Taxpayer haircuts on Greece debt loom

In his Telegraph column, Ambrose Evans-Pritchard lays out why taxpayers are going to end up taking losses on Greece's excess debt.

Left out of the column is the simple fact that it was the banks that originally lent Greece more than it could afford to repay and governments have pursued policies that allowed the banks to transfer these losses to the taxpayers.

These policies reflect the choice of the Japanese Model for handling a bank solvency led financial crisis under which bank book capital levels and banker bonuses are protected at all costs.  A choice that the bankers advised policymakers to make at the beginning of the financial crisis.

Here we are five years later and it is the taxpayers, rather than the bankers, that are being stuck with the bill for the debt that the bankers should never have extended given the ability of the borrower to repay.

Germany, Holland, and the creditor states of northern Europe have not lost a single cent on eurozone rescue packages, so far. 

They have lent money, at a theoretical profit. They have issued a fistful of guarantees to Europe’s twin bail-out funds, covering Greece, Ireland, Portugal, Spain, and soon Cyprus. They have taken on opaque and potentially huge liabilities through the European Central Bank. 

Yet little has disturbed the illusion that the euro is a free lunch for the surplus powers. 

An assumption persists that the creditors will - and should - be spared the consequences of flooding Southern Europe with excess capital....

Regular readers know that this assumption is false and that taking action based on this assumption makes the situation worse.

Since the Great Depression, modern financial systems have been designed so that the creditors are suppose to recognize upfront the losses on the excess debt.  This is done to protect the real economy and society.

We are at last nearing the awful moment when the curtain is ripped away. Greece’s economy has contracted 7pc over the last year. Public debt will spiral to 190pc of GDP in 2013. Leaving aside the Gothic horror of youth unemployment at 58pc, Greece’s debt trajectory is simply out of control. 

The International Monetary Fund says the country cannot claw its way back to viability unless EU governments and bodies take their punishment. The Fund’s Board and the powers behind it - the US, China, Japan, Brazil - will withdraw if the current farce goes on. 

Greece needs €100bn of debt forgiveness to get back on its feet, according to Barclays Capital. 

I suspect the reality of what it will take to get Greece back on its feet is significantly higher.  Barclays Capital's estimate reflects what was needed when the financial crisis began and before the Greek economy was forced into a depression.

A lot of this is coming Germany’s way....

Der Spiegel says the looming cost for Germany is over €17bn, enough to leave a big hole in the country’s 2014 budget. A line item would have to be written into the finance bill. 

Chancellor Angela Merkel would have to explain to critics on Left and Right in the Bundestag why her past assurances had come to nought, and why anybody should believe fresh assurances that Portugal is a safer bet. 

Or that Spain, Italy and France are safer bets?

German taxpayers would at last discern - as some already suspect - that their elites have led them into a monetary Stalingrad. 

It was the choice of the elites, particularly the banking elites, to choose a monetary Stalingrad for the taxpayers.

Mrs Merkel was still trying to duck the ghastly implications of this last week. There will be no taxpayer losses, she insisted after a meeting with the French. "Of course we did not talk about debt haircuts: our view has not changed and nor should it." 

Not talking about something does not mean that the losses will not occur anyway.  Haircuts are voluntary.  When a borrower defaults, the creditor still gets the losses.

The fond hope of EU leaders and commissars is that the North-South chasm in competitiveness will be closed by "internal devaluations" in Club Med states before their democracies blow up. This morally indefesible policy relies on pushing unemployment to such traumatic levels that it breaks labour resistance to pay cuts, and as we can see from the youth jobless rates in Greece (58pc) Spain (55pc), Portugal (36pc), Italy (35pc) it can take carpet-bombing to achieve effect.... 

It is not just the policy of "internal devaluations" that is morally indefensible, it is the choice of the Japanese Model that is morally indefensible.

Putting bank book capital and banker bonuses ahead of the real economy, the social contract and society is simply wrong.

What is certain is that EU authorities have made the task much harder by fixing all key policy settings on contraction. Fiscal policy is too tight. Monetary policy is too tight. Regulatory policy is also too tight since it is forcing banks to raise capital buffers even as the slump deepens....

The combined effect of this triple-barrelled "pro-cyclical" shock is to push the eurozone into a second downward leg of the Long Slump. Last week’s confirmation of a double-dip recession hardly does justice. Euroland is sliding into structural depression. 

A downward slump that your humble blogger predicted and has been arguing since the beginning of the financial crisis is a result of pursuing the Japanese Model.

Regular readers know that there is an alternative that could be pursued at any time.  The alternative is to require the banks to recognize upfront the losses on the excess public and private debt in the financial system.

This lifts the burden of servicing this debt from the real economy and restores growth.

As for the competitiveness between North and South in the EU, that is a problem that is better left to be addressed to a time when the EU economy is growing.

Professor Paul de Grauwe from the London School of Economics said the deepening crisis is "entirely self-made" and "very dangerous" as passions fly.

The professor confirms my observation.

The ongoing crisis is the choice of the EU policymakers.  A choice that at a minimum is likely to dramatically increase the cost of the financial crisis that began in 2007 to the taxpayers.