The more I read about the Greek debt crisis, the more convinced I become that policy makers are looking at an insolvency problem but seeing a liquidity problem. Getting this wrong is a great way to make a bad situation both worse and more protracted.
In a liquidity crunch, your banks are sitting on bad loans and are too undercapitalized to do much about it. Your credit markets freeze and your economy tanks. But your government and central bank are able to leap into the lurch and become the banking system for awhile, reflating the private system until it can run on its own again. That’s pretty much what the TARP did.
For something like that to work—and I’m not saying it was the best or only way for us to have gone—a few things need to be in place. Your government must be able to reliably borrow at favorable rates (and lenders must believe you can later pay them back), your banking system must be able to get back into borrowing and lending markets once their balance sheets recover, and if your currency can adjust to help boost external growth, that’s nice too.
If none of those things are in place, misdiagnosing insolvency as illiquidity can prolong a disaster and waste a lot of money along the way. I would argue that these conditions were, in fact, present in the US case. They are not in the Greek case.
I don’t mean to downplay the stakes of recognizing Greek insolvency. It’s one thing to whack shareholders—they made a bet and they lost…not pretty, but it happens. But creditors are different, and once you start defaulting on sovereign debt, you’re telling the world that blood transfusions (liquidity injections) to your financial system will not work. It’s time to call in the surgeons and amputate. (Note to U.S. Congress: is that the message you want to send to the world?!? If not, please raise the #!&&! debt ceiling!)
But you know what? Defaults happen too, even among sovereign nations. The longer policy makers misdiagnose insolvency for illiquidity, the longer this crisis will fester, ever deepening the human costs and far-reaching economic disruption.
I think you could credibly argue that some of the major US banks are still insolvent (Citi, BofA, etc.) and illiquidity was never the central problem. This is why our economy is still sputtering. The banks have kicked the can down the road instead of implementing major debt restructuring.
Hi there,
Interesting post, but perhaps you could clarify a key point:
Are you suggesting that European actions related to Greece amount to attempts to inject liquidity into the Greek financial system, as opposed to attempts to bridge the financial chasm between government coffers running dry and a sufficiently reduced budget deficit? ie. What actually leads you to believe they’ve mis-diagnosed the issue?
Whether they’re right or not, isn’t the intent to buy time to give the Greek government a chance to sort out its finances? If not, could you perhaps speak to what indicates that this isn’t their intent?
Jared,
Hungary is now growing at 2.5 percent a year.
United States GDP increased at an annual rate of 1.8 percent in the first quarter of 2011.
On growth, we’re really getting shown up in the world.
In the words of John Kennedy, we need to get this economy moving again.
Poland has been growing a lot more than Hungary and has for the past few years. I would be interested in an explanation for that.
Jared,
I think the important thing that people are missing in this is how much the players in this game have a real interest in what happens. German and French banks are major holders of Sovereign debt including Greek debt. Their governments are backing them up. That should hardly come as a surprise.
FWIW, I tend to put more credence in FT and the European press on issues like this. Something rather interesting just popped up at guardian.uk: http://www.guardian.co.uk/business/2011/jun/15/greece-debt-default-eurozone-austerity
Greece is at the forefront, but there are definitely echoes in the U.S. and elsewhere.
Reality bites the deluded.
Ouch.
“(Note to U.S. Congress: is that the message you want to send to the world?!? If not, please raise the #!&&! debt ceiling!)”
Jared, they’ve said it enough times, why don’t you believe them. That’s what the Republicans mean when they say, ‘we’ll become Greece if we keep spending’
They mean, they will make us into Greece if we don’t do what they want, which of course will ensure we are Greece 😉
“Creditors are different”?
How, exactly? I had the silly idea that the different rates paid by different borrowers reflected default risk. If you’re taking a higher yield in return for the possibility of not getting paid in full, how are you not making a bet? You seem to be saying here that creditors have a moral right not to actually bear the risk they’re supposed to be getting paid to bear.