Greece Moves to Become a Banana Republic

Here is a picture of what a real European leader looks like (Associated Press):

Greek politicians have overplayed their hand. "Give me more money, or I'll shoot myself!"  Let's say, in the eternal Euro-Optimist view, French mathematics are applied to Greek sovereign debt, i.e. stretched out to 40 years, with rates and face values TBD.  It is guaranteed that there will never be any meaningful economic reform in Greece, other than maintaining the current government employment/pension mess and taxing a small private sector into oblivion.  The European Union itself is the big loser, but Chancellor Merkel will earn the devil's horns, while the French and the French-led IMF will proclaim victory.  The ECB will live to waste capital another day.  Other peripheral countries, and perhaps some core members, will realize that there are no teeth in the rules of the EU.

We hear from private economists and a few think tanks that Greek sovereign debt risk has been "ring fenced."  If that is true, then the only real impact of Greece's ill conceived intransigence will fall on their own people, which may be appropriate and the best thing for their democracy in the long run. What comes after the debacle will bear watching, but the economic risk to the EU can be absorbed

Greek PM Tsipras has 61% of his electorate behind him.  If he really is leading his country down this path, he needs to accept the consequences, get driven from office eventually, and the body politic can repair itself.

The only European politician who has stubbornly and effectively tried to show leadership on key bilateral and multilateral issues, like Ruusian sanctions,  has been Chancellor Merkel.   Strong and effective leadership in Europe is something at which elitists crinkle their noses.

If Greece defaults, it is their medicine of choice, and a convulsive purging is much better than a 40 year, slow bloodletting, where spending trajectories don't change and economic growth will be minimal.

France Reappears To Support Greece?

From the very beginning of our posts on the Euro, dating back to 2011 we have talked about the fundamentally divergent interests of France and Germany. For a while, French President Sarkozy made a concerted effort to have arms outstretched for his partner, Chancellor Merkel.  Since the next regime, things have become somewhat aloof, if not frosty.

We noted in a recent post, that French President Hollande was not visible as Chancellor Merkel was playing the despotic aunt, refusing to finance her profligate nephew, Greece.  The Wall Street Journal reports that President Hollande is visibly counseling about the risks of continuing to play hardball with Greece and a consequent default and Grexit.

It comes down to the original conception of  the European Union, which dates back to 1950-51 and initiatives championed by French foreign minister Robert Schuman, whose work we studied in our European economics seminar at the University of York, which I attended as an overseas student during my junior year of college. Here is a quote ascribed to Schuman,

• "Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity."

Customs union, currency union, free movement of capital and labor, harmonization of regulation, abolition of non-tariff barriers, and the unspoken political union.  It was a grand vision, to be sure, but more than half a century later, its defects and limitations continue to show.  

Looking at the history and origins of the two world wars, one would be very hard pressed to make a case for the notion of 'solidarity' across national boundaries, when solidarity within those same boundaries is becoming more questionable.  

Greece and its vaunted talent bank of American-trained economist/politicians have been irresponsible, but their actions are rational responses to the sometimes perverse incentives built into the whole currency union operations.  If money and credit are being given away, why not take it?  

We may now see the consequences of that strategic gambit. 

The EU and Greece Share a Cup of Hemlock

Since 2012, we have written about the inevitability of the events the European union are facing today, a Greek sovereign debt default, an exit from the euro currency zone, political chaos at home, and a fundamental failure of the grand European experiment.

To reach this conclusion, no complex economic models are needed.  The design of the system and the notion of divergence, along with the history of relationships within the zone, point the way.

To be sure, along the way, there were many false dawns, as European politicians do what they do best summit meetings and consultations with smiling faces and bowed heads, walking in some countryside.  Hedge fund managers used their tools to call a bottom in bond prices and got involved.

Fast forward to today, and there are no financial markets to impose any discipline on Greece.  Hedge funds have gone home chastened with their losses, and Greek sovereign debt is owed to the IMF and to the ECB, with the biggest chunk being owed to Germany.

For all the Ph.D.s among the Greek expat intelligentsia, for all the worship of game theory and Nash equilibria, Greek politicians have gone beyond brinksmanship to simple economic lunacy.  Asking the EU to wait for a Greek national referendum was irresponsible. Greek government pensioners don't want any changes in the status quo and blame outsiders, like the IMF, for their problems.  A "No" to acceding to further fiscal discipline may be a vote against the EU, but it is also a repudiation of failed Greek political parties.  It does no one any good, except to save face for the Tsipras leadership failure.

For Germany, not how French President Hollande is no longer at the Chancellor's side, as they were inseparable a few years ago, co-leaders of the European experiment, along with the IMF, now led by a French national too.  Chancellor Merkel is now by herself forcing Greece over the cliff.  Of course, she has no real choice.

The Greek alternative to fiscal austerity has been a plan in which, for example, pension payouts were guaranteed, and a plan dependent only on revenue raising through taxes on small businesses, with no more fiscal austerity.  No Ph.D. is needed to see how this plan would turn out.  So, any rational observer has to realize that Greece is no longer serious about reforming its economy to meet substantially higher growth targets.

