Saturday, July 11, 2015

Greece: The Deja Vu is Killing Me

So, while waiting for developments in Greece, I will take time out to discuss the annoying tendency to treat debtors as sinners and creditors as blameless, or to treat importing as sin but exporting as virtue.

The logical flaws here are obvious.  Every export is necessarily an import.  Every amount borrowed is necessarily an amount lent.  If borrowing and importing are sins, then lending and exporting abet sin.  If using drugs is a sin, then the drug dealer who never samples his product is not virtuous or even neutral, but deeply complicit.  Or the teetotaler bartender, or the chaste pimp, etc etc.  As Paul Krugman likes to say, the world economy is a closed system, which means that until we find another planet to export to, it will not be possible for every country to run an exports surplus.  (Well, I suppose we could make stuff and blast it into outer space even if there were no buyers, but that would be stupid).

In the case of Greece today, as in Latin America in the 1980's and many times since, the banks have made foolish loans, but the entire cost of their mistakes is expected to be born by the people of the borrowing country.  Well, at the risk of sounding libertarian, that sounds awfully collectivist to me. The nation has sinned and the nation has suffered without any thought to the individuals involved. Well do I remember reading about the Latin American debt crisis in the 1980's and hearing about the boom that preceded it and all the VSP's of the day shook their heads and said that Latin American countries had lived beyond their means and would have to pay the consequences.  Then you read about the boom that preceded the crash, vast growth in GNP, almost all of it concentrated in the upper quintile of income distribution while the poorest quintile received an increased income of about $2 per year.  And when the crash came, it was the people who benefited least (and certainly did not borrow any money from foreign banks) who were expected to bear the brunt of the adjustment. Financial moralists scolded the boy shining shoes on the streets of Brasilia and others in the marginal sector, telling them that they had lived beyond their means during the preceding boom and would just have to tighten the belt now to pay for their old extravagance.  And in Greece today when children search the garbage for food, when mental patients are thrown out on the street and malaria makes a comeback, creditors tell them that it serves them right for borrowing so much.  The attitude was then and appears still to be that countries should not squander resources on people who don't even produce foreign exchange when banks are facing losses.

So I thought I would quote this article on why it is unreasonable to place all the costs of adjustment on the debtor and let the creditor off scot-free:
For the record, my sophisticated hard-working elite European interlocutors, the term moral hazard traditionally applies to creditors. It describes the hazard to the real economy that might result if investors fail to discriminate between valuable and not-so-valuable projects when they allocate society’s scarce resources as proxied by money claims. Lending to a corrupt, clientelist Greek state that squanders resources on activities unlikely to yield growth from which the debt could be serviced? That is precisely, exactly, what the term “moral hazard” exists to discourage. You did that. Yes, the Greek state was an unworthy and sometimes unscrupulous debtor. Newsflash: The world is full of unworthy and unscrupulous entities willing to take your money and call the transaction a “loan”. It always will be. That is why responsibility for, and the consequences of, extending credit badly must fall upon creditors, not debtors. 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.
This is, perhaps, a bit overly harsh to creditors.  The concept of moral hazard is that if people are shielded from the consequences of their mistakes, they take excessive risks.  But the opposite applies. If the consequences of failure are too harsh, people become overly risk-averse.  This can shrink credit to the point of crimping the entire economy.  But if there is one thing events from 2008 onward have proven, it is that the upsurge in credit caused by an overly creditor-friendly regime is only a short-term blessing.

The author goes on to explain why it is dangerous to give creditors too much power in cases of default:
A state cannot be liquidated. In bankruptcy terms, it must be reorganized. Corporate bankruptcy laws wisely limit the control rights of unconverted creditors during reorganizations, because creditors have no interest in maximizing the value of firm assets. Their claim to any upside is capped, their downside is large, they seek the fastest possible exit that makes them mostly whole. The incentives of impaired creditors are simply not well aligned with maximizing the long-term value of an enterprise.
Yeah, basically.

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