Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 12 July 2015

The Great Recession and the Eurozone crisis

Pandemonium erupted in Congress yesterday as senators disagreed on how to deal with the subprime problem. Borrowers are still finding it difficult to repay, despite the government buying these mortgages from the banks seven years ago and imposing strict conditions on the borrowers. Some senators favour continuing the program of compulsory community service and self-improvement lessons, but now others in the senate are openly talking about revoking the US citizenship of these borrowers.

The Great Recession and the Eurozone crisis are normally treated as different. Most accounts of the Great Recession see this as a consequence of a financial crisis caused by profligate lending by - in particular - US and UK banks. The crisis may have originated with US subprime mortgages, but few people blame the poor US citizens who took out those mortgages for causing a global financial crisis.

With the Eurozone crisis that started in 2010, most people tend to focus on the borrowers rather than the lenders. Some ill-informed accounts say it was all the result of profligate periphery governments, but most explanations are more nuanced: in Greece government profligacy for sure, but in Ireland and other countries it was more about excessive private sector borrowing encouraged by low interest rates following adoption of the Euro. Seeing things this way, it is a more complicated story, but still one that focuses on the borrowers.

However if we see the Eurozone crisis from the point of view of the lenders, then it once again becomes a pretty simple story. French, German and other banks simply lent much too much, failing to adequately assess the viability of those they were lending to. Whether the lending was eventually to finance private sector projects that would end in default (via periphery country banks), or a particular government that would end up defaulting, becomes a detail. In this sense the Eurozone crisis was just like the global financial crisis: banks lent far too much in an indiscriminate and irresponsible way.

If borrowers get into difficulty in a way that threatens the solvency of lending banks, there are at least two ways a government or monetary union can react. One is to allow the borrowers to default, and to provide financial support to the banks. Another is to buy the problematic loans from the banks (at a price that keeps the banks solvent), so that the borrowers now borrow from the government. Perhaps the government thinks it is able to make the loans viable by forcing conditions on the borrowers that were not available to the bank.

The global financial crisis was largely dealt with the first way, while at the Eurozone level that crisis was dealt with the second way. Recall that between 2010 and 2012 the Troika lent money to Greece so it could pay off its private sector creditors (including many European banks). In 2012 there was partial private sector default, again financed by loans from the Troika to the Greek government. In this way the Troika in effect bought the problematic asset (Greek government debt) from private sector creditors that included its own banks in such a way as to protect the viability of these banks. The Troika then tried to make these assets viable in various ways, including austerity. Two crises with the same cause but very different outcomes.

53 comments:

  1. Different outcomes for borrowers not alike. Sovereign debt cannot be treated in the same way as private's

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    1. In what way? Do you mean that private borrowers have rights, whilst sovereign borrowers do not?

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    2. Magnus12 July 2015 at 04:37

      Sovereign borrowers have rights because you cannot send gunboats any more.

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    3. The way you may see in all the fuss at Brussels this very evening. Bankruptcy proceedings do not get usually that kind of attention, because all there is almost mandatory, seize this, sell that, fire that division, and so forth. Countries have land, people who vote, protests, things like that.

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  2. I was in the USA in late 2005 when parts of the property market began to get "sticky". When this continued during 2006 and became stickier, I moved out of banks and building societies and into cash.in 2007. It was all there to be seen but too many did not want to see it or to believe in the risks and liabilities arising.

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  3. SW-L says “French, German and other banks simply lent much too much, failing to adequately assess the viability of those they were lending to.” Wrong, at least in this sense: those banks reckoned that European governments would not let a sovereign or a large bank go bust. Turned out banks’ “reckoning” was correct.

    The moral is that taxpayer backing of any sort for banks does not bring safety: it makes banks even more reckless.

    The solution is a total ban on all forms of such backing: i.e. have banks funded just by shares. That way it’s impossible for banks to go bust. That’s “full reserve” banking: backed by Milton Friedman, Irving Fisher and many others.

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    1. The solution is not a ban on backing but providing a legal framework for removing defaulted liability from bank books just as the bankruptcy proces is. In aa bankruptcy process a judge allows bank liabilities to be erased when a loan gooes bad and a borrower gets to keep colateral. No need for state money to back iresponsible banking.

      Yes banks loose the money from not realizing the profit and large compensation to loan officers that aproved bad loans. Banks will not achieve projected profit and their shares will colapse but banks will not unless they colaterilsed their shares for loans. So there should be a ban on using value of corporate shares for colateral. There ahould ba a ban on using own shares for colateral because just a drop in share value can bankrupt a company if they used it as colateral.

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    2. «The solution is a total ban on all forms of such backing: i.e. have banks funded just by shares.»

      The problem is that banking like the oil trade and the arms trade is state-sponsored and driven sector of "national interest", even if nominally private.

      Banks (like oil companies and arms industries) do what the government tells them to do, or else. And viceversa of course :-).

