Sunday, 4 April 2010

Beware of the people who cite you...

for the wrong reasons. Over at the Daily Telegraph, Ambrose Evans-Pritchard had lunch with Carmen Reinhart, who (together with Ken Rogoff) wrote a well-timed, erudite and enormously important book on financial crises: This Time Is Different. Evans-Pritchard cites my work with Mauricio Drelichman on the debts and defaults of Philip II. He argues that Greece is a bit like Habsburg Spain -- and that default is inevitable. I actually agree with the conclusion, but I cannot agree with his characterization of why bankers lent to Castilian Crown. Mauricio and I basically say -- the defaults were anticipated; bankers made money, on average; and a default was simply a bad outcome that everyone anticipated could happen. Much like in the case of insurance, the insurer sometimes has to pay out. In good times, they collected a lot of money upfront. It all evens out.

Somewhat oddly, Evans-Pritchard drags out the old chestnut how Philip II's defaults ruined his bankers, including the Fuggers. This is what Fernand Braudel famously claimed, but we find the exact opposite -- the same banking familes who lent to Charles V also lent to Philip, and the ones affected by the early bankrutpcies (in the 1550s) are still there in the 1590s, doing a healthy business, including the Fuggers. Even a default needn't be a calamity, if you play it right.

The implications for today? I think a Uruguayan solution (ie a healthy haircut for the bondholders) would make a lot of sense. It won't be fun for the investors, but we are creating a world of monstrous moral hazard if we bail out Greece and, in turn, the French and German banks who bet that the taxpayer will always help. Will this create another Lehman-style meltdown? I don't think so. Financing costs on sovereign debt are going to go up anyway, by a bit, in the next few years; many people are worried about the overall level of debt as it is. A Greek default won't change a thing. A lot of people received higher interest on their Greek bonds (unless they bought in the last 2 years); the higher return goes with higher risk, which should materialize in their portfolios roundabout now.

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