It is often claimed that imposing a haircut (i.e. a partial default) on holders of Greek bonds is fair, sets incentives correctly, and avoids moral hazard. Haircut fans on Right and Left use slightly different arguments, but the basic point is the same. If you invest money, you must accept the risk of losses. If that risk is artificially removed, bad decisions will be taken. (On the Right it is more about destroying the idea that governments, which conservatives/liberals largely hold in contempt, are trustworthy and safe borrowers and deserve low interest rates. On the Left the focus is on punishing greedy banks and unscrupulous speculators, and taking the debt burden off nurses and firefighters.)
It sounds reasonable but it is not. There are at least two related problems. The key point to recognise is that in most crisis-resolution proposals, including the recent deal that was to end all deals, the Greek haircut is supposed to go hand in hand with a firewall around other countries, such as Portugal, Spain and Italy. Their bondholders are not to suffer losses. Quite how this is supposed to be fair or compatible with ‘good incentives’ has never been clear to me. On the intellectual level I can only see an across-the-board haircut as meeting these requirements. But everyone knows that that would unleash Armageddon, which is why (thankfully) no-one is proposing it. (It would thus indirectly hurt a lot of ‘innocent’ people who wouldn’t recognise a government bond if it jumped up and hit them: so much for the fantasy that you can neatly set correct incentives and avoid moral hazard. But then the idea of externalities has always been a bit of a struggle for liberals wedded to methodological individualism.)
But then there is a more, if you like, practical issue. As regular readers of my SEJ posts know, I have long been against ‘bailing-in’ the private sector in resolving the euro area crisis (e.g. here, here and here). One of my main concerns (there are others) has been that I have never believed that it is even credible, never mind fair, to tell one set of bondholders ‘you must take (voluntary!) losses of 50%’ while telling others ‘you will never ever suffer any losses on your holdings until the end of time’. This view, I accept, was initially based primarily on what passes for my insight into basic human psychology. But the spiraling interest-rate spreads soon confirmed its plausibility.
In any case it’s nice – ok, that’s not the right word – to see some direct, if anecdotal, evidence that this risk of contagion from obviously poisonous Greek government debt to the supposedly pristine debt issued by every other government is well understood by market actors, and that they are, indeed, acting in accordance with the ‘incentive’ that politicians have, perhaps inadvertently but in my view stupidly and unnecessarily, set. Mark Schieritz at Herdentrieb has dug out some relevant facts.
He finds a FAZ report in which a board member of the German Commerzbank – the perhaps inappropriately named Martin Blessing – says (all translations mine) that it “had above all else sold on the debt of the so-called PIGS countries in the third quarter.” “I am winding it down, obviously.” He pointed out that European politicians had sworn in 2010 that there would be no haircut on Greek bonds until at least 2013, and so banks should not dump bonds. Consequently: “if a politician were to come to me today and demand that we keep sovereign debt on the books I would say, that I just don’t trust you.”
Mark also reproduces a chart from the quarterly accounts of French bank BNP Paribas which show substantial offloading on peripheral debt. In just four months (June to October 2011), in addition to selling more than half its holdings of poisonous Greek bonds, it disposed of almost its entire portfolio of ‘pristine’ Spanish bonds (down from EUR 2.7 to 0.5 bn) and, most worryingly, a massive EUR 8.3 bn in Italian treasuries. In four months it virtually liquidated its Spanish and halved its very large Italian portfolios.
Of course if these bonds have been sold on they have also been bought. Whether they have been spanned up by ‘speculators’ buying at a large discount or have landed in the balance sheets of the ECB or other quasi-public institutions I know not. I find neither thought comforting in the slightest. The large discounts imply exactly the large spreads that we see reported by Bloomberg et al. And ECB bond purchases have merely bought time. They have lengthened not resoled the crisis.
We need more encompassing statistics on who has bought and sold sovereign debt in the course of this year. I would be happy if a reader with more knowledge of bank balance sheets that I posses and/or more time to dig, could provide them. But for me, all the signs are that, of all the myriad factors that have contributed to the ongoing crisis, lazy or short-sighted or populist-driven thinking on the so-called bailing in of the private sector has been critical.
A bad haircut is not a pretty sight.