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    3. Jure Jordan,

      “..he solution is not a ban on backing but providing a legal framework for removing defaulted liability from bank books..” But if “liabilities” are removed “from bank books”, who does that, apart from the state? No one else has a deep enough pocket. So are you advocating a “ban on backing” or are you advocating it?

      Next, you say “No need for state money to back irresponsible banking.” Well I quite agree. In fact I’d put it more generally: ban all state backing for banking. But that contradicts your first sentence: “The solution is not a ban on backing…”.

      “There should be a ban on using own shares for collateral because just a drop in share value can bankrupt a company if they used it as collateral.” How on Earth does a firm use its own shares as collateral? Shares in a firm are by definition owned by entities other than the firm itself!

      Blissex,

      You’re right to say “he problem is that banking like the oil trade and the arms trade is state-sponsored and driven sector of "national interest", even if nominally private.” Of course the irony there is that at least 99% of politicians haven’t the FAINTEST idea how the bank and monetary system works.

      Positively side splitting.

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    4. The solution is not a ban on backing but providing a legal framework for removing defaulted liability from bank books just as the bankruptcy proces is. In aa bankruptcy process a judge allows bank liabilities to be erased when a loan gooes bad and a borrower gets to keep colateral. No need for state money to back iresponsible banking.

      Yes banks loose the money from not realizing the profit and large compensation to loan officers that aproved bad loans. Banks will not achieve projected profit and their shares will colapse but banks will not unless they colaterilsed their shares for loans. So there should be a ban on using value of corporate shares for colateral. There ahould ba a ban on using own shares for colateral because just a drop in share value can bankrupt a company if they used it as colateral.

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    5. Ralph
      Abou bank bad loans: if you erase bad liabilities as in bankruptcy, there is no need to fund banks by the state. No need for deep pockets, liabilities are just erased, just as in bankruptcy procedeengs.
      Presently there is no legal framework to make that possible except in USA and it was limited in scope in 2005 by Bush administration as if they knew what was comming.

      And by rhe way, heve you ever heard of share buyback?

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    6. I completely agree with you here Ralph, banks were not incompetent in assessing the risks, they rightly assessed that they could get the state hold the bag when things went sour. It created a situation where rates were high (greece had a higher chance of default) but risks were low (portofilio's could be moved to the state). The amount of damage done in the process while making some extra profits is huge.

      The failure is with the states, allowing these banks to be to big to fail en allowing for situations where the implicit garantees can be turned in to profits for banks at great costs for society.

      States are not free collection agencies for banks. They should stop behaving like them.

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  4. "banks lent far too much in an indiscriminate and irresponsible way"

    Too much comparring to what? Comparring to aftermath, sure, but not too much comparing it to previous 30 years. Previous 30 years had prety steady debt growth, but what really decides how much debt is too much? INCOME.
    income did not grow along the debt growth. If income grows along the debt then there can not be too much debt or iresponsible borrowing.

    On another hand, old debt can be payed off only with providing new debt (not necceserily to the same borrowers). Did everyone forgot compounding interest problem? Only way for a system to have liquidity to pay for compunding interest cost is more lending.

    Why is this question of compunding intetest avoided by economists?

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    1. Jure Jordan,

      You think banks acted in a responsible manner in the 30 years prior to the crunch? You must be joking. According to the opening pages of Robert Peston’s book “How do we fix this mess”, several large UK banks were technically insolvent for significant periods during that 30 years.

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    2. Ralph
      Here the topic is the amount of lending , too much or too litlle, not what kind of lending.even the small amount of lending can be irresponsible.

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    3. Ralph
      What i mean is that in order to prevent old loans from defaulting, banks have to grow the lending exponentially.
      To explain it a bit better using hipotetical scenario, imagine a fixed money supply system where state doesnt provide new money, realy realy fixed amount of money. Debt is accumulated, prices and incomes rise and debt. What would happen with such economy if issuing new debt stoped?
      Liquidity would dry up. It is mathematical certainty.
      So, to prevwnt default of old loans banks have to keep providing new loans. Debt has to keep growing exponentially to prevent debt deflation , secular stagnation, deleverage, deppressions, business cycle, qhatever you want to call it. It all comes from slowdown in issuing new loans. This is mathematical certainty.


      Reasons for slowdowns in issuing new loans are another story. Basic reasons is that growth in debt was not followed with growth in incomes that are supposed to finance more and more debt.

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    4. Ralph
      What i mean is that in order to prevent old loans from defaulting, banks have to grow the lending exponentially.
      To explain it a bit better using hipotetical scenario, imagine a fixed money supply system where state doesnt provide new money, realy realy fixed amount of money. Debt is accumulated, prices and incomes rise and debt. What would happen with such economy if issuing new debt stoped?
      Liquidity would dry up. It is mathematical certainty.
      So, to prevwnt default of old loans banks have to keep providing new loans. Debt has to keep growing exponentially to prevent debt deflation , secular stagnation, deleverage, deppressions, business cycle, qhatever you want to call it. It all comes from slowdown in issuing new loans. This is mathematical certainty.


