Kudlow’s Money Politics

An Interview with Charles Dallara

Last night on The Kudlow Report I interviewed Charles Dallara, former assistant secretary to the U.S. Treasury and the current managing director for the Institute of International Finance. Fresh back from Brussels, Dallara was the lead negotiator for the banks and the private creditors regarding the Greek debt.

Here are the video and transcript:

LARRY KUDLOW: A dramatic late night meeting that was somehow last night, although it probably seems much longer than last night for you. Let me ask you, in that meeting, can you tell us what actually happened? You’ve got Merkel, you got Sarkozy, you got LeGrange, rather. Did Sarkozy, for example, actually threaten you with 100 percent haircut on the Greek bonds for your banks? Did he actually come in threatening, two guns out? What was the story there?

CHARLES DALLARA: No, Larry, he was not threatening. We had a good, good discussion about the remaining issues that needed to be resolved in order to put this issue behind us there. We had spent the prior two and a half weeks negotiating and it came down to this final meeting between me, one of my colleagues)…and Chancellor Merkel and President Sarkozy. It was not a threatening meeting, it was a professional meeting where we exchanged views on the differences. And where it was very important for us to secure an increase in the amount of collateral that Europe would fund in order to underpin these new claims on Greek debt.

KUDLOW: Is that the 30 billion euros that’s being talked about that Greece has to borrow in order–this is important, you have to explain this to us. Greece borrows that money, that money goes into these new bond instruments, and that is what’s being traded out, that’s the actual transaction?

DALLARA: Well, that’s a core part of it. Of course, the key of all this is reducing Greece’s debt. You know, we agreed an historically significant reduction, 50 percent in the nominal value of Greece’s debt held by all private investors. It’s a remarkable agreement, Larry. But key to this forus was to insure that the new claims on Greece, the new paper, would not be full Greek exposure. And that’s where the 30 billion euro became pivotal. They had not been willing to commit that amount until that final meeting which we had with the chancellor and the president in order to secure for us what was a balanced deal.

KUDLOW: And regarding the 30 billion euros, what percentage of the total deal, what’s the net present value of this deal as you would estimate it, because after all, Greece is going to get this money but doesn’t Greece still stand behind most of these bonds in this transaction?

#more#DALLARA: Well, Greece will stand behind the remaining bonds, but for every 100 billion euro bonds that’s outstanding today, when the transaction is done, there should be roughly only 50 billion outstanding at that time. The new bonds will be Greek debt but the collateral will underpin the value of the principal on this so that the investors which we represent, Larry, will be exposed to Greek risk for the interest risk and will be collateralized for the principal risk. That’s the key to this, and it was the 30 billion that made it possible for us to agree to such a large, up-front haircut.

KUDLOW: Well just…

DALLARA: The net present value is something that we have to work out in the next round of more mechanical negotiations, but it’ll be somewhere probably just north of 50 percent.

KUDLOW: And you’re saying in published reports before you got on the plane, this is a voluntary decision on the part of the creditors that you represent. Is that still true now in the–after your long plane trip, and does that mean that the credit default swaps will not be triggered in?

DALLARA: Well, Larry, on the first question, it is absolutely a voluntary deal. I was in constant communication with my chairman, Joe Ackerman, will all of my board members, and with all of the major investors who were not represented on our board, to insure that they were willing, in this final hour, to go along with this transaction. We are confident that it will be very, very highly subscribed when the deal is done. And so I’m very confident that this is voluntary and it will lead to a very successful debt exchange when the details are ironed out and when the deal is implemented.

As far as the credit default swap is concerned, we’re not the judges of what activates a credit default swap. That’s up to those who are responsible for the standard setting in that–in that important element of the industry. It is my understanding, however, based on conversations that my staff have had with them, that it is unlikely that this would trigger the credit default—a credit default event, since it is a truly voluntary deal.

KUDLOW: Can you help us understand, a lot of people are asking this question.Two hundred and ten billion euros worth of private credits in this Greek deal but there’s still 350 billion bonds outstanding. In other words, the private creditors are only 60 percent of the total. People want to know, A, what is the participation rate going to be among private creditors, and B, what about the outstanding balance that is with the IMF and governments and elsewhere? How does that get handled in this transaction?

