A day after the Greek elections, and we are all in speculation mode. Here is what I’m thinking.
Greece faces two short-term financial obstacles, service on its outstanding sovereign debt and backstopping of its financial sector, and the longer-term challenge of rebooting its economy. Let’s take them one at a time.
Thanks to the extend and pretend policy of the Troika, virtually all the external holdings of Greek sovereign debt are in the ECB. The point of the fictional bailout program, which had no overlap with reality, was to buy time so that private financial institutions could unload the bad stuff, which they did. Now the creditors are public. And they can price these bonds however they want. The point is that a formal writedown is not required; all that matters is servicing.
Now, in an economic sense, Varoufakis is right when he says that these bonds have already lost value: they can’t possibly generate their official payment stream. One way or another the creditors have to take a hit. But the problem is not distributional, it’s political. Demanding a level of servicing beyond the ability of the Greek state to provide, and then financing these payments through a “bailout” conditional on Greek “reforms” is a shell game, to be sure, but its purpose is to punish the Greek population and impose policies they would never accept through democratic processes. If you put it this way, the question is not about how the shell game is reconfigured—how large or small the fictitious flow of financing to Greece and then back to its creditors—but the role and content of political conditions. Syriza’s position seems to be maximalist in this respect: no political conditions. If they stick to this, there can be no deal unless Germany and its allies do a complete about-face, which is difficult to imagine for domestic political reasons.
But the political terrain is wide and has many dimensions. For instance, Syriza has proposed an overhaul of the tax system to finally end the impunity of the upper class. That ought to qualify as a “reform” to any reasonable person, and if moral hazard is your concern, it gets to the heart of it. Similarly, Syriza claims it wants to release the state from the clutches of the oligarchs, who have managed it as a source of profit for decades. I don’t know how they will pull this off, but surely this is the sort of reform Greece really needs. In other words, from the very beginning what was distinctive about the Greek case compared to the other financially strapped peripheral countries was the extent of corruption by the elite. This is widely known. If Syriza can package its domestic program as “reform”, and if some portion of it can be acknowledged on those terms by Germany and its allies, there is a basis for a sovereign debt settlement. Again, the issue has nothing to do with how much money is transferred in a “bailout” or how much of the debt is written off. The only real question is political.
Second, what about the Greek banking system? Between their large holdings of sovereign Greek debt and the nonperformance of much of the rest of their books, given the state of the Greek economy, these institutions are presumably bankrupt. Even though, under eurozone rules, Greece cannot supply its own currency, it remains on the hook as lender of last resort—an intolerable situation. In a better world, the ECB would assume responsibility for this function, since it is the liquidity creator of first, last and in-between resort. But that’s not the world we’re in. So what can Syriza do about this?
There are two sets of parties whose assets are at risk in the Greek financial system, investors (shareholders and creditors) and depositors. A plan for getting through a domestic financial crisis has to take both into account.
I think the first, if it can be separated from the second, is relatively easy. Allow existing private institutions to fold and let the investors take the full hit. But be prepared: take immediate steps to create a public institution that can function as a “good, new bank”. In the resolution of failed institutions the public entity would acquire still-performing assets, including those deemed to be potentially performing when normal conditions return—the Bagehot test. Let the rest go down with their respective ships. Meanwhile, the public entity can hire experienced, talented staff from the banks forced to close their doors. This is essentially the plan proposed in 2008-2009 for the US and Europe by many economists, such as Willem Buiter, Joseph Stiglitz and, much less prominently, by yours truly. It confronts moral hazard head on, and it avoids the continuing drag of zombie, or at least balance-sheet impaired, financial institutions. It is not without risk, but if the public entity is up and running before the private institutions collapse, it should do the job.
The bigger problem, of course, is the depositors. Again, this would not be such an obstacle if Greece could legally issue its own currency, but it can’t. Worse, the eurozone does not have a clear policy for backstopping depositor protection, as we saw in the Cyprus episode. At this point, it is quite possible that Europe would stand aside and allow the Greek public to have its accounts wiped out. There are elements in various governments that would even relish the spectacle as retribution for the sin having voted for Syriza in the first place. If depositors cannot be protected, Syriza will be out of power in a flash. This is Argentina territory.
I won’t bother with a discussion of the evolving eurozone banking supervision system; it is too slow and conditional to matter for Greece in 2015. In all honesty, I can’t see any substitute for an immediate arrangement specific to backstopping Greek deposits. My sense of the Cyprus experience is that it was chastening for the eurocrats, but I could be wrong. What can Syriza do if depositors are held hostage as leverage for austerity? I might be crazy, but I think this could be the one realm in which a print-your-own-euro plan makes sense. What would happen if the Greek CB created new currency for the sole purpose of redeeming deposit accounts at insolvent banks?
It should be added that, as soon as plans are begun to anticipate a banking crisis, that crisis will accelerate. This means that negotiations on deposit protection ought to begin immediately in private, and that plans to establish a resolve-and-replace financial facility in Greece have to wait until some solution is reached. This is the part that worries me the most.
So much for the short term. The long term objective is to get the Greek economy growing again—to provide jobs, raise incomes, and rebuild public services. To some extent this will happen by itself as the restraints are lifted. I disagree with Bill Mitchell, that growth is primarily a function of fiscal stimulus. Yes, stimulus would do wonders. But there is immense pent-up demand in Greece, and if a modicum of social security can be restored I think the income multiplier would be quite high—if the trade balance does not become sharply negative again. Trade has rebalanced during the crisis as a result of demand suppression, not export competitiveness. In some sectors, like tourism, it is possible that internal devaluation can have an effect, but for the most part this is limited. I could write a different, equally long post (or longer) about strategies for improving productivity and export shares, but these are very long term and will not do much for Greece in the next several years.
The only alternative in the time frame that matters for Syriza is offsetting transfers. In a better world the eurozone would come equipped with a range of automatic stabilizers, like a zone-wide unemployment insurance system, that would supply much of the necessary transfer, at least during the initial period in which the Greek economy is severely depressed. That’s not the real world, though. The modest proposal of Varoufakis and Galbraith looks to the European Investment Bank to massively expand their portfolio, which, from a Greek point of view, would be experienced as a transfer. You could regard the current Juncker initiative, which envisions a fifteen-fold leveraging that borders on hallucinatory, as either evidence that the prospects for serious action are hopeless, or that the principle has been acknowledged and now begins the step-by-step process of coughing up the funds. I don’t know which reading is correct.
A final word about politics. In his public statements Tsipras looks to upcoming elections in Spain and elsewhere to ignite a pan-European progressive, anti-austerity (can we say Keynesian?) movement which will change the political landscape and put pressure on Merkel et al. to reverse course. He could be right, but it is all very iffy. This vision is undercut by the profound, perhaps irreparable, defects of Die Linke as a political force in Germany, and the fact that in several northern European countries the threat from the extreme right, not an upwelling from the left, is the main dynamic. I wish for the best, but if I’m a Syriza planner my Plan A will not assume a political alignment more favorable than the one we see today.
UPDATE: And here is what Lagarde has to say: "They must reform the efficiency of the state and get their tax collection system working. That’s not austerity. Those are reforms that they still need to do.” I especially like that she says this sternly, as if it were several more strokes of the cat 'o nine tails.