      Reasons for slowdowns in issuing new loans are another story. Basic reasons is that growth in debt was not followed with growth in incomes that are supposed to finance more and more debt.

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    5. Jure,

      A load of viable new loans would obviously be one way for a bank to pay for old non-performing loans. But any bank RELYING on that windfall is living in la-la land. Thus the basic question remains: how to deal with a bank which finds its loans are worth a fraction of book value?

      The conventional wisdom is to have taxpayers rescue the bank (though of course the deluded authorities constantly claim there’s no chance of taxpayers being robbed – till the authorities are proved wrong in the next crisis). In contrast, like Milton Friedman, Lawrence Kotlikoff and others, I suggest we set up a system where there is not the remotest chance of taxpayers ever being robbed. The way to do that is to have banks funded just by shareholders.

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  5. Krugman blog October 12, 2008, 'Wrong-way Paulson',

    Henry Paulson, September 23:

    ‘Some said we should just stick capital in the banks, take preferred stock in the banks. That’s what you do when you have failure. This is about success.’

    Me, September 21:

    ‘[S]houldn’t the public intervention also be at stage 2 — that is, shouldn’t it take the form of public injections of capital, in return for a stake in the upside? Let’s not be railroaded into accepting an enormously expensive plan that doesn't seem to address the real problem.’

    I'm not claiming special insight here — a number of economists arrived at the same conclusion. What’s striking is the way Treasury misfired, yet again. New management can’t arrive a moment too soon.


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  6. «French, German and other banks simply lent much too much, failing to adequately assess the viability of those they werelending to.»

    They were not required to "adequately asses": the official credit rating of the greek government was AAA. This by political decision. Those bankers were in effect told to lend anything that the greek government wanted to borrow, and they were rightfully bailed out.

    Now giving someone by decree an AAA credit rating in the middle of a massive "vendor financing boom" (the euphemism some people use is "savings glut") is like giving them a loaded gun. Some people handle it with care, some people don't. The greek government used it as if it were a newly discovered elephant oilfield in the North Sea: to fund a giant consumer boom, and damn the consequences. That's what banana republics do.

    «Another is to buy the problematic loans from the banks (at a price that keeps the banks solvent), so that the borrowers now borrow from the government. Perhaps the government thinks it is able to make the loans viable by forcing conditions on the borrowers that were not available to the bank.»

    Indeed the other eurozone governments forced on the greek government conditions that were not available to the banks: a massive cut in interest rates, enormous lengthening of the repayment period, free default insurance. Something worth probably a few dozen billions euros per year to the greek government (just default insurance on greek debt is 20% per year in the private market), in addition to having their interest rate payments halved.

    Nobody in their right mind would have forced such conditions on the greek government, least of all greek citizens, who have in foreign accounts more than enough to bailout their own government (the greek government is bankrupt, Greece is far from bankrupt), but are rather unwilling to do so, and would rather the citizens of other countries took "leadership".

    «In this way the Troika in effect bought the problematic asset (Greek government debt) from private sector creditors that included its own banks in such a way as to protect the viability of these banks. The Troika then tried to make these assets viable in various ways, including austerity.»

    But there has been virtually no austerity! Greek GDP per person has gone back in 2014 to the level of 2001, when its current account was also not totally out of balance. Many EU countries who did not have an AAA-rating fueled debt boom have a 2014 GDP at the same level as the 2001 one. Countries that go on a borrowing boom tend to overshoot on the way down when the borrowing boom ends, and Greece did not, because of the absurd generosity of the their EU partners.

    Their EU partners have been *talking* austerity in order to apppease their own voters and to hide the fact that they have given Greece a phenomenal amount of help, and that the ECB has given immense overdradfts for the banking systems of Greece and some other countries and thus their governments.

    How could Schauble explain to german voters that Germany after lending a large part of the extra €9,000 per household that the average greek household spent on more imports in 2008 (on a baseline average income of €40,000 per household) then bought out a large chunk of all the resulting debts, extended its duration and cut interest rate payments to keep Greece from falling below their baseline GDP per person as in 2001, thus assuming colossal and very expensive debt default risks?

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    1. "But there has been virtually no austerity!" How can you be so divorced from reality?

      The Greek economy is in shambles with Depression levels of unemployment and poverty. That's what happens when you combine austerity with overly tight monetary policy.

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    2. «The Greek economy is in shambles with Depression levels of unemployment and poverty.»

      That's not quite right: in 2014 most people in Greece were doing pretty well, even if some people were doing a lot worse. As I pointed out in 2014 greek GDP per head is much the same as in 2001 and at PPP is slightly better, and in 2001 Greece had not suffered from austerity or a depression and its economy was not in shambles. It was just business as usual. Like in 2014.

      Greek GDP boomed between 2001 and 2008 and then shrank only because of spending a lot of borrowed money that resulted in a huge net import boom (of €230 billion in a few years, around $320 billion, €9,000 per household per year in the peak year of 2008)..

      «That's what happens when you combine austerity with overly tight monetary policy.»

