The New York Times
Eight experts and analysts discuss the merits of an IMF-EU bailout on the New York Times “Room for Debate” forum.
Introduction
Europe’s finance ministers on Monday said they would hold off in sending a new infusion of aid to Greece until July, demanding that the Greek government first agree to spending cuts and financial reforms.
Greece needs the money to stay solvent. The International Monetary Fund was asking the European Union to effectively keep the Greek government afloat if its financing plan fell short over the next year. A Greek default would be twice the size of the two largest defaults in history put together — Argentina and Russia.
What form should an I.M.F. intervention in Greece take, who stands to gain, and what lessons have been learned from Argentina and other national financial crises?
The discussion
Bailing Out Europe’s Elite
By Simon Johnson, professor at the M.I.T. Sloan School of Management and a senior fellow at the Peterson Institute for International Economics, is the co-author of “13 Bankers: The Wall Street Takeover and The Next Financial Meltdown.”
The Greek government owes more than it can afford to pay, now or in the near future, at market interest rates. There are two options: reduce the payments through some form of restructuring, or move the debt into the hands of people who are willing to charge below market rates for the foreseeable future.
In this decision, the International Monetary Fund has relatively little to say. This is really a political decision to be made by the European Union, with discrete backing from the U.S. and China.
While European Union leaders are surely tired of Greek politicians at this point, they also fear the implications for other euro zone countries if Greece says it can’t pay or won’t pay. And the damage would not be limited to Spain.
Do not underestimate the smugness with which the euro zone has completely and utterly failed to prepare for any kind of sovereign default. The lack of loss-absorbing capital in major European banks is a first order scandal that could bring down governments.
Fortunately for the undeserving European policy elite, the I.M.F. has plenty of money it can lend at low rates and the Europeans have plenty of votes at the I.M.F.
The I.M.F. can also access considerably more funding as needed, with the agreement of the United States, which really does not want another short-term shock to the world economy. And funding is available from China and other emerging market countries with large stockpiles of foreign exchange reserves.
China has every interest in making sure that the euro survives and prospers as a major reserve currency, and that over a longer period of time the U.S. dollar will decline as the primary place in which to hold public and primary rainy day funds.
The I.M.F. will do as it is told by its major shareholders: help refinance Greece, and effectively protect creditors and euro zone politicians to the fullest extent possible.
The Moral Hazard in Greece
By Aristides N. Hatzis, associate professor of philosophy of law and theory of institutions at the University of Athens. He is the author of the Greek Crisis blog.
Apparently there is a God and he’s Greek, as some people in Greece seem to believe. One of the proofs of his existence is the fact that Greek political leaders have the luxury to play opportunistic games — and hell hasn’t broken loose. Yet.
Despite the low quality of the Greek political class (conservative, economically ignorant, populist and shortsighted), Greece was lucky enough to be governed, during its tumultuous history, by at least three great leaders who ensured Greece’s place in the Western world. One of them, K. Karamanlis the elder, managed to persuade European leaders to accept Greece into the European Economic Community in 1981, seven years after the fall of the military junta.
Greece is not Argentina. One of the fundamental differences is that Greece is a member of the European Union and the euro zone.
Greece, however, lost a great opportunity to transform itself into a modern capitalist economy. On the contrary, after joining the E.E.C., the party began.
The Greek New Deal was not based on the redistribution of wealth created by the market since the market in Greece is highly regulated: it is a paradise for oligopolies, closed shops and pressure groups where tax evasion is socially accepted and politically excused. Greece’s aggressive pressure groups (unions, government agencies, cartels, closed professions, etc.) seized big chunks of the E.E.C. transfers and government borrowing.
The combination of corruption, rent-seeking and political opportunism led to the perfect storm. But Greece is lucky. The Argentina option (which included a period of time when more than 25 percent of Argentines lived in extreme poverty) is out of the question for a E.U. member.
The International Monetary Fund, the European Central Bank, the European Union, Germany and the United States will do their best to salvage Greece in order to avoid the dire consequences of a Greek default for world economies.
In addition, an exit from the euro will be devastating for both Greece and the euro zone. The I.M.F.’s preferential treatment, Obama’s attention and Germany’s anxiety are illustrative. However, the rejection of the Argentina option has induced moral hazard behavior in Greece, which has only worsened the crisis. Let us pray again.
Lessons From Argentina
By Alan Cibils, chairman of the political economy department at the Universidad Nacional de General Sarmiento in Buenos Aires.
