Tuesday, March 20, 2012

Under Japanese model, Greece is heading for hell

A Guardian column by Costas Lapivatsas lays out how choosing to implement the Japanese model rather than the Swedish model for handling a bank solvency led financial crisis has left Greece in far worse shape.

Take the restructuring of Greek debt. When the crisis burst out in 2010, Greece had €300bn of debt, held overwhelmingly by private creditors and governed by Greek law. It would have been a painful but fairly straightforward exercise to default, putting the country back on its feet.
Doing so would have been to implement the Swedish model.

In this case, Wall Street rescues Main Street by absorbing the losses and preventing the impact of the excesses in the financial system from impacting the real economy.
Instead, the EU advanced expensive bailout loans, imposed ferocious austerity, and created the worst depression in Greek history.  The result was that by early 2012 Greek debt had risen to €370bn. Of that, however, only about €200bn remained in private hands. In less than two years, the EU had saddled Greece with a massive official debt, much of which had been used to retire old debt, allowing large private creditors to exit without losses.
By choosing to implement the Japanese model, the losses were socialized and imposed on the real economy.
Restructuring in March extricated the remaining large private creditors with as little damage as possible. .... Greek banks faced major losses, but the Greek state has generously agreed to borrow €50bn to recapitalise them..... 
There is no need for the Greek state to borrow 50 billion euros to recapitalize the banks.  The banks can recapitalize themselves through retention of future earnings and issuance of new equity.

What is needed instead is that the European Stability Mechanism backstop the Greek deposit guarantee.  This ends the current run on the Greek banking system by depositors who are concerned that they might not get their money back.

At the same time, to show that they have recognized all the losses on and off their balance sheets, the Greek banks need to provide ultra transparency.  They need to disclose on an on-going basis their current asset, liability and off balance sheet exposure details.
If fresh borrowing by the Greek state to finance the deal is taken into account, the actual reduction of Greek debt in 2012 will be less than 10%. Even worse, Greek debt will become largely official and governed by British law. More than €40bn will be owed to the IMF, which has absolute seniority in repayment.
Every time the Japanese model has been implemented, it has made the situation worse.

This is a direct result of the fact that the Japanese model is based on a flawed assumption:  the need to protect the banking system, in particular, bank book capital at all costs.  This is simple not true as banks can operate for years supporting the real economy with negative book capital.  This is made possible by the existence of deposit guarantees and access to unlimited central bank liquidity.
EU policy has thus succeeded in transforming a debt problem between a state and its private lenders into a debt problem among states and bilateral organisations. 
When restructuring raises its head again, there will be major ructions between Greece, the EU and the IMF. Ireland and Portugal, both of which will almost certainly need to restructure debt in the future, would do well to avoid the Greek path of switching official and private debt. 
And there are still more lessons from the unfolding Greek disaster for the eurozone periphery. 
The new bailout programme promises growth by crushing wages and liberalising the economy. Yet, as long as Germany continues to keep its own wages stagnant, no country in the eurozone can significantly gain competitiveness by reducing wages. As for liberalisation, it might have been more persuasive if it was actually applied to the monopolistic structures that keep the prices of food and other goods high in Greece. Instead, the plan is to liberalise the operations of doctors, surveyors, petrol stations, tourist guides and hairdressers. 
Greece is heading for stagnation, but even that will look desirable compared with the hell the country will face in 2012-13. Amid an unprecedented depression, the government is aiming for large primary budget surpluses, and there will be substantial cuts in investment and consumption. The prospects for economy and society are catastrophic. 
It is hard to believe the Greek people will consent to national suicide, whatever might be the obsessions of the Greek elite. 
The trouble is, however, most sensible options to deal with the Greek crisis have gradually been blocked during the last two years.
This was the choice made by policymakers and financial regulators at the behest of the banks.
The path increasingly left to the country is that of social upheaval leading to default and exit from the eurozone. This would inevitably bring political unrest to both Greece and Europe. 
The EU has refused to deal with the eurozone crisis through radical measures such as debt cancellation and wholesale reorganisation of the monetary union. Instead it has mollycoddled the banks and imposed harsh austerity.
Please re-read the highlighted text as it neatly summarize the difference in outcome from rejecting the Swedish model for handling a bank solvency led financial crisis and implementing the Japanese model.

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