Greek Crisis Avoided — For Now

One cannot open a newspaper or listen to news on the radio without hearing about Greece, Greek default, and the possibility of “Grexit” or Greece exiting the Eurozone. The new bailout deal does not change the fact that Greece and Europe have multiple issues, all inter-related, and none easily soluble. Here is a high level summary:

• Greece itself is insolvent. A country of 11 million people, with a Gross Domestic Product of $240B, owes well over $300B. The third bailout (just announced) would take Greece’s total debt to over $400B. In recent years (2013, 2014, 2015), Greece has come close to balancing its budget before debt and interest payments, and may even have had enough extra tax revenue after expenses to make some debt and interest payments. Paying down the debt, however, would require larger surpluses (e.g., to pay off a $400B debt in 30 years would require a surplus of over $10B per year plus interest every year for 30 years).
  • Therefore, as in any bankruptcy, at least some lenders will have to forgive some of their loans, or accept a “haircut” or “writedown” in “lendingspeak.”
  • Some open questions are:
    • When will the lenders recognize that their loans are worth less than they think?
    • How large will the aggregate writedown be? If too small, another will inevitably follow. If too large, it will embolden other European countries (like Portugal, Spain and Italy) to request forgiveness, too.
    • How much will each lender have to write off? The loss sharing discussion will offer a good deal of theater, and will be very important for the lenders. It will be far less important for the interested spectators.

• If Greece is insolvent, Greece’s banks are insolvent. That is, the major Greek banks have made large loans to the Greek government which is itself insolvent. Many of these loans are officially (as evaluated by bank regulators) so good, so strong, so collectible as to be equivalent to cash. They count as capital. The banks’ depositors do not seem to believe the banks are solvent. They have been withdrawing their money (demanding their deposits, which are loans to the banks) at such a rapid pace that the government has imposed capital controls, limits on the size and frequency of withdrawals that customers can make.
  • Restoring confidence in the banks (persuading customers that their deposits or loans to the bank are good) will likely require either:
    • Recapitalization – the banks would sell stock and obtain enough cash that customers would believe that their deposits are safe; or
    • Restored confidence in Greek government debt, which might come if the writedowns mentioned above are large enough (and if the banks take no haircuts).
  • A well-functioning banking system is essential to a well-functioning economy. Specifically, consumers and businesses need credit to finance large purchases, and both also need transaction support (think cash, credit cards and debit cards) for smaller purchases.

• Greece’s economy and fiscal systems are very inefficient. Tax evasion is an enormous problem.[1] One team of economists estimated that tax evasion accounted for over $30B of lost government revenue from self-employed professionals alone in 2009. Greek corruption[2] is the worst in the European Union (EU). Politicians take bribes in the awarding of public contracts. Public officials take bribes in return for slicing through red tape. Public employee pensions are unaffordably high.
  • If the economy doesn’t work well,
    • It is even more difficult for the Greek government to repay its debts.
    • Citizens do not feel fairly treated, which makes them reluctant to repay the national debt.
    • Citizens fare poorly economically, which makes them unable to repay the national debt.

All three are big problems. The last is fundamental, and will take decades if not generations to resolve.

• “Austerity” is not necessarily the solution. “Austerity” is simply spending less. In the case of Greece, this means reducing spending on pension benefits and on government spending more generally. There is a noisy discussion about whether this will solve Greece’s debt problem. On its face, reducing spending sounds like a natural solution. As I mentioned above, however, Greece needs a large, sustained budget surplus to be able to pay down its debt. Less spending will help, but will likely be insufficient. Being able to collect taxes and having a solid economy to collect taxes from will also be essential. Improvements to the economic culture will take time, and too much austerity may make it difficult to accomplish these. Unfortunately, there is no roadmap to a strong economy. Otherwise, Greece’s debt would not be as large a challenge as it is.

These are issues for Europe as well as for Greece directly. Greece is a member of both the EU and the Eurozone, a customs union and a currency union respectively. Greece is a weak link, and the strong members are providing subsidies, directly by writing off debt and indirectly by all of the emotional and political energy they are spending trying to help Greece solve its problems.

All of that said, Greek GDP is only 2% of EU GDP, and Greece’s 11 million people are only 2% of the EU’s population. Greece’s significant economic problems will be an obstacle to the success of the European project for at least a generation to come, but only a small obstacle.

[1] http://www.theguardian.com/world/2012/sep/09/greece-tax-evasion-professional-classes?CMP=twt_gu

[2] http://www.theguardian.com/world/2014/dec/03/greece-corruption-alive-and-well