The welfare states of Europe are in deep trouble. Decades of over-taxing and over-spending have sapped economic vitality and produced high levels of debt.
The high debt levels, by themselves, might not be a problem if European governments implemented good policy. After all, debt was even higher in many nations after World War II than it is today.
But Europe also faces a demographic problem. The population is aging, meaning that the fiscal situation will get worse – in some cases, much worse. So international investors are appropriately worried that today’s high debt levels will become tomorrow’s crippling debt levels.
And the cherry on the ice cream sundae of Europe’s fiscal nightmare is that many people have been lulled into dependency thanks to excessive government handouts combined with a political culture that tells people there is nothing wrong with mooching off others (as this cartoon aptly illustrates).
This sounds quite depressing, but there is a shred of hope. Simply stated, nations that hit rock bottom presumably have little choice but to move in the right direction.
Actually, let me qualify that statement. Governments do have the ability to maintain bad policy if they have access to bailout cash. And that’s been a problem in Europe. Nations such as Greece have very little incentive to reform if they think the European Union (German taxpayers) or International Monetary Fund (American taxpayers) will cough up some cash.
But that game, sooner or later, comes to an end. As Margaret Thatcher noted, the problem with socialism is that sooner or later you run out of other people’s money.
So what, then, should be done to address the European debt crisis? The European political elite in places such as France and Germany say more bailouts are needed. Why? Because without more bailouts, there will be contagion and the world will plunge into another 2008-style crisis.
But when you strip away the hysterical rhetoric, what they’re really saying is that bailouts are needed for the banks in their own nations that foolishly lent too much money to reckless governments in other nations.
As you might suspect, this is self-serving nonsense that would simply create a bigger debt bubble that ultimately causes bigger problems.
The right answer to the European debt crisis is simple. And it only requires two steps.
1. Do not give bailouts to nations, even if that means they default. This isn’t good news if you bought, say, Greek or Portuguese bonds, but there are two big advantages of default. First, it means that the bailouts come to an end so the debt bubble doesn’t get even worse. Second, it forces the affected governments to move – overnight – to a balanced-budget rule.
So what’s the downside? There isn’t one. The aforementioned bondholders won’t be happy. They gambled in the expectation that bailouts would enable them to get high returns, but that’s their problem. Overpaid government workers and greedy interest groups in the affected nations doubtlessly will be very upset because the gravy train gets derailed, but that’s a feature, not a bug.
2. If banks become insolvent because they recklessly lent money to governments that default, those financial institutions should be allowed to fail. More specifically, they should be put into something akin to receivership (similar to what the U.S. did 20 years ago with the S&L crisis and a few years ago with WaMu and IndyMac, and also like what Sweden did in the early 1990s). This automatically prevents financial crisis since the financial sector gets recapitalized, but without the moral hazard and/or zombie bank problems associated with TARP-style bailouts.
So what’s the downside? There isn’t one, at least compared to the alternatives. Governments would be holding harmless depositors at the failed banks, so there would be additional debt. But this debt would be a one-time burden for a policy that actually stops the bleeding, and there would be no moral hazard since shareholders, bondholders, and senior management at the failed banks would get nothing.
This raises an obvious question. If my proposed solution is so simple, why aren’t governments choosing this option?
Part of the answer is that simple solutions aren’t necessarily easy solutions. We know how to fix America’s fiscal crisis, for instance, but that doesn’t mean it will happen. Governments will sometimes do the right thing – but only after they’ve exhausted every other option.
Europe isn’t quite at that stage. Yes, Greece is being allowed to default, which is a small step in the right direction, but the political elite hope that the right blend of additional bailouts and patchwork reforms can fix the problem.
I suppose that might happen, especially if the world economy somehow begins to boom. But don’t hold your breath.
[…] That’s an unpleasant outcome, but at least it will stop the bleeding. […]
[…] no longer can pay its bills. On the other hand, the European Union and the euro currency are being weakened by the mess in Greece, though that’s because they’ve been subsidizing bad fiscal policy with […]
[…] There’s a rather simple solution to Europe’s fiscal crisis, but politicians will never do the right thing unless every other option is exhausted. […]
[…] There’s a rather simple solution to Europe’s fiscal crisis, but politicians will never do the right thing unless every other option is exhausted. […]
[…] no longer can pay its bills. On the other hand, the European Union and the euro currency are being weakened by the mess in Greece, though that’s because they’ve been subsidizing bad fiscal policy with […]
[…] no longer can pay its bills. On the other hand, the European Union and the euro currency are being weakened by the mess in Greece, though that’s because they’ve been subsidizing bad fiscal policy with […]
[…] “hands-off” approach would have been the right way for the IMF and European Commission to deal with the fiscal crisis in Greece and other nations. […]
[…] think it’s a mistake to bail out profligate governments, and I have the same skeptical attitude about bailouts for mismanaged banks and inefficient car […]
[…] think it’s a mistake to bail out profligate governments, and I have the same skeptical attitude about bailouts for mismanaged banks and inefficient car […]
[…] is why I stand by my original arguments that bailouts won’t work and that a tough-love policy of benign neglect is the only feasible […]
[…] the scam may be coming to an end. Margaret Thatcher famously warned that the problem with socialism is that sooner or later you run out of other people’s […]
[…] this story is yet another example of why bailouts are a bad idea. As I’ve explained before, governments will only make the right reforms as a final option. Bailouts, by contrast, simply give politicians more time to delay, while also making the debt […]
