Bailing Out Greece Not Like the 2009 Bail-Out of U.S. Banks
April 20, 2010
Watching the drip-by-drip evolution of talks to avoid a near-term Greek government default leaves me with a feeling of deja vu. Didn’t the plan to infuse major U.S. banks that began in late 2008 also take much longer than expected and include several big and unexpected steps backward along the way? Many faux pas were committed back then, like the bust of a first press conference by incoming Treasury Secretary Geithner, which created considerably more confusion than it dispelled. Many doubted the youthful-looking Geithner would be up to the task, and critics urged him to resign. Then, like now, officials spoke mostly about general objectives but were miserly in dispensing illuminating details of the plan. We saw then, as now, how terribly impatient markets can be with a situation that’s dictated by the politics of deal-making, and that’s actually a good trait. When unpleasant decisions have to be made, disorderly market behavior provides the disciplining motivation for officials to take the plunge and quit putting off what needs to get done.
Federal support for illiquid banks in danger of insolvency proved to be a win on numerous counts and worth the interminable wait. The intensifying downward spiral of financial markets was stopped in many cases and reversed in others, notably world equity markets. The Federal loans made a profit for taxpayers. The bailout didn’t prevent a wrenching recession or stop unemployment from soaring to a peak of 10.1%. 90% of active U.S. job seekers still have work, however, and both they and those without a job feel much more comfortable now than they would if market capitalization were stuck at the levels of early March 2009. This turnaround has enabled consumer confidence to mend much more rapidly than still-soft income growth can explain. Aiding banks a year ago set in train a process that replaced a toxically vicious cycle with a virtuous one. The United States experienced a much shallower drop of GDP in 2008-9 than anticipated by analysts in the first quarter of last year, and with each passing week, the upturn seems somewhat more sustainable.
I don’t expect a bail-out of Greece to produce a similar reversal in mood about that country or the European Monetary Union. There are some notable differences in the two situations, which outweigh the similarity of two sagas played out in super slow-motion. The arithmetic of Greece’s debt problems will still be extremely adverse. Crunching the numbers suggests that aid from the EU and IMF only buys time in which a default and restructuring of debt will still become necessary. All the uncertainty of the eventual terms of such an arrangement will still linger. A default in 2010 will have been forestalled, but there will be no guarantee that the extra time to work out a longer-range deal will be utilized wisely. Greece is only one of several countries facing an extraordinary squeeze on its public finances. The Greek bail-out has not been used as a prototype for other cases like Portugal, Spain, Ireland or Italy. The aid given U.S. banks came with strings, as all rescue packages must. However, the most important policy move that the Greeks need to implement to transform fiscal trends into something that looks sustainable will remain forbidden.
Greece needs a depreciating currency, not just against the dollar but versus its neighbors, while imposing draconian fiscal cutbacks that will throw domestic demand into severe recession. But the whole point of the rescue is to prevent Greece from leaving the European Monetary Union and devaluing the drachma. The goal of the plan inherently undercuts its ability to succeed. So there’s little point to this theater, which exposes the disharmony among EMU members. Without currency depreciation and a looser, Greek-customized monetary policy to mitigate the pain of a very restrictive fiscal stance, the Greek economy will be chasing its tail, as austerity depresses growth and tax revenues, keeping the deficit ratio excessively high and the excessive debt ratio on an upward trend.
The bail-out of U.S. banks did not erase the root economic imbalances like the chronic current account deficit and low savings rate. But it addressed enough of the problem to rebuild the house of cards upon which the U.S. economy had previously rested contentedly. The U.S. bank rescue did not explicitly rule out the one policy option above all others that would be necessary for the plan to succeed. Another bust probably lies ahead, but it could be well down the road. Frankly, nobody knows the length of this respite. Sufficient uncertainty exists for investor psychology to have improved significantly. A bail-out of Greece that leaves that economy strait-jacketed in a common currency with no way to restore competitiveness is unlikely to reassure investors even in the short run and will leave psychology about the long-term outlook also quite depressed.
Copyright Larry Greenberg 2010. All rights reserved. No secondary distribution without express permission.
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Very insightful.
What is the chance nationalism will appear and some of the European Union countries will decide to exit? It looks like Greece will not able to really recover from this due to the high interest rates it will have to pay from now on.