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Greece: Haven’t we seen this movie before

February 25th, 2010

My piece in today’s Fin compares Greece with some Australian states who also play games to conceal debt. The emerging news (also in today’s NY Times) is that the same banks who facilitate the dodgy debt deals established a CDS market for Greek sovereign debt and some have large short positions (translated from marketspeak: they are betting that the deals they set up will go bad and Greece will default). This can of course be defended as insurance, but it obviously changes your relationship with your bank or financial advisor if they can steer you into a deal and then bet on its failure. The potential for moral hazard in the CDS market has yet to be fully explored, but I think we will get to find out the hard way before too long.

Commentary on the debt crisis facing the Greek government has focused primarily on big international issues such as the implications for the euro, contagion effects on other sovereign debt markets, and the possibility of a renewed global downturn.  These issues are important, but there are also some lessons to be learned with more direct relevance to Australian public policy.

When we ask how Greece got into this mess, it’s easy to offer a simple answer. Greek politicians, prefer spending to taxing,and those preferences were endorsed by the electorate. So governments of both left and right ran large budget deficits, made much larger by the massive infrastructure investment associated with the 2004 Olympics. When the financial crisis hit, the deficits got worse, and Greece was unable to refinance its existing debt except on punitive terms.

The real story is more complex. Politicians everywhere prefer spending to taxing, so political systems (at least those that survive) must evolve mechanisms to prevent unsustainable deficit financing. In the eurozone, those mechanisms are represented by the ‘convergence criteria’ agreed in Maastricht in 1992. 

The criteria require countries using the euro to limit budget deficits to 3 per cent of GDP and public debt to 60 per cent. Although these limits have been breached by a number of countries they still  create problems for governments who want to spend more, but not to raise taxes.

The Greek government, with the aid of clever financial advisors such as Goldman Sachs managed to find ways to solve these problems. A wide range of financial transactions can provide governments with ready cash, without any corresponding debt being created. Greece tried most of them. There were sales of future revenue, such as airport fees and lottery proceeds, PFI and PPP deals and many others. 

Most strikingly, there was a deal set up by Goldman Sachs, which was presented as a long-dated interest rate swap, and could therefore be kept off the balance sheet. The deal ensured that the Greek government would receive about a billion euros upfront, but that it would incur liabilities to Goldman Sachs to be repaid in 2019. It was, in other words, a loan. 

But under the prevailing rules of the European Statistical Agency, Eurostat, such deals did not count as debt, so Greece piled into them. Over time, however, Eurostat has tightened up the rules to prevent such abuses. The result is that, as well as facing massive deficits as a result of the crisis, the Greek government has been forced to bring the debts arising from these transactions on to the balance sheet. The results are not pretty.

The final irony in the Greek tragedy is the claim that, having profited from the deals that pushed up Greece’s national debt, Goldman Sachs quietly took out short positions, effectively betting on a default by Greece. From Goldman’s point of view, arguably this was just sensible risk management. But it certainly makes a mockery of their claim that the innovative financing mechanisms used here served to reduce the riskiness of Greece’s fiscal position.

At this point, a fair number of readers might be asking ‘haven’t I seen this movie before?’. Australian governments, and particularly successive New South Wales governments, have made an art form of transactions designed to disguise debt and evade limits on borrowing.  Examples from the 1980s included the sale and leaseback of Eraring Power Station, and the pseudo-private financing of the Sydney Harbour Tunnel. Through the 1990s, we saw a string of Public Private Partnerships, Build Own Operate and Transfer (BOOT) schemes and quasi-privatisations, all designed to reduce measured debt.  And, of course, Sydney had its own Olympics.

The consequences of these accounting tricks are now coming home to roost. Fortunately, our problems are not on the scale of those facing Greece, but they are much worse than they would have been if governments had been transparent about the state of their balance sheets.

Yet far from learning the lesson, state governments are still playing the same games, selling off income earning assets to finance non-commercial investments, providing debt guarantees to nominally private investments in public infrastructure, and trying to keep debt off the books.

