Someone I respect once said, 'Even a Blind Dog Finds a Bone...Sometimes'. That's what happened in the New York Times recently. Landon Thomas Jr. (could your name sound more pretentious?) dares to consider the unthinkable...Default Better than Bailouts?
http://www.nytimes.com/2010/11/23/business/global/23default.html?pagewanted=1&_r=2&hp
None other than the well known socialist Robert Rubin was quoted as saying, "Holding bondholders harmless contributes to moral hazard and increases risks elsewhere." Of course he (author of the Mexican Bailout in Clinton's time), believes that bailouts are worth the cost. Not surprising from someone who wants the government to have access to an endless fountain of virtually free money.
What moral hazard you ask? That's simple enough. The moral hazard of bailouts is that banks and other large investors who hold the bulk of the bonds for Greece and Ireland today and Argentina and Russia before, are not forced to accept haircuts on their bad investments...namely the sovereign bonds of countries who are not solvent. Those who took risks will get paid the upside gains, while somebody else (mostly taxpayers) will take the downside losses. And you wonder how George Soros never loses money?
What 'risks elsewhere'? That's more complicated. The risk is that no overspending government will ever learn their lesson. They will never run out of willing lenders to feed their politicians' insatiable appetite for handouts, vote buying, power expansion, and general greed. No matter what the debt level, bondholders will never stop lending to a proliferate government because they know that the IMF will never allow the bondholders to take a haircut. The more indebted the government, the better. Why? More indebted governments pay higher returns, and they will never be allowed to fail.
The IMF hardly goes out of its way to make bondholders wary of buying high-yield bonds. I'll note here that the IMF is run by bankers from large countries who hold a large percentage of sovereign bonds and are therefor aiding themselves and their cronies (with taxpayer dollars). The IMF recently issued a staff paper entitled, “Default in Today’s Advanced Economies: Unnecessary, Undesirable and Unlikely.” In it they laid out the arguments against allowing those who took risks to take losses. Amongst the arguments, Greece and Ireland are running large current account deficits, which means that if they default on their obligations, they will still need to borrow money. They would have no access to bond markets because they are bankrupt.
What if Greece and Ireland did default? Well, they would have to run balanced budgets. Could you imagine the horror? Balanced budgets for advanced economies? That's like asking a shopaholic to live within a budget. It's totally inhumane. Can you imagine the cuts in services? The tax burden to actually pay for all the luxuries citizens have demanded from their government? Torture is still illegal under the UN right?
The only fair prescription for the ills of indebted economies? Make the risk taking bondholders take losses. Make the over-borrowing governments suffer. Only then can we avoid the same mistakes in the future.
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