The Corner

Greece and Us

A number of commentators have compared the EU bailout fund to the $700 billion TARP fund used to the bail out the U.S. banks. I’m not sure that’s right: The U.S. banks had other incentives — market incentives — to stop engaging in the money-losing behavior that necessitated the bailout. The U.S. government did not need to impose “austerity measures” requiring the banks to refrain from lending to uncreditworthy borrowers. In fact, the government pushed the banks to keep lending and, in the case of Fannie Mae and Freddie Mac, encouraged them to throw good money after bad by offering delinquent borrowers new loans they could use to make payments on their old loans and stay in their houses for a few more months. Unsurprisingly, around 70 percent defaulted on the new loans, too.

It turns out that this program, not TARP, is the right analogue to the EU bailout fund: Greece is the (nearly) delinquent borrower, and the ECB and IMF are Fannie and Freddie, offering it a new loan it can use to pay off its old ones. The TARP’d banks were at least able to repay taxpayers (with an admittedly huge assist from the Fed’s zero-interest-rate policy, quantitative easing, the suspension of mark-to-market accounting rules, and the cuckoo-crazy S&P). Greece has no viable strategy for paying off its debt. Few believe its government will keep to the austerity plan now that it has gotten the money. Felix Salmon likens Greece to a rebellious teen whose parents have just bailed him out of jail. Anne Applebaum alludes to a defeated Germany after the First World War. (The austerity plan is “the kind of thing a surrendering field marshal signs in a railway car in the forest at the end of a bloody war” — Hey Anne, tell us how you really feel!)

So it’s not likely to work. But why should the U.S. care — aside from the $50 billion or so our government is kicking in for the bailout? Because, as investor David Einhorn put it late last year, “I believe there is a real possibility that the collapse of any of the major currencies could have a similar domino effect on re-assessing the credit risk of the other fiat currencies run by countries with structural deficits and large, unfunded commitments to aging populations.” In case you haven’t been paying attention, that’s us. A recent note from Cornerstone Investment Services puts the situation into stark terms:

White House has estimated that rates for the 10 year Treasury will climb to about 5.20% by 2013 and then stay there, staying flat for the following 7 years.

This is an incredible forecast and one that throughout the history of the yield on the 10 year Treasury has never happened. A more likely scenario is that yields continue to climb as the Treasury issues more and more debt.

Cornerstone lays out an alternative scenario in which interest rates spike, similar to what happened in the late ’70s/early ’80s. This could happen for a number of reasons: Investors could reprice all sovereign debt after a round of European defaults (see Einhorn above); the U.S., Europe, and Japan could engage in a competitive currency devaluation, leading creditors to charge higher rates to compensate for the prospect of being paid back in funny money; or the economy could recover and government borrowing could start to crowd out private investment. Whatever the cause, the results would be striking: Under Cornerstone’s alternative interest-rate scenario (in which rates temporarily spike above 14 percent), interest payments on the national debt reach 71 percent of all tax receipts. Would we even have enough left over to pay for Obamacare at that point? The way CBO keeps upping the estimates, I’m not sure.

This is why Obama urged Merkel to intervene. The EU bailout is about propping up a defunct model of governance by giving the delinquent borrower another loan. This also might be why Obama has such a soft spot for foreclosure-mitigation programs. Perhaps he realizes that the lenders are coming for him next.


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