Investors continued their flight from risky assets as the wobbling Greek rescue looked ready to morph into a broader sovereign debt crisis, compounded by fears that a China’s expansion, once seen as inevitable and enduring, is now looking at risk of fading as the officialdom tries to dampen inflation.
But the focus on the Greece trigger is masking a bigger and more complicated set of issues. The supposedly successful rescue of the global financial system was achieved by making sure bank investors took no pain. That was a dangerous decision: it promoted moral hazard (risk capital, like shareholders and bondholder, are supposed to take losses when businesses come a cropper) and kept the incumbents in place, assuring that there would be no change in any of the firms that had driven themselves off the cliff. The rationales were many: there wasn’t enough time to wind down a dealer, the banks were too interconnected to permit any major one to fail.
But Greece is now showing how blinkered this calculus was. No one in the EU officialdom appears to have anticipated that the populace would seek to shut down the economy to protest the austerity measures; they perhaps hoped for the gentler repudiation of cheating and budget shortfalls as deflation took hold. It unwittingly reveals that in a complex, volatile situation, they focused unduly on the demands of the market and underestimated the pushback from the public at large.
The effect of the bank rescues was a massive transfer from the citizenry to financiers, the greatest looting of the public purse in history. And the perps have behaved in a singularly ungrateful fashion, paying themselves record bonuses a year after being saved from their own greed and recklessness and adding insult to injury by carrying on, all too frequently, about how talented and invaluable they are.
Greece and Germany are demonstrating, vividly, how a comparatively small number of people who aren’t willing to play by the rules of the financiers, can cause disproportionate dislocations. Now pretty much everyone who wasn’t selling the viability of a Greek rescue package was of the view that a default, most likely in the form of a restructuring, was inevitable. Reader Hubert in German put it at six months; the somewhat more cautious Wolfgang Munchau opined that Greece would not default this year, but deemed it to be certain. Simon Johnson has also repeatedly said that the austerity program demanded of Greece was unprecedented and a default was in the cards.
But the unspoken consensus was that the authorities could kick the can down the road a little while. This optimistic view has collided with two ugly realities: social unrest and rising violence in Greece, and alarm and anger in Germany over the demands that they assist Euro debtors.
The irony here is that both sets of actions are self destructive, and both are rooted in the same reflex. In each case, a social compact under strain has been pushed to its breaking point by the crisis aftermath. You can argue that the Greek arrangements were ripe for breakdown, given the country’s chronic fiscal deficits, accommodative posture towards wealthy tax evaders, and acceptance of bribery as a way of doing business. But as dysfunctional as it looks, it functioned nevertheless. And now that it is breaking down, many citizens are striking out at the parties they think have sold them out: the banks and government officials. This too has a certain logic. Many studies have found people will spend time and effort to punish cheaters, even if they wind up worse off as a result (I’m not saying the violence is effective or aimed at the right targets, merely that this kind of reaction isn’t surprising).
Although the reaction of the German citizenry looks more reasoned, it too ultimately is self destructive. Even though the Greek model was (arguably) based on corruption and the German on hard work and thrift, the German was ever bit as unsustainable precisely because it was overly export dependent. That meant it required countries that would go into debt to buy its exports. Germany and Greece are not independent phenomena; they are merely two sides of the same coin. And many Germans seem as keen to punish profligate debtors as Greeks are to punish the banks and officials they think sold them out.
Was there a better way out? Hindsight is always 20/20. The eurozone’s fracture lines were bound to be tested in a crisis, but this one has the potential to kick off a new phase of the global financial meltdown (hopefully a mere August-September 2007 version rather than a September-October 2008 variant). Had the banks and investors taken more pain, had more rescue funds gone to ordinary people rather than those at the top of the food chain, calls for austerity and shared sacrifice may well have been much better received. There was never going to be a pretty way out of this mess. But political fights are taking a decidedly parochial, combative tone at precisely the time when it would be best for everyone to take a deep breath and consider how high the stakes really are.
Update: Martin Wolf reminds us who the real winners and losers are: “Greece is being asked to do what Latin America did in the 1980s. That led to a lost decade, the beneficiaries being foreign creditors.”