In my last post, The
Modern Greek Drama: Comedy, Tragedy, or Both?, I offered the insights of Cleary
Gottlieb Steen & Hamilton partner and sovereign debt guru, Lee Buchheit, on the current Greek
sovereign debt drama. In this
post, Buchheit’s frequent co-author, Duke law professor Mitu Gulati, discusses his reactions.
The spectre of a string of sovereign
defaults — remember the drama over the Dubai World default some months ago —
is back again. It was the scare
over Dubai that appeared to get the markets to ask whether there were other
economies that might produce surprise defaults. Attention moved from the usual suspects in regions like
Latin America to the previously unthinkable members of the European Union. Specifically, to Greece (and maybe now
also to Italy and Spain). Risk
premiums increased and serious scrutiny was put on Greece’s finances in
particular. A couple of months
later, the markets do not like what the heightened scrutiny has revealed (the words
“book cooking” or their equivalent show up frequently, see Charlemagne's notebook in The
Economist.).
But what precisely is going on? Do sophisticated investors seriously
think that Greece will be allowed to default? Won’t the IMF or the European Union be sure to bail them
out? After all, a default in
Greece would present the risk of spillover effects into its European
compatriots. And some of those
other European nations appear not to be in the best of fiscal conditions (read,
Italy and Spain) and others (like the U.K.) are very much hoping to be climbing
out of a painful recession.
In theory, there is a constraint on a Eurozone
bailout. The Lisbon Treaty imposes
a “no bailout” provision. I am no
expert on European treaties, but am guessing that one of the functions of this clause
is to provide a protection against moral hazard. In relevant part (see Tony
Barber’s FT blog post from last week), the Lisbon Treaty says that
assistance is permitted if a Eurozone member “is in difficulties or is seriously threatened with severe
difficulties caused by natural disasters or exceptional occurrences beyond its
control, the Council [of national governments], on a proposal from the
Commission, may grant, under certain conditions, Union financial assistance to
the member-state concerned.” That
clause is probably supposed to function as a commitment device. It tells the more profligate
among the European spenders that the more austere nations (think Germany) will
not come to their rescue even though the failure to rescue has the potential to
cause harm to the entire Eurozone community.
Well, the rubber seems to have met the
road, and the question is whether anyone will take the “no bailout” clause
seriously. If the clause were
taken seriously, there would be no bailout because financial profligacy (along
with a dose of book cooking) are probably precisely the circumstances under
which the commitment against bailouts
was supposed to operate. In other
words, not the “exceptional circumstances” contemplated by the treaty. The question though is whether the political
flesh will be weak (as it usually is) and whether, so long as Greece makes some
efforts in the direction of showing that it is serious about austerity, a
bailout will be in the offing. Many
experts seem to think that the inconvenient clause will either be explained
away or just ignored. If so, that
should lead us to ask: Does anyone take moral hazard seriously anymore? Or have the pundits decided that the
costs of moral hazard are not that high?
— Mitu
Gulati
Much like bad luck, great blog posts on sovereign debt
crises come in threes. Stay tuned tomorrow
for an upcoming post from Anna Gelpern, Associate
Professor of Law at American University, who’ll add her views to the mix.
Related posts:
The
Modern Greek Drama: Comedy, Tragedy, or Both? (Reactions from Lee Buchheit)
Verge
of the Unböring (The Modern Greek Drama, Part 3) (Reactions from Anna
Gelpern)