Ode on a Grecian Burn

The Greek bailout is proceeding apace. Their budget deficit was again revised upward and their bond rating accordingly again revised downward, so their debt refinancings are getting ever closer and more expensive. The EU and the IMF are committing around 40 billion Euros in funds.

But, is this a good idea?

Not many people believe the package is big enough to avoid a future restructuring of Greek debt, and now the Fund and the EU will be at the front of the line of creditors.

The Greek economy with its inflexible labor market, low productivity, low R&D spending, corruption, and bloated government sector desperately needs reform. While the Germans are insisting on "tough conditions", giving the money obviously reduces the pressure on the Greek polity to reform. It also reduces the pressure on the Portuguese and Spanish polities to reform as once the bailout lamp has been lit, it is not credible to say "we won't do it again". People, you know I'm talking 'bout moral hazard!

Further, things are so badly out of whack that it is not clear any set of reforms, no matter how tough, can fix the problem. To me, the choice between defaulting now or taking on a bunch of additional debt only to default later is a no brainer: just do it!

Paul Blustein's excellent book on the Argentine crisis shows how delaying the inevitable can just make things worse, and Greece is in much worse shape than Argentina was.

The argument in favor of giving the bailout and having Greece muddle on, to me, is that European banks have a large exposure to Greek debt and are still fragile from the recent crisis. A Greek default might re-start a general European banking crisis, putting the relatively solvent governments back on the hook anyway. The bailout thus buys time for banks to adjust their balance sheets in an orderly fashion.

In a way, the early attempts to deal with the Latin American debt crisis in the 80s worked this way, but the cost to the debtor nations of stringing out the process was considerable.

People, the only thing that can save Greece is an extremely large hot tub time machine. Lacking that, they should choose the least bad of a set of very bad alternatives, which is, in my opinion default and restructure now.