Two Thoughts on Greece

As we approach another round of talks on the third Greek bailout package, I thought it would be appropriate to share two thoughts on the importance of debt forgiveness and on Europe’s preparedness in case this all goes wrong. My basic line is that debt-forgiveness is the only pragmatic choice. I also worry that Europe is not as prepared for the alternative as it should be.

Let’s start with pragmatism and debt-forgiveness. Roughly five years ago, I had the fortune to join a panel with Yves Mersch, the Luxembourg central banker and now Executive Board Member of the European Central Bank. There were other notable participants, but Mersch made a particular impression. At one stage in the proceedings he pointed out that the basic rule of capitalism is that you pay back your debts. The reference was to Greece and the message was earthy and pragmatic. The Greek government borrowed the money and the Greek government should pay it back. That is how capitalism is supposed to work.

Only capitalism doesn’t work that way. Five year’s later, we all know what happened. The Greek government borrowed the money but it will not pay it all back. Instead lenders or investors received roughly 25 cents on the euro. What sounded like earthy pragmatism now sounds like fluffy idealism. If only debtors were as good as their word.


Borrowers often don’t pay their debts

But debtors are not as good as their word, or at least not always. That is a harsh reality. Moreover, the fact that borrowers do not always honor their debts should be deeply ingrained in European financial planning. It certainly is in Texas. When I grew up there, people used to joke that you couldn’t become someone until you went bankrupt at least once. They were only half kidding. Risk-taking was part and parcel of the Texas frontier experience. Much of the state’s entrepreneurship is still very risky. Usually it falls flat. Failed Texas wildcatters are a dime a dozen. Still the dream is to strike it rich.

Such dreaming is ambitious but not unethical or immoral. For this aspect, I turned to the Bible. I am sure most Texans would approve. When Mersch made his comment about paying back debts, all I could think of was the biblical rule against usury. Actually, I was thinking of an episode of the Sopranos about a guy who owned a sporting goods store and then got into trouble but it sounds better as an ethical and moral argument if I put it in religious terms. The issue in question is the law of compound interest and that law is more powerful than any rule about paying back your debts. In this context, Greece is less the exception than the rule. Greece borrowed a lot of money cheaply and then found out it couldn’t support the debt once the cost of borrowing shot through the roof. The Sopranos know all about how that works. Religion seems less closely connected to the grittiness of the real world. Even so, what I found in the Bible was surprising.


Biblical insight

I am not a theologian and so I will not bother to put references here. Instead I encourage anyone who is interested to look for a full text, searchable version of the Bible online or, failing that, to talk to a minister or priest. The basic message I gleaned is the following. The Bible contains no injunction against borrowing. The Old Testament promises the chosen people that they will not need to get into debt but it seems to accept that everyone else will. Life is too often beyond the means of normal experience. Borrowing is the only way to fill the gap.

Faced with the inevitability of indebtedness, the Bible has very few rules and they all fall on lenders. The first is the well-known rule about usury. Lenders should not charge an unsustainable interest. The Bible is very practical in that respect. Then there is the seven-year release. Lenders should forgive their debtors on a regular basis to avoid forcing them into servitude. That was a bit more unexpected.

The most surprising injunction came in a passage I found in Exodus (22:26) which commands lenders to hand back collateral on failed debts. The example there was raiment (or clothing). Borrowers should not be left to go naked, otherwise they will never get back on their own two feet. So even if borrowers pledge their raiment as collateral, lenders should be a good sport about it and hand the raiment back. There is a similar passage in Deuteronomy (24:6) that cautions against taking millstones as security because you deprive the borrower of any means to pay you back. That notion seems very pragmatic. It also struck a chord with my Texas heritage. At least as I remember it, bankruptcy in Texas protects the borrower’s horse and homestead – even if nowadays the ‘horse’ has wheels and is made in Germany or Japan.


Idealism and Pragmatism

The point here is not to celebrate delinquency or default. People, firms and governments really should pay back their debts. That is the capitalist ideal and, in that sense at least, Mr Mersch is an idealist. The reality is, however, different. Sometimes people, firms and government borrow more than they can afford to repay. Sometimes they borrow responsibly but then find themselves trapped by falling incomes or rising interest rates. That is all part of the capitalist experience. Europe’s financial architecture should take better account of that fact.

This brings me to my second point about how well prepared Europe is for another Greek crisis. It is no secret that the Greek government is struggling again to live up to the commitments required by its creditors. Outside observers may believe they have seen this movie before. Elsewhere in Europe, however, there is a feeling that this time is different. Greece is no longer systemically important in economic terms, they argue. The politics is also different. Indeed, by drawing a firm line on Greece, Europe as a whole may benefit from the demonstration effect. In the meantime, the Greek people may come to their senses. Rather than supporting Syriza government that seems determined to evade European requirements, they may throw their electoral support behind a New Democracy-led coalition that would make greater efforts to meet European conditions for assistance.

