One New Solution For Europe

Europe continues to bumble from one band aid to the next, and continues to just add more and more debt on already weak countries and weak banks. Whether it is loans to sovereigns, or the ECB loaning liquidity lines to banks, it is still debt which must eventually be serviced and potentially reduced, if not repaid. That debt service drains available capital from the banking system which could otherwise be available for lending. It strains fiscal initiatives that might come from governments to prime the pump. Combine that with some higher taxes and there is no way Europe is ever going to grow its way out of the mess. The banks have been forced to compound the problem by using the ECB liquidity lines to buy the sovereign debt of the mother countries in order to try to keep the cost of capital somewhat manageable for the sovereign. This cannot continue much longer. It is purely a cycle of debt on debt which can only end in collapse.

In a bankruptcy the solutions are a cram down of the debt, a stretching out of the payments, and more equity. It is not adding debt to debt and nothing more. DIP financing is purely a stop gap to the above steps. Often the other major step is a change in management and a shrinking of the business by selling off lines of business and assets to generate cash and reduce losses of cash.

Europe needs to same thing. The principles are no different. Thus far we have had positive change in management in Greece, Italy, Spain, Ireland and the ECB. Most of the new top managers of these countries are technocrats or have a much better understanding of the economic issues. The change in France was a negative with the lowering of retirement ages, and the increase in hiring of more government employees. The exact opposite of what was needed. Hollande is a bumbling socialist pandering to the unions and not a technocrat.

The following is one piece of a solution which I understand has no chance of happening, but it is possibly an idea someone else can take and create a workable solution from. Governments need equity. They can’t sell LLC interests or stock in countries. But countries have assets and cash flowing properties which they can sell, and a lot of it. It is generally good credit since these are backed by the governments as you will see. The concept is simple. Europe could form a huge REIT. The REIT could get seed capital from the IMF, the ECB or one of the emergency funds now created by Europe. Countries could then contract to sell income generating assets to the REIT and a public offering by the REIT could then be had of massive proportions paying a government backed return of say 4% in the form of rent. Maybe Germany sells in some assets just to pump up the credit quality. So each country could sell office buildings it occupies, highways, transit systems, or other infrastructure systems to the REIT and provide a minimum rent guarantee to the REIT. In many cases they would simply be signing long term NNN leases for the office space, transit system or whatever. In the cases of toll roads or transit systems, they have a revenue stream now which may be operating at a loss, but then they may have to slightly raise fares. Strong political leaders can get this done in the name of sharing the burden to get through the crisis and avoid a depression. It is a tax in a form that is less politically stigmatized, and one that does not hit anyone very hard. The whole point is to generate cash equity to be used to reduce sovereign debt. Maybe you even allow banks to sell office building into the REIT to relieve their capital issues. It would be just like a Chapter 11 bankruptcy and that is exactly what is required.

The sale of assets to the REIT would free up varying amounts of cash equity to the sovereigns which would then be required to be used to reduce debt. At the same time various countries would have to reach a debt accommodation with bondholders. While I understand all of the issues regarding such a cram down, if it is small, combined with a extension of maturities, a period of interest only, and if it is done continent wide, then with real political leadership it is possible. The sales point is we can keep on as we are and eventually the whole world suffers a major recession or worse, or we can do this or a version of it and try to move ahead to rebuild the world economy. Yes it is politically tough. Yes there will be all sorts of push back. Yes bondholders will scream that nobody will want to buy new bonds, and yes the rating agencies and others will claim it is a default and can’t be done. Yes it can be done. It has been done before. Failure to do this in some way is simply to condemn the world to relive Japan and its never ending economic problems. If the world does not take bold steps like this, or some other way to get to the same place, then we risk a social upheaval in the next few years as standards of living deteriorate, unemployment rises and hopes of a better life get trashed. Eventually that leads to bad things and bad leaders promising military solutions. History is replete with these scenarios.

While I realize this is likely just a futile idea, hopefully someone takes it and finds some way to make something work. We cannot go muddling on like this.

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Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.