Europe's Bailout Boogie - the new mood music of the EU
It is not the EU which is bailing out Greece or Ireland so much as it is Greek and Irish citizens who are bailing out banks in Germany, Britain, France and elsewhere who made duff loans
This weekend music lovers (sic) from around Europe will gather in Dusseldorf for this years Eurovision Song Contest in a carnival of camaraderie and flag waving. However, such displays are getting rarer around the European Union.
From the frozen north, where the anti bailout True Finns party made massive gains in April’s election, to the sweltering south, where this week saw protests against spending cuts erupt into violence again, the political and social costs of holding the euro together are spiralling as rapidly as the economic costs.
When the euro was founded, countries which had previously paid a premium to borrow found themselves basking in the reflected glow of German monetary stability and the fiscal discipline of the stability and growth pact.
Their borrowing costs plunged and countries on Europe’s fringe went on a well documented spending spree; Ireland buying itself a new sports stadium with the government stumping up €190 million, just over half the cost, and Greece staging the Olympics at a cost of over €7 billion were just two notable examples.
Such illustrations serve the economic purpose of reminding us of the dangers of the Keynesian prescription of conspicuous spending as a driver of economic growth. But currently they also serve a dual political purpose.
On the one hand they shift the blame for the current crisis from the fundamental flaws in the euro as a currency to the fecklessness of a few of its members. They also justify applying a remedy of swingeing cuts in public spending and drastic tax rises to rebalance budgets and protect bondholders.
Amid the plethora of economic debates kicked off by the credit crunch this stands out as rather anomalous. One popular narrative of how we got into this mess is that greedy banks recklessly forced loans on people who hadn’t a prayer of being able to repay in an even moderately adverse credit environment. This is clearly far too simplistic, blame lies on both sides with reckless borrowers bearing some culpability too.
This unsatisfactory one sidedness permeates discussion of the European debt crisis but here it is inverted. The stories of Greek civil servants retiring in their 40’s and Irish judges being paid twice their continental counterparts have focused discussion on only one side of the equation, the borrowers.
This is as unfair as placing all the blame for the sub prime crisis on ‘greedy bankers’; there are two parties to any loan after all, a lender and a borrower, and in discussions on the Euro debt crisis the lenders have got off largely scot free so far.
When a party lends money the interest rate it charges reflects a number of factors. In part it reflects a reward for foregoing consumption in the present period. In part it reflects a surrender of liquidity. In part it reflects the danger that inflation will erode the real value of the debt. And in part it reflects the chance that the loan will not be repaid.
The total elimination of this default risk has been the primary thrust of the EU response to the debt crisis. European bureaucrats have visited Greece, Ireland and Portugal to hand out loans and dictate draconian repayment terms.
The race is on between Spain and Italy to join the list. The conditions of these loans have included sharp tax rises and spending cuts. In Greece, Ireland and Portugal the new loans are piling on the old and, with the fiscal tightening tipping them back into recession, the interest is increasing the debt burden on these economies.
The EU leaders claim that all this is necessary to save the euro. They are right, though this just goes to show what a deeply flawed arrangement it was in the first place. But these massive loans to the struggling PIGS, with the attendant rise in their indebtedness is also, in the short term at least, great news for their bondholders.
According to figures from the Bank for International Settlements the big holders of Greek, Irish, Spanish and Portuguese debt are German and British banks followed by French banks.
Germany’s exposure amounts to $569 billion, Britain’s to $431 billion and France’s to $380 billion. There is variation within this with Britain being heavily exposed to Ireland ($225 billion) and Spain ($152 billion) while France has a hefty exposure to Greece ($92 billion). All told foreign banks hold $2.5 trillion of debt in the four countries.
A default, exit from the euro and devaluation, or even a rescheduling of debts on a scale necessary to enable Greece or Ireland to pay them back would be a disaster for these foreign bondholders and the governments that would be required to recapitalise them in the event. Thus it is that the power of the EU is being brought to bear on the PIGS to protect the bondholders at all costs.
Which brings us back to default risk. When these foreign institutions lent money to the PIGS to pay for all the conspicuous consumption of the boom years they did so at an interest rate which included an element to cover default risk.
It now emerges that that risk was far higher than these lenders calculated but that is the name of the capitalist game. You profit on winning investments and lose on failed ones. Unless you are a vast bank in which case every bad position will be covered by either a domestic or foreign taxpayer.
The banking sector has become ‘Too Big to Fail’ because it has never known the consequences of failure. Time and again governments and monetary authorities have stepped in to shield them from it.
The PIGS certainly need to tackle their debt problems but it is not the EU which is bailing out Greece or Ireland so much as it is Greek and Irish citizens who are bailing out banks in Germany, Britain, France and elsewhere who made duff loans. That, not Boom Bang a Bang, is the mood music of Europe.
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