[…] Sounds like a good guy, right? Just the type of person who can explain that Europe’s problem is too much government. The kind of policy maker who can argue for cutting back the welfare state, slashing tax rates, and ending bailouts. […]
[…] written many times about the foolishness of bailing out profligate governments (or, for that matter, mismanaged banks and inefficient car […]
[…] written many times about the foolishness of bailing out profligate governments (or, for that matter, mismanaged banks and inefficient car […]
[…] always bееn a unadorned аnԁ desirable solution tο Europe’s monetary crisis, bυt nobody іn Europe wаntѕ tο ԁο thе rіɡht thing […]
[…] is why I stand by my original arguments that bailouts won’t work and that a tough-love policy of benign neglect is the only feasible solution. Rate this: Share […]
[…] written a couple of serious posts about the European fiscal crisis, including an explanation of how the problem could be solved and one about the importance of gun ownership in case the pessimists are right and civil society […]
[…] always been a simple and desirable solution to Europe’s fiscal crisis, but nobody in Europe wants to do the right thing because it means admitting the failure of big […]
[…] written a couple of serious posts about the European fiscal crisis, including an explanation of how the problem could be solved and one about the importance of gun ownership in case the pessimists are right and civil society […]
[…] always been a simple and desirable solution to Europe’s fiscal crisis, but nobody in Europe wants to do the right thing because it means admitting the failure of big […]
[…] regularly been a simple as well as fascinating resolution to Europe’s mercantile crisis, yet nobody in Europe wants to do a right thing since it equates to revelation a disaster of large […]
[…] always been a simple and desirable solution to Europe’s fiscal crisis, but nobody in Europe wants to do the right thing because it means admitting the failure of big […]
The problem here is that much of the debt accrued by banks isn’t necessarily ‘their fault’. EU banking rules (Basel rules) set the levels of debt that banks can hold, and is skewed, as you might expect, towards sovereign debt. The politicians are gaming the system to make sure there’s always a ready buyer for the debt, regardless of how profligate they may be. (the only thing they haven’t done is limit the cost of the debt (wait for a rule like that one to follow). This effectively acts as a check on Bank responsibility, forcing them to put capital into investments that may not be sound. We had a similar problem here in the US (and abroad) that helped contribute to the housing crisis meltdown. Secondly, allowing default might wipe the slate clean, but it would also create significant and painful hardship to many vulnerable people who’s only crime was trusting the state – people like the elderly, and yes, some mooches, who simply got used to a system that didn’t create enough opportunity for them. So, ethically, there are some very seriously problems here with ‘doing the right thing’.
[…] always been a simple and desirable solution to Europe’s fiscal crisis, but nobody in Europe wants to do the right thing because it means admitting the failure of big […]
[…] There’s a rather simple solution to Europe’s fiscal crisis, but politicians will never do the right thing unless every other option is exhausted. […]
[…] There’s a rather simple solution to Europe’s fiscal crisis, but politicians will never do the right thing unless every other option is exhausted. […]
[…] think about what this means, and we’ll start with an assumption that European politicians won’t follow my sage advice and that they’ll instead continue to kick the can down the road – thus making the debt bubble […]
[…] think about what this means, and we’ll start with an assumption that European politicians won’t follow my sage advice and that they’ll instead continue to kick the can down the road – thus making the debt […]
[…] governments can default, which would be disreputable, but at least they would then be cut off from credit markets, thus […]
[…] despicable political class has not learned from their mistakes. They are not taking the simple and obvious steps that are needed to address the problems of spendthrift […]
[…] written about the fiscal implosion in Europe and warned that America faces the same fate if we don’t reform poorly designed entitlement […]
[…] written about the fiscal implosion in Europe and warned that America faces the same fate if we don’t reform poorly designed entitlement […]
[…] I’ve written about the fiscal implosion in Europe and warned that America faces the same fate if we don’t reform poorly designed entitlement […]
[…] written about the fiscal implosion in Europe and warned that America faces the same fate if we don’t reform poorly designed entitlement […]
[…] written about the fiscal implosion in Europe and warned that America faces the same fate if we don’t reform poorly designed entitlement […]
[…] written about the fiscal implosion in Europe and warned that America faces the same fate if we don’t reform poorly designed entitlement […]
I only wish that people here in my country would listen to and could understand your message.
Kostas, Athens, Greece
[…] there is no good news. Sarkozy, Merkel, and the other statists have once again failed to do the right thing and instead have decided to throw good money after bad and dig the debt hole even […]
Let the banks fail and the bankruptcy proceedings proceed. It is a natural occurrence as it the breaking down of cells in the human body and ultimately death. You need to see the much bigger picture and the consequences of excessive greed and corruption, as ugly and widespread as it may be.
Dan, you make very good arguments that I agree with but I don’t quite agree that there is no downside other than what you mentioned. Huge banks collapsing affects all other businesses in some way, leading to a recession, lower govt revenue and higher unemployment. Civil unrest follows at some point.
Secondly, many financial institutions are “too big to fail” because they got in bed with the government which regulated competitors out of the market in exchange for loans. The smaller competitors may not manage to fill the vacuum after wide-scale insolvency which adds weight to the bailout arguments.
I certainly am against govt involvement in the economy but we have a Catch-22 situation here and your solutions are not as simple as you seem to suggest.
One reason governments don’t go for the solution you propose is that the the individuals in the government decision-making positions are either bondholders and shareholders that will lose money on their investment, or they are beholden to those bondholders and shareholders for campaign donations or employment when they no longer hold public office.