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 It seems like the moral debate has superseded the economic reality of the situation.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.
mathbabe 
Very excellent summation. It is getting dirtier by the week. The demonization of the working Greeks really does not “cut it.” It just highlights the true class nature of the struggle.
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A Portuguese, a Greek, and a Spaniard go into a brothel. Who pays?
The German.
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Your summary is very true, but arguably incomplete. The German and French banks should have realized their losses, but that would have meant allowing Greece sovereign bonds to default which would have never happened politically in the Euro Zone. So they kicked the can down the road. It’s hard to say what the best course of action was at that point, but in general I think this just represents the inevitability of the institutional weakness of the Euro Zone as a currency union without a fiscal union.
Debt as a moral issue is unfortunately played up too much, since debt is rarely a moral issue rather than a financial one. However, the Greeks can be totally left off the hook – they were outright lying about their deficit/debt levels (with some help from Goldman) and so their ability to pay back loans was inaccurately measured by those German and French banks. Lying about this, in order to feed from the trough of already overeager lenders, is a moral issue.
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The Greeks can’t be totally left off the hook*
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What do you call the last five or six years in Greece, being left off the hook? Those who claim that the Greeks must suffer more make sadists look morally clean.
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Thank you for this fresh air on the “lazy Greek” meme that is bruited about by the know-nothings. Blaming the poorest for being poor never seems to fade….
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just seems like the entire world is engaged in a giant kick-the-can-down-the-road Ponzi scheme that will end in 15, 50, or 150 years when the final player (hopelessly indebted nation-state) kicks the final can one last time… with any luck, humans will be cyborgs by then and no longer require silly money to work or live!
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I’ve been fascinated as well by the moral tone of the debate. We’re often told economics is value neutral or that economic planning doesn’t have value assumptions… it’s never true, but in this case it’s been bizarre to me how people you’d think would propping up the “neutral efficiency” point of view are willing to get immediately into promise-keeping and the virtues of hard work and charges of laziness and yada yada yada. Great summary of the issue, thx!
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You touch on this in your last paragraph, but the common currency is a significant factor.
One implication of the averaging of the domestic currencies that the Euro represents is that Germany has been trading in a weaker currency than it “should” have, meaning that it exports more than it would be able to if it was still dealing in DM, and giving it a commensurately larger surplus. The flip side of this is that Greece has a much stronger currency than it “should”, increasing its ability to import and leaving it with a deficit.
In many common currency areas, capital is recycled (through taxation and government spending) to adjust for regional imbalances. Conversely, with an independent currency, the government can pursue devaluation as a way of restoring balance. Those avenues are closed in the Euro area, and so the imbalances continue to build until a breaking point is reached.
They have also have been exacerbated by the factors that you’ve described, and it’s fair to say that both sides are at fault. Greece has done a terrible job of addressing its inefficiencies and structural weaknesses. The German government does not acknowledge the role that its own economy has played in the problems now faced by Greece, and has unhelpfully refused to contemplate any policies other than those which are congenital to its national psyche – despite the manifest failure of those policies to date.
While I have every sympathy for lenders who want to be repaid, the political machinations in this side do tend to push me towards Greece’s side of the argument (notwithstanding my distaste for the various idiocies perpetrated by Greece). If Germany (or any other country) had a state or province that was dealing with 25% unemployment, with 65% of its young people unable to find jobs, it would NOT be talking about loans and austerity. Grants would be made and spending increased; the focus would be on growth, and not on cuts.
That this has not been the focus of the political thrust gives the lie to a common currency; lending money to repay loans that the borrower can’t afford to repay on its own is equally dishonest. Ultimately, the problem will not be resolved until the quantum of the debt is reduced (via creditor write-downs in some form), and some consideration given to the structural issues that drove this crisis to its current point.
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Lenders are expecting borrowers to repay loans, not because it’s the “right thing to do”, but because there are serious negative consequences to defaulting. For Greece, the consequence is leaving the Eurozone. For a homeowner, the consequence of defaulting on a mortgage is getting kicked out of her home. Lenders presume that the borrowers’ desire to avoid these outcomes creates sufficient incentive to continue repaying the debt. Defaulting is always a choice, but it should be a tough one.
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I liked interfluidity’s competing morality tales,
“There is one morality tale that says the debtor must repay, or she has sinned and must be punished. There is another morality tale that says the creditor must invest wisely, or she has stewarded resources poorly and must be punished. We get to choose which morality tale we most use to make sense of the world. We do, and surely should, use both to some degree. But if we emphasize the first story, we end up in a world full of bad loans, wasted resources, and people trapped in debtors’ prison, metaphorical or literal. If we emphasize the second story, we end up in a world where dumb expenditures are never financed in the first place.”
More, http://dkretzmann.blogspot.com/2015/07/greece_8.html
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It wasn’t just the German gov’t that bailed out German banks. The early bailouts of Greece were actually stealth bailouts of French and German banks. Only 11% of the money stayed in Greece. That is one reason that Greece is in a deep depression now. (I call it a stealth bailout. A lot of people knew about it. But it was presented as a bailout of Greece, not the banks.)
