Viewpoint: Why bailouts are bad

 
German Chancellor Angela Merkel and members of the Bundestag, voting

Bailouts are bad ethics and bad economics, argues philosopher Jamie Whyte.

Newspapers last Friday ran a photo of Angela Merkel, the German chancellor, surrounded by parliamentary colleagues. They had just passed a bill allowing them to provide hundreds of billions of euros for the European Financial Stability Fund (EFSF) - a fund used to "bail out" eurozone governments that cannot pay their debts.

From their delighted smiles, you might have thought they had done something to be proud of. They are lost to all shame.

Seeking a profit, some people lent to the Greek government. As it turns out, they made a mistake. In the process of promising gifts to voters, the Greek government has increased its financial obligations so far beyond what it can cover from its tax revenues that no-one is willing to lend it any more.

Without borrowing more, however, the Greek government cannot repay the debts that are coming due. Its current creditors are going to lose their money.

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The bailouts positively encourage future debt crises”

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Or they would be, if not for the bailout. Emergency loans from the International Monetary Fund (IMF) and the EFSF allow the Greek government to repay its private creditors.

The people of Greece are not being bailed out - their debts are increasing. The beneficiaries of the bailout are those who made the initial mistake of lending to Greece. The risk of a Greek government default is being transferred from those who chose to take it to people who did not - namely, the taxpayers of Germany and the other countries that donate to the EFSF and IMF.

Unlearned lessons

If the wickedness is not immediately apparent, a parable may help.

A loan shark lends 100 euros to a poor but romantic young man to buy flowers for a girl he is wooing. When the loan falls due the romantic boy has no money and no-one will lend him what he needs to repay the loan shark. The loan shark is about to be out of pocket, and the lover-boy out of teeth.

Greek demonstrator holding flowers Were the flowers funded by debt?

But wait a minute! A man with a gun hears of this sorry tale and, knowing a woman who has saved 100 euros, threatens to shoot her unless she lends the boy the 100 euros to repay the loan shark. She makes the loan and is never repaid by lover-boy.

Europe's political elite seem to regard the principle that you should take responsibility for your own mistakes as a simple-minded impediment to their task of "managing the economy". They are mistaken. Protestant ethics and wise economic policy are in perfect harmony.

Consider our parable again. If not for the intervention the "compassionate" man (German politicians), using his gun to extract 100 euros from the woman (German taxpayers), everybody would have learnt a valuable lesson.

Lover-boy (Greek politicians) would have learned not to borrow money to spend on flowers, the loan shark (the banks who lent to Greece) would have learned not to lend to irresponsible boys, and the beloved girl (Greek voters) would have learned that she cannot expect to receive debt-funded flowers. And everyone watching would have learned the same lessons.

But with this intervention, what is learned? That there is no price to be paid for spending money wastefully, no risk in lending to the reckless and no point in saving your money since it will be confiscated to pay for the folly of those who have not.

How will leaders encourage judicious spending and lending? By relieving reckless lenders from the cost of their folly, the bailouts positively encourage future debt crises - or, in the popular economic jargon, they create "moral hazard".

Deferring pain

Some will think my parable misrepresents the situation.

A democratically elected government is not in the moral position of the man who extracts €100 from a woman at gunpoint. In a democracy, fiscal transfers are consensual. By electing Ms Merkel's government, everyone in Germany has signed up to whatever bailouts it decides upon. This was the argument made by Matthew Taylor, Tony Blair's former policy adviser, on the BBC Radio 4's Moral Maze last week.

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Bailouts will not avert calamity, they will merely delay and enlarge it”

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It is a bizarre idea in general. Many German taxpayers voted against the current government. Despite this explicit refusal of consent, they must still pay their taxes. If they do not, they will be imprisoned. The popular political fantasy that taxes are paid voluntarily is just that.

In the case of the bailouts, the "you signed up to it" argument is even more obviously absurd. The Maastricht Treaty, which created the euro, explicitly prohibits bailouts. Insofar as eurozone citizens signed up to anything, they signed up to no bailouts.

"But this is an emergency! Without forcing eurozone taxpayers to take on the losses of banks that lent to Greece, Ireland and the rest, the global economy will 'melt down'. This is no time for the niceties of personal responsibility, moral hazard and the rule of law." So say those who arrange the bailouts.

This is indeed an emergency. But bailouts will not avert calamity, they will merely delay and enlarge it.

The monstrous quantity of debt in Western economies is the result of decades of deferring pain. Whenever an economic downturn looms, governments run deficits to "stimulate the economy" and central banks lower interest rates to encourage borrowing and investment. Public and private sector debt grows and the next emergency is even worse.

Politicians always want economic pain to come after the next election. Transferring the debts of insolvent governments from banks to public bodies, such as the EFSF, achieves this. It shifts the cost of bad lending decisions on to future taxpayers.

Even though it exacerbates the problems that caused the crisis, it serves the interests of the politicians who do it, and they may well smile about it. The rest of us should weep.

Jamie Whyte is a philosopher and Senior Fellow of The Cobden Centre and the author of Crimes Against Logic

 

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  • rate this
    +10

    Comment number 69.

    I fully agree with Jamie Whyte's point of view, and I guess most Europeans would. If so, than the question is, why do we most of the time seem to choose the wrong politicians. Or do we really have no choice, because politics attracts certain characters, or changes that of those who initially were not without some kind of honest philosophy.

  • rate this
    +1

    Comment number 68.

    Regarding Mr Kay's (62) comments about my posting. I take it that his use of speech marks around the word citizen implies his mistrust of the word. Well, it has been around since Roman times and does not imply anarchists pillaging the property of others.Good, honest, hardworking members of society don't have to pray at the altar of capitalism. Joe Public doesn't play bingo with billions,bankers do

  • rate this
    +2

    Comment number 67.

