CHICAGO – A
Greek tragedy is typically composed of three acts. The first sets the scene. It
is only with the second that the plot reaches its climax. For current-day Greece,
the imposition of “voluntary” losses on the country’s private creditors
represents just the end of the beginning. The real tragedy has still to unfold.
On the face of it, the “voluntary” arrangement with creditors might appear
to have been a big success. The volume of Greece’s
foreign debt has been reduced by more than €100 billion ($130
billion). Greece’s
European partners have provided €130 billion in new loans. As a result, Greece
has avoided generalized bank failures, and it has been able to continue paying
its public employees.
But, despite these trumpeted results,
the reality is much harsher. Even with the latest deal, Greece’s
debt ratio remains at 120% of last year’s GDP. With a projected drop in GDP of
7% this year and a sustained deficit, the debt ratio would exceed 130% before
stabilizing at 120% in 2020.
But even this reduced level is not
sustainable. With its population set to contract by 0.5% annually over the next
30 years, even if per capita income in Greece
were to rise at the German rate of 1.5% per year, the debt would be difficult
to service. Assuming that Greece
could borrow at a real interest rate of only 3% (the current level is 17%), the
government would need to run an annual 2.6%-of-GDP primary budget surplus (the
fiscal balance minus debt-service costs) for the next 30 years just to keep the
debt burden stable.
To put that task in perspective, in
the last 25 years, Greece
ran an average primary deficit of 2% per year. To reduce the debt-to-GDP
ratio to 70%, Greece
would have to maintain an average primary surplus of 4% for the next 30 years,
a level that it has temporarily achieved in only four of the last 25
years.
If the situation is so dramatic, why
are the European Union and the International Monetary Fund celebrating the
recent agreement? Simply put, these institutions’ primary objective was to
minimize the repercussions that a Greek default would have on the international
financial system. Greece,
frankly, was not their priority.
Given the reaction in financial
markets, they have succeeded. The delay in reaching an agreement enabled most
private creditors to escape the consequences of their reckless lending to Greece.
Roughly half of Greece’s
external debt migrated from the private sector to official institutions.
But the group of lenders that the EU
and the IMF wanted to help the most – the banks – only partly reduced their
exposure. Between May 2010 and September 2011, the value of Greek sovereign
debt held by French banks dropped by €4.6 billion (39%), while German banks
reduced their holdings by €2.9 billion (31%) and Italian banks by €530 million
(30%). In part, this drop reflects the reduction in market value of the
existing liabilities. Thus, on average, banks have sold very little.
But, while private-sector losses have
been minimized, at what price? Had Greece
defaulted on its debt in 2010, imposing the same “haircut” on private creditors
as it has imposed now, it would have reduced the debt-to-GDP ratio to a more
manageable 80%. That would have been painful, but it could have spared the
Greeks from a 7% decline in GDP and a rise in unemployment to 22% (including an
increase in youth unemployment to a whopping 48%).
More importantly, a default in 2010
would have left some room for adjustments. Under the current plan, there is
none: if the economy does not turn around quickly, Greece
will need more help. But where can it go now to find it? Most of the sovereign
debt is now held by the official sector, which traditionally does not allow any
haircut. The remainder has been reissued under English, not Greek, law, putting
it outside of the control of the Greek government and its new collective-action
clause, which facilities partial defaults.
In other words, Greece
has exhausted its ability to share part of the burden with the private sector.
Next time, Europe’s taxpayers will be on the hook.
The second act of the Greek tragedy
will cast desperate Greeks against angry and disenchanted Europeans elsewhere.
Only at the climax will we know whether the effort to delay the inevitable
contributed to undermining the idea of Europe for the
current generation.
Luigi Zingales is the Robert C. McCormack Professor of Entrepreneurship
and Finance at the University of Chicago’s Booth School of Business, and serves
on the Committee on Capital Markets Regulation.
