November 17, 2010
Bailouts and the 'Contagion' Metaphor
Is infectious disease an analytically useful economic metaphor? For those who favor bailing out states that can't control spending, it certainly seems so.
A November 15, 2010 article in the Daily Telegraph -- "Contagion hits Portugal as Ireland dithers on Rescue" -- says that Portugal and Ireland need some sort of debt reorganization/bailout. German and French pressure for bondholders to take a haircut have had the (predictable) result of driving up bond yields (and borrowing costs). Ireland (apparently partly in response to the "haircut" idea) is refusing help.
¡No somos Grecia! The real concern is Spain -- which is insisting that it isn't Greece. In that regard,
Jose Manuel Campa, Spain's economy secretary, said his country is "neither Greece, nor Ireland, and never will be". Spain's economy has stalled again but public debt is still just 66pc of GDP, and both budget and current account deficits are falling fast.The same cannot be said of Greece, where the debt crisis is going from bad to worse despite its €110bn rescue in April. Eurostat has revised Greece's debt from 115pc to 127pc of GDP last year, while the deficit was even worse than thought at 15.4pc. The debt will jump to 144pc of GDP this year, risking a debt-compound trap.
Spain matters because its economy is bigger than Greece's plus Portugal's plus Ireland's. Spain's response to Ireland:
Spain's central bank governor, Miguel Angel Ordonez, lashed out at Dublin on Monday, calling on the Irish government to halt the panic and take the "proper decision" of activating the EU-IMF bail-out mechanism.
Spain's expressed concern, apparently, is "contagion," a word that appears three times in this (short-ish) article. As in, "Contagion has already pushed Portugal to the brink, pushing yields on 10-year bonds to the danger level above 6.5pc. Finance minister Fernado Teixeira dos Santos said the country was at the mercy of global forces and may be forced to call for help."
I feel stupid (although perhaps not as stupid as Fernado Teixeira dos Santos ought to feel). It sounds to me like "contagion" = if Portugal and Ireland "fail" -- that is, don't pay off their lenders -- credit will get more expensive all over Europe, at least for those economies perceived to be weak, and that will make their economies weaker. So, I guess, the idea is that other (healthy) European economies should "weaken" themselves (and pay off their banks) to "strengthen" the weak economies. Do economies really work like that?
In this regard, consider these views:
"The risk is high because we are not only facing a national or country problem. It is the problems of Greece, Portugal, and Ireland. Markets look at these economies because we are all in this together in the eurozone. Suppose we were not in the eurozone, the risk of contagion could be lower," [Spain's finance minister] told the Financial Times. [Is there any planet in which that statement would be true? It sounds like this metaphorical disease has gotten to the minister's brain.] Financial Times
[The Irish finance minister] appears determined to dress up any rescue as a bail-out for banks rather than for the Irish sovereign state. This may not be easy. The ECB's vice president, Vitor Constancio, said the EFSF "cannot lend directly to banks: the facility lends to governments." [Darn it! They need a TARP.] Telegraph
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Rick Bookstaber has observed that recent economic crises have been in the financial markets, not in the fundamental economy. My reaction is that of course Greece is going from bad to worse because no matter how much European paper you give it (which is really just rolling over another year the problem it has with its lenders), its economy is still crappy.
"Contagion" doesn't seem like a useful metaphor here, unless you are trying to talk the German and French people into thinking they are behaving like doctors while the banks pick their pockets. I don't see how Greece being "sick" is making Portugal "sick." All these weaker economies (and their lenders) are facing a reckoning. An unavoidable one.
I don't like these medical metaphors for economics, but if I had to choose one, I would say that Germany and France are being asked to donate parts of their livers to a couple of (low-function) alcoholics, so that the alcoholics can be kept alive long enough to pay another year of hospital and (bogus) alcohol-rehab bills.
But, you might say, the cost of lending to weaker countries is artificially high -- the result of lenders not being able to do cost-effective due diligence. A Europe-wide guarantee of credit makes lending to these countries more efficient. Everyone wins -- but the rich countries do have to bail out the banks when the random small and poor one goes south.
Does anyone (besides me) think that that argument sounds like, say, the rationale for U.S. sub-prime lending? I guess my bottom line is this: certainly with respect to European sovereigns (do you think maybe sovereign there should be in quotes?), a bad credit risk is a bad credit risk, and anybody who lends to it gets what he deserves.
Does anyone doubt that advocates of a federal bailout of California or Illinois are going to lean heavily on the "contagion" metaphor? Will it, by then, have lost all respectability anywhere to the right of, say, Harry Reid? In that regard, consider this quote from an article posted November 16, 2010 about Illinois's budget, entitled "Governor, Lawmakers Could Have Budget Deal":
The budget plan that lawmakers passed in May came up $9 billion dollars [sic] short by some estimates. The new budget plan won't fully fund programs and operations at 2009 levels either, but it is expected to leave a smaller gap. The state could borrow several billion dollars to pay the pension fund, freeing up money to spend elsewhere. [Emphasis added.]
Some deal! If you're not laughing at that, your sense of humor is not dark enough.