Sunday, 12 February 2012

Greece before Greece… Betting on Victory and Patriotism

Greek is under the spotlight…and, with my partner and in laws from Cephalonia, I could not resist sharing my thoughts about the earliest Greek default.

Following the fall of Constantinople and the end of the Byzantine Empire, Greece fell under the Ottoman rule. Many attempts to regain independence failed during the following centuries. At the beginning of the 1820s, the war between Persia and the Ottoman Empire opened a window of opportunity to start a revolution. As had been the case with Latin American countries seeking independence at the same time, the Greek insurgents badly needed external finance to wage the war.

The strong legacy from Ancient Greece had lead to the development of a strong positive feeling towards Greece in Western Europe. Philhellenic movements in Europe flourished. In Great-Britain, the London Philhellenic Committee helped float the two first Greek bonds. In 1824 an amount of £800 000 was raised followed by £2 000 000 the year after. Both loans paid a 5% coupon and were issued respectively at 59 and 55% of par. At this price bondholders could expect substantial gains should Greece gain independence. Quite presumptuously, the issuer was pledging “all the revenues” of Greece even though the country was still under foreign rule! Proceeds of the bonds were used to buy war material, most notably warships. The Greeks usually astute traders were in this case not as sharp as expected and bought ships which were delivered with huge delays…

One may wonder why bondholders would be willing to invest in such a bond. From an objective point of view they were buying a bond from a country which did not yet exist as such!!! Were they simply irrational or can one think of another motivation? From a financial point of view, reimbursement was almost without discussion conditional on independence. So, bondholders were in fact taking a bet on a Greek victory but also on Greece’s ability to repay the debt should it become independent. Alternatively one could have expected investors to buy bonds for Philhellenic or Patriotic Motives. Distinguishing each motivation is pretty hard since bondholders don’t make public their inner motivations.

In another context, Kang and Rockoff (2006) have suggested an elegant way to disentangle motivations. They analyze the case of Liberty Loans issued by the US to finance its contribution to the First World War. At the time, no efforts were spared to convince US citizens to buy war bonds. Boy Scouts volunteered to sell these and Hollywood stars such as Douglas Fairbanks, Mary Pickford, and Charlie Chaplin were involved directly to facilitate their placement. But did it work? Were people buying bonds because of their patriotism? To answer this question Kang and Rockoff (2006) look at spreads between the Liberty Bonds and other bonds at the end of the war. If investors were ready to forego part of their returns for patriotic motives at the end of the war this element should have disappeared. In other terms if bond pricing included a negative premium because of patriotism, this premium should disappear at the end of the war. They conclude that patriotism had limited effects.

In the case of our Greek bonds such an analysis is unfortunately not feasible. Indeed, Greek insurgents were hoping for a quick victory but failed to repay their bonds before gaining independence. In 1827, bonds ended up in default and Greece would only gain independence in 1832. In dire needs of funds it turned itself to international markets again. With the guarantee of France, Great-Britain and Russia it issued a loan in 1833. However it refused to settle the case of the previous loans leading to many protests from bondholders associations. It was not until the 1860s and following repeated defaults that a settlement was agreed upon.

Holders of these first Greek bonds eventually won the military bet (Greece became independent) but lost the financial one… In Virgil's Aeneid, the Trojan priest Laocoön is quoted saying “Quidquid id est, timeo Danaos et dona ferentis” (Whatever it is, I fear the Greeks even when they bring gifts). In our case, gifts were the last thing holders of the 1824 and 1825 bonds received from Greece. Whatever their motives, recognition was not on the agenda for the first Greek governments.

Kang Sung Won, Rockoff Hugh, (2006), "Capitalizing patriotism: the Liberty Loans of WW1", NBER Working Paper No. W11919, 55p.

Wynne William H., (1951), State insolvency and foreign bondholders, New Haven, Yale University Press, vol. 2, p. 284

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