Tuesday 19 April 2011

It's not a bail-out, but it might need to be

Jon Worth has a good post (and also pointed to this great post by Henning Meyer) on why the bail-outs are not actually bail-outs: they are loans to countries which will be paid off, with the creditor countries getting a profit at the end of the process. However, a problem with this can be seen in Meyer's post when he explains this:

"It is a widespread myth for instance that the European bailout fund is giving away money for free to countries such as Ireland and Greece. This is simply wrong! The ‘bail-out’ is a lending facility that lends money at rates with which the underwriting countries will make a profit if the debtor countries do not default. This is far from giving away money for free from presumed ‘responsible’ countries to ‘irresponsible’ countries to support their luxurious lifestyle."

"If the debtor countries do not default" looks like a big if to me. The structure of the bail out is such that it reinforces the austerity model that the debtor countries have been trying to enforce. This has been done with varying degrees of success when it comes to sticking to the programme. However, the plan is to change the EU structure so that countries can have a managed default after 2013, which means that there will be many voices (as there is currently in Ireland) questioning why they have to go through the harsh readjustments of austerity when after 2013 default would be the accepted option. Surely only a fool would go through that pain for no real reason?

It doesn't help that the rescue loans are structured so that they have fairly high interest rates, even if they are below the market rate - Europe seems to be caught in between solidarity and ensuring the hair-shirted redemption of the debtor states through some cleansing punishment. With the rates higher than the growth rates of the debtor countries, it may be that their debt could grow - particularly in Ireland. The Irish case seems to be different from the Greek case, in that the European system has stepped in to prop up the Irish banks to ensure that their debts to British and Eurozone banks are repaid. As they cannot be bailed out directly, the loan facility means that essentially the Irish government borrows money from the EU to give to the banks to pay off their loans to private continental banks, and the Irish taxpayer picks up the tab at the end of the process.

Allowing the private banks in Ireland to fail now is not an option as the ECB ensures that the banks keep running as the lender of last resort, but it is widely accepted that Ireland cannot pay off the debt, and the Irish government is looking to renegotiate parts of the EU-IMF deal, starting with the interest rate on the loans. Eventually Ireland may ask for some restructuring of the debt - which seems to essentially mean that some of it simply isn't paid back. Now that part would be a bail-out.

This is very different from the situations in Portugal and Greece, but with the domestic political pressures building up, it should be borne in mind that default only seems a scary prospect for debtor countries for so long. Once the pain of austerity becomes too much, with too little reward, then the option of default - which would turn the loans into lost money - becomes more realistic.

The current plan for the Eurozone has failed - it doesn't seem to be working in the Member States it's supposed to help out, as it forces them into narrow austerity plans that do a lot of damage to their economies and therefore damage their ability to pay the loans back; and it has failed to stop the debt crisis spreading. The loans have bought time to deal with the Eurozone more comprehensively, but there doesn't seem to be many good or imaginitive ideas on the table.

So while offering - and accepting - the loans was a good idea in order to buy time, if it's not followed up with effective action, then things could get worse. Not offering the loans, however, would have brought about default in the debtor countries, which would have meant that their debt would wash back into the economies of the creditor countries. This would have had an immediate effect on the economies of all the Eurozone members, since the credit originally came from their private sectors, or they would be simply affected by the damaging effects of the debt washing back into Germany and the Netherlands, etc. Which is why I think that mainstream European political parties need to put forward a realistic and effective vision - or at least start vigourous debates on options* - to combat the platforms of the populist parties. There's no excuse not to.

* I know, that will be the day.

1 comment:

  1. If an attempt is made to bypass the ordinary interest-setting mechanism, where a credit-worthy country A loans money to a basket case B, surely the markets will simply increase interest charged on loans to A. So even if B doesn't default, A pays more interest over time, which more than offsets the "profit" it appears to make at the end of the process.