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"Draw Down The Revolvers"


I write at Yahoo: “Draw Down The Revolvers

It was what they needed to do, they all agreed. But what ended up dying wasn’t a human — it was a company.

In Enron’s dying days, the company started to see problems with its debt. It had issued billions of dollars in short term commercial paper, a form of debt where it would borrow for short maturities and when the time came to pay back, simply borrow again to pay back the initial investors. Repayment was a “rollover” — you never actually had to pay any money back. Towards the end though, everyone in the market realized that Enron was in serious trouble, and wouldn’t lend them money for too long; after all, who wants to be left holding the bag?

In Conspiracy of Fools, Kurt Eichenwald goes through the horror of the last few days at Enron, with commercial paper shutting Enron out. First they couldn’t “place” 30-day maturity paper, but there were some buyers for two-week debt. Within a few days, no one wanted anything to do with even multiple day debt — Enron would only get money for twenty-four hours. Eventually, they couldn’t sell any debt. But there was a small ray of hope.

Enron had revolving credit lines, or revolvers where they had money they could draw on demand, similar to an overdraft. This money supposed to only be drawn in a crisis; yet, the arguments were that using these credit lines would “send the wrong signal”. After all, when you access emergency money, there must be an emergency.

And being in an emergency is not acceptable, because that would destroy the very business Enron was in — Energy Trading. If the party on the other side isn’t very sure that you are stable, they won’t trade with you. Like you won’t keep your money in a bank that is rumoured to be bankrupt soon.

The incredible part of the Enron story was that the money Enron had due for repayment went up based on their credit rating. If the rating agencies downgraded them, certain loans immediately became due for repayment. Rating agencies downgrade companies when they feel they can’t pay their debt, if the downgrade triggers some debt to come due instantly, it causes a cash crisis; companies go and borrow at high rates to pay back, and thus cause a further downgrade and so on. The circle gets vicious, and in Enron’s case, made the company bankrupt.

The current situation with Greece is similar. Greece’s government has a lot of debt outstanding — nearly 150% of it’s GDP.  The country’s sovereign debt, issued in Euros, is being held all over Europe. Much of this is placed with the European Central Bank as collateral for overnight loans; in addition, the ECB itself owns some Greek sovereign debt.

Greece can’t pay back unless it’s being bailed out, but it is safe for now until the loans come due. Some loans, unfortunately, come due later this year. Greece needs to get money from a tranched 110 billion Euro bailout package to pay up, but the tranches are coming with increasing demands for austerity, from the other Euro nations, who believe that Greece can’t be allowed to be profligate and hold a begging bowl at the same time. Yet, there is only so much austerity can do. With a largely government-run economy and low private tax collections, if Greece spends less, it earns less, which gives it less to pay out as interest. Next week, the Greek parliament will vote to pass another round of austerity measures, that will cut spending by 28 Billion Euros, a fairly hefty part of the 113 billion euros it would otherwise spend, and government expenditure is 50% of their GDP!

It seems that regardless of bailouts there will be a Greek default, now or later. In other words, Greece will say we can’t really pay everything back. In that case, the ones bailing Greece out today are the stupid ones, because their money would only have rescued current debt holders. The ones bailing out Greece today are the Euro governments of Germany, France and Finland, and they are loathe to put only their money at risk. They want some of the current owners of Greek debt to take some of the risk, by rolling-over part of their debt, in effect saying, Listen, we know your paper matures today, but let it stay on for a few more years. But a forced rollover is equivalent to a default, at least according to the ECB, which won’t accept the bonds as collateral if such a forced rollover occurs. That opens a whole can of worms — if the ECB won’t take them, any bank owning Greek bonds has a liquidity problem, which will hurt Greek banks the most, but also German and French banks, and eventually lead Ireland and Portugal to default as well, which is the financial equivalent of Hitler.

The answer seems to be a “Vienna-style” rollover of the debt, where the current creditors are “encouraged” to rollover their debt voluntarily. This might technically meet the no-force-involved ECB conditions, but it’s fairly obvious that anyone who knows the numbers knows that Greece is going to default in some way or the other later, and they would highly prefer their money today instead. Current lenders might choose to agree only because their governments have other strings to pull. Any rollover, Viennese or not, is going to be done facing the barrel of a gun — no wonder they use the term revolver.

Even if things went very well, there is no happy ending. A voluntary rollover assumes that Greek debt can be repaid at some point in the future, and that Greece can curtail spending and increase taxes. But it can’t, realistically. Taking away 1/4th your government expenditure, when the government is half your economy, is not going to be taken well; to the Greeks, this must sound like:

Option A: Don’t default, but you will lose your job.

Option B: Default, and Greece will be penalized, and you will lose your job.

But the real problem is political and emotional. Look at what it really means:

Option A: We don’t default, I will suffer, but German and French taxpayers will be happy. My government is to blame.

Option B: We default, I will suffer, but German and French taxpayers will also suffer. My government is with me.

Politically Option B is far more palatable, if the degree of suffering in both options A and B are similar. Till now, Greece has been threatened with extreme consequences if they ever default; yet, in the face of a massive recession if they don’t, a Greek citizen may not see the difference. And perhaps they’re right.

Unfortunately, we listen to economic theories that the world will surely come to an end if a big crisis hits us; we look back at 1929 in the US, we look at the temporary drama in the US after Lehman and presume that life as we know it will stop if there is a massive default. But like a butterfly struggles to emerge from its cocoon, and the struggle gives it the strength to fly, it is likely that we discover the best solutions only when we can see the crisis and adapt with it. The death of dot coms brought about cheap telecom infrastructure that benefits us to this day; and it was paid by a gazillion investors that thought dot-coms were the next big thing. Enron’s failure actually made energy trading better, and created systems that made public companies a lot more accountable. But what if a country fails and causes a global depression?

The big banks will die, but better, smaller banks will come and take their place. Some of us will lose our jobs and gain an education on why jobs aren’t forever, and go on to build better businesses. Some of the uber-rich will lose their wealth. Some will find new ways to make it.

Hopefully, without needing a revolver.

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