As for the morality aspects, that seems to be deeply ingrained in the German psyche. For instance, the German word for debt, die Schuld, mainly means guilt, blame, sin. The joke that abekohen tells us reflects the view of a lot of Germans, who believe that they are paying for the misdeeds of people in other countries, instead of the mistakes of their own bankers. In our modern economies, money is created along with debt as its flip side, but most people are not aware of that. They look at the national debt and only see the debt without seeing the money it represents. They think that it would be a good idea to pay it off, not realizing that it would be a disaster.
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A lot of the bailout money now, it is true, is being channeled from the creditors back to their own countries. But it should be noted that in 2010 the private creditors got a pretty substantial haircut so they’re not walking away from this totally unscathed.
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Given what the Germans did to my people, I could hardly be considered a philo-German.
Ignoring Germany and Greece for a moment, I wonder how many of you would feel comfortable stiffing a friend or family member from who you borrowed money. I can tell you I would not feel comfortable at all. To me it’s about ethics. Yes, blame the politicians and the bankers all you want, but bottom line the Greeks enjoyed the loan when things were good. Now it’s time to pay the loan back or work out a deal.
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Abe, if you land money to your drug addicted nephew, then you should know you are likely to lose your money. Moreover, you are probably getting your nephew into bigger troubles than before. Everyone knew the Greek were lying about the state of their economy when they joined the Euro-zone, but no one wanted to spoil the party.
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Yiftach, none of the Greeks that I know are drug addicts. And if I had a drug addicted nephew, I sure would not be lending money to him.
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Abe, it was a metaphor (possibly not the best one). Nevertheless, when Greece was accepted into the Euro-zone everyone knew they were lying and whoever lend them money knew they cannot pay it back and everyone knew they are not investing in improving their economy, but in raising their standard of living. When the Greeks got into the Euro-zone they felt like they won the lottery and we know that often these winning stories have a sad ending.
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Yes, I was aware that you were using a metaphor, one meant to absolve Greece of any and all responsibility and to place all of the blame on the lenders. Yet, not “everyone knew,” and not everyone agrees that such deception should be rewarded.
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No, it wasn’t meant to absolve Greece from all responsibility, but rather to put some blame on the rest of Europe (blame is not zero-sum, in my view). Moreover, there is a difference between the Greek government and the Greek population. If someone didn’t know, then they were idiots. I tend to suspect they didn’t want to know. Europe was caught in the idea of the united states of Europe and wasn’t willing to let reality spoil it.
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Another fool who thinks that the beating the Greeks have absorbed is not enough.
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I think it is incorrect to try to dismiss the moral aspect of these deals. Moral hazards are important in economics.
However, it is not the Greeks that haven’t held their end of the bargain with these loans. Prior to this latest crisis, the Greeks had achieved a primary surplus through deep cuts and government reforms.
The problem is also not that private banks made loans to Greece. If you believe no loans should have been made to Greece then well no loans should be made to Greece now when they are arguably in a worst position to repay. Plus if monetary policy would have been implemented competently these loans would have been viable to the banks.
The problem is that these loans were made and then Greece and other economically disadvantaged Eurozone countries were forced into a position where it was impossible to repay them. This was not Greece’s mistake so it shouldn’t be Greece paying for it. This was the error of those promoting a too tight monetary stance, of those that pushed interest rates above market rates. Morally speaking, it is those people that should pay.
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Overly tight money disproportionately affects economically vulnerable regions. If the average business return in Germany is 3% and it is 1% in Greece, maybe because of government structural issues but likely just because of natural disadvantages, because of less urbanization etc., if interest rates are pushed up to 2%, the average German business survives while the average Greek business perishes.
This is largely what happened in Greece (and other disadvantaged regions) and it wasn’t the fault of the people or governments in those regions.
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Consequentialist ethical reasoning (such as utilitarianism) is standardly applied in economics. It is unclear how the act of borrowing money is right or wrong for its own sake, so deontological reasoning seems not to apply.
The expected consequences of continued austerity are unfortunately rather clear, and aren’t good for anyone.
The expected consequences of a major write off of Greek government debt would perhaps harm lenders to some extent, or perhaps would merely confirm what has to happen anyway for them. The expect consequences of a major write off would benefit Greeks.
The consequentialist case for a major write off of Greek government debt is clear. Other reasons for or against are not.
Supporters of austerity claim there are long term political benefits of European unity. If so, this would introduce other considerations. I think this means that an economically integrated Europe makes war less likely. But austerity seems to make a rightwing reaction more likely in many European countries. So as an American, I’m puzzled by the claim of long term political benefits of the currency union.
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Analogously, in the US after the financial crisis, there was a similar debate over bailing out mortgage holders. On the right, starting with Rick Santelli’s televised rant against bailing out “losers,” the moral argument was made that mortgage holders were getting what they deserved.
