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

    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

    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

    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

    Comment number 38.

    The whole system requires a new economics, based on realistic returns and risks combined with ethical long term capitalism and common sense lending decisions by banks. Despite what has happened and all the protestations of reform by financial institutions we are not there yet. It also requires an adult approach to life by the public, sorry you can't have it all now. Grow up !

  • rate this

    Comment number 37.

    There is one problem with this parable. The wise bankers (or loan sharks) who did not lend to the boy are still vilified as they are in the same industry as the ones that did.
    Everyone screams for the whole industry to pay for a few stupid lenders.
    You are doubling the moral hazard by punishing the innocent lenders for the sins of the guilty.
    Not all banks and countries need a bailout.


Comments 5 of 9



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