Archive for the ‘Moral Hazard’ Category

As a general rule, I’m not overly concerned about debt, even when looking at government red ink.

I don’t like deficit and debt, to be sure, but government borrowing should be seen as the symptom. The real problem is excessive government spending.

This is one of the reasons I’m not a fan of a balanced budget amendment, Based on the experiences of American states and European countries, I fear politicians in Washington would use any deficit-limiting requirement as an excuse to raise taxes.

I much prefer spending caps, such as those found in Hong Kong, Switzerland, and Colorado. If you cure the disease of excessive government, you automatically ameliorate the symptom of too much borrowing.

That being said, the fiscal chaos plaguing European welfare states is proof that there is a point when a spending problem can also become a debt problem. Simply stated, the people and institutions that buy government bonds at some point will decide that they no longer trust a government’s ability to repay because the public sector is too big and the economy is too weak.

And even though the European fiscal crisis no longer is dominating the headlines, I fear this is just the calm before the storm.

For instance, the data in a report from Citi about the looming Social Security-style crisis are downright scary.

…the total value of unfunded or underfunded government pension liabilities for twenty OECD countries is a staggering $78 trillion, or almost double the $44 trillion published national debt number.

And the accompanying chart is rather appropriate since it portrays this giant pile of future spending promises as an iceberg.

And when you look at projections for ever-rising spending (and therefore big increases in red ink) in America, it’s easy to see why I’m such a strong advocate of genuine entitlement reform.

But it’s also important to realize that government policies also can encourage excessive debt in the private sector.

Before digging into the issue, let’s first make clear that debt is not necessarily bad. Households often borrow to buy big-ticket items like homes, cars, and education. And businesses borrow all the time to finance expansion and job creation.

But if there’s too much borrowing, particularly when encouraged by misguided government policies, then households and businesses are very vulnerable if there’s some sort of economic disruption and they no longer have enough income to finance debt payments. This is when debt becomes excessive.

Yet this is what the crowd in Washington is encouraging.

Writing for the Wall Street Journal, George Melloan warns that misguided “stimulus” and “QE” policies have created a debt bubble.

…while Mr. Bernanke and Ms. Yellen were trying to prevent deflation, the federal government was engineering its cause, excessive debt. And the Fed abetted the process by purchasing trillions of dollars of government paper, aka quantitative easing. Near-zero interest rates also have encouraged consumers and business to releverage. Cars are now financed with low or no-interest five-year loans. With the 2008 housing debacle forgotten, easier mortgage terms have made a comeback. Corporations also couldn’t let cheap money go to waste, so they have piled up debts to buy back their own stock. Such “investment” produces no economic growth, but it has to be paid back nonetheless. Amid the Great Recession, many worried that the entire economy of the U.S., or even the world, would be “deleveraged.” Instead, we have a new world-wide debt bubble.

The numbers he shares are sobering.

Global debt of all types grew by $57 trillion from 2007 to 2014 to a total of $199 trillion, the McKinsey Global Institute reported in February last year. That’s 286% of global GDP compared with 269% in 2007. The current ratio is above 300%.

Professor Noah Smith writes in Bloomberg about research showing that debt-fueled bubbles are especially worrisome.

…since debt bubbles damage the financial system, they endanger the economy more than equity bubbles, which transmit their losses directly to households. Financial institutions lend people money, and if people can’t pay it back — because the value of their house has gone down — it could cause bank failures. …Economists Oscar Jorda, Moritz Schularick, and Alan Taylor recently did a historical study of asset price crashes, and they found that, in fact, debt seems to matter a lot. …To make a long story short, they look at what happened to the economy of each country after each large drop in asset prices. …bubbles make recessions longer, and credit worsens the effect. …the message is clear: Bubbles and debt are a dangerous combination.

To elaborate, equity and bubbles aren’t a good combination, but there’s far less damage when an equity bubble pops because the only person who is directly hurt is the person who owns the asset (such as shares of a stock). But when a debt bubble pops, the person who owes the money is hurt, along with the person (or institution) to whom the money is owed.

Desmond Lachman of the American Enterprise Institute adds his two cents to the issue.

…the world is presently drowning in debt. Indeed, as a result of the world’s major central banks for many years having encouraged markets to take on more risk by expanding their own balance sheets in an unprecedented manner, the level of overall public and private sector indebtedness in the global economy is very much higher today than it was in 2008 at the start of the Great Economic Recession. Particularly troublesome is the very high level of corporate debt in the emerging market economies and the still very high public sector debt levels in the European economic periphery. …the Federal Reserve’s past policies of aggressive quantitative easing have set up the stage for considerable global financial market turbulence. They have done so by artificially boosting asset prices and by encouraging borrowing at artificially low interest rates that do not reflect the likelihood of the borrower eventually defaulting on the loan.

In other words, artificially low interest rates are distorting economic decisions by making something (debt) seem cheaper than it really is. Sort of financial market version of the government-caused third-party payer problem in health care and higher education.

And Holman Jenkins of the Wall Street Journal makes the very important point that debt is encouraged by bailouts and subsidies.