But, since the Maastricht Treaty is silent about unilateral exits and the mechanics thereof, a Grexit really calls into question the whole value of the euro, the ECB, the ESM, and all the bureaucratic empire that has been created in Brussels.  Which peripheral member would be the next to take bitter medicine?

Although Plato took liberties with the poisoning of Socrates, in terms of describing symptoms and a drawn out death, it probably applies well to Greece and to European Union.  If Greece takes its bitter medicine and defaults, leaving the Eurozone, there will be great economic weeping and gnashing of teeth.  But, Greece will have made Europe pay a price too, finally exposing the emptiness and futility of the eurozone as it has been laid out and administered so far.

Satya Nadella Shuffles Executives: Microsoft Still Too Ponderous

One of our best read and most forwarded posts was about the accession of Satya Nadella to the Microsoft CEO chair, which really excited us, in the midst of all kinds of Wall Street consternation.
Perceptions about Microsoft among its customers, developers and Wall Street really picked up quickly, and the contrast with the imperial Ballmer Reign was also a refreshing change.

Microsoft continues to be a cash flow behemoth, with untold flexibility to speed up product development and to rebound from its historical behavior of misreading consumer trends and being a clumsy, heavy handed late follower.

But really, the latest executive shuffling is just the traditional reversal, which puts more and more onto the plates of two existing executives.  Here is the relevant quote from the CEO,

"To better align our capabilities and, ultimately, deliver better products and services our customers love at a more rapid pace, I have decided to organize our engineering effort into three groups that work together to deliver on our strategy and ambitions."

Delivering better products and services faster, which work together the way customers want, is something that needs to be achieved now, not ultimately. Making this change doesn't really seem to be demonstrably positive for the important goal.

Microsoft still seems like a big, ponderous organization that is hanging the hat on making the "Windows experience" available across all platforms.  That may be a noble goal, and Windows 10 seems to be generating a lot of excitement among Microsoft store employees, but so many of its features and capabilities, though a move up for Microsoft, will probably be leapfrogged by the far more consumer-aware and organizationally agile Apple.

If the culture of Microsoft is ever going to change it has to be at the layers below the EVPs and deep into the structure of the organization.  I still wonder how this can be done, and how long it will take.

Greek Default Without Leaving the Euro? The Wrong Question.

The Wall Street Journal online header asks this question, which John Cochrane of Chicago Booth and many others have answered, "Most definitely, yes."

However, it is the wrong question to ask. For Greece, its political leaders and the electorate have to decide about the rising costs and declining benefits of staying in the eurozone, including the never spoken about effective loss of national sovereignty and damage to the Greek democracy of being beholden to the ECB, ESM, and the IMF, all faceless bureaucrats with other agendas and different cost-benefit ratios.

Greece has lots of economic problems, one of which is the relatively small size of its export sector which has also been hurt by its growing, self-inflicted loss of manufacturing competitiveness, as pointed out in the financial press.  If Greeks are ever to turn their economy into something other than an object of derision and pity, they need to take charge of it, apart from a non-stop, weekly crisis in the world view.

Yes, that pathway will be messy and their will be prices to be paid.  However, the current situation, even with sovereign debt holders taking a haircut, won't end the problems of a "transfer union" that is the euro today.

The EU needs to look at itself, a Greek settlement with significant investor haircuts and write downs, even without a Grexit calls into question the value of the currency union in its current design.

It is not just Greece that faces a day of reckoning.

Uber Plans to Master Delivery? It Hasn't Yet Mastered Its Core Business.

The $50 billion implied valuation of Uber must have everyone scrambling to come up with a new twist on the story while putting their brains on the sideline. 

According to the Wall Street Journal, " Investors are counting on Uber to upend the delivery business much as it has for taxis.." 

The first problem is that Amazon, a public investor darling which has actually proven that it can upend and dominate traditional businesses, starting with books, has targeted rapid delivery with drones. Amazon, unlike Uber, has figured out that it's not worth using a service like this to deliver burritos.  As an investor, I wouldn't feel comfortable putting in capital to take on Amazon.

The next problem is again a limiting factor in Uber's phantasmagorical world of network effects: curb space.  In cities, like San Francisco or New York, there is no curb space, period.  Now, the Uber driver has to leave his car to pick up the burrito, during which time it may be ticketed or worse, and then do the same thing at the destination end to bring the merchandise to the customer. Spoilage and dissatisfaction, including cancelled orders, are another headache, cited in the article.

Assume that Uber wakes up and realizes there is no value-added in delivering low tickets.  Doing this kind of work isn't additive to the core business of driving customers, rather it detracts from it and really raises the stress levels and lowers the returns for its already taxed drivers.  

Even early investor, relentless cheerleader and company director Bill Gurley has trouble choking out this story.  Witness this quote, "Bill Gurley, a partner at venture-capital firm Benchmark in San Francisco and director at Uber, says he has never seen a financial projection for Uber which includes revenue from deliveries. “This company is growing faster than any company I think there’s ever been in Silicon Valley, and that’s on the core product offering,” Mr. Gurley says.

