Greece’s PSI is Dead on Arrival: An error in search of a rationale but also a failure that may prove a harbinger for the Modest Proposal

A brief history of Greece’s PSI

In the beginning there was Wholesale Denial. Then the Denial began to subside under the weight of circumstances. It did so slowly, agonizingly so, with the result that, in the process, Greece lost any capacity it might have had to rebound. It also caused the Crisis to spread like a bushfire throughout the eurozone, turning liquidity problems into unyielding insolvencies first in Ireland, then in Portugal. Still, to this day, Denial is in the air. But it cannot remain intact, without the whole eurosystem crashing and burning. The Greek PSI may be the harbinger of denial’s end. If not, it is hard to see what will stop the juggernaut of the Crisis from destroying the few chances the euro has of survival.

Taking things from the top, the Wholesale Denial began life two years ago when imploding Greece was issued a triple ‘Nein’: No bailout, no interest rate relief, no haircut.[1] A few months later, with a second credit crunch looming, one of these Neins was revoked. The calendar read May 2010 when a massive bailout was agreed. But, still, no interest rate relief to mention and, of course, no haircuts. A few short months later, when it became abundantly clear that the disease had spread to the Emerald Isle, and it was on its way to the Iberian peninsula, Germany decided that another of the three Neins ought to be revoked: There would be haircuts, but not until the creation of the permanent ESM in 2013. It took another eight months of so (early summer of 2011) before the Greek haircut was given a snazzy new acronym, PSI they called it[2] (making it sound as if it was the bright idea of the… private sector).

The idea was not without appeal: Why should the taxpayers of the surplus countries fork out untold zillions to shore up silly bankers, who knew quite well why they were receiving interest rate premia by lending to basketcases like Greece, without having the bankers themselves take a haircut too? How else would banks be given an incentive to think twice before lending to profligate states? Such talk sounded good in the Federal Parliament, in Berlin, but also in Athens, in Paris, wherever the politicians used these ‘lines’ to feign ‘toughness’ in front of an audience aching for the bankers’ blood.

Alas, in the era of, what I call, Bankruptocracy,[3] even a haircut imposed upon bankers can be a blessing in disguise for the most sinister operators of the runaway banking sector. After the Greek PSI was announced in July 2011, shadow banking (hedge funds, special vehicles et al) lived its finest hour. They bought en masse Greek government bonds, at basement prices, with a view to swapping them for fresh bonds of much greater value. Why? Because PSI Mk1 specified no face value loss but a drop of expected net present value (estimated at around 20%) due to a swap with new bonds of much longer maturity. So, hedge funds bought old Greek government bonds (GGBs) for 30% to 35% of their face value in order to exchange them with bonds whose value was estimated at 80% of the old ones’ net present value. A nice little earner. This was one of the reasons why PSI Mk 1 bombed out, leading to PSI Mk2 in October 2011. (The other was, of course, the fact that this pitiful diminution in Greece’s debt burden was neither here nor there given the viciousness of the Greek recession.)

Back to the drawing board, our European leaders came up with a deeper haircut in October 2011. They called it PSI Mk2 and even had the foolish Greek PM fall on his sword, to be replaced by a hitherto loyal ECB functionary, so as to ensure that PSI Mk 2 would become Greece’s new light on the hill; a beacon of the last glimmer of hope for a desperate nation. PSI Mk 2 envisaged an impressive sounding 50% reduction in the GGBs’ face value which, in present value terms, would result in a haircut no less than 60% (since the interest rates charged on the new bonds, that would be swapped with the old ones, could not exceed the interest rates charged by the ECB and the EU for the original bailout funds). In other words, holders of GGBs would be hair-cut in two ways: a 50% reduction in face value and an interest rate less than 5% which would cut further into the present value of the old GGBs.