As an economist who lived through the Argentine crisis nearly a decade ago, I am distressed by the trouble in the euro zone because it has many of the same ingredients that led to the Argentine debacle.
The International Monetary Fund’s mistaken prescriptions (yet again) and the European Central Bank’s intransigence leave Greece no option but to default and exit the euro zone. A brief recap of the Argentine experience may shed some light on where Greece is inevitably headed.
The Argentine crisis was the consequence of a decade of I.M.F.- and World Bank-sponsored free market economic reforms, which included pegging the peso to the U.S. dollar on a 1 to 1 exchange rate. This all but eliminated the ability to conduct independent monetary policy — much like the euro arrangement today. All barriers to trade and financial flows were removed, and all state enterprises were privatized. The 1994 privatization of its social security system alone explains Argentina’s explosive debt accumulation between 1994 and 2001 and the resulting default.
Argentina’s policy framework proved too restrictive when a recession set in during the last quarter of 1998. When external sources of funding dried up, Argentina turned to the I.M.F., which recommended the same austerity policies currently being promoted for Greece (and Ireland, Portugal and Spain). The I.M.F.-promoted spending cuts only deepened the Argentine recession, as any introductory macroeconomics student would have predicted. By 2001, the recession had turned into a depression, making accumulated debt impossible to service and resulting in enormous capital flight, a run on deposits and the largest sovereign default in history.
After the default and the January 2002 devaluation, Argentina’s economy continued to contract for only one more quarter. By the second quarter of 2002, Argentina’s economy began to grow and did not stop until 2009, when the global financial crisis made its impact felt there. The doom and gloom predictions of what would happen after default never materialized. Furthermore, after defaulting, Argentina no longer needed to access international capital markets, eliminating their stronghold on Argentine economic policy.
Greece (and Ireland, Portugal and Spain) should learn lessons from Argentina’s experience. First, the I.M.F. still promotes policies that inevitably make matters worse, demonstrating an inability to learn from past mistakes. Second, default can be a solution, since it can end an unsustainable situation, frees up fiscal resources for more productive use and eliminates the need for access to bond markets. And third, regaining control of the national currency and the ability to conduct independent monetary and fiscal policies are essential for economic recovery.
Why the I.M.F. Isn’t the Solution
By Veronique de Rugy, senior research fellow at the Mercatus Center at George Mason University.
As sovereign default in Greece becomes increasingly likely, a lot of people are turning to Argentina in hopes of learning something from that country’s 2002 default experience and its recovery. To be sure, there are significant parallels between Argentina’s financial debacle of the 1990s that led to its default, and Greece’s current financial nightmare. Like Greece, Argentina carried a large amount of debt (almost $100 billion), had tied its currency to another currency (the dollar) and was relying on loans from the International Monetary Fund.
However, some clear differences also make Argentina a bad role model for Greece. First, if anything, the financial situation is much worse in Greece than it was in Argentina. According to the European Commission, this year, Greece’s public debt reached a whopping 158 percent of gross domestic product, the biggest in the euro’s history. By contrast, Argentina’s public debt was 62 percent of G.D.P. in 2001.
Second, Tyler Cowen reminded me recently that Greece, unlike Argentina, does not have another printed currency available to ease a break with the euro, as Argentina did when it broke with the dollar. But the peso gave another advantage to Argentina over Greece. While Argentina didn’t have access to bailout money from other countries (than through the I.M.F.,) the country was ultimately able to devaluate, which likely contributed to its recovery.
This option isn’t available to Greece for now, even if a weaker currency than the euro would be more appropriate for this relatively poor country. Germany and France are unlikely to allow it for fear that a bank run in other weak countries like Portugal and Spain would follow, exposing European banks to serious, maybe insurmountable, problems. The same contagion risk exists if the Greek government decides or is forced, as will likely be the case at some point, to restructure its debt. That, too, wasn’t the case for Argentina
Does the solution rest with the I.M.F.? Hardly. First, it should be obvious by now that there is no silver bullet to addressing this systemic problem. What isn’t obvious, however, is that the I.M.F. can effectively turn things around. It didn’t in Argentina before the country’s default. According to Peter Boone and Simon Johnson, in 2003, the IMF “recognized that their decision to repeatedly bailout Argentina from the mid-1990s through 2002 was wrong.”
Yet, the I.M.F. has agreed to another program that will likely fail. Not surprisingly, this path is vigorously supported by the French and German governments, which aren’t willing to let their taxpayers know the full extent of the euro zone’s financial mismanagement. But the debt will have to be paid. One lesson from the past is that the I.M.F. always gets paid back. It’s hard to see how there could be any happy ending to this story.