      That's the usual story in other situations, but again in 2014 greek GDP per head and private final consumption were the same or better than in 2001 and in that year there was no austerity and no overly tight monetary policy. Plus in 2014 GDP, GDP-per-capita, and other important numbers started growing.

      Also, several EU countries have today the same or lower GDP per head and final consumption as in 2001 and arguably they have not suffered austerity or an overly tight monetary policy.

      After a gigantic credit-fueled import boom Greece went back in 2014 to their 2001 *aggregate* position, which was a very soft landing indeed, only thanks to enormous, very expensive help from their eurozone partners, which those eurozone partners misdescribe as being tough austerity only because admitting that they have been very generous indeed would be extremely unpopular with their voters.

      The *aggregate* numbers are crystal clear. Again, if some greeks today are worse off than in 2001, which were the good old days, this must be because of greek internal policy choices, redistributing from some groups to other groups, not because of «austerity with overly tight monetary policy».

      The numbers seem to say that the constraint on greek GDP is not austerity or tight monetary policy, but the ability of Greece to buy net imports with "debt" meant to be never repaid.

      Some of most obvious numbers:

      Employed, unemployed, work force:
      research.stlouisfed.org/fred2/series/LFEM64TTGRA647S
      research.stlouisfed.org/fred2/series/LFUN64TTGRA647S
      2001: 4.11m 0.51m => 4.62m
      2008: 4.52m 0.39m => 4.91m
      2014: 3.48m 1.27m => 4.75m

      GDP inflation adjusted:
      research.stlouisfed.org/fred2/series/NAEXKP01GRA189S
      2001: €197 billions (€47,900 per worker)
      2008: €250 billions (€55,300 per worker, +15% wrt 2001)
      2014: €187 billions (€53,700 per worker, +12% wrt 2001)

      Final private consumption, inflation adjusted, and net imports:
      research.stlouisfed.org/fred2/series/NAEXKP02GRA189S
      research.stlouisfed.org/fred2/series/BPBLTT01GRA636S
      2001: €132 billions (net imports €10 billion)
      2008: €172 billions (net imports €35 billion)
      2014: €130 billions (net imports approx. zero)

      Some additional interesting data as to 2014:

      en.wikipedia.org/wiki/Immigration_to_Greece
      «The percentage of foreign populations in Greece is as high as 8.4% in proportion to the total population of the country. Moreover, between 9 and 11% of the registered Greek labor force of 4.4 million are foreigners. Migrants additionally make up 25% of wage and salary earners.»

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    3. Even if a bond is rated AAA, no government offical forced the banks to buy it. If your banks cannot tell the difference between Greek bonds and German bonds, then they need new traders.

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    4. 25% of the Greek workforce is out of work; until they get jobs, life is not going to be very good there.

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    5. «your banks cannot tell the difference between Greek bonds and German bonds, then they need new traders.»

      Hindsight is always a wonderful device.

      «25% of the Greek workforce is out of work; until they get jobs, life is not going to be very good there.»

      That's a distributional problem for Greece to solve.

      Some hints: in 2001 unemployment was lower because worker productivity was way lower and in 2008 it was lower thanks to €35 billion a year of net imports paid for with lots of debt.

      How to bring back those happy days? :-)

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    6. "That's a distributional problem for Greece to solve."

      You have highlighted some interesting comparisons with the 2001 position but to say unemployment is a distributional problem is utterly ridiculous and skates over all the social /economic ramifications of the situation

      Henry

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    7. «interesting comparisons with the 2001 position»

      I have chosen 2001 because it was when Greece joined the Eurozone (even if arguably the net import madness really started in 2004), 2008 because it was the peak "free" money year, and 2014 because both it is the last year for which statistics can be made, and it was the last year before the "magic" of Tsipras and Varoufakis had its effect on the greek economy. When 2015 and 2016 end we'll see how much that "magic" has worked on Greece.

      «but to say unemployment is a distributional problem is utterly ridiculous»

      In the general case it is arguable but in the specific case the main feature is that the pie is the same size in 2001 and 2014, so if someone is worse off in 2014 than in 2001, then someone else must be better off and then it is an internal greek distributional problem.

      To change the distribution of the pie Greece could do worksharing, or tax the better off greeks to pay welfare or workfare to the worse off greeks. What they are trying to do instead is to "tax" the rest of the EU so that better off greeks stay better off, like they did in 2008.

      The very simple numbers that I have shown demonstrate that Greece's 2001-to-2014 unemployment falll seems due to higher productivity than in 2001, and the 2008-to-2014 GDP fall seems due to lack of never-to-be-repaid borrowing funding net imports grown to 20% of baseline (2001) GDP.

      Neither problem seems due to "austerity" and neither seems a tragedy *in the aggregate* to me. If Greece wants to go back to the good old days what they have to do is, based on the strong evidence of 2001-2008-2014:

      * If they want to to back to the the GDP/final private consumption and employment levels of 2008, find someone that is willing to "lend" them never-to-be-repaid funding for around 20% of their baseline (2001) GDP every year to pay for net imports. Any volunteers? :-)

      * If they want to get again the employment levels of 2001 (they already were in 2014 on the same or higher GDP/final private consumption as 2001) they need to decrease per-worker productivity, by worksharing, welfare transfers, workfare.