Alas, there is never a dearth of silver linings for the shadowy universe of our modern financial sector. Even when facing such a substantial haircut, many financiers will find something to smile about. In the case of PSI Mk 2, their smiles can be traced to two reasons: First, many of them bought GGBs for something around 30%. If PSI Mk2 implies an overall (present value) haircut of less than 70%, they are home and dry. Secondly, hedge fund managers have had more playful thoughts: Given the EU’s zeal to keep the semblance of a voluntary haircut (a ‘private sector initiative’) alive, what is there to stop them from pursuing a legal battle against any compulsory expropriation of even a cent of the GGBs they hold? Already a major hedge fund has opted out of the negotiations with the Greek government over the terms of PSI Mk2, clearly preparing for a legal challenge or, more precisely, for extracting a nice little out of court settlement once the all-singing-all-dancing PSI Mk2 ‘concordat’ is announced by the Greek government and the  EU.

In short, and so as not to overlabour the point, PSI Mk2 is dead in the water. The shenanigans of the shadow banking sector (which, lest we forget, includes not only the hedge funds but also, remarkably, the ‘proper’ banks shady Special Vehicles) plus the predictable deterioration of the Greek economy have put paid to it. The negotiations may go on for a little while longer, the announcement of a brilliant agreement may be made but, in truth, the idea that the Greek haircut will put Greece’s debt-to-GDP ratio back on a course towards 120% has sunk without trace. And if you need hard evidence for this, the European Summit of 9th December provided it even before 2011 was seen off: Officially, Europe’s great and good announced the end of PSI as a policy of the new ESM; Europe’s future central, permanent bailout fund. It had all been a mistake, they seemed to confess.

And now what?

This year’s first significant statement came from Athanasios Orphanides, the Central Bank of Cyprus’ Head and his country’s  representative on the ECB’s Council. In a letter to the Financial Times, published on 5th January 2012,, Mr Orphanides wrote: “Government debt markets are about trust”, blaming the Crisis’ inexorable progress within the eurozone on “…[a] collective failure of euro-zone decision-makers.” So far so excellent. As for the PSI, Orphanides repeated that which many have said before him: It signalled to investors, especially non-Europeans, that “euro-zone sovereign debt should no longer be considered a safe asset with the implicit promise that it would be repaid in full.” Like I have been writing ad nauseum in this blog since PSI Mk1 was announced, back in July 2011, Orphanides agrees that the Greek PSI, rather than being the bankers’ scourge, has proven a bonanza for shadow bankers and mainstream banks’ Special Vehicles. [He mentions the example of funds that purchased GGBs 35 cents or 40 cents on the euro who now insist on an agreement that allows them to profit from the swap.]

Now, some will say, with considerable justification, that the Head of Cyprus’ Central Bank is saying all this because Cypriot banks are sinking in a mire of their own making, having bought oodles of GGBs. Still, the fact that Mr Orphanides has an ulterior motive in calling for an end of Greece’s PSI is not the reason why his argument is lacking. The reason is that he is making precisely the same mistake as that Mrs Merkel, Mr Sarkozy and, indeed, the Greek government have been making for almost two years now: They keep thinking of the Greek public debt crisis in isolation to (a) the deep malaise of Northern Europe’s banks and (b) the public debt difficulties of most eurozone states. The fact is that the Greek crisis cannot and will not be dealt with unless the ‘solution’ is part of a systemic redesign that deals with (a) and (b) as well as containing a program for stemming the tide of recession that is currently engulfing our continent.

As evidence of Mr Orphanides’ narrow focus, which detracts from his case against Greece’s PSI, I offer the alternative that he is proposing: Greece should be issued, in lieu of the failed PSI, thirty year loans at 3% interest rates. Similar suggestions come from different quarters (see here an article by George Zestos) canvassing the idea that, instead of the PSI, the ECB ought to guarantee GGBs (with the Greek government paying the ECB a small premium in return for these guarantees). The problem with such proposals is that they fail to incorporate their solutions to the Greek Problem within a broader plan for Europe. Mr Orhpanides cannot possibly believe (and I do not think he does believe) that 3% thirty year loans can be extended to Greece but not to Ireland, Portugal, Italy, Spain, Belgium even. And he cannot believe that the banks will be left with ECB loans but not be forced to recapitalise ‘big time’. But where will the trillions involved come from? He does not answer the question, leaving it to us to imply that he is in favour of eurobonds. But then the question becomes: What sort of eurobonds?

