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.