Photo: AP/Riccardo De Luca
The European Central Bank is taking a “peculiar” stance on the prospect of a Greek default and it needs to change its mind, argues Economist and Columbia Professor Joseph Stiglitz in an editorial published in Project Syndicate today.The ECB’s refusal to let Greece provoke a credit event in a deep, disorderly default—rather than avoiding credit default swap payouts in a voluntary restructuring—just doesn’t make sense anymore.
(For a full guide to what’s going on with these discussions, click here.)
He sees three explanations as to why that the ECB might be so averse to the prospect of a credit event:
The first explanation is that the banks have not, in fact, bought insurance, and some have taken speculative positions. The second is that the ECB knows that the financial system lacks transparency – and knows that investors know that they cannot gauge the impact of an involuntary default, which could cause credit markets to freeze, reprising the aftermath of Lehman Brothers’ collapse in September 2008. Finally, the ECB may be trying to protect the few banks that have written the insurance.
However, he argues that this reasoning is really very thin, and in fact harmful to both Greece and the financial system.
The most cogent argument against a credit event is that it would provoke contagion, as investors speculate against other countries at risk of default, raising yields and causing turmoil. There’s also the moral hazard that other countries like Portugal, Ireland, Italy, or Spain would be tempted to default on their debts as well. However, avoiding a credit event would simply change the market conditions under which financial institutions purchased sovereign bonds in the first place:
Why should an involuntary restructuring lead to worse contagion than a voluntary restructuring of comparable depth? If the banking system were well regulated, with banks holding sovereign debt having purchased insurance, an involuntary restructuring should perturb financial markets less…
The riskiest countries already have been shut out of financial markets, so the possibility of a panic reaction is of limited consequence. Of course, others might be tempted to imitate Greece if Greece were indeed better off restructuring than not doing so. That is true, but everyone already knows it.