By Simon Johnson; for more on related issues, see my new Bloomberg column on the IMF succession. For more background on the IMF, see Tuesday’s Planet Money Podcast.
Greece has no good options. Without question, Greece brought debt problems on itself – this is the consequence of politicians using irresponsible fiscal policy to win elections.
As the International Monetary Fund put it when Greece became the first eurozone country to borrow from the fund in May 2010, “Even with the lower deficits envisaged under the program, the debt as share of GDP will continue to peak at almost 150 percent of GDP in 2013 before declining thereafter.” The situation has not improved in recent months – even under the most optimistic scenario, the debt-GDP ratio will peak above this number.
The problem is that loose talk among European leadership of potentially “restructuring” or “reprofiling” Greek debt creates more problems than it solves. Financial markets fear another Lehman moment, in which authorities decide to let a significant borrower fail – without fully understanding the consequences.
Who in the private sector or the various responsible governments or at the IMF can tell you exactly what would happen – and to whom and where – if Greece were to default in any fashion?
European banks have very low levels of capital, meaning they are highly leveraged – having a great deal of debt relative to their equity. They are not in a position to withstand losses on their large portfolios of European government securities if, as seems likely, Greek problems cause a fall in the market price of Spanish, Italian, Belgian, or other eurozone sovereign debt.
The banks convinced themselves – and their regulators – that lending to all these governments was “riskless”. This was the structural mistake at the heart of the eurozone. Greece and others were able to borrow so much relative to their economies because creditors believed this debt was very nearly just as safe as German Bunds.
European politicians are now choosing between what they see as three options (a) restructure Greek debt, take big losses at French, German and other banks, and deal with the systemic consequences on the fly, (b) provide additional financing to Greece, allowing them to run for another five years without having to come back to the private markets, (c) muddle through, with various promises of further fiscal adjustment, quick privatization, and greater structural reform from the Greek side, while really just hoping that a sufficiently strong global growth boom will lift all ships.
The right approach would be to deal with all troubled eurozone sovereigns and global vulnerable banks in the same pan-European package of debt restructuring where appropriate, fiscal adjustments as needed, and improvements in competitiveness for all countries that have consistently been running current account deficits.
But there is a nearly zero probability for this course of action. European politicians understand the issues just fine, but they do not want to face the electoral consequences that would follow from acknowledging the currency union was poorly designed and implemented.
An edited version of this post appears on the NYT.com’s Room for Debate: Is there any hope for Greece’s debt problem? See that page for alternative views of what Greece could or should do.
The Baseline Scenario 
According to the IMF, its purpose of existence is: (a) Surveillance (b) Poor country policy assistance and most importantly (c) (im)balance of payments lender.
Can anyone explain at what point did its mandate change to resolve and underwrite (30% of funding assistance to troubled euro countries comes from the IMF budget) the internal structural issues of the euro area. In what way does Greece’s problems warrant its involvement?
Why is the rest of the world footing the bill for someone else’s poorly designed currency union and then having to agree for a compliant political-lackey of an insider, Ms. Lagarde, to be appointed to head up the process?
Yes, the banks that lent were naïve. But they legitimately did not know the extent of Greece’s debt, as the Greek government (with the help of Goldman Sachs and Morgan Stanley) was cooking the books to hide the deficit.
Simon, I followed the conversation at the NYTimes.
To the solution you suggest I would add Barry Eichengreen’s one:
The solution is for the Greek government to retain warrants on these newly privatized assets. Ask Greece to do the privatization now, in other words, as a way of locking in reform. But require the buyers to give the government additional payments once the economy starts doing better and the value of those assets recovers.
Yours is technical, whereas Barry’s takes care of procedural justice.
Thanks!
I’ve read and heard a plausible alternative to the weak sisters of the “EuroZone Currency”, which in all reality seems quite doable:
*Silver Standard (periphery weak sisters)
**Gold Standard (the German, French, and original makeup before the grand inclusion of questionable adoptions?)
Having a explicit bifurcated currency denomination…what say you?
Thankyou Simon and James
“Having a explicit bifurcated currency denomination…what say you?” This is the financial version of an older vision of an Europe with two speeds. Maybe that’s the end goal of the big countries, but the shock ought to be much stronger to disentangle politics from economics.
On the other hand, if the small countries have to pay more interest to finance their deficits, you have in effect a two tier system. Which then begs the question, why stick with the Euro?
So, you either drive unifying change (e.g., tax regimes, labor laws, etc.), or the European entities will choose difference radii of convergence. For example, did you hear the Danes’s wanting out of Schengen?
This isn’t directly related to Simon’s post, but more for those wanting to keep abreast (not maid’s breast) on Strauss-kahn circus show.
Apparently Mr. Kahn has had the extreme foresight to get himself a hotshot J.o.o.ish lawyer (shocker, eh??). Read here:
http://nymag.com/nymetro/news/crimelaw/features/1984/index3.html
So let’s see…. what will this result in??? Let me get my magical crystal ball and some kozher Tarot cards here kids……. I see….wait… getting dizzy now as I go into psychic mode…oh dizzy kiddies…….more dizzy….74% into psychic mode……..ok I’m there kids……… eeeeehh, oh so dizzy……..I see….. I see………. ZERO prison time, a semi-hefty fine (hefty for us average Joes anyway), and a nice “Oh, you been such a bad boy. bad boy!!! bad boy!!!” lecture from the judge, and a one-way ticket back to France, with a “thanks for the memories” send off from Benjamin Brafman before Brafman deposits his check for services rendered at the bank. Isn’t it nice to see happy endings kids????