      One implicit point I have been making thruout is that in the 15 years the elasticity of Greece's GDP and final private consumption to net imports seems to be around 1, so every gain in GDP and final private consumption implies finding someone willing to finance for "free" the purchase of net imports for much the same amount. Unless very deep "structural" changes happen, and that is amazingly unlikely in the short-medium term.

      That's more or less what Y Varoufakis wrote 3 years ago already:

      «idle productive resources in Greece cannot produce much for which there is
      increasing demand»

      «With judicious top-down reductions wages and pensions, plus the issue of tax-bonds, the Greek public sector could finance itself for the foreseeable future. All that is needed is that the ECB continues to provide liquidity to the Greek banks.»

      The latter condition translates to "the ECB continues to provide an unlimited euro overdraft to the greek government". That's a very "clever" condition: I think that almost any economic problem can be solved with an unlimited overdraft at the ECB. I wish I had one myself of course :-). But unlimited overdrafts at the central banks are only given to corrupt and bankrupt megabanks like Citigroup and RBS and to "first tier" governments like the USA and UK ones. Too bad for me and Greece :-).

      BTW the surge in net imports and in productivity in Greece between 2001 and 2008 were not spotted by me but some perceptive bloggers, I am not crediting them by name because they are "progressives" and I am sure they'd rather not be associated with the ideas that Greece has not suffered austerity nor needs it to gain "competitiveness".

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    8. "That's a distributional problem for Greece to solve."
      Right, the solution is Grexit, rationing of basic goods, ban luxury imports to ensure only what is needed comes in, land reform and full employment with a Job Guarantee. But I doubt the "socialist" Greek government will do this.

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    9. Blissex, I am in the bond business; even in 2000, given the Greek history of defaults versus the virtue of the German government, and the warnings of multiple economists - such as Alan Blinder - we shook our heads at the interest rate spreads in sovereign debt.

      I do not know what you mean about unemployed people and distrubutional probelms. These people need jobs not just redistribution of income.

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    10. Why is it the task of governments to be a free collection agency for banks making bad lendings?

      When banks want to privatize their winnings, they should not socialize losses.

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    11. If you want to let the banks off the hook by saying that the bonds were AAA by fiat, then the bonds should have been treated like AAA bonds after the crisis. That would mean the ECB acting as an unlimited lender of last resort and none of the conditions imposed.

      Instead we got the EU labeling the bonds AAA and Greece expected to pick up the tab for the difference between the rated risk of the bonds and what the bonds actually were.

      In economics, like any science, a lot of different sounding statements actually converge at the same meaning. Anyway you look at it there was a gap between the market rate and reality which everyone benefited from in the good years and Greece is expected to cover everyone elses losses from in the bad years.

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    12. «the solution is Grexit, rationing of basic goods, ban luxury imports to ensure only what is needed comes in, land reform and full employment with a Job Guaranteed»

      But that would be the start of ferocious austerity, as GDP would fall drastically wrt to the 2001 baseline. Everybody would be employed but rather poorer than now. The points I have been making are about employment given a GDP at least as high as that of 2001.

      «Blissex, I am in the bond business;»

      Then you must know how bond salesmen behave... :-)

      «we shook our heads at the interest rate spreads in sovereign debt»

      So did many, but an official AAA rating is powerful, and on the buy side there are a lot of suckers who trust AAA ratings or bond salesmen or spivs who don't care (IBG-YBG).

      «These people need jobs not just redistribution of income.»

      What to you looks like a job to someone else might look like redistribution of income. In 2001 in Greece 4.1 million workers produced much the same GDP as 3.5 million workers produced in 2014: this was in some sense redistribution from the 0.6 million workers who lost their jobs to the 3.5 million who kept theirs, and/or to the their bosses: the pie is the same, some people get more, some people get a lot less. In 2008 the 0.6 million were employed despite higher productivity of the 3.5 million only because of a gigantic spending boom that resulted in net imports growing by 560%.

      Therefore looking at 2001 and 2008 there are two main ways to give those 0.6 million their jobs back:

      * As in 2008, give Greece "free" (never-to-be-repaid) loans to fund a surge of net imports (and GDP) of 15-20% of "baseline" GDP.

      * As in 2001, decrease the overall productivity of the greek workforce by 10-15%, by worksharing, workfaring, or outright welfare transfer from the 3.5 million who have a job, or their bosses, to the 0.6 million who lost theirs.

      That's based on a simple look at 2001-2008-2014, which suggest two simple tradeoff between productivity and jobs, and imports/GDP and jobs, which suggest that greek GDP elasticity to net imports is around 1, and similarly for productivity.

