Greece should default and reschedule

February 15, 2010

The drama unfolding in Athens contains all the usual ingredients for a modern crisis. Poorly disclosed derivative transactions. Inadequate accounting for off-balance sheet liabilities. Investment banks eager to structure complex transactions in return for fat fees. And a furtive but gullible government that thought it could get something for nothing.

Life is a lottery; some loans go wrong in the ordinary course of events. But behind every really bad loan or class of loans, like subprime mortgages, there are greedy and foolish bankers and equally culpable borrowers. Greece is no exception.

The Greek state has only itself to blame for manipulating accounting rules and derivatives markets to run up unsustainable debts. But the banks that structured those transactions are hardly blameless and cannot really complain if they do not get all their money back.

One part of the problem is the use of swap transactions to provide upfront payments to the Greek state in return for deferred payments, ensuring Greece would scrape in under the Maastricht criteria for euro membership.

Swap transactions involve the exchange of one stream of payments for another. But these are confidential bilateral deals. The terms need not be actuarially fair or at current market prices.

In this instance, the terms of the swap transactions ensured that Greece was a net recipient of funds in the early years but would pay the money back later.

These were credits. But because they were structured as swap transactions rather than loans they did not have to be recorded as debt or count against the country’s compliance with the Maastricht criteria for eurozone membership, which was precisely why they were so attractive.

The swap transactions were perfectly legitimate. They were not the only cause of this crisis. But they have helped Greece accumulate more debt that would otherwise have been possible, pushing the country closer to the brink.


Most commentators have concentrated on the need for the EU to bail out Greece. But in reality any rescue would be another subsidy for excessive-risk taking by the country’s bankers and the institutions that have sold credit default swaps (CDS) on Greek debt.

Forcing the country into an austerity programme and arranging an emergency loan from other EU members or the IMF would ensure the bankers got their money back (again), but inflict years of misery on the country’s households and businesses.

If market discipline is ever to be re-established after the boom and bailouts of the last five years, it is imperative creditors face the real prospect of making losses if they extend large loans and fail to price the risk on them properly. The sellers of CDS insurance must face up to making real payouts in return for all the premiums they pocket.

Bailing out Greece would be wrong. Not because it would harm the eurozone’s credibility, but because it would reinforce the rampant moral hazard in financial markets. It would perpetuate the inequitable and politically unacceptable situation where structuring fees are retained by the banks as private profits while credit losses are socialised and passed onto taxpayers.

Greece would do everyone a favour by declaring a moratorium and forcing a rescheduling. The country faces years of misery in any case. The threat of being shut out of capital markets rings hollow. But by triggering losses on these derivative transactions and a credit events under the CDS it would help ensure a much more prudent approach in international banking markets.

Bailing out Greece so everyone can pretend the country can remain “current” on its loans when it patently cannot would simply deepen the moral-hazard crisis. If market discipline is ever to be re-established (something which everyone agrees is desirable) then at some point creditors must take a loss. Greece is a good place to start.


The other slightly Alice-in-Wonderland aspect of this crisis is the long list of banks, countries and institutions demanding Greece undertake brutal budget cuts to honour the bankers’ loans and before any emergency assistance can be pledged.

These are the same banks, countries and institutions that urged pro-growth policies in response to the subprime and banking crisis to avoid a deflationary spiral and widespread default. It seems shock therapy is appropriate for Greek households (“pour encourager les autres”) but not U.S. homeowners or the banks themselves.

After bailing out American homeowners and the banks themselves in 2008-2009 with vast quantities of cheap money, fuelling moral hazard, governments and financial markets have suddenly discovered a new commitment to fiscal rectitude — mostly someone else’s rectitude.

Fiscal consolidation (the polite term for tax rises and spending cuts) is an essential part of Greece’s debt workout. But the trajectory is crucial. Greece is being asked to undertake rapid consolidation mostly for symbolic reasons to maintain the EU’s commitment to treaty-purity even though it will push the country into a deep downturn, slashing incomes and budget revenues.

But “liar loan” mortgages to subprime households are not much different to the debts Greece has run up. If rescheduling and a gradual workout is a desirable outcome in the United States and the rest of Europe, to share losses more widely, it is hard to see why similar restructuring should not be the optimal outcome in Greece.

In the rest of North America and Western Europe, exceptionally low interest rates and central bank programmes to buy mortgage-backed securities and other instruments have provided a disguised form of rescheduling (in favour of lenders and borrowers, at the expense of long-suffering savers and taxpayers).

In a similar vein, there is a strong case for Greece’s debts to be defaulted and rescheduled (at the cost to creditors and sellers of default swaps) in order to share the burden more equitably between banks (who have profited handsomely from their transactions) and the local economy.


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somebody’s going to end up standing in a soup line. crapitalism has fallen and we taxpayers are left ‘holding the bag’ and it’s full of nothing but…well, you know. the trick now, is for the rich guys of the world to pass on their losses while picking up their bonuses! this is where their brilliance shines so brightly. unfortunately, we fools who carry them on our backs are too blind to see it. (lack of the appropriate phds, i guess…)

Posted by jborrow | Report as abusive

Although I can partly share your views that a default would under circumstances be “beneficial” for greek taxpayers, I cannot however see how these circumstances would materialize in the current hostile environment.