The Advantage of a Clean Start
By Eduardo Levy Yeyati, professor of economics at Universidad Torcuato Di Tella in Buenos Aires and a senior fellow at the Brookings Institution. He was chief economist of the Central Bank of Argentina in 2002.
Let´s be clear from the beginning: insolvent debtors need genuine debt relief, in the form of a debt restructuring that reduces the nominal value of debt obligations. Sovereign countries are no exception.
The debt crises in Latin America in the early 1980s offer an eloquent illustration. Back then, the first response was to make time for drastic fiscal adjustments through an United States-sponsored International Monetary Fund package, to which the 1985 Baker Plan added a voluntary rescheduling of private bank loans. The result was a huge debt overhang that discouraged investment and growth, and led to growing debt ratios. It wasn’t until 1989 that the players involved recognized the need of a debt haircut and launched the Brady Plan, which exchanged unrecoverable, unmarketable loans for discount marketable Brady bonds — the seed of emerging markets as we know them.
In this light, Argentina was just a recent example of a more general principle: a debt restructuring may bring forward economic pain (hence, the reluctance of politicians to press the default button) but it is a necessary condition for insolvent economies to recover, which Argentina started to do in mid-2002.
Would the Argentina option work for Greece? Yes. It would not solve Greece’s lack of competitiveness or unbalanced fiscal accounts, but it would offer a clean start and a strong political incentive for Greece to adjust.
That said, a final note is in order. Unlike Argentina, Greece belongs to a euro zone that, many would argue, should move to a fiscal union if it wants to succeed. In other words, euro members may choose to pay for the Greek debt relief themselves. Would a euro zone bailout work? Yes. It would require stronger euro zone rules and enforcement at the expense of fiscal sovereignty, but it would put default fears to rest.
Whatever the final choice, a Baker-style rescheduling halfway between a default and a bailout would only postpone the day of reckoning.
Avoiding the Default Trap
By Daniel Gros, director of the Center for European Policy Studies in Brussels.
European policy makers are caught in the “default” trap. They realize that Greece’s debt is unsustainable, and that Greece is actually much worse than Argentina was 10 years ago. But they fear the consequences of the kind of disorderly default that happened to Argentina. So they just keep on financing Greece as the lesser evil of options.
But disorderly default or further bailouts are not the only alternatives. Instead, one should take advantage of the current low prices of Greek debt to go for a market-based debt reduction. This could work in the following way:
The European rescue fund — European Financial Stability Facility, or E.F.S.F. — should offer holders of Greek paper an exchange into E.F.S.F. paper at the current market price. Banks could be “induced” by regulators to accept the offer.
The E.F.S.F. could then be the only remaining creditor of Greece and propose a bargain to the country: “We write down the nominal value of our claims (say, 280 billion euros) to the amount we paid (say, 150 billion euros) and extend all maturities (at unchanged interest rates) by five years provided you (Greece) agree to additional adjustment efforts (and asset sales).”
This should be too good of a bargain for Greece not to accept since it avoids default and saves the country 130 billion euros. While the E.F.S.F. exchanges the stock of Greek bonds, the International Monetary Fund could finance the remaining deficits in the usual way, with bridge financing until the fiscal adjustment is completed.
Greece would then be left with some I.M.F. debt and the 150 billion euros it owes to the Europeans. Together, this would be about 85 percent to 95 percent of its gross domestic product, which is not far from that of France. It would be high but manageable.
The ratings agencies might still judge this operation as a “default,” but the market reaction is likely to be mooted since all that is happening is that investors realize the losses that they have already on their books if they “mark to market.” There would be no uncertainty nor endless haggling with the creditors as is unavoidable with a disorderly default. The Greek economy would not collapse, and the debt servicing capacity of the country would be left intact.
Prevent Contagion
By Edward Harrison, banking and finance specialist at the economic consultancy Global Macro Advisors. He is also the principal contributor to the financial Web site Credit Writedowns.
Defaults by large national economies have occurred many times in history, Argentina being the most memorable recent example. Financial crisis often precipitates these defaults. A number of countries were forced into International Monetary Fund programs when Argentina was under stress early last decade. Of those countries, Argentina is arguably the worst example for today’s I.M.F. aid recipients to follow.