My apologies, page 1 (the beginning title page of the above link)
http://nymag.com/nymetro/news/crimelaw/features/1984/
Having a seat in the EuroZone brings about many advantages as does disadvantages. Bumps in the road build character, so you get up, brush yourself off and get back in the human race as the European Community is currently doing…digesting its “Rock and a Hard Place”, this “Scylla and Charybdis Moment” of “je ne` sais quoi”? This is a classic “Caught Between the Horns of a Dilemma…with the Ox having the Run of the Roughshod”?
Quote: “The political dilemma in attempting to invest funds, create regulatory programs, or other efforts to avert losses in the first place stems from the fact that the cost [or burdens] are up front, while the benefits are longer term and uncertain” (Peter May)
Quote: “If you learn only methods, you’ll be tried to your methods, but if you learn principle you can devise your own methods” (Ralph Waldo Emerson)
The IMF is as European as “French Bread & Wine” while diving through Northern Italy in your Mercedes Benz – quite simply, it is Europe’s Child!
Lastly, on a humorous note;
Quote: “there is no dilemma compared with that of the deep-sea diver who hears the message from the ship above, ‘Come up at once, we are sinking'” (Roger Cooper 1943)
Thankyou Simon
@MH: Have a look at the central image: http://imotion.blogspot.com/2011/05/dsk-facing-american-americanism.html
It’s as if DSK could not believe his French super-lawyer eyes who’s represented by…
The whole thing started going smoothly once DSK presented his resignation, shortly after Geithner suggested it, if I may add. So, no drama here…
This comment is directed to via fCH
I like the grouping of pictures, it’s fascinating to see the different facial expressions near each other and Kahn’s body language. I do appreciate you sharing the pictures/link.
Nonetheless, I think your other comments are an example of vacuous conspiracy theory which is near humorous, and really is why many people ignore legitimate conspiracy theories when they do in fact come along. Brafman is not a publicly chosen lawyer, he doesn’t, nor would he ever, work “on the public dole” as the wage rate would not be to Brafman’s standards. Kahn may be a man of generally low character (certainly as to his treatment of females), but we can’t doubt that he is typical of his let us say “genetic ilk” as this site blocks some J words. Kahn is extremely extremely intelligent. Kahn chose Brafman himself. I might add, Brafman is a Brooklyn boy, not French.
Whether there is or isn’t some “conspiracy” or “Plan” here to get Kahn out of IMF (which I highly highly doubt, in fact quite the reverse, French have been protecting his abusive behavior with their liberal culture), I can pretty much guarantee you, Brafman is not a part of it.
SJ writes:
“The right approach would be to deal with all troubled eurozone sovereigns and global vulnerable banks in the same pan-European package of debt restructuring where appropriate, fiscal adjustments as needed, and improvements in competitiveness for all countries that have consistently been running current account deficits. … But there is a nearly zero probability for this course of action.”
The political economist Mark Blyth (at Brown University) puts it this way: The banks got away scott free. They passed the problem to the taxpayers and government. If a sovereign debtor (Greece, Ireland, Portugal, Spain) defaults it will start a domino affect and cause a global Depression. The reality is bond holders must take a “hair cut” and taxpayers / governments will have to pay up. Blyth also argues against fiscal austerity because it slows economic recovery.
A remarkably restrained post from a euro-hater.. As everynoe should know, the euro is and always was, a political project of european federalism. And European federalism is an elite project to make Europe into a very large state, not only an economic union a la Nafta. Preferably, smaller countries should have merged with bigger ones (like Holland, Austria, Flemish Belgium are basically independent units of Greater Germany). However, there were a few unfortunate events in the 1940s that make that temporarily unfeasible, due to an Austrian who hijacked Germany. The Germans would not like that to happen again. Just imagine a Dutch-born leader of Greater Germany who would like to bring Indonesia back into the fold, or get rid of Muslims, or whatever.
As everyone who has done his homework, the two problems most talked about, do not exist: (1) Greece can default (in fact that is already in the Stability Pact). It would not have to, if it simply taxed its citizens properly, including the shipping industry (in return for US-style merchant navy protectionism at EU level?). But the Euro rules allow for a gvt default. (2) there would be a banking crisis: not really: the British market fundamentalists nationalized their banks to prevent a bankruptcy. The same could happen in Germany, France and the UK again. Much cheaper than bailing out the blackmailing Greeks.
As to the IMF: if the US would put a non-european (or a European eurosceptic) in this position, it would be the equivalent of a casus belli. The appropriate response for Europe would be to pull out of the IMF and/or fire the IMF as assistant with the PIGS program.
@MH: I cannot explain images that way one does in class in reading comprehension. Where do I make anything of Brafman? My comments for the center piece in the image was referring to the expression of DSK face.
As for the ‘c’-thing, I am much more relaxed than worrying about it. Would ‘set-up’ suit your taste, sir?
The poor “Greek’s” were “Goldman`d, and now sadly, so have the Libyan’s – surely a “Greek Tragedy” that knows no boundaries?