Furthermore – please correct me if I am wrong – I understand that you recommend a repetition of the Lehman Brothers model, i.e “let the bad guys who lended / borrowed” recklessly take the cost”. It is this model that in countries other than Greece has led to the increase of sovereign debt and to an extent to the waste of taxpayers’ money. What exactly is it that makes you believe that this time “the system will be purged” and all of a sudden the “burden will be shared equitably by banks”? Is this perhaps yet another “Alice-in-Wonderland” aspect?

Posted by Yiannis34 | Report as abusive

When a credit card company basically tricks an 18 year old to run up a debt, or a bank tricks a high school dropout into a mortgage beyond their means, the bank has responsibility. Greece is different, Greece is presumably run by adults with some level of education, they cant claim being tricked and that they don’t understand debt. They were smart enough to find a sneaky way to get loans just like they’re smart enough now to try to find a way to not have to pay them.

Posted by NewsReader2 | Report as abusive

Everyone seems to have forgotten the Asian Financial Crisis! At that time, the Asian government were told by the gurus, IMF and World Bank to take the “bitter pill” and to bear the burns. What happen to those thoughts now? Isn’t the Greece and some other government facing the same situation as those by the Asian government back in 1997?

Posted by Fairgames | Report as abusive

Greece should just default. Declare it now. So shall it be written so shall it be done.

Posted by vinman1 | Report as abusive

Εθνική Υπηρεσία Πληροφοριών … thanks… short the olives…season is bad…very bad

Posted by vinman1 | Report as abusive

The key is the Asian government for example like Thailand and Indonesia, after taking the “bitter pill”, have since recovered well! The basics is really you don’t expect to spend your future earning and expect someone to come to your rescue without costs?

Posted by Fairgames | Report as abusive

The 3% budget deficit constraint that every member country of the Euro-zone has to abide by was not set yesterday – it was set back in 1999 when the Euro-zone was created and it was the prime condition to be satisfied for any country that wanted to become a member of the Euro-zone. With all the data coming out into the light, it is clear that Greece never met that precondition. They were able to “mask” the true state of their finances by securing deals from Goldman and others. Those deals were made on Greece’s own request and not the other way around. Greece cheated their way into the Euro-zone and now have the whole system held hostage to the crisis caused by their lavish government spending. Greece is perennially one of the biggest arms buyers in the world spending several tens of billions on various expensive weapons systems, while being a NATO member since 1949 with continuous NATO and US presence on its soil throughout the cold war. They were locked in decades-long arms race with – Turkey of all countries, another NATO member. Correct me if I am wrong, but to me personally seems totally impossible that two NATO members would ever be engaged in a war against each other. NATO is supposed to be a collective security system. The Greeks are plagued by an irrational mentality which is the only explanation on how they managed to amass a national debt of 170% their GDP. Now that the chickens have come home to roost, Greece wants a bailout. I don’t think it’s gonna happen. There is no way they are going to persuade anybody inside EU to land them money, specially since now everyone knows how they became a member of the Euro-zone in the first place. They are headed for a default and a major restructuring of not only their economy, but their elitist mentality as well.

Posted by AlexZ83 | Report as abusive

As AlexZ83 stated, Greece was a cash guzzler throughout the cold war, not only giving freebees to its government employees but also trying to catch up with Turkish arms purchases. The Turks were trying to get strong enough against their neighbors on the east, namely Soviet Union; while the Greeks were scared that the Turks would attack them. The Turks were buying their arms from the US and Germany, while the Greeks were making payments to the French arms manufacturers, subsidizing them more than the French government. Therefore it should be France, rather than Germany that should pick up the bill now. The trouble is that the French government debt is almost 100% of GDP, which itself is also ringing the alarm bells.

Posted by localmichael | Report as abusive

Much more needs to be done “If market discipline is ever to be re-established”. Recommending Greece to be allowed to default while western governments are bailing out companies; inflating their debt and charging it back to the people, is as good as saying that the Lehman default has saved capitalism. I’m sorry, I’m no expert, but I find the article shallow to say the least.

Posted by YiannisG | Report as abusive

In response to Localmichael:

Yes, France needs to pay its fair share…well said, but Germany had to, too. Like I mentioned before, there’s still a debt pertaining to WWII, so this is not a matter of bailing Greece out…is all about justice…

As far as NATO is concerned, I don’t think that things are as innocent as they appear to be. Why do the turks violate our airspace every once so often. Do you know the cost incurring to Greece each time we have to watch our borders??? The European borders? And I think the Americans are right in the middle of this..

Posted by Alex_Pgreece | Report as abusive

Greece is one of the largest weapons buyers in the world today, having armed forces that absorb disproportionately large amounts of resources, due to the known problems on the turkish border and the turkish aggression (real or perceived). These weapons are mostly bought from the US, UK, Germany and France, supporting their own economies. So, in a sense, Greece has been bailing out all these countries for very long. Similarly, most greek imports come from the same countries, especially for high-tech products. If Greece is forced to abruptly reduced its spending, these would be among the first to go, causing a severe blow to the economies of the countries involved. Therefore, assisting Greece would be a step towards financial stability and recovery in many richer nations. On the other hand, crippling the greek ability to import would mean that many other coffers would become emptier.

Posted by DimitrisUK | Report as abusive

I think all the bailing-out solution senario will be concerned with the profit.if EU can’t give their hands.the investbank will came out to creat some new tools to help them.and the asian financial crisis is hard to happen again.As it is Euro-zone not the Thailand or some small countries which are quite easier to be attacked by the hot money.if such expectations exists the IB will try their best to get a share of profit from the behavior of helping GReece.

Posted by snowspring | Report as abusive