The Modern Greek Drama: Comedy, Tragedy, or Both?

Earlier this month, we asked the question, “Is 2010 The Year of Odious Sovereign Defaults?”  As predicted, Greece (and Europe more generally) will have to answer that question soon.  According to Bloomberg:

Jan. 29 (Bloomberg) -- Greece is losing the confidence of bondholders that it will reduce the largest budget deficit in the European Union amid increased speculation that the country won’t be able to meet its debt obligations.

The nation’s government bonds are the world’s worst performers in January, losing 6 percent in local currency terms and extending their decline over the past three months to more than 11 percent, Bloomberg/EFFAS indexes show. Credit-default swaps tied to Greece trade at about the same levels as Dubai when it got a $10 billion bailout from Abu Dhabi in December. . . .

The German and French governments denied a report yesterday in the newspaper Le Monde that European Union member states are examining ways to provide assistance. Prime Minister George Papandreou said the country doesn’t need to borrow from European nations. . . .

“There is no bailout problem,” the bloc’s top economic official said in an interview with Bloomberg Television at the World Economic Forum’s annual meeting in Davos, Switzerland. “Greece will not default. In the euro area, default does not exist.”

For more, see Mish’s Global Economic Trend Analysis and Charlemagne's notebook in The Economist.

I asked Cleary Gottlieb Steen & Hamilton partner and sovereign debt guru Lee Buchheit for his reactions to the Greece situation and, gracious as ever, he agreed. Buchheit’s response is below. Buchheit’s frequent co-author, Duke law professor Mitu Gulati, has also agreed to post about his reactions to the Greek drama, and his post will follow in due course. 

Borrowing money has several things in common with substance abuse.  It can be hideously addictive.  It provides an anodyne to today's budgetary discomfort, while laying in store even more suffering down the road.  And, until the very end, the afflicted will deny the problem. 

When the addict is an individual or a corporation, a mechanism (bankruptcy) exists by which the creditors who unwisely or unknowingly fed the addiction will share the pain of withdrawal.

Sovereign borrowers are different.

With any luck, the government that resorts to borrowing as a means of covering its budget deficits in normal times (such deficits being the product of a politically understandable aversion to taxation coupled with an equally understandable urge to spend) won't be around when the time comes to repay the debts.  This may trouble the conscience of statesman; it doesn't seem to disturb the sleep of most politicians.

But when the day of reckoning does arrive for the sovereign debtor, however, no formal bankruptcy process can be relied upon to shift part of the pain to the creditors.  For the addicted sovereign borrower, the choices are (i) impose fiscal austerity to a degree that will convince some group of lenders -- official or commercial -- to refinance the maturing (inherited) debt stock until such time as good fortune can allow the debt stock to be rolled over on a purely voluntary basis, or (ii) default and restructure as best one can.

Neither option is pleasant.

The first requires the government to convince its citizens to accept a degradation of their standard of living in order to expiate the sins of their profligate forebears.

The second (restructuring), quite apart from national humiliation, forces the debtor country into the financial equivalent of cold turkey.  Whatever residue of the debt is left after the restructuring (as well as all other expenditures) must be serviced out of current government revenues with no expectation of new credit inflows for an indeterminate period of time.

Greece finds itself facing these two options.   The smart money -- at least the buyers of Greek bonds this week -- bet on the first alternative: self-imposed fiscal austerity at a level that will unlock a bailout (from the Eurozone, a coalition of willing Eurozone members or perhaps the IMF).

There are three risks.  First, the required fiscal austerity proves to be politically or socially untenable and is abandoned.  Second, the expected bailout fails to arrive notwithstanding the government's adjustment efforts.  Third, someone (like the IMF) demands BOTH fiscal austerity AND a debt restructuring.  This, after all, was precisely what dozens of over-indebted countries, starting with Mexico in 1982, were told to do in order to win IMF support.

-- Lee C. Buchheit

Lee’s point about the stark choices faced by sovereign borrowers reminded me of Reinhart and Rogoff’s discussion of the importance of willingness to pay versus ability to pay in the sovereign context.  (Coincidentally, I’ve assigned This Time Is Different: Eight Centuries of Financial Folly to my Ethics in Financial Crises class this month, and that chapter is particularly salient right now).  According to Reinhart and Rogoff (pp.51-52):

[C]ountry default is often the result of a complex cost-benefit calculus involving political and social considerations, not just economic and financial ones.  Most country defaults happen long before a nation literally runs out of resources.

In most instances, with enough pain and suffering, a determined debtor country can usually repay foreign creditors.  The question most leaders face is where to draw the line.  The decision is not always a completely rational one.  Romanian dictator Nikolai Ceausescu single-mindedly insisted on repaying, in the span of a few years, the debt of $9 billion owed by his poor nation to foreign banks during the 1980s debt crisis.  Romanians were forced to live through cold winters with little or no heat, and factories were forced to cut back because of limited electricity.

Few other modern leaders would have agreed with Ceausescu’s priorities.

Related posts:
The Modern Greek Drama, Part 2 (Reactions from Mitu Gulati)
Verge of the Unböring (The Modern Greek Drama, Part 3) (Reactions from Anna Gelpern)

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