The worst offender at present is the Queensland government, which still pushes the claim that selling income-generating assets will allow new investment in schools and hospitals. Economists from across the political spectrum have pointed out that this claim is nonsensical, but the government thinks it’s good enough for the people of Queensland.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.

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  1. February 25th, 2010 at 14:08 | #1

    They shouldn’t have been allowed to join the Euro astheydidn’t qualify. They shouldn’t have joined as the Euro was doomed anyway. And now they’re all going to gefault together.

  2. Graeme Bird
    February 25th, 2010 at 14:27 | #2

    If they all defaulted together that would be a good thing. At last we would be free of these wealth-destroying financial institutions that have passed no market test. Even as we speak, these institutions are still funding Greek deficits. Well I’m assuming so. Unless individuals are lining up to buy Greek government bonds. So there they are throwing good money after bad. Which brings up a bit of a mystery. How can they be so powerful as to know that they will be bailed out? You wouldn’t think they could have that much power, that they can continue to relentlessly destroy wealth in this way, without seemingly a care in the world.

  3. smiths
    February 25th, 2010 at 14:35 | #3

    The Euro has been touted as something of a capstone of the European Unification project. – Chris Maven

    is this not back to front?
    economic union has come before sovereign union, which would make ecomic union the cornerstone, starting with the very old customs zones,
    it will come i think, the capstone,
    i think merging of the sovereign European states is on the agenda and i would bet any who is interested that the Euro will not dissolve, the monetary union will not break,
    and that within twenty years Europe will be a single state
    interesting choice of keyword as well Chris … capstone,
    reminds me of something but i cant put my finger on it

  4. TerjeP (say tay-a)
    February 25th, 2010 at 14:52 | #4

    Government spending should be constitutionally constrained with no increase (beyond population growth and inflation) without direct support from the people. However perhaps politicians would then invent creative ways to spend in a manner that is off the books.

  5. Matt C
    February 25th, 2010 at 15:14 | #5

    Terje,
    In a recession, your proposal would result in either significant reduction in outlays or significant increases in taxes. Either of these counter-cyclical measures would be likely to exacerbate the recession itself.
    Is your notion of fiscal purity more important than sustaining output and employment?

  6. Graeme Bird
    February 25th, 2010 at 15:21 | #6

    If you think that then why not advocate a ban on deficit spending except in case of recession? A ban, state, federal and local? There always seems to be an excuse for deficit spending. If its not one thing its another. Governments will pay a lot more attention to the quality of their budgets if they didn’t have the capacity to borrow money, at least under most circumstances.

  7. Chris Warren
    February 25th, 2010 at 15:37 | #7

    TerjeP (say tay-a) :
    Government spending should be constitutionally constrained with no increase (beyond population growth and inflation) without direct support from the people. However perhaps politicians would then invent creative ways to spend in a manner that is off the books.

    Presumably then the same should apply to level of profits.

    These should be constitutionally constrained with no increase (beyond inflation) without direct support from the people.

    In these circumstances (and only these circumstances) – Government spending could reasonably be constrained.

    Could TerjeP be right for once?

  8. Ernestine Gross
    February 25th, 2010 at 15:53 | #8

    Yes, we’ve seen this movie before and reruns seem to be profitable for some.

  9. February 25th, 2010 at 17:28 | #9

    @smiths
    A capstone is what used to go on top of old stone walls to stop water going down through the wall itself.

    Possibly you’re thinking of a keystone, which is a more usual metaphor. A keystone is the last stone to go into an arch. It’s at the top, and helps hold the whole thing together.