      If you have a way to raise GDP and employment in Greece in a few years by 20% without net imports booming to 15-20% of GDP, or to increase greek worker productivity without reducing jobs, please write *today* to Alexis and Euclid!

      I have asked that question on some blogs frequented by "resolutionary socialist" economist, and never received a reply.

      Dear Yannis opined as to this some years ago, as quoted above, that "no way".

      «When banks want to privatize their winnings, they should not socialize losses.»

      But banks are quasi-governmental organizations, part of the "establishment", they are driven by government policy and depend on government support, regulation, liquidity to function. When governments say "jump" banks jump twice. When government say "lend lend lend" bankers go wild!

      Also: Citigroup and RBS were bailed out not just "because too big to fail" but I am sure also because their management have copious archives of letters and conversations in which government sources told them "lend lend lend". Hey Greenspan told suprime borrowers to "borrow borrow borrow" in a famous public speech.

      PS to indicate how much banks depend on government policy, here is a truly brilliant example of Greenspan helping them get lots of free money:

      www.interfluidity.com/posts/1160447599.shtml
      «the spread between the Federal funds (and Treasury bill) rate and the prime rate widened from 1 1/2% to 3% in 1991. That was Greenspan’s gift to the banking sector to insure that major banks would not fail. You may recall at the time that rumors were rife — including some repeated on the floor of the House — that Citibank was about to go under. By doubling the margin between the prime and the funds rate — and essentially increasing the profitability fourfold after taking into consideration the costs of processing loans»

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    13. "In the general case it is arguable but in the specific case the main feature is that the pie is the same size in 2001 and 2014, so if someone is worse off in 2014 than in 2001, then someone else must be better off and then it is an internal greek distributional problem."

      It may well be so. However, this entirely ignores the question of how and why Greece got to where it is and the social and political ramifications of 25% unemployment and the vaporization of a million jobs.

      Henry

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    14. «BTW the surge in net imports and in productivity in Greece between 2001 and 2008 were not spotted by me but some perceptive bloggers»

      Wikipedia contributors also have a nice page with nice graphs:

      en.wikipedia.org/wiki/Greek_government-debt_crisis

      for example the "Current account balance" section.

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    15. «"With judicious top-down reductions wages and pensions, plus the issue of tax-bonds, the Greek public sector could finance itself for the foreseeable future. All that is needed is that the ECB continues to provide liquidity to the Greek banks."

      The latter condition translates to "the ECB continues to provide an unlimited euro overdraft to the greek government". That's a very "clever" condition: I think that almost any economic problem can be solved with an unlimited overdraft at the ECB.»

      To support the notion that my interpretation of Varoufakis' words is correct, this is what an unnamed greek negotiator said:

      «We are going to get some new financing, is the ECB going to lift all these caps, all these restrictions, these limits on how much the banks can borrow, the state can borrow from the banks? Because we can't borrow. We used to. Up until February, we could still issue treasury bills. Short-term, three-month fixed bonds, mostly one-year. But this government was never allowed to do that because it was finished. No more treasury bills […] You see, the problem with treasury bills, [is that] it is the Greek banks who buy it. And the ECB said: “No more treasury bills”. So the state could not borrow from the banks.»

      BTW I am not saying that the greek government should be able to or should not be able to get an unlimited overdraft from the ECB via greek banks, "secured" by greek government treasury bills. Just that they really want to, and expect that as a right.

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    16. «Indeed the other eurozone governments forced on the greek government conditions that were not available to the banks: a massive cut in interest rates, enormous lengthening of the repayment period, free default insurance. Something worth probably a few dozen billions euros per year to the greek government (just default insurance on greek debt is 20% per year in the private market), in addition to having their interest rate payments halved.»

      This is what *the* ordoliberal academic in Germany writes as to this:

      www.ft.com/cms/s/0/828d3f62-2a42-11e5-acfb-cbd2e1c81cca.html
      «In March 2012, private creditors accepted a loss in present value terms of about 70 per cent.
      In November 2012, eurozone members accepted a loss in present value terms of about 50 per cent.»

      And what the IMF chief economist writes:

      «And the shift from private to official creditors came with much better terms, namely below market rates and long maturities. Look at it this way: Cash interest payments on Greek debt last year amounted to 6 billion euros (3.2% of GDP), compared to 12 billion euros in 2009. Or put yet another way, interest payments by Greece were lower, as a proportion of GDP, than interest payments by Portugal, Ireland, or Italy.»

      and a private investor:

      klauskastner.blogspot.co.uk/2014/12/paul-b-kazarian-greece-has-practically.html
      «Kazarian makes two principal claims: (a) Greece's net debt to GDP ratio is, in actual fact, significantly below 60% and only about 1/3 of the ratio of peer countries. And (b) Greece's cash net interest payments are close to zero; i. e. no cost of debt service.»
      «Kazarian makes a claim which sounds outrageous but he says that he can provide detailed calculations to interested parties. That claim is: Greece's creditors have already sustained 340 BEUR in net present value losses from debt relief, 'thus providing Greece with extremely generous breathing space'. Kazarian calls this a 340 BEUR wealth transfer to Greece (149 BEUR from private creditors and 191 BEUR from official creditors).»

