From the February 15, 2010 Wall Street Journal Europe
February 15, 2010
by Irwin Stelzer
If it waddles like a duck and quacks like a duck, it's a duck. If members of a club come to the rescue of a profligate member— call it a loan, call it a temporary liquidity infusion—it's a bailout. Perhaps sensing that they are all Greeks now, or at least many of them, and that the club had better hang together lest several of its members hang separately, the powers-that-be in the euro zone seem to be moving towards bailing out Greece, or, as EU president Herman Van Rompuy put, have reached "agreement on the Greek situation."
No surprise. The political class has a large political investment in the euro, and has no intention of allowing Greece to abandon the euro or to default on its enormous outstanding debt. So rather than see it leave euroland, the more affluent members decided to bail Greece out, some details of the bail-out to be announced sometime today.
Those finance ministers who haven't yet read Henry Paulson's "On The Brink" might give it a look. The former U.S. Treasury Secretary tells the tale of his efforts to prevent a collapse of the financial system. Mr. Paulson felt it necessary to bail out Bear Stearns—it was billed as a sale, not a bailout—having decided that moral hazard was less of a problem than a collapse of Bear. Enter Lehman Brothers, and its chief executive, Dick Fuld. Mr. Fuld was reluctant to sell his troubled investment bank.
"Does he know how serious the problem is?", Mr. Paulson asked an aide. "He's still clinging to the view that somehow or other the Fed has the power to inject capital," the aide responded. What was good enough for Bear Stearns, a Wall Street maverick, was surely good enough for Lehman, Mr. Fuld reasoned, as he held out for the $10 per share price paid for Bear.
Mr. Fuld guessed wrong, Lehman collapsed, and all heck broke loose. So moral hazard is more than a textbook concept concocted by economists to scare policy makers. Worse still, there are bailouts and there are bailouts. Mr. Paulson and, later, his Obama-appointed successor bailed out several big banks and insurers deemed too big, and/or too interconnected to fail.
But in the end taxpayers were covering only losses already incurred, some of those losses recognized on the banks' book, others yet to be acknowledged. The inflow of bad paper was being halted by better control of, among other things, dicey mortgages.
Greece is another story altogether. The bailed-out banks stopped writing duff mortgages; Greece's debts mount every day. Whatever relief the rich, or at least less financially troubled euro-zone countries can provide will get Greece through to its next financings in April and May. But it does nothing to encourage the change in behavior that will be needed if the flow of red ink is to be stanched. Indeed, it sends a signal to politicians in the so-called PIGS—Portugal, Italy, Greece, and Spain—that cutting spending can take a more leisurely course than would be necessary if default looms. Never mind that Article 122 of the Lisbon Treaty restricts financial assistance to circumstances in which "a member state is in … severe difficulties caused by natural disasters or exceptional occurrences beyond its control…". The wordsmiths in Brussels can drive a tank—or a bailout through that loophole.
A bit of simple math, laid out by consultants the Lindsey Group, tells the tale. A bailout would indeed enable Greece to refinance its debt at a slightly lower rate, but the reduction in rates on the new debt would bring the deficit down by only about 1% of GDP. Larry Lindsey, the firm's chief executive, reckons that "a swing in the primary deficit of, say, 5% of GDP (roughly a 10 percent cut in the government budget) is needed to bring Greek finances close to within sight of sustainability."
That would have been difficult to achieve before the euroland rescue package. Government workers are striking in protest against a pay freeze and a ban on new hires, and an increase in the retirement age from 61 to 63; farmers are demanding increased subsidies; and businesses are up in arms at the government crackdown on tax evaders, which includes a requirement that all businesses issue receipts—an estimated 30% of VAT goes uncollected. Now that all these parties know there are deep pockets available to prevent a default, resistance to real austerity will undoubtedly increase.
Unfortunately, Greece, which accounts for only 2.5% of euro-zone GDP, has become the canary in the coal mine. It's gasping for air has increased scrutiny of the finances not only of peripheral countries, but of France, which has not balanced its budget in 30 years. So we are to have Europe-wide fiscal austerity just when the European Central Bank is planning to announce its exit strategy. That combination of tight fiscal and monetary policy surely bodes ill for Europe's fragile recovery, at least in the near term
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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