Sunday, July 19, 2015

Greek Moral Hazard and Haircuts: ηθικού κινδύνου and κούρεμα


Holy moral hazard! Those immoral Greeks. Borrowing too much and sticking it to the stolid Northern Europeans! Would that it were so easy.

Moral hazard is usually used to refer to the risk that nations, companies or individuals will borrow more than they can repay if they know or believe they won't have to pay some or all of what they borrow. 

But moral hazard goes both ways: economists also refer to creditor moral hazard: the risk that lenders will lend too much if they know or believe that they will be bailed out. The "Too Big to Fail" banks in the U.S. made creditor moral hazard all too real when they went beserk lending to deadbeat borrowers in the 2000s. 

The 2010 and 2012 international bailouts of Greece actually were bailouts of the European and Greek debts that lent to Greece. Only a small percentage, maybe 10%, went to Greece.

A recent Financial Times column focused on the little-ballyhooed lender moral hazard:
There are two sets of moral hazard over Greece. First is the moral hazard of the lenders. Just like the criminally irresponsible banks in the run up to the 2007 subprime crisis, lenders took no account of Greece’s ability to repay when advancing them ludicrously cheap loans. But when the crisis first hit, the German and French banks and other owners of Greek bonds were bailed out, allowing them to escape relatively unscathed. (The 2012 haircut hurt those bondholders who stayed in, but Europe’s banks had already cut their exposure to Greece.)
Is there any doubt that this will happen again and again and again?



The IMF staff has recently made it clear that Greece will not be able to meet the targets for reduction of debt established in the 2012 bailout. ("It is clear that the policy slippages and uncertainties of the last months have made the achievement of the 2012 targets impossible under any scenario.") But Angela Merkel cannot stand the political risk to her own government if it agreed to a haircut. So, haircuts are, for now, off the table. So says Christine Lagarde, Managing Director of the International Monetary Fund, 

What's wrong with haircuts?

In debt restructuring agreements, a haircut is a percentage reduction of the amount that will be repaid to creditors. Haircuts occur when the value of a loan -- the amount the borrower is willing or able to repay -- drops precipitously. Generally, a haircut has to be agreed to, unless it is shoved down the lender's throat as a matter of law. Think bankruptcy.

Sovereign defaults are fairly commonplace. According to Database of Sovereign Defaults, 2015recently published by the Bank of Canada, during every year from 1975 to 2014, over 40% of all nations were in default to one extent or another. There have been many instances of sovereign debt haircuts--from 1970 to 2010, 182 haircuts in 68 countries, according to statistics contained in a report, Sovereign Defaults: The Price of Haircutspublished by a Munich-based research group, the CESifo Group.

A new paper, Sovereign Debt Relief and its Aftermath, issued by the same group, found that "[t]he economic landscape of debtor countries improves significantly after debt relief operations, but only if these involve debt write-offs. Softer forms of debt relief, such as maturity extensions and interest rate reductions, are not generally followed by higher economic growth or improved credit ratings." In other words, debt write-offs enhance the debtor's economic prospects. 

In bailing Greece out, Germany, in reality, bailed out international banks, putting taxpayers, not stockholders, at risk. Of course, if the banks had remained at risk, each nation would eventually have had a choice: let the shareholders suffer or pass the risk onto the taxpayer. Lehman Brothers or AIG, Merrill, RBS, etc. 

The question is, would the taxpayers of Germany be better off in the long run if Greece is allowed to continue to stagnate and suffer or if it were helped back to its feet?