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    17. Blissex, I would tend to agree with that but the loans came with "conditionality" in plain English we will screw over Europe's taxpayers if you implement policies that screw over poorer Greeks.

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  7. The next step in your analysis could be to debate who has been in control . In my opinion, after the decision to borrow has been made, the borrower is NEVER in control . It is always the lender who is relinquishing his property to the borrower.

    A lender who makes a loan always has a motivation. Thinking of Europe, I would suggest that EU loans to Greece through the TARGET2 mechanism were seen as a temporary method of keeping not-Greek workers working. The loans were an example of Keynesian stimulus. Support for higher employment provided the motivation for lending.

    Returning to the issue of control, by borrowing, the borrower has surrendered control of his economic destiny. Year-after-year borrowing surrenders control pervasively. The borrowing economy, whether an individual or a nation, builds patterns of behavior that become increasingly dependent upon the continued year-after-year new loan. A borrowing economy becomes increasingly dependent upon the controlling lender.

    I see a pattern of year-after-year lending as one paradigm. A change to a second year-after-year lending pattern is a change to a new paradigm. A change in paradigm could be initiated by the lender who is in control, or could be initiated by the borrower who desires to take control.

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  8. Excellent post about the central political-economic issues which will just keep reoccurring.

    I wonder how much the Cold War played into the debt forgiveness and restructuring we saw in those years whether for Germany or in the US. As the Cold War fades into the distance, the creditors are taking a harder and harder line. Pretty soon we'll have debtor prisons again.

    In the US, the banks were bailed out but the recovery was painfully slow as the government turned to deficit-reduction too quickly and interest rates were at the ZLB. So the bailouts were given a bad name. I doubt there will be bailouts the next go around.

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  9. Hudson's Georgist take on this:
    http://michael-hudson.com/2013/07/china-avoid-the-wests-debt-overhead-a-land-tax-is-needed-to-hold-down-housing-prices/
    Let's hope the Chinese have more sense than us.

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  10. "In this sense the Eurozone crisis was just like the global financial crisis: banks lent far too much in an indiscriminate and irresponsible way."
    But the GFC originated not in the US banking sector, but in the shadow banking sector; more precisely the repo market

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  11. SWL means well but ...

    He does not make clear the flip side of the unwise lending. The flip side was growth. The lending allowed a reasonable amount of spending in the world economy and so a reasonable amount of growth. Now we don't have the lending and we don't have the growth.

    George Osborne has just taken a whole slug of spending out of the UK economy with his budget. He is hoping UK consumers will continue to run down savings and borrow more. That's the only hope for the extra spending needed in the UK.

    We need more spending everywhere now. We need fiscal action.

    Thats it fartig.

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    Replies
    1. Anon
      You said itt better then i said. "Too much" lending also produces growth and hides income stagnation.
      Just because income did not grow as it must to support any lending, you could say "too much" lending but only ex post the colapse once the realisation that low income can not support that much lending.

      But lending has to grow exponentially in order to make paying off old loans possible. The real question is: why incomes did not grow.
      The model here is; debt and incomes must grow to prevent depressions. That is how the world works and it worked between WWII and apearance of Reagan and Thatcher providing for unprecedented prosperity or as Pikketty calls it: an outlier in historic growth of the world.

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    2. The UK and the US were growing well prior to decontrolling the banks and allowing them to run amok.

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  12. "between 2010 and 2012 the Troika lent money to Greece so it could pay off its private sector creditors "
    You should really qualify this by pointing out how bad a return the private sector creditors got on their investment.

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  13. Many years ago on the Jimmy Young show on Radio 2 Mrs Thatcher issued the following statement, "profit without risk is an obscenity Jimmy" , so these banks took a risk and lost , get over it guys , thats capitalism for you there is risk and reward.
    Sack the fools who made the loans not the country which borrowed foolishly.
    What ever the out come democracy is dying before our eye's , if the money men win we all lose. It's turned me from a staunch EU man into a time to leave this farce, man.

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  14. "... banks lent far too much in an indiscriminate and irresponsible way."

    What I want to get clear about here is, why did the banks (i.e., the bankers) lend too much, beyond what was prudent (and in general, why do they do that)? Is there an incentive of some sort for lending beyond what is prudent? E.g., why did they continue to lend to Greece when they were aware of the risky situation wrt repayment? It seems as if the initiative in this dubious transaction is with the lenders; they are in a position of power. Instead of adhering to the principles of responsible lending, they decided knowingly to violate those principles in this case (and others): why did they do that? Who are the people who made those decisions? Why do the borrowers get the punishment and blame? (I'm aware that gangster loan sharks don't care about the ethics of their transactions and they are good at "forcing conditions" on the borrowers..) Rereading your last paragraph, I begin to understand the answer, at least for the latter stages: the Troika acting as crony, then as gangster.