DALLARA: Well, that’s a very good question, Larry. It was very important for us to hear that both European governments and the IMF are going to sustain and augment their commitment to Greece because they don’t pursue the debt reduction route. They’re actually extending more debt, more loans to Greece. But I would say that it is extremely low interest rates on concessional terms and it is also an important part of helping funding the Greek economy in the next years. But one of the reasons why we resisted going any higher than the 50 percent was because there’s only so much you can squeeze out of the private sector turnip here. We only hold, as you said, 60 percent. And a substantial portion of that, Larry, substantial portion of that is held in Greece by Greek banks, Greek citizens, Greek pensioners, Greek insurance firms. So we still have to work out some important arrangements to protect the Greek economy from this decision that has been made.

KUDLOW: Could these arrangements be possible deal-breakers, Charles?

DALLARA: No, I don’t see any. I mean, I feel comfortable after the extensive discussions we’ve had, and they were not only with leading European officials but with Greek government officials as well, that there are no deal-breakers lying ahead of us. So, of course, one can never say never, and we do have a lot of technical issues to be worked out, but I’m quite confident these are not issues, based on my experience, that should pose insurmountable hurdles, Larry.

KUDLOW: Charles, you’ve been around this block many times. You’ve been involved in a lot of important international negotiations down through the years when you were in the Treasury Department, now as a private citizen. Let me just ask you, at the end of the day, when people look at this deal, is it really backed up ultimately by the ESFS, and I want to ask you if this emergency fund is going to be levered up four to five times to at least a trillion euros or more? There’s confusion about this, there’s no specific statements. Part of the original money from the EFS–EFSF has been sequestered, apparently, to–for emergencies for Italy and Spain and Portugal and perhaps other countries. Will there be enough money in this emergency fund or in whatever special investment vehicles it may also hold, to cover, to ring-fence to backstop your deal and the banking system in Europe?

DALLARA: Yes, Larry, this is very complex, you’re right. The 30 billion euro that’s been committed to us will come through the ESFS structures. In addition, they have developed two different arrangements, which are quite, I think, workable and complementary. One will be an insurance fund and one will be a special purpose vehicle lending facility which will enable the ESFS to leverage its capital fire power and support countries such as Spain and Italy, if necessary. I actually think that even though once again, all the technical arrangements have not been worked out, that Europe is on the verge of breaking the back of this sovereign debt problem. A lot of work additionally needs to be done. Countries, especially such as Italy, will need to really earn their credibility in the markets, Larry. But I think these firewall arrangements, alongside the Greek debt deal, now provide the best opportunity that we’ve had, really, since the sovereign debt crisis erupted, for Europe to move past this crisis.

KUDLOW: And do you feel longer term–this is my last question, Charles, and again, drawing from your extensive experience in these matters–do you feel that the conditionality from the emergency rescue fund, from the IMF, from whomever else, whether the ECBS is participating, the individual governments, the so-called troika and so forth, will this force these countries to live within their means, to downsize their governments, to downsize their entitlements? And is there any hope of an economic growth plan as well? Do you see what I’m saying? Is this just a short-term fix we’re going through with euphoria in the markets or is there a long-term solution that you, yourself, foresee?

DALLARA: Well, Larry, I think you’re going to the heart of the matter there now. A lot of the adjustment plans that are being developed now for Greece, for Spain, for Portugal, Ireland and Italy, have a focus on budget discipline. There are, however, crucial elements of structural reform, liberalizing labor markets, bringing pension benefits back into reasonable proportions, reducing a wide range of structural rigidities in their economies, which inhibit efficient allocation of resources and inhibit growth. Those areas will really prove to be the ultimate test of whether Europe can move through this and establish sustainable growth again. If you look at the measures announced by Italy last night as part of this package, for example, increasing the retirement age from 65 to 67, removing restrictions on various industries in terms of how a person can be employed and how a person can be released, these are crucial to the future of Europe, Larry. And I believe they are just getting their shoulder to the wheel on these areas.

KUDLOW: Hm. All right, Charles Dallara, we thank you ever so much for your time. Please go and get a great night’s sleep. Congratulations on the deal you worked out. It’s a great pleasure for me to interview.