The continuing appeal of the Modest Proposal

So, we have returned to the question that this blog has been built upon over the past year and a half. We certainly need eurobonds. But we neither need nor want eurobonds jointly and severally issued and backed by member-states (for reasons that Mrs Merkel can explain better than anyone; namely that such bonds will sell at interest rates that are too high for Germany and not low enough for the periphery). And since we cannot have a Federal Treasury do this on Europe’s behalf (as opposed to member-states), it is imperative that it is the ECB that issues and backs such bonds so as to convert the Maastricht compliant part of the eurozone’s aggregate public debt into Union/Eurozone debt; a common pool of debt that is, however, to be serviced pro rata by member-states at interest rates reflecting not their individual credit ratings but those of the ECB that organises this debt conversion on the Union’s behalf. (For more see our Modest Proposal.)

Interestingly, George Zestos’ recent proposal (mentioned above) points in the Modest Proposal’s direction. Zestos’ idea that the ECB should guarantee new issues of GGBs is, in fact, more radical than our proposal for ECB bonds issued on behalf of each member-state and to be serviced in the long run by the member-state. While Zestos is asking of the ECB effectively to take on its books the new issues of Greek, Italian and Spanish bonds, the Modest Proposal, much more… modestly, suggests that the ECB issues debt on behalf of these member-states but then charges them for their servicing on the basis of some super-seniority baring loan agreement. In fact, the two ideas are close in spirit except that the Modest Proposal (i) gives more guarantees to the ECB that it will not have to print to service member-states’ debts and (ii) gives international investors more ground for confidence (since they would be much happier buying bonds issued by the ECB than bonds issued by Greece or Italy under a complicated insurance scheme backed by the ECB).

To recap, the Greek PSI was always an error in search of a rationale. It gave shadow banking a great new opportunity to profiteer at the expense of Greece and of Europe and escalated the latter’s Crisis rather than help tame it. The question is: What is the alternative? After two years of studying carefully all alternatives, I still believe that our Modest Proposal is the natural candidate. More recently, I had the dubious honour of talking to a hyper-smart Goldman Sachs apparatchik. He more or less agreed with the Modest Proposal’s basic thrust, albeit in a manner not at odds with the usual cynicism associated with his firm. This is how he put it: “Well, in the end your proposal will be adopted by default. Once the ECB has accumulated so many rubbish bonds, they will have to start borrowing to service them. Once they make it official, they will see the merits in charging the member-states for the cost of servicing what will effectively be ECB-bonds.” As they say, the Devil has the best of tunes.

[1] A fourth Nein was not even verbalised: A Nein to an exit from the eurozone.

[2] Private Sector Initiative/Participation

[3] The New Regime that emerged from the ashes of 2008 in which the greatest power to extract rents from the rest of the social economy was granted to the banks with the largest black holes in their assets’ books. See my Global Minotaur for more.


  • Good morning
    excellent analysis and review of the PSI (hi)story…
    Please let me propose an amendement to note [3] PSI : Private Sector Involvement
    best regards,

  • amendment to my previous comment…..
    sorry for the inconvenience

    Good morning
    excellent analysis and review of the PSI (hi)story…
    Please let me propose an amendement to note [2] PSI : Private Sector Involvement
    Best regards,

  • The Modest Proposal will only be adopted when the damage to the European political economy is so extensive that the macroeconomic benefits of the Modest Proposal will not obtain.

  • Your proposal is an interesting one but again a “middle way”

    There is no “middle way” that does not involve the giving up of soveriegnty and basic civil libertites by the citizens of Greece.