Argentina suffered a significant downturn in 1998 in the turmoil after Russia’s default. After a painful three years, Argentina was forced to ask for an I.M.F. loan. But this was not enough, Argentina unilaterally defaulted on its financial obligations to foreign creditors in early 2002. That is to say, the country stopped paying its creditors without having reached mutual agreement to do so. The result was a large currency depreciation and high inflation that impoverished the country’s people and made Argentina a pariah in international credit markets. The country was able to recover economically and eventually regain access to credit markets, but it took a decade.
This is not a success story. Argentina’s recovery fares unfavorably to other sovereign debtors like Uruguay and Turkey, which had similar problems at the time but recovered much more rapidly. Argentina’s problems owe largely to the unilateral nature of its decision to default.
So the question is not whether the Argentina option would work for Greece? The Argentina option will not work for Greece because Greece is a member of the euro zone and will not see a 75 percent depreciation in its currency’s value. The real question is what lessons can Greece, the European Union and the I.M.F. learn from previous bailouts to avoid Argentina’s fate?
To answer that question, look at the following issues:
1. A sovereign debt crisis is also a banking crisis. Were Greece to fail to meet its financial obligations, its creditors would suffer capital impairment. This would render the large Greek financial institutions insolvent while damaging the capital base of a number of foreign institutions.
2. Contagion is always an issue. This was true during the less-developed-country debt crisis in the 1980s, during the Asian and the long-term capital management crises, and it is true again today. Ireland and Portugal have already been forced to take aid packages. Yet, as with Greece, credit market participants doubt whether those countries will be able to make the fiscal adjustments that would allow them to pay their debts without defaulting. If Greece were to default, it is likely that these countries would lose market access and be forced to default. Moreover, the contagion would then spread further to Belgium, Italy and Spain. These contagion issues are more important to the viability of the euro zone than a Greek default.
3. If debtor sovereigns don’t grow, they won’t pay. Austerity is a poor way to solve unsustainable fiscal trajectories. Fiscal contraction reduces output and tax revenue and, therefore, increases budget deficits unless the cuts are large enough to overcome this effect. Greek citizens will not abide the level of cuts now contemplated, nor will that austerity program solve Greece’s longer term prospects. As in Argentina, the likely scenario after austerity would be depression followed by default.
An effective plan is primarily about political will. Europe needs to stop dithering and accept the fact that Greece is insolvent. They can then proceed with the I.M.F.’s assistance toward a solution that allows Greece to grow while offering incentives to Greece to cut deficits and to creditors to accept interest and principle reduction. Greek banks and the most exposed foreign creditors will need to be recapitalized. And contingency plans for Ireland and Portugal must be publicized at the same time to prevent contagion.
Putting off the day of reckoning makes the situation politically unpredictable and, therefore, considerably worse. This would increase the likelihood of other defaults and of the euro zone coming undone. Acting now maximizes the recovery value for Greece’s creditors and allows the E.U. time to develop the institutions needed to support a single currency.
Get It Over With
By Dani Rodrik, professor of international political economy at Harvard’s Kennedy School of Government, and the author of “The Globalization Paradox: Democracy and the Future of the World Economy.”
When Argentina defaulted on its debt a decade ago, the country became a pariah in the eyes of foreign bankers and bondholders and was shut off from international financial markets. Yet its economy recovered quickly and experienced rapid growth thanks to a large boost in external competitiveness provided by a vastly depreciated currency. The lesson is that default can be the better option when the alternative is years of continued austerity.
In the case of Greece, this scenario is greatly complicated by the country’s membership in the euro zone. Greece would have to exit the euro zone to be able to engineer a currency depreciation. Since this is something for which euro zone rules do not make any allowance, a unilateral exit will unleash huge uncertainty about the rules of the game. And a Greek default will almost certainly be considered a hostile act by Greece’s European partners – never mind that German and other euro zone banks were equally at fault for having over-lent to the Greek government.
Unfortunately, the current strategy seems destined to force Greece to this outcome. It is predicated on protecting German and other European creditors and bondholders while Greek workers, retirees and taxpayer pay the bill. This makes no sense economically, and will not work politically.
One way or another, Germany, France and other euro zone creditor countries are on the hook. If Greece eventually defaults, they will have to pay for their banks’ mistakes. It would be far better for them — and for the future of the euro zone — if this reality were recognized quickly. A coordinated, agreed-upon reworking of the rules will not be easy. But it will do less damage than insisting on politically unsustainable levels of austerity and having default and exit from the euro zone forced on the Greek government by protests on the streets.
