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.

Page 1 of 3 | Next page