There are weighty discussions going in in Europe over the need to prop up/bail out the Greek economy by guaranteeing Greek sovereign debt. The argument goes this way: Greek banks, which have a vast portion of their assets in the form of Greek sovereign debt instruments, need that debt made good, or the banks will fail. If the banks fail, the Greek economy fails. Further, major banks central to the economies of other nations of Europe, both private financial institutions and national central banks, are major holders of Greek sovereign debt; if that debt is defaulted, those banks will fail. Other economies of the EU—Portugal, Italy, and Spain (the remaining PIGS)—will fail if their banks, holding all that Greek debt, fail. The financial institutions of sounder economies are also major holders of those remaining PIGS’ debt; if those economies fail, so do these additional banks, and the cascade continues. So it’s necessary to prop up the Greeks, to prevent bankruptcy and default there, in order to prevent the cascade from getting started.
The argument in Europe currently is from the perspective that since this cascade must be so widespread in its final outcome, it is legitimate for taxpayers to be forced to bail out the failing banks (the current mechanism for this is for the taxpayers’ money to be used to increase the capitalization—the cash on hand—of the exposed banks, so they’re better able to handle the losses in the even of a Greek default; however, the specific pathway of committing taxpayer funds is irrelevant to this discussion), even of other countries: the taxpayers are only protecting themselves by doing this.
Let’s look at this from another perspective, though. Is a mandated bailout truly necessary, or appropriate?
To answer this, we must first understand whose money will be used to recapitalize (let us say) those banks. If governments, individually or behind the veneer of an EU demand, mandate the recapitalization, it will be the taxpayers of the constituent nations whose money will be used, including taxpayers of nations different from the nationality of the banks being recapitalized.
If, on the other hand, the market is left to recapitalize the banks, it will be the market participants, the citizens* of the constituent nations whose money will be used, including the participants/citizens of nations different from the nationality of the banks being recapitalized.
We see, though, that these are the same people in both cases; it is the same money being used in both cases. We also readily see that a critical difference between the government and the market solutions is that with the market solution, the decisions will be made by the people whose money is being committed—or withheld—but with the government solution, those decisions to commit (and not withhold) are made by government, committing other people’s money by diktat. We also see the nature of that diktat in this paraphrase by Spiegel International Online of Luxembourg Prime Minister Jean-Claude Juncker’s remarks, revealing EU leadership disparaging attitude toward democracy and the crass citizenry having any input:
The German parliament’s right to co-decision on important matters pertaining to the euro bailout is one of the reasons that the summit has been stretched out over a period of several days. And while some have demonstrated sympathy for Merkel’s problems, others have been irritated by the extra burden the co-decision has created. Berlin isn’t the only place with a parliament….
In the nature of free markets, though, the decisions will be made far more quickly and far more transparently if they’re made by those citizens themselves. Any damage done by a Greek default (for instance) will be far more limited in its cascade effects and far more quickly repaired.
On the other hand, government cannot keep up with the changing market conditions or with the rapidity of failure when failure is in the offing. We’ve seen how the governments of the EU have been unable to understand the European economic problem, for instance. The European nations have vastly and repeatedly underestimated of the amount of money needed to bail out Greece: an original estimate of some €120 billion was discovered to be insufficient last summer, and it ballooned to an additional €110, or so, billion; now those governments are finding that to be insufficient, and estimating another—in addition to that summer estimate—€252 billion.
Finally, for all those efforts these last 2 years, a Greek default now is being arranged anyway: the latest attempt is for a write-down of Greek debt of 60%. In addition to this is the conversion of the European Financial Stability Facility (EFSF), the original pool of funds for the bailout, into an insurance scheme wherein the existing €440 billion of the EFSF will be leveraged, via insurance bets, into a €1 trillion backstop. Both by government mandate.
But these decisions are properly those of the investors whose money it is in a free society, not a decision handed down from on high by government(s). Let the taxpayers, in their free markets, make these decisions. Greek default may well have the cascade of failing banks described above, especially if taxpayers decline to keep feeding the bad decision-makers, decline to continue funding bad debt issuers, against the wishes of their governments (though I doubt it’ll be so bad as the doomsayers wail). However, without government’s involvement, the decisions and the outcomes, via the pricing mechanisms of a free market, or even a centrally-guided (if not so much, anymore, centrally managed in the EU) market, will move much faster. Results will be known much more quickly without governments in the way as middlemen.
Thus, those taxpayers—citizens—will, as is entirely appropriate, decide for themselves, via their Invisible Hand, who the winners and losers will be; who will, or will not, receive bailouts; they need no assistance from governments. The pace of the free market may deepen the downturn from a Greek default and any potential cascade, but with taxpayers in a free market making the decisions, the recovery will be much faster, too, and it will rise far beyond the condition preceding the onset of the Greek problem. Indeed, had Greece been allowed to default two years ago when the problem became apparent, both the Greeks and the EU would be on the path to recovery, growth, and prosperity today.
Out of the creative destruction of a bankruptcy in a free market grows a refreshed, stronger, more vibrant economic entity than before the bankruptcy—even at the national economy level. And the lessons learned from the bankruptcy and recovery are enormously valuable. Out of the destruction of a propped up entity that is not allowed to go through bankruptcy grows more widespread bankruptcy and destruction and a far broader, longer lasting economic dislocation—especially at the national, and continental, levels. And the lessons missed by that intervention and impeded recovery would have been enormously valuable.
*For exposition purposes, I hold that private enterprise, including private/commercial financial institutions, are agents of their individual, citizen, owners, and so in the context of this discussion, I make no distinction between citizens and the businesses they operate.
Update: Clarified Juncker’s paraphrase by indenting it.