In other words, if this puffery turns out to be nothing, we don't need it to justify the valuation; never mind that other early investors are being mouthpieces now.  Signs of a market top? 

Starr CEO Greenberg Wins Against the Lawless and Discriminating Feds

The Federal Claims Court today ruled in favor of Starr International Company, the largest shareholder of AIG, against the Federal government's treatment of AIG during the "Lehman Weekend" and its unprecedented, claimed illegal extraction of equity in exchange for an $85 billion rescue loan.  No damages were awarded, and though that outcome seems inconceivable, Judge Wheeler's logic had some very weak merit.

 It is a clean, well written opinion, in which the text's many pithy sentences speak for themselves:

• "This sizable loan would keep AIG afloat and avoid bankruptcy, but the punitive terms of the loan were unprecedented and triggered this lawsuit." 
• "Operating as a monopolistic lender of last resort, the Board of Governors imposed a 12 percent interest rate on AIG, much higher than the 3.25 to 3.5 percent interest rates offered to other troubled financial institutions such as Citibank and Morgan Stanley. Moreover, the Board of Governors imposed a draconian requirement to take 79.9 percent equity ownership in AIG as a condition of the loan. Although it is common in corporate lending for a borrower to post its assets as collateral for a loan, here, the 79.9 percent equity taking of AIG ownership was much different. More than just collateral, the Government would retain its ownership interest in AIG even after AIG had repaid the loan. 
• The weight of the evidence demonstrates that the Government treated AIG much more harshly than other institutions in need of financial assistance. In September 2008, AIG’s international insurance subsidiaries were thriving and profitable, but its Financial Products Division experienced a severe liquidity shortage due to the collapse of the housing market. Other major institutions, such as Morgan Stanley, Goldman Sachs, and Bank of America, encountered similar liquidity shortages. Thus, while the Government publicly singled out AIG as the poster child for causing the September 2008 economic crisis (Paulson, Tr. 1254-55), the evidence supports a conclusion that AIG actually was less responsible for the crisis than other major institutions.

Though the opinion doesn't recount the discussion, the mere association of an $85 billion loan facility to fund a relatively small Financial Products Division with an 80% stake in a holding company with extremely profitable insurance businesses defies logic; surely other arrangements for collateral pledges could have been made had the Feds decided not to put the gun to AIG's head.  

• The Government did not demand shareholder equity, high interest rates, or voting control of any entity except AIG. Indeed, with the exception of AIG, the Government has never demanded equity ownership from a borrower in the 75-year history of Section 13(3) of the Federal Reserve Act. 

The government is cited by Judge Wheeler as carefully orchestrating the taking of equity, installation of management, and overrunning of the company by its favored consultants without requiring a shareholder vote, and to maximize the benefit to AIG Financial Products Division counterparties, the taxpaying public and to the U.S. Treasury.  

On the fundamental issue of illegal extraction of value from AIG shareholders, the court found,

• "Having considered the entire record, the Court finds in Starr’s favor on the illegal exaction claim. With the approval of the Board of Governors, the Federal Reserve Bank of New York had the authority to serve as a lender of last resort under Section 13(3) of the Federal Reserve Act in a time of “unusual and exigent circumstances,” 12 U.S.C. § 343 (2006), and to establish an interest rate “fixed with a view of accommodating commerce and business,” 12 U.S.C. § 357. However, Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower’s equity as consideration for the loan. Although the Bank may exercise “all powers specifically granted by the provisions of this chapter and such incidental powers as shall be necessary to carry on the business of banking within the limitations prescribed by this chapter,” 12 U.S.C. § 341, this language does not authorize the taking of equity."

Oops.  While the smart folks at the Fed and the Treasury were working hard to save us from a thirties style depression (a red herring), they did manage to violate a fundamental statute of the Federal Reserve Act in the process.  However, when an enemy with unlimited time, funds and access to the court of public opinion comes gunning for you, surrender might be the lesser of two bad alternatives, and so the AIG board capitulated based on that logic. 

• In the end, the Achilles’ heel of Starr’s case is that, if not for the Government’s intervention, AIG would have filed for bankruptcy. In a bankruptcy proceeding, AIG’s shareholders would most likely have lost 100 percent of their stock value.

The last sentence threw me because I thought surely that the extremely profitable insurance businesses would have provided some real residual value to shareholders. However, state regulators which are charged with protecting policy holders at all costs, would have brought assets which supported those policies into their ambit through existing state insurance regulations, as well as through other protections.  

In some ways, Starr and Mr. Greenberg are to be congratulated for using their slingshot against our own rapacious, selective prosecuting, and plundering financial regulatory Goliath.  Goliath has almost finished plundering the financial services sector for cash, and as it continues to selectively apply its novel legal theories to its enemies, perhaps other victims may stop and say "Basta!"  Let's see how Met Life does.