Greece is screwed, and it’s because of irresponsibility.
The troubled Mediterranean country's government accumulated massive amounts of public debt after it joined the Eurozone in 2001. By April of 2010 it owed a total of €310 billion, 130 percent of the country’s GDP.
Caution was thrown to the wind out of the belief that A: the good times would last, and the economy would grow fast enough for the government to continue servicing its debt, or B: it's Eurozone partners would never let it leave the currency union.
The Greece crisis was caused by what economists call “moral hazard,” the expectation that outside intervention will provide insulation against losses in a given transaction, so risky behavior carries higher returns without correspondingly higher potential costs.
The bailout conditions currently being imposed on Greece – under which it will received €86 billion in European taxpayer money over the next three years – are harsh. The country’s parliament was required to enact pension reform, raise taxes, and introduce automatic spending reduction mechanisms in the event that future budget surplus targets aren’t reached. And those are just preliminary measures; negotiators haven’t even rolled up their sleeves yet.
Observers including Philippe Legrain (former economic adviser to the president of the European Commission) and economist Barry Eichengreen speculate that this harsh deal is intended to send a message to all EU members: if you break the rules, you will pay a severe price.
Its official creditors, the largest being Germany (which holds more than €60 billion in Greek sovereign debt), are attempting to shutter the moral hazard(ous) window that got Europe into this mess in the first place.
But in the process of squashing one form of moral hazard, it appears they’ve created another, this one being potentially more dangerous.
By providing emergency funding to Greece, the country’s Eurozone partners have ensured that the interests of bondholders will be put above all other considerations. The Greek bailouts have insulated the country’s creditors from the risk they were supposed to have assumed when they purchased Greek sovereign bonds during the years prior to 2010.
The worst aspect of this series of government intervention is that it made taxpayers in fiscally-responsible European countries responsible for holding Greek debt.
To illustrate this point, when Greece first asked for a bailout in May 2010, the vast majority of its €310 billion public debt was owed to private creditors, including hedge funds, banks and individuals. Der Spiegel reported in April of that year that Greece owed €43 billion to German banks alone. The nature of Greek debt changed during the first bailout, when euro-area governments extended $53 billion of (taxpayer-funded) bilateral loans to Greece.
This amounted to a transfer of debt from the private to the public sector: new loans were used to pay off old, substituting obligations to private creditors with obligations to EU member state governments. As Legrain put it in a recent op-ed, “through their loans to Greece, Finns and Slovaks bailed out German banks, not Finnish and Slovak ones.”
The Economist reported that by June 2011 more than half of the country’s outstanding debt was in public hands. Paradoxically, other crisis-ridden countries were forced to take part in the bailout. Spain, Ireland, Portugal, Cyprus, Estonia and Latvia each suffered financial crises and had to ask for bailouts at least once between 2009 and 2013. Every country on that list has also contributed to Greece’s bailout fund.
2012 brought another, larger state intervention. The second bailout saw €130 billion extended to Greece through a vehicle called the European Financial Stability Facility (which was later succeeded by the European Stability Mechanism). Rather than the loans being bilateral, this time the taxpayers of every euro-area government contributed to a common pool of funds.
Private creditors finally received some of the market discipline they had coming. One hundred billion euros in Greek treasury bonds were written-off, forcing creditors to take “haircuts” on the money they were owed. (One shouldn’t feel too bad. The only thing standing between them and an outright Greek default was the insistence of Eurozone governments to play fast and loose with taxpayer money).
By January 2015, a staggering 83 percent of Greece’s €388 billion debt (a total of €322 billion) was held by public institutions: the other 18 Eurozone governments (62 percent), the ECB (8 percent), which is capitalized by the contributions of member governments, the IMF (10 percent) and the Bank of Greece (3 percent).
Private lending institutions, which had been willing partners in creating the Greek disaster, were on the hook for only 17 percent of the country’s outstanding debt.
That massive, government-engineered shift of financial resources from taxpayer to creditor (a redistribution of wealth from many private hands to fewer private hands) represented crony capitalism at its near-worst. I say “near” because things did in fact get worse.
According to the agreement of the July 13 2015, Greece will be extended another €86 billion over three years. The loans will be provided via the ESM, meaning that taxpayer money will be pooled by member states and loaned to Greece so that it can make payments on its existing debt, the majority of which is now held by those same member states (along with the ECB and IMF).
The Greek government had lobbied hard for another “haircut” on its debt obligations, a la the one it received in 2012. The text of the agreement squashed any hope of that: “nominal haircuts on the debt cannot be taken.”
This time, refusing a write-down has a perverse justification, because most of the money is owed to public institutions which are funded with taxpayer money. Giving a haircut to citizens in any of the other 18 euro-area governments that now hold Greek debt is off the table, which looks like a good thing.
But here’s the rub: Greece is unlikely to ever reduce its public debt to a sustainable level (where budget surpluses are consistently large enough for its debt to GDP ratio to fall) unless it gets a significant write-down from its existing obligations. Total public debt currently stands at 170 percent of GDP (it was 130 percent when it first asked for a bailout in 2010). Eurozone governments – with the exceptions of France, Italy and Cyprus – won’t consent to a write-down largely because that money is owed directly to their constituents.
But the reason that Greek debt is now in public hands is not because the Greek government (let alone the citizenry) willed it so. In 2010, when it was clear that the state was bankrupt, the government of center-left Prime Minister George Papandreou considered declaring bankruptcy and defaulting on its debt in a legal, orderly fashion.
Those creditors first in line would have gotten paid, the rest wouldn’t have, and the market would have punished irresponsible investors for putting money into a clearly dysfunctional enterprise.
But because Greece is a member of the common currency area, its partners decided that it would do too much damage to the institution’s credibility. If a Eurozone member could default on its debt, what was the currency worth?
More importantly, the prevailing belief was that Europe’s financial architecture, mostly banks located in wealthy Northern countries like Germany, the Netherlands and the UK (the latter not being in the Eurozone), wasn’t strong enough to withstand a default.
Eurozone governments would have had to bail out their banks directly, something that was politically less palatable than providing emergency loans to Greece. Financial institutions would have been bailed out in either case, but this way it could be spun as a display of European “solidarity.”
Where things currently stand, the Greek people will suffer through another several years of austerity. Higher taxes and lower public spending will continue to depress private-sector growth, which, in addition to its harmful effect on living standards, will make it more difficult for the country to improve its credit position.
Failure to dramatically reduce its debt burden means that Greece will most likely need more bailouts, which will be financed by taxpayers in other Eurozone countries. In order to qualify to receive those funds, the Greek government will need to implement additional austerity policies, which will depress growth further, weakening its debt position still more.
It’s a raw deal for Greeks being squeezed by austerity and Eurozone citizens on the hook for ever-larger amounts of Greek debt. It’s a fantastic deal for creditors who kept their rewards while having the risk spread across euro-area taxpayers.
That’s the real moral hazard. If you lend money to a Eurozone government, no matter how profligate, corrupt and dysfunctional, the continent's political muscle will ensure that you are paid (at last almost) in full.
So if you hear rhetoric about Germany and its partners protecting free-market principles by imposing financial discipline on a profligate, left-wing government, ask yourself: who is really trampling on free-market principles here?