by David Malone
The problem with saying the headline of this piece out loud is that as soon as you do, a great clucking flock of Chicken Littles come speeding out of their corners, kicking up dust and confusion and drowning out any attempt to discuss the issue beneath a frenzy of shrill cries of “Don’t listen to the madman. If you do the sky will fall on our heads. All the banks will burn down, the ATMs will all stop working, our houses will be repossessed, all our pensions – Oh woe! – all our pensions will be seized and eaten by a rampaging army of angry vengeful bond holders and we will never, ever in the whole future of the universe be allowed to borrow money from the bond market ever again, till the end of time.”
So before they get here I want to say the sky would not fall in. There is, in fact, a history of sovereign default and restructuring of debt and there are recognized and tried methods for doing it. Those countries that have, Mexico, India, Russia, Argentina, Ecuador to name only a few, are still with us, are able to borrow on the bond markets. Generally the sky did not fall on their heads nor on ours.
Somehow the word default has come to be for nations a bit like suicide is for people: terminal and immoral because of the misery it causes to those left behind. We must stop listening and believing those who take this view. They do so because it profits them for us to be afraid of default.
Greece can and, I argue, should default and sooner rather than later, for the reason that it is going to anyway. The bond market knows this. It has been made almost explicit in the newly agreed European Stabilization Mechanism (ESM). The ESM was the product of German and French negotiations on how to augment the EFSF (European Financial Stability Fund) with something more believable and long term. But in the ESM there is the explicit agreement, which Germany insisted upon, that for bonds after 2013, some bond holders would be expected to share in any future losses on these bonds. Which has led to an expectation that 2013 marks the moment at which it will become accepted that bond holders in general should take losses and that this might well become retroactively applied. None of this is in the ESM but it is widely expected. And if these expected things came to pass, then Greece would be ‘free’, perhaps even encouraged, to restructure its debts by making bond holders take their share of the losses.
So default is already on the table. It just has a thin cloth politely draped over it for now. Because it is on the table the bond market is, in a way, already pricing it in and that is helping to push up the costs of borrowing now for Greece, Ireland and Portugal. Thus it would simply be better for both the Greek and Irish people and perhaps also for the Portuguese, and for the broader bond market if they all got on with it. Of course it would not be better for Germany nor France and that is the hold up.
Germany and France are trying to put off the moment when their banks will have to deal with more losses. They would rather have a few more years when their banks might raise more capital or make more money or, or … something. And of course it is fine for them to put it off. In the interim it’s not their people who are suffering. It’s the Irish, the Greeks and the Portuguese.
It would be far, far better for the Irish and Greek people to default because they have already entered a terminal downward spiral last travelled by Zambia. Zambia was forced principally by the IMF at the point of a financial bayonet down the road of crippling austerity cuts and trying to service a debt that grew faster than they could pay it off, forcing the country ever deeper into debt, not getting it out of it at all. The IMF did not care and did not allow any deviation. In the end the IMF’s diktats caused Zambia’s economic output to collapse by 30%. Instead of this solving Zambia’s debts it caused their debt to GDP burden to double to 150%.
The IMF has learned nothing since then. It is ideologically and intellectually moribund but sadly still very powerful.
So … Ireland, Greece and perhaps Portugal should default. The questions then are: how, who decides how much, and what happens then?
Recently a campaign was started in Greece and now in Ireland as well for what is called a Debt Commission and Audit. The idea is simple and has legal precedent. The nation which decides to restructure its debt forms a Debt Commission. Such a Commission is generally made up of experts in debt, bond and swaps contracts, forensic accountants, prominent civil servants, members of various civil society groups (charities etc), interested NGOs and representatives of labour unions as well as employers organizations. Such Commissions have to be nationally based with wide and varied roots in the broader civil society. A wide representation is essential to prevent it becoming the tool of any one group.
The purpose of the Commission is first to simply find out who is owed what and by whom. What debt was private, what public and in each instance what was the debt for? Would you like to know what debt has been bought by the Bank of England, or the Fed or the central Bank of Ireland? I would. Or what debts we are insuring? I would, considering I am personally expected to pay for it out of my taxes.
The Commission’s next job is to establish if any of that debt was odious, illegitimate, illegal or unsustainable. Each of these has legal standing and precedent and each is enough to send a cold shudder through board rooms of banks and their lawyers. For we already know, from a small tidal wave of cases pending in the US alone, that fraud there was. Lots of it. Many cases have already been ‘settled’ out of court. Time to close the option of settling on the court house steps and haul the malfactors into the public dock. Banker bashing? Those involved in fraud are criminals. Criminal bashing? You bet!