    In my humble opinion the only recourse for your country is that path taken by Iceland.

    Why do you not seriously examine the “Icelandic” path?

    • Because we do not have our own currency. And creating it now, while in the clasps of the euro, will create not a new Iceland but something more akin to what Turkey was in the 80s.

  • Everyone of these ‘cloudy’ solutions to a now insoluble mathematical problem of too much debt seems to have a silver lining for the profiteers of the shadow banking system. Just watch the stock markets of the planet jump in unison at even the most transparently faux prospects of more speculative gains. Meanwhile the people of Greece are having trouble buying aspirin.

    • Yani, it’s not like Greece never had its own currency.

      What I am saying is that Greece (I hesitate to use the term “Greek government” since there is none to speak of at the moment) should be prepared for a return to the drachma. If the northerners say no to the Modest Proposal, I say fook them … and fook their phony surpluses! .

    • Yes and no. Of course we should be preparing for the moment the euro dies and we need either to go back to the drachma or to forge some other union (perhaps with Italy, Spain and Portugal as a member of the Bank of Italy suggested to me recently). But, I still insist that breaking out of the eurosystem at this moment, and while the euro remains legal tender, would be suicidal.

    • This new year 2012 is bringing already several revelations. For example, why they call you the last Greek.

      Because you are probably that last person to ask on matters completely out of your depth.

      Here is a refresher course for you. Should Greece were to return to drachma the following would ensue:

      1. All Greek sovereign debt, denominated in Euros, will immediately double or more than double.
      2. All Greek assets in private hands (real estate, savings etc) will be immediately halved or less than halved.

      Now, all the above are on the practical level of finance. But there is an even more important chapter called national interests. A marginalized Greece could hardly pursue and influence any matters vital to her at a European level.

      And this, last person of dubious origin, is completely out of the question.

    • This new year 2012 is bringing already several revelations. For example, why they call you the last Greek.

      Why do you care? It’s only a username, nothing to get excited about. (Btw, it’s one word, “lastgreek,” and not two.)

      Because you are probably that last person to ask on matters completely out of your depth.


      This coming from a guy who didn’t even know the Swiss franc was pegged to the euro … LOL

      Here is a refresher course for you. Should Greece were to return to drachma the following would ensue:

      Here’s a reality check for you: Without the adoption of the Modest Proposal — and that is just for starts, btw — staying in the euro would be … insane.

      1. All Greek sovereign debt, denominated in Euros, will immediately double or more than double.

      That would depend on whether Greek sovereign debt is rolled into drachmas at the devaluation rate … or if they are rolled into drachmas at par. If it’s the latter, then it’s a forced devaluation, an automatic haircut. Of course, you know that already, eh, Dean?

      Now, all the above are on the practical level of finance.

      You don’t say! Really, you don’t say!

      But there is an even more important chapter called national interests. A marginalized Greece could hardly pursue and influence any matters vital to her at a European level.

      “National interests”?

      “A marginalized Greece could hardly pursue and influence any matters vital to her at a European level”?


      You don’t know your history, do you?

      How many times did the Europeans revise the dreaded Annan Plan at the behest of Turkey? All of Turkey’s demands were met — which explains why the Cypriots — rightfully and courageously — voted NO.

      Why doesn’t Greece, as a EU member no less, claim it’s exclusive economic zone (EEZ) as it has a right to do under international law?

      “Yeah,” Greece has influence.

      Greece should be looking at ALL its options, and then do what is best for the Greek nation. What it shouldn’t do is sit and wait with the proverbial thumb up its rump waiting for others to decide its fate. Ttat’s all I am saying.

      PS: And, Dean, please don’t come back with any more of your absurd accusations of antisemitism against me. Pretty please.

    • lastgreek or whatever:

      You just gave youself away. You are a Turk living in Canada.

