People generally think the Great Recession of 2009 and the eurozone crisis of 2010 to 2012 are distinct events. In fact, they have a common cause: the banks of major economies lent too much. This is well understood for the Great Recession, as it followed a global financial crisis that was caused by irresponsible lending by US and UK banks in particular. The eurozone crisis seems different, because here the focus is on borrowers, and the Greek government in particular. But for every profligate borrower there is an irresponsible lender.
Why is the focus on lenders for one crisis, but borrowers for another? The answer has a lot to do with the way in which each crisis was handled. With the global financial crisis, the borrowers – such as those who had taken out sub-prime mortgages in the US – were allowed to default. When this threatened the viability of the banking system, governments stepped in to support the banks.
The eurozone crisis arose because the banks of the richer eurozone countries lent huge sums to periphery countries such as Greece. In contrast to sub-prime borrowers, the Greek government was not allowed to default. Other eurozone governments were worried that default would threaten the viability of their banks. Instead, the Troika – the European Central Bank, the European Commission and the International Monetary Fund – made loans to the Greek government so it could pay off its private-sector creditors, including the banks. Most of the money lent by the Troika has gone to these creditors, rather than to helping Greece adjust as it cut its deficit.
If someone cannot pay their debts, it is not normally wise to stave off default by giving them new loans. It is throwing good money after bad. However, the Troika thought they could change the solvency of Greece by imposing strong conditions. These were of two types: various structural reforms and stringent austerity.
Unfortunately, this was wishful thinking. The structural reforms were never going to have an immediate impact on the Greek economy. Acute austerity, on the other hand, had a completely predictable impact. GDP fell by 25 per cent and youth unemployment rose to 50 per cent. As the economy collapsed, the ability to repay the Troika decreased. So began a sequence that the former Greek finance minister, Yanis Varoufakis, calls “pretend and extend”: keep lending to Greece, and keep pretending that this time they will be able to pay it back.
All this stemmed from irresponsible decisions by French, German and other countries’ banks to lend to Greece. Imagine if the global financial crisis had been dealt with this way, with borrowers who couldn’t pay – US sub-prime borrowers, say – being lent money by the US government to pay off their debts. That might have kept US and UK banks solvent, but the problem would now be that taxpayers would not get their money back from these borrowers. Perhaps some would be made to attend self-improvement lessons and do community service – which would have had the same effect on their ability to pay as the “structural reforms” and austerity imposed on Greece. Eventually this might have led to heated debates in Congress, with some politicians saying it was time to revoke the US citizenship of the debtors.
Perhaps, given the uncertainties during the eurozone crisis, the Troika’s decision to protect its banks by taking over most of Greece’s debt was understandable. However, once the crisis was over, most of the debt should have been written off. This was too toxic for politicians to contemplate, because by then voters had begun to view this as lending their money to the Greek people. So the Troika must continue to “pretend and extend”. The pretence is not only that they will get their money back, but also that the dire state of the Greek economy has nothing to do with the austerity imposed on it.
In thinking about lenders and borrowers, it is easy to allow morality to dominate: debtors should be made to pay because contracts have to be upheld; or creditors should pay (through default) because they are normally wealthier. These kinds of arguments miss the lessons of history. When it comes to unsustainable government debt, trying to prevent default does little good to the creditor and leaves the debtor impoverished. This debt needs to be written off, one way or another. Of course, earlier Greek governments borrowed too much, but there is no reason why that had to lead to the current disaster. The responsibility for that rests with eurozone politicians and the IMF.
Simon Wren-Lewis is Professor of Economic Policy, Blavatnik School of Government, University of Oxford
Hamish McRae is awayReuse content