Beware of Greeks Bearing Debts?

Since the debt crises of the 1980s, private sector involvement (PSI) has been a source of debate and controversy. The term PSI refers to the imposition of financial contributions on private sector investors to help finance or reduce the present or future financial obligations of governments of countries in financial crisis, including the obligations of their banks, as part of a financial rescue package.  The euro area debt crises, in particular the Greek case, have revived and intensified a debate that has surrounded most financial crises of recent decades. Many experts are now saying that PSI should have been imposed on Greece's creditors in a big way three years ago. In short, the question is, has PSI for Greece been too little and too late? My answer is yes, but imposing PSI in Greece in May 2010 would have been too early and insufficient.

In the European debt crises, the question has not been whether, but when and how, to impose losses on private sector creditors, via informal understandings, formal negotiations, or unilateral government action. Because of its concern about financial stability, the European Central Bank (ECB) was the principal advocate of caution, warning against the dangers of aggressive private sector involvement either via negotiation or unilateral government action. The concern invoked was that such a step would have produced market contagion affecting everyone, including innocent bystanders among countries and financial institutions. Jean-Claude Trichet lobbied long and hard against imposing financing contributions—"bailing in"—government or bank creditors (Irwin 2013). No one was angrier than he at the French-German agreement at Deauville in October 2010. As far as markets were concerned, that agreement opened the door to the possibility of PSI in Europe sooner rather than later, in particular in Greece. One can suspect that the ECB position also was motivated by a desire to protect its own balance sheet. On the other hand, public anger at bailing out governments and banks runs high, which was one of the motivations behind the ill-timed Deauville agreement.

The debate over the treatment of Greek debt has recently been reignited.  Pisani-Ferry, Sapir, and Wolff (2013) argue that the official sector should have entertained debt reduction during the first five months of 2010. The International Monetary Fund's (2013a) ex post evaluation of exceptional access under the 2010 Greek stand-by arrangement reaches a somewhat ambiguous conclusion: "Upfront debt restructuring was not feasible at the outset. While the Fund began to push for PSI once the program went off track in early 2011, it took time for the stakeholders to agree on a common and coherent strategy." Barry Eichengreen (2013), a long-time advocate of debt reduction in sovereign financial crises, is unambiguous: "The country's sovereign debt should have been restructured without delay," writing down its debt burden by two-thirds.  

On May 20, 2010, I addressed this issue in congressional testimony, expressing concerns about the repercussions of PSI (Truman 2010):

Some observers advocate an immediate adoption of an alternative approach that would involve a restructuring in which the stock of Greek government debt would be written down. A restructuring may ultimately be necessary, but it is not a cheap or easy way out. The broader negative ramifications for the world economy and financial system could be severe right now while the recovery is still fragile. Moreover, if there is to be a restructuring of Greek debt, it should be a one-time event, and its appropriate dimensions are obscure right now.

These are not easy issues, but I am disinclined to revise my earlier judgment.¹

The contagion argument is the most compelling in the Greek case. If the International Monetary Fund (IMF) or non-Europeans had insisted on a deep reduction in the face value of Greece's debt in May 2010 over the objections of the Europeans, it would have exacerbated the already rampant spread of the euro-area debt crises under conditions where the Europeans had not yet established even the flimsiest of firewalls.

Second, no one could know in May 2010 how much debt reduction granted by the private sector or the official sector was required to put Greece back on the road to economic and financial recovery. It was not entirely unrealistic, at the time, for analysts to think that no debt restructuring, to say nothing of debt reduction (write-downs), would be necessary.  We still do not know how much debt reduction will be required in Greece. Five write-downs of Greek debt have already been arranged so far.² Many observers think that there is more to come. Moreover, the longer-term ramifications for creditors and borrowers in financial markets of granting more debt reduction than is necessary are substantial.  

Third, the official sector, with good reason, was reluctant to provide immediate debt relief and in the process lift the pressure on the Greek authorities to fulfill their commitments to much-needed economic reform.

Weak arguments that debt reduction for Greece should have been provided in May 2010 are:

• Greece's debt was a burden holding back recovery of the Greek economy. The debt-overhang argument for debt reduction is that taxpayers are uncertain about their future obligations to honor a country's debt, which dampens economic recovery. This argument has never been empirically well-grounded. Objectively, the added uncertainty in the Greek case was trivial given the size of the overall fiscal adjustment that the Greek program required.
• The IMF was forced to take on a large part of the total exposure to Greece. It is the IMF's job to take on risk in the collective interest of the system as a whole.
• The Europeans would not have agreed. If reducing Greece's sovereign debt in May 2010 was the right thing to do, the other members of the IMF should have insisted, but the case was not overwhelming.
• Generally, as argued in IMF (2013b), debt reduction is too little and too late. Without a dramatic change in the collective approach to PSI issues, which was not in the cards in May 2010, early debt reductions will almost always be too small and will need to be repeated, which is a good reason to wait. Without an outright Greek default or suspension of payments, which in May 2010 would have been economically and financially catastrophic for Greece and for the viability of the euro area, Greece could not have achieved the two-third reduction in face value of its debt that Eichengreen argues was appropriate.

I conclude that the IMF management and staff were right not to include debt reduction as part of the May 2010 Greek program, but it was a mistake to wait until March 2012 to implement debt reduction for Greece because the delay at that point weakened the commitment of the Greek authorities to implement their reform program.  

References

Eichengreen, Barry. 2013. Lessons of a Greek Tragedy. Project Syndicate (June 13).

IMF (International Monetary Fund). 2013a. Greece: Ex Post Evaluation of Exceptional Access Under the 2010 Stand-By Arrangement. Washington: International Monetary Fund.

IMF (International Monetary Fund). 2013b. Sovereign Debt Restructuring: Recent Developments and Implications for the Fund's Legal and Policy Framework. Washington: International Monetary Fund.

Irwin, Neil. 2013. The Alchemists: Three Central Bankers and a World on Fire. New York: The Penguin Press.

Mussa, Michael. 2010. Beware of Greeks Bearing Debts .

Pisani-Ferry, Jean, André Sapir, and Guntram B. Wolff. 2013. Financial Assistance in the Euro Area: An Early Evaluation. Bruegel Blueprint. Brussels: Bruegel.

Truman, Edwin M. 2010. The Role of the International Monetary Fund and Federal Reserve in the Stabilization of Europe. Testimony before the Subcommittee on International Monetary Policy and Subcommittee on Domestic Monetary Policy and Technology US House Financial Services Committee (May 20).

Notes

1. I was comforted that my late colleague Michael Mussa (2010) agreed.

2. The IMF staff rejected the first private sector involvement (write-down) for Greece in the late summer of 2013 because it provided insufficient debt reduction with the result that the entire operation took more than eight months, while the Greek program was on hold, and was only completed in March 2012. By the end of 2012, another partial write-down was required in the form of a debt buyback as part of a further revision in the Greek program. Meanwhile, there have been three instances of official sector involvement in Greece, reducing interest rates, stretching out maturities, and as a result reducing the net present value of Greek debt. See IMF (2013b).