Tuesday, April 22, 2014

Restore The No-Bail-Out Clause!

This Op-Ed by Philippe Legrain (NYT) is very worth reading. One excerpt:

"The primary cause of the crisis was the reckless lending of German and French banks (both directly and through local banks) to Spanish and Irish homeowners, Portuguese consumers and the Greek government. But by insisting that Greek, Irish, Portuguese and Spanish taxpayers pay in full for those banks’ mistakes, Chancellor Angela Merkel’s government and its handmaidens in Brussels have systematically privileged the interests of German and French banks over those of euro zone citizens ... The bungled decision to bail out German and French banks by lending to an insolvent Greece in May 2010, rather than writing down its debts, scarred the euro zone. It violated the legal basis on which the euro was formed: that a government in difficulty should not be bailed out by its peers".

From the beginning of this blog, I have stated the above position over and over again, albeit not in such a one-sided fashion: reckless lenders can't do it alone; they also need reckless borrowers. However, the point is that bailing-out banks via Greece's balance sheet was either an irresponsible act or an incompetent act, or both.

Regrettably, there is one mental trap which, I believe, Phillippe Legrain is not avoiding: when lenders go bankrupt, it has absolutely no bearing on the loans of their borrowers. Those loans continue in place until they are either repaid, converted to equity, forgiven or whatever. When banks go bankrupt, it is their creditors who lose; their borrowers don't gain a thing. Greeks should know this the best because they continue to claim a loan which they (involuntarily) made to the Third Reich. The Third Reich went bankrupt but Greece has not forgiven the loan. Thus, strictly from a legal and contractual standpoint, Greece still has a claim. A loan taken down remains debt until it is repaid, converted to equity, forgiven or whatever.

According to the IMF, Greece received rescue loans of 247 BEUR from 2010-12, of which 206 BEUR went straight back to lenders and only 41 BEUR stayed in Greece to finance the deficit. The critical figure is the 41 BEUR, not the 206 BEUR. It is the 41 BEUR which drove Greece's austerity. Had it, instead, been 82 BEUR, twice as high, Greece would have had a much less painful adjustment. 

The textbook would have suggested that lenders figure out how much the borrower needs in order to make the necessary turn-around in the least painful way. That might have turned out to be 82 BEUR. But it was not the textbook which drove those decisions. Instead, it was politics. The question was: How high is the lowest possible amount which we need to give in order to avoid that Greece collapses entirely?

The textbook might also have suggested the following: GDP is the sum of the public and private sectors. If we are going to starve the public sector to death (because that is necessary) without damaging overall GDP too much, we have to make offsetting increases in the private sector. By-pass the public sector and extend financing to the private sector directly. Here, however, one would have had to consider what the former Chief-Economist of Deutsche Bank said in an interview: "The question is what kind of growth do we want? Do we want the private sector to grow because of loose monetary policy or because companies invest when they are not hindered by archaic economic and political structures?"

With one exception, Greece was/is in the same situation as many Latin American countries were in the 1980s when they faced 'sudden stop' in foreign loans: they could only stay in business if they complied with the IMF's medicine. The exception is that the Latin countries had a local currency which they could devalue and, thus, accelerate and/or inflate their way out of the crisis. I am not aware of any debt forgiveness in Latin America; only debt restructurings.

Legrain suggests that "in forder to get out of this mess, the Eurozone needs a change of policies and institutions. Banks need to be restructured and unbearable debts written down. More investment is needed, along with bold reforms to boost productivity". 'Writing down unbearable debts' sounds very civil and easy, but if lenders write down their loans it does absolutely nothing for the borrowers. The only thing which does something for the borrowers is if lenders forgive their loans.

Forgiveness of sovereign debt is an issue which has been treated far too lightly since 2010 because it is an issue which affects principle and precedent. Forgiveness of sovereign debt has historically been limited to impoverished countries of the Third World or to cases of one-time destructions. No one can predict the longer term finanical consequences of the precedent that sovereign debt of a First World country is easily forgiven. Not to mention the political consequences in the forgiving countries.

The much easier solution would be to bring interest rates to zero and to extend debt maturities way out into the future. To take Greece as an example: Greece's GDP is around 180 BEUR; 60% of that would be 108 BEUR. One could take the debt exceeding 108 BEUR and convert it into an interest-free loan with a bullet maturity in 50 years (or longer). In short, for the next 50 years, Greece's debt service would be limited to the Maastricht debt level. It would economically be equivalent to a haircut with limited duration. No investor of today would worry about Greece's debt sustainability in 50 years from now (or more). During this time, the debt would devalue in real terms. And let's be honest: if Greece couldn't make a recovery in the next 50 years (or more), then Greece would be, by the time the loan maturity comes up, one of those impoverished countries of the world where debt forgiveness is justified.

Still, Legrain's analysis is very valid, particularly the following conclusion which he draws:

"The 'no bailout' rule should also be restored. Elected national governments must have much greater flexibility to tax and spend as they please, constrained by markets’ willingness to lend to them and ultimately by the possibility of default. A mechanism for the orderly restructuring of sovereign debt should be established for that purpose".


  1. Herr Kastner, es ist furchtbar. Dieser Bericht ist entlarvend über Griechenland.
    Die Zustände, die geschildert werden, sind noch katastrophaler, als ich in meinen pessimistischsten Annahmen gedacht habe!

    Die Story im Ersten - in der ARD: Griechisches Roulette
    Seit fast vier Jahren versuchen EU, EZB und IWF (Troika), Griechenland vor der Staatspleite zu retten. Politiker in Athen und Europa verbreiten Optimismus und verweisen auf erste bescheidene Erfolge. Doch wie sieht die Wirklichkeit hinter solchen Botschaften aus?


    ehemals PC-Support und Netzwerkadministration
    Hamburg Bangkok Düsseldorf

  2. You take Philippe Legrain's article and twist it around to suit a German/Austrian bankers viewpoint.

    On the public sector:
    Only neo-liberal economics declares that the public sector needs to be "starved to death (because it is necessary)". Why is it necessary? Only banks and vulture capital wants to undo the 20th century political/economic vision that privileged social / economic health.

    Au contraire, Europeans WANT a strong state, ie public sector, that ensures access to education, health, and a social safety net for those in need.

    They also want banks that lend to business ('risky') not banks that invest in the non-risky as defined by Basel III: in other words, banks that function as they should. Furthermore we want separate banks as before: one type for depositors, savers, pension funds and small business; and another for risky investment.

    On what basis and what insane logic should the people of Europe be broken and impoversished to pay for the irresponsible decisions of private banks that don't serve their needs, and gambled away their savings?

    Further, the IMF programmes in Latin America in every case privileged external investors over the economic health of those societies - as Legrain points out, economic colonialism. Nothing to boast about and much to be ashamed of.

    1. Could it be that you do the twisting? I wonder how many other readers would understand my comment about the public sector to mean that Greece should not have a public sector. I have yet to meet a Greek who does not consider Greece's huge, inefficient and corrupt public sector as one of the major reasons for the country's demise of the last 30 years. A burden on the economy instead of support for society. If the argument were that Greece should have a public sector the size of Scandinavian public sectors (also not small) but with their efficiency, integrity and quality of service, and if Greeks were prepared to pay for that, I would be all for it.

      The other points you make I would not disagree with.