Unfortunately, Europeans who feel they are more in control of the situation than they were in the past are probably guilty of wishful thinking. It is true that the economic consequences of a Greek failure are more manageable given the many changes both in exposure to Greek assets and in resources for European bailouts that have taken place. It is also true that the social consequences of another Greek crisis can be locally contained. Nevertheless, the structural implications of a failure of Greece for the rest of the European project should not be underestimated. If Greece’s creditors believe they can cut their support as some kind of teachable moment without suffering disproportionately, they are mistaken.

Let’s start with the good news: The economic consequences of a further Greek failure are still negative but more easily contained than in the past. French and German banks no longer have large stockpiles of Greek assets; neither do the banks in other European countries like Cyprus. Moreover, Europe has a stronger framework for banking recovery and resolution – and established funds for sovereign bailouts. This makes it less likely that there will be significant contagion from Greece to other parts of the euro-area and even less likely that any turbulence in the euro area would spread the rest of the European Union.


Preparation comes at a cost

These more robust economic firewalls have not come for free. The change in the banking recovering and resolution framework has slowed down the pace of cross-border capital movements. It has also resulted in a re-nationalization of much of Europe’s banking activity. In turn this makes for a less efficient single marketplace with a greater collective imbalance in savings relative to investment. Further troubles in Greece will reinforce that trend and so put downward pressure on European macroeconomic performance. For those who believe that a more conservative, rule-based system will result in less moral hazard, however, the results in terms of greater stability will be worth the cost in terms of higher levels of output.

The social consequences of a further crisis for the Greeks themselves will be dramatic. The Greek people have already experienced a sustained loss of output, both actual and potential. They have also suffered high levels of unemployment among the youth and poverty among the elderly. This situation would only worsen if Greece suffered another setback. Those refugees who entered Greece in efforts to reach other parts of the European Union will also suffer from any sudden downturn in performance. This suffering can be contained through tighter controls on Greece’s borders, but that containment does not make the suffering any less significant for the people who experience it directly.

There is a chance as well that other countries will learn the lesson from Greece that accepting European assistance is not worth the consequences. Although the creditor countries are frustrated with Greece’s lack of compliance with aid conditions, many other countries note that the Greeks have engaged in more extensive reforms more quickly than at any other time in the country’s past. Those reforms may not have resulted in enhanced debt sustainability, but the reason is that the conditions were counter-productive and not that the effort made was insufficient. In such a situation, handing control over to European creditors is self-defeating as well as humiliating. It would make more sense to hold out so long as possible even if that increases the costs associated with any eventual assistance program.


Solidarity and moral hazard

These social and political consequences are mostly speculative. Advocates of greater discipline can argue that the benefits of drawing a firm line against moral hazard are worth the risks. They can also point to the solidarity associated with having come up with bailout resources and the broader architecture for a banking union in the first place. Having bailed out Greece three times already, they have earned the right to suggest a different tack.

Unfortunately, the structural implications of another crisis in Greece have not changed significantly. This is the bad news that offsets any positive developments. The most important of these concerns the irrevocable nature of participation in the euro as a single currency. If Greece has a crisis sufficient to push it out of the monetary union, then financial market speculators will have reason to speculate that other countries will follow. They may not move against other participating countries immediately and that is not the main consideration. What matters is that market participants will know that it is possible for a country to exit from the euro and so they will hold onto a strategy of betting against continued euro membership in case a suitable opportunity emerges.

Even if Greece remains inside the single currency, a further crisis could affect its participation in European institutions. Greece remains a full member of the Council of the European Union; it also remains a full member of NATO. Those roles give the country significant bargaining leverage, particularly where decision-making requires unanimity. Moreover, Greece has shown as willingness to use such leverage in the past. If the Greeks feel as though they have been abandoned by the rest of Europe, they will look for ways to regain standing and to reassert their significance. A reorganization of the European Union in the aftermath of Britain’s exist seems ideally suited – as does the negotiation for Britain’s departure. The European Union is institutionally too fragile at the moment to be worth the risk of a significant showdown.


The inexorable logic of interdependence

The situation in Greece is problematic and yet the European Union is not well positioned to take advantage of that fact. Europe’s heads of state and government have made great strides in building mechanisms to contain the economic fallout of another Greek crisis, but the EU remains vulnerable to the structural implications of isolating the Greeks. Moreover, the Greeks do not deserve isolation. Although there remain important issues attached to the program conditions, successful efforts Greek governments have worked hard to live up to their commitments. The challenge for the rest of Europe is to find a way to reward that cooperation and to underscore the benefits of EU membership. Leaving Greece behind is not in Europe’s interest; bringing Greece forward is still well worth the effort.


The second half of this piece was drafted in January and published in the 1 March 2017 issue of the EastWest Magazine. For the edited version, please go here.

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