Debtors have failed to make good on their obligations throughout history, and yet we’re still here, writes Kevin Hassett
world’s economic policy makers have talked up a zero-tolerance attitude toward
sovereign-debt defaults. For every troubled national borrower, there seem to be
a dozen central bankers ready to hand out cash, always to avoid Armageddon.
have failed to make good on their obligations throughout history, and we’re
still here. Defaults by financial institutions are, of course, too numerous to
count, but governments crash as well. We have a long record to see just how
they play out.
to “This Time Is Different: Eight Centuries of Financial Folly,” the 2009 book
by Carmen M. Reinhart and Kenneth Rogoff, there were 238 external debt defaults
or reschedulings from 1800 to 2008. Spain tops the list with 13 occurrences in
its history, though none since the 19th century.
we are supposed to believe that if one small country such as Ireland goes down,
the rest of us will too. Yes, the world is more interconnected now than 200
years ago. That doesn’t make every cough a sure sign of pneumonia.
the risk of understatement, throwing money at a country teetering at the brink
of default isn’t how things used to be done.
1902, European nations responded to a Venezuelan government debt default with
military force. German, Italian and British gunboats blockaded ports, seized
customs houses and bombarded a Venezuelan fort. Venezuela caved, agreeing to
restructure and pay its debts.
days, when European leaders see Greece and Ireland on the brink of default,
they don’t send gunboats - they send money. The word “restructure” is taboo.
Somewhere along the line it became unacceptable to take 80 cents on the dollar
from a debtor nation, but acceptable to give that same nation 20 cents to keep
its payments on schedule.
problem is, once you do that, everyone wants 20 cents.
theory of bailouts is intricately related to the fear of Armageddon. If
investors see Greece go down, the story goes, they might panic and stop lending
to other nations, even ones that should be considered healthy. In this view,
default spreads like influenza in 1918.
theory doesn’t stop with national governments. If California defaults on its
debts, then the credit crisis might sweep up all the other states. If Bear
Stearns Cos fails, then so will everyone else.
seem to have become a world in which we assume a panic is around every corner.
When markets are irrational, it’s impossible to say what might set them off,
and fear of disaster becomes a powerful excuse for policy makers to do whatever
Vincent Reinhart reviews the legacy of the 2008 Bear Stearns bailout in an
article to be published in the Journal of Economic Perspectives. As he points
out, the US government, in its wisdom, wiped out equity holders but saved
bondholders, and investors began to expect this policy.
writes, “This expectation made it profitable to identify the next financial
firm to be resolved and then to sell its stock short and use the proceeds to
purchase its unsecured debt. If the candidate firm was identified correctly,
the debt would appreciate in value and its stock collapse.”
Bear Stearns bailout, then, only delayed the inevitable realization of losses
from the collapse of the real estate market. It abetted the fiction that
government can save us. Only when Lehman Brothers Holdings Inc. was allowed to
go down did markets realize that the losses were just too big. The process
would have been more orderly if the restructuring began at once.
just as bad for countries. Central bank interventions become an excuse to avoid
no one would recommend that we return to the gunboat days, the old-fashioned
hard-nosed approach had a big effect on contagion.
Kris Michener and Marc Weidenmier studied what they call supersanctions -- the
use of military or political pressure to force repayment of sovereign debts, a
commonly used enforcement mechanism from 1870 to 1913.
found that following supersanctions, “on average, ex ante default probabilities
on new debt issues fell by more than 60 percent, yield spreads declined
approximately 800 basis points, and defaulting countries experienced almost a
100 percent reduction of time spent in default.” In other words, a Tony Soprano
approach toward a defaulting nation can inspire some major improvements.
world economy has survived sovereign debt defaults in the past, not by bailing
out the miscreants, but by paying close attention to their own balance sheets.
If you don’t want a Greek default to lead to a crisis in your country, balance
your own budget ahead of time.
stop whining about Armageddon.
Hassett, director of economic-policy studies at the American Enterprise
Institute, is a Bloomberg News columnist. The opinions expressed are his own.)