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    Replies
    1. «It seems as if the initiative in this dubious transaction is with the lenders;x

      Really? All EU governments gave themselves AAA ratings, only some of those borrowed as much as they could or let or even encouraged their private sectors to borrow as much as they could.

      «they are in a position of power. Instead of adhering to the principles of responsible lending, they decided knowingly to violate those principles in this case (and others): why did they do that?»

      This kind of hallucinatory argument always make me laugh: because that might apply when a big bank deals with a poor widow.

      But the finance ministry of a big rich country is not a poor widow: greek finance ministers and top civil servants have been professors of economics, ex-IMF top functionaries, ex-bankers, all assisted in any case by the best and brightest at Goldman-Sachs on richly paid advisory contracts.

      The idea that these people could be taken advantage of by even megabanks, as if because of their simple minded innocence, seems completely stupid to me.

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    2. I was responding to the OP, but I've just read the comments of Ralph Musgrave @ 12 Jul 15 5:57 and Luit @ 13 Jul 15 6:02, which suggest a path to an answer to my question above. I'm still wondering, was it perhaps more than just "reckoning" or "assessing"? Further possibilities might be "collusion" or "class solidarity via shared conventional (and sociopathic) values". The problem (of reckless lending) has more general relevance: Bankers these days (as compared to earlier periods) seem always to be driven by an insatiable lust for immense wealth, which they think perhaps will give them a favourable and dominant standing among their group of fellow point-one percenters (and which btw allows them to indulge their unthinking arrogance wrt the rest of society). The creative ways bankers try to do this should be identified and all of them should be blocked, and all possible such ways should be blocked in principle. I would still like to get a record of the reasoning process engaged in by the bankers who made the decisions in the Greek case.

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    3. Blissex @ 13 Jul 15 13:09

      I never said anything about bankers taking advantage of supposed Greek naivete; I was not talking about the situation on that level. I was talking about the basic logical mechanism of that kind of economic interaction. If the Greek government (or anybody at all) says to the lender, "Hey, can you spot me a few billion here?", and the lender says, "No, can't do it. Wouldn't be prudent.", then nothing happens, the transaction doesn't get off the ground, and the borrower will have to find other ways to solve their problem. It's the lender that triggers the transaction, and so that decision is subject to certain principles, guidelines, best practices, etc. The dependability of the borrower, e.g., would be taken into account. Possibly you think it was the lenders who were naive.

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    4. Bliss, I am aware of the practdical aspects of the problem of regulating the big banks and hedgefunds. There are an inadequate number of regulators and too many investment firms. And the pay of the regulators is desristory in comparison with the pay of the money managers. Sure, the last two Fed chiefs in the US were sophisticated people, but the field perssonell are not. And there are way too few of them to monitor the system adequately.

      The problem with AIG was not just that the government did not monitor AIGs adventures in GB well enough. Even the President of AIG did not understand how exposed the traders were leaving his company. People complained when AIG managers were paid bonuses, but it was really only one small part of the company that produced all the losses.

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    5. «All EU governments gave themselves AAA ratings,»

      BTW this statement has been questioned by someone very naive on another economists blog, and I have found in reply (which has not appeared there...) this truly delightful document from the Bank for International Settlement who write rather testily about how the "Basel" lending regulation framework has been implemented by the EU:

      http://www.bis.org/publ/qtrpdf/r_qt1312v.htm

      «In the European Union (EU), authorities have allowed supervisors to permit banks that follow the IRB approach to stay permanently on the Standardised Approach for their sovereign exposures.

      In applying the Standardised Approach, in turn, EU authorities have set a zero risk weight not just to sovereign exposures denominated and funded in the currency of the corresponding Member State, but also to such exposures denominated and funded in the currencies of any other Member State.»

      A good recipe for lots of fun! :-)

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  15. It doesn't really matter in the end "who is at fault", when it comes to sovereign debt, we know the people responsible for the bad loans will land on their feet, we know the people responsible for taking the bad loans will land on their feet, and we know the people who mis-rated the loans will land on their feet.

    Why, because in the end, whether they be bankers, politicians, of financial leaders they all come the same class of monied interests. They will have enough spirited away to ensure that their children will be fed and they will always have willing "friends" from the same class to hire them, no matter how utterly malfeasant they have been.

    Sure, one or two will hit bottom, but as a percentage, massively less than those outside their clique.

    In the meantime, we also know the failures whether in lending or borrowing will be borne by in brunt by the little guys, the ones who actually need a job, who have nothing sacked away and no convenient nepotism ("networking" as it is called today) to ensure future employment. We will blame those millions who know little if nothing about finance and economics, and mostly believe what they hear, instead of the hundreds who were elected or paid to know better and were the source of all advice.

    We also know, even if the public of Greece and other PIGS countries are guilty, that their children are not. We know that those children are the first to suffer. And meanwhile as we sit back in our ivory towers and discuss the hypothetical failures and solutions, most of us bloggers having the benefit of economic comfort lest we be spending time in other endeavors, those children suffer.

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