Greece should default and reschedule
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.
BAILING OUT THE BANKS, AGAIN
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.
PURGING THE SYSTEM
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.