Odious debt is debt that was taken on by a former government that was in no way in the interests of the people or nation and which the people under a new government should not be asked to pay. The USA was considering using the idea of odious debt to clear Iraq of Sadam’s debts. In the end, when they realized this could open a can of worms for ‘people’ who were still their friends, they reconsidered.
Illegitimate debts are when debts were taken on that are palpably contrary to the well being and interest of the people. For instance, bailing out Anglo Irish Bank, in which the Irish people had no deposits nor interest, would likely be found to be illegitmate.
Illegal debts are those where fraud was involved in the selling and buying of the debt. This could be fraudulent mis-selling, by not making clear the risks or liabilities etc. Many such cases are pending against the big banks right now in both Europe and the US.
And the most contentious, unsustainable debt, is when debt was legally taken on by a legitimate government but where repaying the debt would cause great harm to the lives of people in the nation who were never involved in the taking on of the debt. An example would be bailing out banks with public money who had made bad loans to some of the people but not all. Such debts cripple the lives of people who were never part of the debt and property bubble but whose taxes and savings are being plundered to bail out those who were, and the banks who encouraged them.
Can such a Commission actually work? One already did in Ecuador. The Ecuadorians had a free and fair election. The winner won on a platform of debt restructuring. He formed the Commission. The Commission found a lot of the debt was illegal and immoral and the Ecuadorian government therefore said flatly it would not be paying. The price of its bonds collapsed. Once its debt was trading for a few cents on the dollar the government then bought it all back. Meaning it paid those who were holding its debt only a few cents on the dollar.
What happend then? Surely the sky fell in, and Ecuador was never allowed to borrow ever again? Well actually nothing of the sort. You see the there isn’t any evidence that nations get locked or priced out of the bond market after default. There is a short term spike and then a fairly rapid return to a rate that is in line with the future prospects of the country. Sure, the country defaulted and some of the bond market players lost money, but not all. And those who didn’t lose are likely to simply say, “Glad it was them and not me, but now let’s talk business, shall we?” The fact is, once a country has got rid of its debt overhang and as a consequence is much better placed to do well in the future, it becomes a much better prospect for lending to. The market isn’t monolithic and has no loyalty to its own. Think of the bond market as a tank of exceptionally greedy gold fish. They are ‘short’ memory and ‘long’ greed. They swim up and down looking only forward and forget what happened five minutes ago. Goldfish Sachs.
Ecuador defaulted and within just a few years was back in the market selling debt. The rate wasn’t punitive but in line with its actual economic prospects which were improved by having rid itself of much of its old debt. Greece and Ireland would do well to take note.
Of course there would be massive opposition from the IMF, the EU, ECB, Germany on behalf of its banks and France on behaf of its banks. But you know what? A government is supposed to put the interests of its people above the interests of banks, bankers and bond holders.
What about pensions? Pensions will do worse if our economies stagnate for a decade trying to pay off debts they cannot afford to pay, than if they take a huge loss now, and then find they are in better, sounder financial shape going forward. This is what the bond market will think too. As noted above, the bond market players themselves will look forward not back and simply see that going forward the nation that has defaulted is now in better shape to make everyone a profit than it was before. Growth is what sustains pensions not paying off old debts. You can’t and won’t grow if your economy is weighed down paying debts. That is the position we are in now and look at how every nation is reducing its estimates of growth. Portugal just revised their negative growth to be even more negative. There is a hint in there somewhere.
And lastly, the contentious notion of declaring perfectly legally agreed upon debts to be ‘unsustainable’. Surely this is just some woolly, do-gooder, semi-socialist notion dreamt up by financial fat heads? Actually it is just saying that just as there are laws against usury for people so there should be for nations. A nation can, because of greed, stupidity or getting advice from bankers about how prices will ‘never go down’ and ‘it’s different this time’ get into debt that cannot be paid off. Companies that do it declare bankruptcy all the time. No one bats an eye.
Nations don’t get into unsupportable debt on their own. Banks and bond holders have to help them. In the standard theory and legal practice of lending it is the duty of the lender to monitor the borrower to make sure too much debt is not being taken on. Lenders to Europe never bothered. Caveat emptor. Don’t think you can lend and lend and then tell the debtor it was their fault for taking on too much debt. True they did. But it’s also true the lender helped them. Both are at fault, both take the consequences.
You can find out more about this subject and make contact with those running the Debt Commission campaigns in Greece and Ireland here.
David Malone is the author of the book Debt Generation. You can read and listen to excerpts from his book here: http://www.debtgeneration.org/index.php