Big banks aren’t automatically bad or badly managed because they are big, but it’s hard to believe big banks would exist without an explicit and implicit government safety net underneath them. …None of this has changed since Dodd-Frank, none of it is likely to change. …we know where the crisis will come from and how it will be transmitted to the financial system. The Richmond Fed’s “bailout barometer” shows that, since the 2008 crisis, 61% of all liabilities in the U.S. financial system are now implicitly or explicitly guaranteed by government, up from 45% in 1999. …Six years after a crisis caused by excessive borrowing, McKinsey estimates that even visible global debt has increased by $57 trillion, while in the U.S., Europe, Japan and China growth to pay back these liabilities has been slowing or absent.

The bottom line is that government spending programs directly cause debt, but we should be just as worried about the private debt that is being encouraged and subsidized by other misguided government policies.

And surely we shouldn’t forget to include the pernicious role of the tax code, which further tilts the playing field in favor or debt.

P.S. Let’s briefly divert to another issue. I wrote last Christmas that President Obama may have given the American people a present.

But the Washington Examiner reports that gift has turned into a lump of coal.

The Department of Justice announced this week that it is resuming its Equitable Sharing program…that allows state and local police to get around tough state laws that limit how much property can be taken from citizens without being charged with wrongdoing, let alone convicted of a crime. …money-hungry police departments can exploit these lax federal rules about confiscating people’s property. The feds like this because they get a cut of the loot. …there is no presumption of innocence. …civil forfeitures by the feds amounted to $4.5 billion in 2014, which is more than the $3.9 billion that all of America’s burglars stole that year. It’s hard to imagine more compelling evidence of gross wrong.

Wow, so the government steals more money than burglars. I guess I’m not surprised.

But if you really want to get upset, check out real-world examples of asset forfeiture by clicking here, here, here, here, and here.

Thankfully, some states are seeking to curtail this evil practice.

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Remember the odious, immoral, and corrupt TARP bailout?

Well, it’s becoming an issue in the 2016 presidential race, with some folks criticizing Donald Trump for siding with Bush and Obama on the issue.

I suppose I could make a snide observation about the absurdity of Trump being perceived as an anti-establishment candidate when he supported a policy that had unanimous support from political insiders.

But I would much rather focus on the policy implications. So when Neil Cavuto asked me to comment on Chris Christie’s rejection of bailouts, I took the opportunity to stress (once again) that it wasn’t a TARP-or-nothing choice and that there was a sensible, non-corrupt, way of dealing with failing financial firms. Simply stated, only bail out depositors and let bondholders and shareholders take the hit.

For the geeks who are reading this, you’ll recognize that the policy I’m advocating is often called the FDIC-resolution approach.

And it’s worth noting that this was used at the beginning of the financial crisis. As I pointed out in the discussion, two of the big financial institution that first got in trouble – WAMU and IndyMac – were liquidated.

But once Bush’s execrable Treasury Secretary, Hank Paulson, took control of the process, decisions were made to rescue the fat cats as well as the depositors.

The bottom line is that a lot of establishment figures, including GOPers like Dick Cheney and Mitt Romney, argue that TARP was necessary because the financial system needed to be recapitalized.

Yet that’s also what happens with the FDIC-resolution approach. The only real difference is whether financial institutions should be rescued along with depositors.

Well, my view is that capitalism without bankruptcy is like religion without hell.

P.S. The other guest in the interview made a very good point about America becoming “bailout nation.” I fully agree. To the extent that we have private profits and socialized losses, we’ll have bigger and bigger problems with moral hazard. After all, if you’re in Las Vegas and someone else is covering your losses, why not make high-risk/high-reward bets.

P.P.S. If anyone cares, my driveway is finally clear. A special thanks to the family next door. Not only were they smarter than me (as I wrote yesterday, they parked their cars near the end of their driveway), they’re also nicer than me. They came over and helped me finish when they were done!

Actually, I like to think I’d be equally thoughtful. I’ll have to look for a chance to repay their good deed.

By the way, I should add that the father next door works for a social conservative organization, which is one more piece of evidence for my view that so-cons and libertarians should be allies.

Tim Carney explains that natural alliance much better.

P.P.P.S. In hopes of convincing some of my leftist friends, I can’t resist making one final point.

When government gets to pick winners and losers, it’s highly probable that those who get the handouts, bailouts, and subsidies will be rich, powerful, and politically connected. Heck, just think of the Ex-Im Bank.

As noted by my former colleague, Will Wilkinson, “…the more power the government has to pick winners and losers, the more power rich people will have relative to poor people.”

I realize that statists won’t agree with me that it’s wrong for the federal government to redistribute from rich to poor. But I hope they’ll be on my side in fighting against redistribution from poor to rich!

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Is the third time the charm, at least for bailouts?

First, we had the TARP bailout in the United States, and that turned out to be a corrupt mess.

Second, we had the Greek bailout, which has squandered hundreds of billions of euros to prop up a welfare state.

Now we have a third big bailout, with China seeking to stabilize that nation’s faltering stock market. So anybody want to guess how this will work out?

To put it mildly, the Wall Street Journal does not have a favorable opinion of this financial market intervention.