    The issue is not just those that lend, it is always the tax payer that foots the bill of politicians mistakes, and who trusts politicians? Were they to have to provide an in-depth yearly balance sheet, and an annual progress report for everything stated in their manifesto, then perhaps this type of situation would not arise. Let the people judge based on facts and call elections if they fail.

  • rate this
    +1

    Comment number 66.

    Like a storm damaged tree or an earthquake damaged building, it is safer & less costly for all for it to be taken down & re-built than to use props in a vain attempt to save it.
    To take such a risk as propping it up is endemically negligent.

    Have we not learnt from history.

    Again & again the powers that be repeat the same mistakes.

    This is financial appeasement, flawed, doomed to fail.

  • rate this
    +9

    Comment number 65.

    The last forty years has seen a succession of banking scandals as UK banks have thrown away billions of pounds. Property speculation, irresponsible lending to Third World countries, derivatives, sub-prime mortgages, the list goes on and on. Each time they have been bailed out by the taxpayer or they have screwed their domestic customers to make up the losses.

  • rate this
    +2

    Comment number 64.

    Greece should be kicked out of the Euro and EU asap. Let them suffer for their stupidity and let it be a lesson to the other irresponsible, inadequate nations who dare to follow in their footsteps of wreckless borrowing and spending. The people of Greece do not pay taxes yet want public money spent on them, time to WAKE UP greeks!!

  • rate this
    +2

    Comment number 63.

    Re 17 Jan. Excellent, as an independent financial adviser I can say you took the right approach, went in with your eyes open and came out at a time you felt was right. Unfortunately, too many people think that because you invest you are always guaranteed to make more money, then jump at the chance when someone tells them what they want to hear. Greed is a dangerous thing, realism is required :)

  • rate this
    0

    Comment number 62.

    50.The remastered Ben Terrion
    Citizens of a country don't make it go bust, speculators do
    =====
    Public sector debt is not created by speculators or bankers but "Citizens" who manipulate a monopoly organisation to behave in a manner totally outside of economic reality and use a debt base pyramid scheme to finance it. That's why Greece is bust. Nothing to do with speculators.

  • rate this
    -2

    Comment number 61.

    Greece is like a tall office block in a financial centre, its foundations are found to be fraudulent & not fit for purpose & enevitability/nature of it falling is the reality.

    To prop up the building with financial scaffolding cannot meet end objective NEED of rebuilding from foundations upwards.
    Either control its descent, or it will fail/fall & do horrendous damage to Greeks & those around

  • rate this
    -15

    Comment number 60.

    i really dont see how you can say there is an ethical issue here, yes greece has run up silly debts, but they had less than the rest of europe to start with, and theres no ethical justification that they should have less than other countries, its not even like the people work less hard than others, or enjoy more luxuries. Also from a practical point of view the bailout is the lesser of two evils

  • rate this
    0

    Comment number 59.

    51.Secretbanker
    Ask anyone ... who has purchased a guaranteed ... investment from their bank/building society what their understanding of their purchase is ... surprise, guaranteed.

    Confirmation if any were needed that we are all in one giant ponzi scheme at the moment! :p i take it from your monica you are in finance, so probabley know a lot more than a mere layman like myself.

  • rate this
    +3

    Comment number 58.

    we shouldn't help them,when have the EU ever supported us in anything. I understand many Greeks take cash for any work so they do not have to pay tax if their debts are paid then this system will continue.We do not even catch tax dodgers over here. I know of one person who has been reported for cash in hand jobs, same time as claiming benefits also drink driving but no interest from authorities

  • rate this
    0

    Comment number 57.

    Tax revenue is only a small fraction of capital requirement, so governments require finance from the private sector. The private sector doesn't have the cash to simply issue governments with loans, so governments have to issue securities in order to obtain the capital needed to fund the public sector. Banks didn't cause the Greek debt problem, overspending and bad economic policy did.

  • rate this
    0

    Comment number 56.

    Let it fall

  • rate this
    -2

    Comment number 55.

    Just as we seem set to never see again a single penny of OUR money that the government used to bail out UK banks, neither should any of us expect to see anything that is given to Greece. Because if we decide that we want to help, we should GIVE not LOAN them money.

  • rate this
    +8

    Comment number 54.

    The reality is that we are entering an age of post-democracy. We elect governments of our choice (ok, that may be a moot point!) but, regardless of their intentions, they are now totally beholden to the markets, big business and the media.
    Before we blame the politicians, let's ask ourselves how many of us are still banking with the same companies who broke the back of the economy

  • rate this
    0

    Comment number 53.

    What an embarrassingly poor analogy. I was sceptical the moment I saw the word "philosopher," as opposed to "economist" or "someone who has any idea what they're talking about."

    A more accurate comparison might be if lover boy made a deal with a bunch of thugs to deliver a truck full of roses, and when he failed to pay for it, they promised to murder his whole family. So they chipped in too.

  • rate this
    0

    Comment number 52.

    So international lenders and bankers are able to take any profits but none of the losses or any of the risk? Seems fair and reasonable....

  • rate this
    +2

    Comment number 51.

    Re 48. Alastair. I agree. Unfortunately, it is true. Ask anyone on the street who has purchased a guaranteed or protected investment from their bank/building society what their understanding of their purchase is. You will be in for a surprise, guaranteed. Now that I would put money on :)

  • rate this
    +6

    Comment number 50.

    Investors, gamblers, whatever name you use make a deal to try and make more money. If you back a racehorse and it loses, do you expect the bookmaker or the other punters to give you your money back? Citizens of a country don't make it go bust, speculators do.

 

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