      The same pattern everywhere Turks post. Use Anglo names, or better yet Greek names to go undetected. Mingle with the crowd and pretend to give “sound” advice while the true aim is to sink and defame Greece.

      O.k. we now know why you are foaming at the mouth. Next patient please.

  • Zestos makes excellent points in his kathimerini ariticle you linked, but once again I read him advocating the neo-liberal agenda , to wit:

    “The amended or new treaty will create a fiscal union which will transfer all fiscal powers to the EU Commission, the European Court of Justice and the European Court of Auditors.”

    in other words, rule by un-elected committees who are already hardline neo-liberal bureaucrats. One other point about Zestos piece: when he says,

    “EU member-state leaders must temporarily delegate authority (perhaps for a year) to the ECB, the EU Commission, and the two European Courts to do whatever it takes to save he EMU and the Euro. The duration of this delegated authority to EU institutions should be long enough to be able to amend the existing treaties or to draft, approve, and ratify a new treaty.”, he is dreaming. A new treaty would be voted down in any country in Europe unless this crisis is very effectively solved FIRST.

    I agree with Migeru, and your take on his comment.

  • Yannis,

    As usual, I enjoyed your blog and your style of writing. On reading it though, additional thoughts emerged. You see, if one is prepared to restrict his “options” framework to the usual suspects (hedge funds, banks, central banks etc.) I would wholeheartedly agree with the modest proposal.
    If on the other hand, one ventures a bit further from the “box”, not just outside it, I wonder what solutions may surface. It is my everyday business to do so, I am an Organisations Architect by trade, and while reading inevitably I came up with few additional.
    Bonds represent (at least theoretically) to their owner a secure investment whereby the anticipation of profit is (was) almost certain. At the point we stand though today, this is not the case any more, as the global fiscal crisis altered the rules of the game, the institutions we all (most of us anyway) believed in.
    I personally see the whole crisis as an opportunity for innovation. Innovations that could possibly replace the lost “profit” certainty, the low risk investment the bonds used to represent into something different, a paradigm shift if you wish, that keeps the low risk principal intact but migrates it away from the “box”, the framework of the usual suspects that lead us rationally to the modest proposal.
    Following this thought path, one can rephrase the question into: what Greece (or any of our suffering partners in EU for that matter) can offer instead, or in addition to, the bonds (that need replacing), that is both secure and profitable and to whom we can offer it.
    Venturing only “ten minutes” away from the box and thinking of Greece, I came up with:
    • Long term exploratory drilling rights for oil and gas to companies that are willing to hold Greek bonds
    • Long term tax reduction to multinational companies that hold Greek bonds and want to use Greece as their EU entry point
    • Preferable trade and shipping rights to governments that hold Greek bonds
    • Free security (commandos as escorts in pirate infested areas) for all shipping companies that hold bonds
    • Tax free residence to members of pension funds that hold Greek bonds
    • … I bet this forum can come up with many more.
    I did not perform any kind of economic or statistical analysis so, I do not know if what I propose is enough or it should be considered an addition, a contingency if you wish, to any potential implementation of the modest proposal.
    What I am advocating is, that it will probably pay dividend to dare escaping from the “box” as at the end of the day, we have nothing to loose and a lot to gain.

    Sotiris Melioumis Organisations Architect, member of the Gaianomy Think-Tank

    • Not in you wildest dreams buddy, Greece will ever subordinate drilling O&G rights.

      These are sovereign rights and if there is a message to be drilled down the throat of Teutonic morons is that any and all such rights are off the table. For ever and ever and ever I might add.

      Now take that and put it in your architecture.

    • In reply to Dean.

      Exploratory rights does not equal exploitation rights my friend Dean…

      Apology accepted.


    • Dean, why don’t you repost the video of the chimp (or was it a monkey)? Go ahead. I want to get a better look at you.

  • Regarding the failure of PSI, I wonder:
    Did ever exist the possibility of a succesfull and profitable “haircut”?

