denominated in hard currency (as they are), then the drop in IOU value comes in the form of impaired creditworthiness as markets adjust to the impending default and haircut.

    If we could wave a magic wand and make all Greek debt drachma-denominated, that would solve the credit problem, but the drachma would drop to a small fraction of the value of a Euro.

    Either way, the value of Greek IOUs has to drop relative to the value of a Euro — unless the rest of the Eurozone decides to hand the Greek government a huge subsidy.

    There is simply no getting around that. Personally, I think Greece should just default, leave the Euro, and redenominate all of their debt into drachma with zero principal haircut. The Greek people will be much better off, and frankly, the Eurozone probably will be as well (if the ECB subsidizes the losses to some degree using your per capita distribution idea).

  8. ESM and Warren,

    First, the Greek public sector has assets (ie,real estate) estimated to be in excess of 300 billion euros, so it does not have a classical case of solvency problem! It has a severe liquidity problem that restructuring and a turn to domestic borrowing tied to tax incentives (reducing capital flight and tax evasion) will be able to solve if also is complemented with better use of the EU cohesion program (20 billion euros still alloted to Greece) and discretionary fiscal policy (from the savings of restructuring) towards growth to raise income and tax revenues. Furthermore,waste control and tax collection measures are needed and not the severe austerity the IMF, the EU and the ECB is proposing!

    1. Panayotis:

      If Greek Govt is finally able to collect taxes (which I doubt very much will happen, I am familiar with tax avoiding nations in the extreme) then this is equivelent to tax rates being raised dramatically, and hence fiscal austerity.

      Since depression caused by Govt deficit being too small relative to private sector demand to net save, do you not beleive that draining private sector of savings (via taxation) will increase that demand?!

      Your point about real assets is good one — but this is where line between liquidity and solvency blurs. You have equity line on balance sheet and can be positive or negative. Negative is clearly insolvent. You write down prices of assets, and it can push equity negative — question is, what is right price for assets!

      In cirsumstances of constrained liquidity and credit contraction, then correct price for assets is that paid by non-leveraged buyer. I doubt that will come to Euros300B.

  9. Zannon,
    I said assets in excess of 300 billion and I mean well in excess which by the way is not a collateral against debt. Technically Greece is not insolvent.

    As far as tax collection is concerned, it is not the same to collect taxes from unreported income which reduces distortions with raising extra taxes to those who report their income and this increases distortions. These are horizontal allocative effects. Furthermore, those do not report their income avoid taxes by sending their funds abroad or hide them in investments that are less productive and more difficult to detect (money laundry). Do not see the point? How is this an austerity measure when Greece is revenue constrained and needs revenue? Austerity measures are measures that reduce wages, cuts services and overtax the population with excessive income, VAT and various sales taxes that reduce disposable income below the poverty line!

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