  10. February 25th, 2010 at 17:34 | #10

    Very simple: governments are building Ponzi schemes.
    http://mgiannini.blogspot.com/2010/02/sovereign-debts-markets-for-lemons-and.html

  11. smiths
    February 25th, 2010 at 17:47 | #11

    governments are aiding and abetting ponzi schemes, but they didnt build them

  12. smiths
    February 25th, 2010 at 17:50 | #12

    Theodoros Pangalos, deputy prime minister, said Germany had no right to reproach Greece for anything after it devastated the country under the Nazi occupation, which left 300,000 dead. “They took away the gold that was in the Bank of Greece, and they never gave it back. They shouldn’t complain so much about stealing and not being very specific about economic dealings,” he told the BBC

  13. TerjeP (say tay-a)
    February 25th, 2010 at 18:15 | #13

    Presumably then the same should apply to level of profits.

    No.

  14. TerjeP (say tay-a)
    February 25th, 2010 at 18:18 | #14

    Matt C :
    Terje,
    In a recession, your proposal would result in either significant reduction in outlays or significant increases in taxes.

    That does not follow at all. A cap on spending does not mean a reduction in spending. Nor does it imply an increase in taxes.

  15. Graeme Bird
    February 25th, 2010 at 18:20 | #15

    “In a recession, your proposal would result in either significant reduction in outlays or significant increases in taxes.”

    Thats the theory. Can you prove it?

  16. smiths
    February 25th, 2010 at 18:28 | #16

    London investment bankers named the American insurer AIG as an additional seller of CDS. It had to be nationalised during the financial crisis, because it had sold default insurance on U.S. mortgage bonds. The burden would have led to the collapse of the once largest insurer in the world. Before the financial crisis, AIG is said to have insured a large amount of sovereign credit risk. If there is still a major insurance positions on Greece, then the American government would have a strong interest in preventing a default of the country.

    http://www.creditwritedowns.com/2010/02/is-aig-the-main-cds-insurer-for-greek-government-debt.html

  17. February 25th, 2010 at 19:30 | #17

    @smiths
    I think that governments are building Ponzi schemes and future generations will have to pay…
    http://mgiannini.blogspot.com/2010/02/sovereign-debts-markets-for-lemons-and.html

  18. Ernestine Gross
    February 26th, 2010 at 11:25 | #18

    TerjeP (say tay-a) :

    Presumably then the same should apply to level of profits.

    No.

    Quite right, Terje, it is not the level of profit which should be capped but the rate of return.

  19. Socrates
    February 26th, 2010 at 13:21 | #19

    I think part of the problem is that the (well meaning but misguided) architects of the Euro and larger EC thought that economic integration might somehow lift the poorer countries up to join the rest. The trouble is that poor countries are often poor for reasons other than economics. Without basic integrity in government processes, respect for individual property rights, and the rule of law, free markets alone can’t really do much. Indeed, as recent Russian history has shown, the rule of law has to come first. A lot needs to change in Greece before it can become like western Europe. The same is true in Portugal as well.

  20. smiths
    February 26th, 2010 at 13:46 | #20

    well meaning but misguided

    this is like a mantra for the era,
    dominant aggressive trading powers who’s aim was to lift up poorer countries,
    just like they have in africa

  21. February 26th, 2010 at 14:05 | #21

    Ernestine,
    If you cap the rate of return are you not producing an option-like payout structure? This would be a sold option payout, with limited upside but unlimited downside – at least, as far as bankruptcy proceedings allow.

  22. Ernestine Gross
    February 26th, 2010 at 15:01 | #22

    Andrew R., I am not prepared to enter a discussion which starts off confused.

  23. February 26th, 2010 at 18:28 | #23

    Fabulous column John.

  24. TerjeP (say tay-a)
    February 27th, 2010 at 05:46 | #24

    I don’t think capping the rate or return makes sence unless you also cap the rate of loss. It seems to be an idea based on sentiment rather than any form of reasoned consideration.

  25. TerjeP (say tay-a)
    February 27th, 2010 at 05:48 | #25

    The Nicholas Gruen comment appears to be spam.

  26. haiku
    February 27th, 2010 at 08:01 | #26

    No, Terje, Nick Gruen is a prominent blogger at Troppo who also happens to run an organisation called Peach.

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