Ireland is headed for a massive international bailout, and it is no surprise that the national governments quickest to put up loan money — Britain and Sweden — are not members of the single currency. The euro-holdouts are to European finances what the United States is to world military order: the knuckle-dragging, unenlightened, anti-social misfits that everybody goes running to when real trouble hits.
Nobody is making much of a stink about bailing out Ireland, and there is something significant in that — but it isn’t Britain’s purported sentimental feelings for “a friend in need.” If Ireland had not been in the euro — if it had been in control of its own monetary policy — then a massive devaluation would have been its likely response to its untenable fiscal position. But that option has been foreclosed, which leaves either a bailout or a much nastier alternative: default.
The short-term reason that Britain and other major powers dread an Irish default is that their banks own a lot of Irish debt. Bondholder haircuts are nobody’s idea of a good time, and the Irish are positioned to put the high-and-tight on their former colonial oppressors but good.
But the long-term reason is narrow governmental self-interest: If Ireland defaults, that is going to make borrowing a lot more expensive for every government in the world. Even with the bailout on the way, borrowing costs are going up, for Ireland (obviously) but also for fellow PIIGS-club member Spain. Politicians fear lots of things — honest labor, easily understood and headline-friendly scandals, constituents who read Hayek — but above all they fear having their credit cards taken away. A government that cannot borrow cheaply is a government that cannot pawn off hard decisions on future generations; it is a government that has to govern, with prudence and thrift, rather than merely to enjoy the pleasures of exercising power. That’s a lot less fun than the current model of political life, and less lucrative in retirement, too.
No surprise that the parties most open to raining pain on bondholders are the Germans, who are in the habit of dealing with fiscal challenges like adults (or at least, as people who behave maturely by European standards.) The New York Times reports:
“Policy makers face the same dilemma as in any crisis with respect to haircutting bonds, and the real-life decisions are always extremely difficult,” said Robert E. Rubin, the former Treasury secretary, who faced just such a quandary in 1994, when he helped arrange a $47 billion rescue package for the Mexican government as it teetered on the verge of default.
“Holding bondholders harmless contributes to moral hazard and increases risks elsewhere,” Mr. Rubin added. “But imposing bond haircuts can make future market access expensive or impossible for an extended time and can create serious contagion effects elsewhere.”
… One signal that the policy pendulum may be swinging away from bondholders came earlier this month when the German chancellor, Angela Merkel, supported by President Nicolas Sarkozy of France, tried to persuade other European leaders that bondholders needed to accept some of the risk in future bailouts.
The move spurred a bond market rout, and Ms. Merkel had to retreat.
… Even so, any talk of default — or a debt restructuring, the term that bankers and technocrats prefer — remains anathema in capitals like Athens and Dublin. Their leaders fear that they would be put in a financial penalty box and denied fresh access to funds.
A similar problem probably will be played out in the United States as unsustainable pension obligations and general fiscal incontinence threaten to send dozens of U.S. states and scores of municipalities into insolvency. Municipal bonds and state debt have long been a preferred investment vehicle for millions of Americans and a great number of retirement funds, both because of the (alleged!) security of government debt and the tax-preferred status of munis. When Illinois, California, and New Jersey come knocking on Congress’s door looking for a bailout, they won’t be alone: Millions of Americans will be lined up behind them, because they stand to lose a great deal of their savings, including retirement savings, if U.S. states go into default — and a default by any U.S. state would probably send borrowing costs skyrocketing for every other state. Lot of elderly muni investors live in swing states such as Florida and Pennsylvania, which are our grayest states. Republican governors and legislatures will have a strong incentive to support Democratic governors and legislatures. (Not that Democratic states are the only ones that will need bailouts, but Republicans are notionally more opposed to state bailouts than Democrats are. I hope.)
In the U.S. as in the EU, saying no to bailouts won’t be easy.
– Kevin D. Williamson is deputy managing editor of National Review and author of The Politically Incorrect Guide to Socialism, to be published in January.