On the Greek crisis and the blame game: creditors vs. taxpayers

One of the arguments that I constantly come across in the debate about the Greek crisis is the argument that the Greek creditors are partly to be blamed for the Greek crisis and thus they should accept a haircut on their loans to Greek government. But it seems to me that this argument is completely unfounded.

The basic argument is that the Greek creditors have been careless in lending money to Greece. But no one bothers to mention why they were so. In this short note I will try to explain who was careless, and if carelessness is the basis for the imposition of haircuts, who should be punished for carelessness.

Prior to the introduction of the Euro, each European country used to issue bonds in the international debt/bond markets. The bond yields were determined by the law of supply and demand. The riskier a government, the higher the yield of its bonds. Accordingly, a less-risky government could borrow with lower interest rates. With the introduction of the Euro, the interest rates converged within the Eurozone and the gap between bonds yields of countries like Greece and Germany were considerably narrowed. 

But why was that the case? Part of this can be associated with the regulations that prescribed the risk weights to sovereign exposures. Although Basel capital requirements framework does not prescribe zero risk weights to banks’ exposure to sovereign risk, the European Capital Requirements framework, even though adopted after the financial and sovereign debt crises, i.e., Capital Requirements Regulation (CRR/Regulation (EU) No 575/2013),  does so. Article 114(4) of the CRR posits that “exposures to Member States’ central governments and central banks denominated and funded in the domestic currency of that central government and central bank shall be assigned a risk weight of 0%”. Moreover, regulations grant additional benefits to financial institutions if they increase their exposure to sovereign debt. For example, the sovereign debt is exempted from the exposure limits to which financial institutions are normally subject. 

While with all these subsidies granted to sovereign debt, EU Member States, in a self-serving manner, tried to free themselves from market forces, it seems paradoxical to blame creditors of sovereigns for being careless in lending to governments. Because when regulators say that investing in something is (at least from the standpoint of regulators) risk free, why blame creditors for listening to regulators’ advice? Indeed, when creditors wanted to grant a loan to Greece or buy Greek bonds they were relying on this regulatory subsidies to some extent, hence market forces failed to price Greek bonds accurately.

At this point, it is important to highlight that regulators are directly or indirectly elected by taxpayers. So, why not blame voters for not electing better representatives and regulatory authorities to avoid such a big regulatory failure? 

My final take is that instead of (or in addition to) blaming creditors, the EU voters/taxpayers should also be blamed and some of the burden of the Greek debt should be shouldered by them for their reckless voting behaviour and not being sufficiently vigilant in having their representatives under constant scrutiny.

PS1: The Greek taxpayers are also to be blamed for not scrutinizing their government behavior. Instead of investing the borrowed money in worthwhile projects, statistical evidence shows that a significant chunk of the loans to Greek government was spent for consumption purposes.

PS2: To the extend that creditors and taxpayers are the same, the taxpayers should be blamed twice. 

On the inverse relationship between age and excitement

That which is new is exciting, and the passage of time erodes its excitement; hence, an inverse relationship between the age of an idea and the amount of excitement it propagates. The same pseudo-natural law mainly applies to ideologies dragging men into fanaticism. As you might have observed, most fanatics are not aged, nor are those who have a credible history of ideological creed. Lesson?! He who newly converts to an ideology is to be most feared. Again, let's borrow from Will Durant: "Tradition is the voice of time, and time is the medium of selection; a cautious mind will respect their verdict, for only youth knows better than twenty centuries."

Smelling a rat in the Greek Deal

One of the strings attached to the Greek Deal is the establishament of a fund or a trust based in Athens and managed by Greece which will consist of Greek public assets that are to be privatized through this fund (also called privatization fund). %50 of the proceeds of privatizations will be used for the repayment of the recapitalization of banks. For me, this seems to be an outright redistribution of wealth from the public to the shareholders and perhaps the creditors of Greek recapitalized banks.

Of course one might argue that the Greek government will be the owner or shareholder of those banks. In this case, again we will have at least two problems. First, it is self-defeating to have a “privatization fund” and again craft a mechanism that enables the Greek government to become a (perhaps majority) shareholder or owner of Greek banks, unless we believe that the public ownership of banks is different from public ownership of other industries!!! Second, even in the case that the Greek government would benefit from owning those banks or being their shareholder, at least in the short run, other existing shareholders and creditors of Greek banks will benefit disproportionately from this deal compared to the alleged benefits to the public. Let’s hope that in the process of sketching the nitty-gritties of the Deal, this redistributive aspect of the deal will be addressed.

Cultural implications of finance

Today I was thinking of the problems that can inhibit the evolution of social cooperation and why some societies could manage to remove the barriers to social collaboration while others are still struggling. In my view, openness in a society can open the door to more collaboration. One such social cooperation that can yield immense benefits to society manifest itself in people’s propensity to reveal and discuss their wealth. With an example, I want to explain how finance can contribute to the culture of openness and cooperation in a society.

If you need to get a loan form a bank, you will need to have collateral or securities to secure your loan. In a society with less developed financial system in which the availability of financial collateral is lower, it is more likely that borrowers would rely on the credit of another member of that society to get loans. For example, in Iran when you apply for a loan and you do not have collateral such as a house or a car, the bank requires you to find someone with relatively high credit rating (such as a government employee) to secure your loan. If the borrower defaults, the lender will have recourse to the guarantor’s (government employee’s) salary or assets (this is called surety or loan guarantee).

In this setting, lenders will depend on wealthy people to get loans and the well-to-do tend to hide their wealth for the fear that if they show off, a potential borrower will ask them to be the guarantor of his loan. On the contrary, in a country with higher availability of collateral, it is more likely for people to exhibit their wealth, because it is less likely that potential borrowers would ask them to be a guarantor by putting their credit (personal liability) as the security for those loans.

A financial system that allows for more monetization, securitizations, and then collateralization of economic values can address this problem. As we know, even in some countries the lender is allowed to put the collateral that he has acquired from the borrower as collateral for another loan that he wants to get from a third party; a practice called rehypothecation. It is telling how all these financial innovations and especially rehypothecation can contribute to the availability of credit in a society.

Hiding wealth can also be observed in societies in which the financial system is not sufficiently developed to offer investment vehicles to savers. An interesting example comes from Tyler Cowen who finds that in rural Guerrero State in Mexico there is a -%70 return on saving. Meaning that when people save and their family, friends or other relatives come to know about it, they come and borrow from the savers, because it is assumed that such savings are in the form of cash. In addition, the rate of default on such borrowings is very high. Therefore, there is no incentive to save in such a community. This is also a setting that will encourage members of the society to hide their wealth. And of course, hidden wealth, if not a road to perdition, is by no means the road to prosperity.