Economists and others said that was beside the point. But the Obama Administration dithered.
Here’s one of many journalistic accounts that repeats the story of the Obama Administration’s limited mortgage bailouts: http://billmoyers.com/2015/02/14/needless-default/
In this story, a quote from former FDIC Chair Sheila Bair (a Republican) puts in plain words the moral dimensions of the easy mortgage bailout that should have given more help to borrowers:
“We would have helped unworthy borrowers, but did that matter at that point?” Bair asks. “We helped unworthy banks too.”
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I think you have correctly described events and that the beginning is the inability to stop making loans in 2000, just as it was in the USA. If you have not read Tanta on calculated risk I think you would enjoy it.
I think you have oversimplified when you say ‘Greeks’ or ‘Germans’ instead of dividing Greeks and Germans into lenders/investors and borrowers.
Not Greek borrowers and German borrowers, but just simply borrowers and lenders whether those borrowers are from Greece, Germany, Detroit, or SUNY Albany.
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SUNY Albany?
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http://www.albany.edu/studentaccounts/tuition.php
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Keep in mind that Greek banks were also beneficiaries of the original bailout. Does your story change if you replace German banks with Greek banks? If so why?
If not, note that Greek banks could not have survived without the bailout while German and French ones would have.
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Then again you have the example of Iceland where the banks did not survive, and neither did the loans. They seem to have made a respectable recovery
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Besides the moral discussion there’s a flaw in your facts:
Risky Greek bonds did not offer a substantial spread on less risky bunds since the introduction of the common currency and before the crisis. Just Google (Image) “historical european bond yields”.
Comment on the 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.”)
This misprizing may hold true only once or for products only offered once. In following offerings the issuing party will adjust its yield downwards (it’s price upwards). The excess demand leads to lower yields almost instantly. Why would the Greek treasury pay high yields if their bonds sell in seconds anyway? And that’s exactly what happened. The markets (wrongly) perceived the risk profile to be the same across Euro-members. As a result the yield became the same.
Your conclusion on moral responsibilities remains intact though. Just blame the bankers for ignorance instead of greed in this case. I also agree with you on the responsibility of bad regulation.
Another small note:
Imagine the total refusal of one major bank to lend to Greece (and the other “overpriced-bond” countries) at the prevailing low rate back then. I think the public and political outcry would have been enormous with headlines like: “Bank X wants to destroy Europe – But luckily everyone else is still sane”.
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Gary Gorton in his book “Misunderstanding Financial Crises” states it is very rare for a government to let a failing bank/s go under because of the knock-on effect and ultimately the impact on the payments system of a large scale banks collapse.
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Economis is by definition related to morals and politics. It is a social science and as such serves the people, not the banks against people.
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Got this from a French socialist:
The EU experts, charged with the examination of the Greek economic situation have reported the following facts. Greece supplied false financial information in order to enter the Euro and continued to conceal the truth until it exploded.
There are many people drawing a pension from the age of 50.
On average, there are 50 drivers for every official car.
There were 45 gardeners for a small lawn with 4 bushes at the Evangelismos Hospital.
Greece has the most fictitious residents over 110 years old in the world because families often fail to register deaths in order to continue to draw the pension.
The EU discovered that there are families illegally drawing 4 to 5 pensions.
40,000 girls draw €1000 per month for life because they were daughhters of state functionaries. The cost to the treasury was €550 milllion but the age has now been reduced to 18 years.
Heart stimulation equipment in Greek hospitals costs 400 time as much as in the UK hospitals.
In Greece, many workers have the right to early retirement (for 50 years old for women and 55 years old for men) because they exercise one of 600 professions classed as having specific risks.
For example Hairdressers (because the hair dyes could contain dangerous materials) Wind instrumentalists (blowing a flute is very tiring) and TV presenters (microphones are suspected of harming the health). This law was approved in 1978 by the then socialist government.
Unnecessary ministries and state institutes. One example is the employment of 1763 people to protect Lake Kopias – it was drained in 1930.
During the past ten years 300 new public undertakings have been created.
Tax dodging is rampant, more than 25% of the population don’t pay a cent of their personal income.
The weight of the public sector is crushing. There are more than 1 million state employees for an active population of 4 million.
The AVERAGE wage of railway personnel is more that €66000 per year. Thhe wage level of cleaners and unskilled labour is included in this figure.
The Athens metro is, to all intents and purposes, free – freee tickets to the value of €90 million are issued each year while thee annual running cost is over €500 million.
THE POOR PENSIONEERS
A Frenchman receives a pension of 51% of his final salary, a German 40%, a North American 41%, a Japanese 34%, a Greek 96%.
There you have it !!!
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I am sorry, but your data is simply false and manipulated. Of course not by you. Such things were massively reproduced in media across Europe 5 years back as a means to justify the bailout (and actually fool the public so that to accept the debt move from the banks to the states).
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