Monthly Archives: July 2015

Notes on Greece #1: it takes two to tango

Bad borrowing is merely the other side of the coin from bad lending. Private banks, particularly German ones, made loans to a state in dire financial difficulty. They tried to make some money from Greece, but as with an investment, it can go down as well as up. They made a bad call, and now, rather than accept the losses, the German government is acting as a thuggish bailiff, abusing the political structures of the EU to strongarm the Greek government into repayment.

There is an argument that we shouldn’t show any lenience to Greece, lest we set a precedent. Forgiveness would create moral hazard, bad borrowing wouldn’t be properly discouraged. First, this is probably not true. Debt forgiveness has happened in the past and will happen again. Borrowing by and lending to states won’t suddenly stop because one extraordinary case required an extraordinary solution.

To the extent that this is true, however, the current status quo sets up a different problem. Rather than one extreme – where states are encouraged to take irresponsible loans – we have arrived at the other – where banks are encouraged to make irresponsible loans.┬áBy taking away the risk in lending to a sovereign state, the incentive for a bank to properly assess the creditworthiness of a potential borrower is removed.

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