Sweetheart deals for Greek banks

I have read a translation of this article by Prof. Yanis Varoufakis in the German language Griechenland-Blog. It is a summary of all the support actions which the Greek banks have received from the state so far, namely:

1) A 41 BEUR recapitalization after the PSI.
2) Another 41 BEUR in state guarantees for ELA funding from the ECB.
3) Recognition of the 37,7 BEUR losses from the PSI as tax-effective losses.

At issue is point (3) which means that future profits (during the next 30 years) up to 37,7 BEUR will be tax-free. Obviously, if there are no future profits, there will be no benefit from saving taxes on them. If, however, there are future profits, the potential tax saving will be roughly 10 BEUR. In accordance with IFRS accounting rules, the banks record those 10 BEUR as 'deferred taxes' on the asset side. Put differently, a rather substantial portion of the banks' assets are future claims which will only be worth something if there is sufficient future profitability.

The risk that there might not be sufficient future profitability and that those claims might not be worth all that much was apparently too much for the bankers to sleep well. So, the government and parliament passed a law that, regardless whether or not there is future profitability, the banks will have that claim against the state. The side effect of this measure is that the banks can now count those 'deferred taxes' towards their capital base (subject to ECB approval).

What is to be made of all that?

First, there is no question that a state – if it wants to avoid total collapse of its economy – needs to bail out its large banks if and when they get in trouble. The cost to society of not doing that would be so much higher. So the question is not whether the state should have supported its banks. Instead, the only question is whether that support was commensurate and what the state got in exchange for the support it provided. 

The logical answer would appear to be that if a bank gets into trouble and needs to be bailed out by the state, the state should get full ownership and the right to replace the board of directors and the management of the bank. That would be too simple a logic. If a bank has a temporary liquidity crisis (a bank run) but is otherwise relatively sound, the state should get less in exchange than from a bank which has essentially become insolvent.

The PSI essentially wiped out the entire aggregate equity of Greek banks. Put differently: even without the 'normal' problems like non-performing loans, etc., the Greek banks had lost their equity. That certainly was a situation where the state could have applied the above simple logic. Did it? No, it certainly didn't! Instead, judging from everything I have read about the recapitalizations, they were EXTREMELY shareholder-friendly! Far from full ownership! Why? No outsider will find the answer to that question.

The 41 BEUR guarantee for the ELA funding is a moot point, as far as I am concerned. Greek banks would have survived without this funding because they could draw on the ECBs target-2. ELA funding was less expensive, as far as I know, and – most importantly – it enabled the banks to buy government bonds. So here I think the benefit was rather mutual.

Recognizing the 37,7 BEUR losses from the PSI as tax-effective losses to be applied against future profits would also appear within the limits of normality. After all, the banks did incur these losses. What is totally out of the ordinary is that the state would guarantee the banks that they will get their future benefit regardless of whether they make profits or not. So that is quite a present for the banks, indeed. What did the state get in exchange? Allegedly, the state will get bank shares as collateral but I have not been able to find details about this collateral arrangement anywhere.

By and large, it seems that the Greek state has been extremely generous to its banks, particularly to the owners of its banks. Will the state need to be generous again in the future?

According to Bank of Greece statistics, the aggregate capital & reserves of all Greek banks is around 70 BEUR. That number is easy to remember because it is identical to the amount of non-performing loans in the Greek banking system. So, if all those non-performing loans were to be repaid in full, the Greek banking system would be in good shape. If they are repaid in half, the banks will again need equity and they will look to the state for support. And if the non-perfomers turn out be complete losses, then the banks' equity is – once again – wiped out. The only thing which is certain at this time is that the requirement on the part of banks of future state support can definitely not yet be ruled out.

Back in 2008, AIG needed to be bailed-out by the US government. AIG was the world's largest insurer at the time and no one really thought that the company was anywhere close to insolvency. However, they needed money in a hurry; a lot of money. It started with 85 BUSD and ended up with 185 BUSD. Given those dimensions, the US government struck a tough bargain (these days, lawyers are arguing in court that it was a'punitative' bargain). Existing shareholders had to watch how what used to be 100% ownership eventually ended up being only 8% ownership and how the US government took a hefty 22 BUSD profit when it finally exited from AIG. Maurice R. Greenberg, the legendary former CEO of AIG and formerly one of its major shareholders, says he lost 90% of his multi-billion USD net worth in the process and he is now suing the US government for 40 BUSD in damages.

The way the US government bailed-out AIG was anything but shareholder-friendly. If the Greek government had done the same with its banks, all those banks would now have new owners, new boards of directors and new managements. Perhaps the Greek government should read up a bit on the AIG bail-out as it prepares for the next bank support program.