Greece: Haven’t we seen this movie before
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.