Greek debt and German banks
Are you fascinated by the “debt as moral weight” arguments you see being tossed around and viciously debated over in Germany and Greece nowadays? It seems like the moral debate has superseded the economic reality of the situation. Even the IMF has declared the current Greek deal untenable, but that hasn’t seemed to interfere with the actual negotiations.
What gives? Many point to history to explain this. Besides the whole Nazi thing, or maybe exactly because of it, the Greeks keep reminding the Germans that they (and others) forgave half of existing German debt after World War II, with the1953 London Debt Agreement. The Germans have responded vehemently that such ancient history is irrelevant, and that the Greeks are a bunch of lazy olive-eating tax avoiders. It’s a dirty fight, and getting dirtier every week.
I maintain we don’t have to examine the history of 60 years ago to understand at least some of the moral anxiety. Instead we should look a mere 7 years ago, at the enormous German bailout of their own banks, which had invested quite recklessly in all sorts of the most risky financial instruments and, most relevantly, Greek bonds.
Start with the basic facts. German and French banks invested very heavily in Greek bonds, partly because they were allowed by European Basel “risk regulation” laws to set the risk of those Greek bonds at zero, and partly because they were just investing in anything and everything with a relatively high yield. Since Greek bonds were at a higher yield than other government bonds that maybe deserved the “zero risk” designation more, they naturally bought an asston of those.
[Side note: whenever there’s a market with a spectrum of products, the ones with the biggest yield for a given risk profile will be snatched up the fastest, because people want to maximize profits. We’ve seen that this almost always is a bad thing and creates bubbles very quickly. But it’s also the reason people are constantly inventing new products that hide risk. In this case they didn’t need to “invent” anything, because it was a political decision to designate Greek bonds at zero risk.]
There are two ways to look at this story from a morality standpoint. One is that, no matter who owns this debt now, the Greek government is on the hook for borrowing it and needs to figure out how to pay it back. From this point of view it was a mistake of the Greeks to issue too much debt and to spend it unwisely, while not cracking down on tax avoiders.
The other way to look at it is that, German banks should have known better to buy this debt in the first place. After all, it’s a free market, and nobody forces you to buy things, and after all if there really were no risk at all on it there would also be no yield (beyond inflation). But the very reason Greek bonds had yield was because the market was differentiating it from German bonds. From this point of view it was a mistake of the German bankers.
Either way, when the Germans bailed out their banks, they took what was a bank problem and made it into a taxpayer problem.
Have I oversimplified? I’ll also admit that, after that whole bailout went down, a series of “Greek bailouts,” all of which were clearly insufficient, made the European governments even more involved, and the Greeks owed way more on paper to the European taxpayers, which layered on the debts while destroying the Greek economy. But most of those bailouts were simply loans which were used to pay back the original loans. Put another way, the Greeks might not have needed bailing out if the original Greek bonds had been refused by risk-averse bankers in the first place.
This is not to suggest that there was perfect planning going on by the previous Greek governments. But I do think that, if we’re looking for who deserves blame in this story, we might want to circle back to the German bankers who couldn’t resist subprime mortgages and Greek bonds back in the early 2000’s.