    As for now, what should the greek government do, regarding that leaving the Eurozone is not an option:
    Demand a deeper, non voluntary “haircut”? Interrupt the negotiation and deny the new mammoth loan, risking a default with all the possible consequences (maybe an expel off the Eurozone, which would be just another more “failure of euro-zone decision-makers”)?

    I fear that the real last hope that ever had the Greek people, was lost six months ago (21st July) . . .

  • Somebody said that between countries exist interests not friendships. Thinking about it, one has to conclude that many European and other countries have different interests than Greece. Some countries just don’t like Euro and will welcome its distraction. Some countries want the Euro to be weak so they can sell their products in more favorable terms. It is in Germany’s interest to have Greece with all its problems. They can sell their products to Greeks and many other countries and keep their workers satisfied. They became dictators on the Greek and other countries affairs. Nobody achieved that so cheaply. They have their own people dictating the Greek ministers what to do and how to do it. In home the German government can direct the anger of those at the bottom to evil and lazy Greeks. It is a god given way to have somebody to hate with government blessing.
    The funds buying the GGB for a fraction of the price and trying to cash or to exchange them for much favorable terms and making a killing while doing it, well that what they do, if they can.
    It is the disservice of the Greek economic thought to think that somebody else will solve their problem. It will not happen. It will only happen if the interests of others will coincide with the Greek interests.

  • Regarding the failure of PSI, I wonder if there ever was a possibility of a succesful and profitable “haircut”. Maybe at the beginning of the crisis (2009 – 2010)?

    As for now, what should the greek government do, regarding that leaving the eurozone is not an option? Demand a deeper, non voluntary haircut? Interrupt the “negotiation” and deny the new mammoth loan, risking nevertheless a default with all the possible consequences (i.e. expel off the eurozone, as another more “failure of euro-zone decision-makers”)?

    I’ m afraid that the last real hope for the greek people was lost six months ago (21st July). “Giving up of soveriegnty and basic civil libertites by the citizens”, as said by James Lee above, is since then a fact for Greece, under destructive terms that soon will evoke, I fear, social explosion.

  • Secondly, hedge fund managers have had more playful thoughts: Given the EU’s zeal to keep the semblance of a voluntary haircut (a ‘private sector initiative’) alive, what is there to stop them from pursuing a legal battle against any compulsory expropriation of even a cent of the GGBs they hold?

    Well, what might stop the vulture funds — sorry, hedge funds — from pursuing legal action is that Greek law governs GGBs. If that is indeed the case, then I hope the hedge funds choke on their Greek CDSs.

  • So, we have returned to the question that this blog has been built upon over the past year and a half. We certainly need eurobonds.

    Yes, and as you stated in the Modest Proposal, eurobonds AND a surplus recycling mechanism. You can’t have one without the other 🙂

    You know, here in Canada we have a SRM. We don’t call it that, of course. We call it “equalization payments” — federal government payments from the “have” to the “have not” provinces. Newfoundland and Labrador, for example, was forever a perenial “have not” province. It was the butt of all jokes (not unlike Greece today). No more. Now it’s a “have” province — payments are going the other way.

  • “Greece will have to exit the eurozone as it struggles under a mountain of debt”, says a senior lawmaker in Chancellor Angela Merkel’s party.

    The comments from Michael Fuchs, the deputy floor leader for Merkel’s Christian Democratic Union, contradict the chancellor’s stance

    The problem is not whether they are capable of paying their loans – they will not, not at all, never.

    Asked about the chancellor’s position on Greece, Fuchs said his prediction of a Greek exit from the single currency is a matter of arithmetic. Merkel “is also capable of calculation,” he said. “She studied physics. And to study physics you need mathematics as well.”

  • From P-SI debate (Private Sector Involvement) to O-SI debate (Official Sector Involvement) and possibly to …N-SI (NO SECTOR INVOLVEMENT)? Notice the letters of each acronym move in inverse alphabetical order as TIME is up….

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