Beijing…officials pumped public money into the market. It hasn’t worked; the Shanghai Composite Index closed Thursday at 3661, 29% below its June peak. …Peking University economist Christopher Balding has added up the bailout and stimulus measures announced since the market panic started in late June. They total $1.3 trillion, or more than 10% of GDP.

So why is this a bad thing?

For two reasons, as the WSJ explains. First, it’s an unjustified wealth transfer. Second, it creates an economic environment contaminated by moral hazard.

Investors who bought when the market was already frothy are getting a chance to exit with some of their profits intact. But Chinese who don’t own stocks are justified in asking why they must subsidize their fellow citizens’ poor decisions. Mr. Balding’s spreadsheet shows that the market-rescue measures represent a huge transfer of wealth to investors who should have been prepared to shoulder the risks when they bought shares. The failed bailout reinforces the expectation that Beijing will attempt to manage the financial markets in the future. This moral hazard means the volatility will continue, along with the costs of future bailouts.

You won’t be surprised to learn that I share the Wall Street Journal’s skepticism. In a recent interview with Neil Cavuto, I said the Chinese government (like just about all governments) is too focused on short-run pain avoidance.

In other words, by trying to prop up markets in the short run, I think the Chinese government will cause a far greater amount of economic pain in the long run.

Two other points from the interview deserve highlighting.

  1. China’s economy needs more economic liberalization (as opposed to the snake oil being peddled by the IMF) if it hopes to become a first-world nation. While there’s been a lot of progress since the wretched deprivation and poverty of Mao’s era, China is still way behind the United States and other nations with more capitalistic systems. Hong Kong, Singapore, and Taiwan are appropriate role models.
  2. Whenever folks on the left point to a “success story” that ostensibly proves big government and central planning are more successful that capitalism, it’s just a matter of time before they’re proven wrong. Some of them were delusional enough to think the Soviet Union was economically successful (see bottom of this post) and events proved them wrong. As I pointed out in the interview, some of them thought Japan’s model of central planning was the ticket for prosperity and events proved them wrong. More recently, some of them have argued that China’s state-driven economy was a role model and they’re now being shown to be wrong.

P.S. Let’s close with some economic humor.

Fans of old-time comedy are probably familiar with the famous who’s-on-first exchange between Abbott and Costello.

Well, here’s a modern version of that exchange that showed up in my mailbox yesterday, only it deals with joblessness. I won’t strain credibility by asserting it’s as funny as the original sketch, but it does indirectly highlight the fact that we should focus primarily on labor force participation since that measure how many people are producing wealth for the nation.

COSTELLO: I want to talk about the unemployment rate in America.

ABBOTT: Good Subject. Terrible times. It’s 5.6%.

COSTELLO: That many people are out of work?

ABBOTT: No, that’s 23%.

COSTELLO: You just said 5.6%.

ABBOTT: 5.6% unemployed.

COSTELLO: Right, 5.6% out of work.

ABBOTT: No, that’s 23%.

COSTELLO: Okay, so it’s 23% unemployed.

ABBOTT: No, that’s 5.6%.

COSTELLO: Wait a minute! Is it 5.6% or 23%?

ABBOTT: 5.6% are unemployed. 23% are out of work.

COSTELLO: If you are out of work, you are unemployed.

ABBOTT: No, Congress said you can’t count the “out of work” as the unemployed. You have to look for work to be unemployed.

COSTELLO: But they are out of work!

ABBOTT: No, you miss his point.

COSTELLO: What point?

ABBOTT: Someone who doesn’t look for work can’t be counted with those who look for work. It wouldn’t be fair.

COSTELLO: To whom?

ABBOTT: The unemployed.

COSTELLO: But ALL of them are out of work.

ABBOTTNo, the unemployed are actively looking for work. Those who are out of work gave up looking; and if you give up, you are no longer in the ranks of the unemployed.

COSTELLO: So if you’re off the unemployment rolls, that would count as less unemployment?

ABBOTT: Unemployment would go down. Absolutely!

COSTELLOThe unemployment rate just goes down because you don’t look for work?

ABBOTTAbsolutely it goes down. That’s how it gets to 5.6%. Otherwise it would be 23%.

COSTELLO: Wait, I got a question for you. That means there are two ways to bring down the unemployment number?

ABBOTT: Two ways is correct.

COSTELLO: Unemployment can go down if someone gets a job?

ABBOTT: Correct.

COSTELLO: And unemployment can also go down if you stop looking for a job?

ABBOTT: Bingo.

COSTELLO: So there are two ways to bring unemployment down, and the easier of the two is to have people stop looking for work.

ABBOTT: Now you’re thinking like an economist.

COSTELLO: I don’t even know what the hell I just said!

ABBOTT: Now you’re thinking like a politician.

P.P.S. While economists deservedly get mocked, we’re not totally useless. We occasionally show a bit of cleverness.

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I’ve shared lots of analysis (both serious and satirical) about the mess in Greece and I feel obliged to comment on the latest agreement for another bailout.

But how many times can I write that the Greek government spends too much money and has a punitive tax system (and a crazy regulatory regime, a bloated bureaucracy, etc)?

So let’s try a different approach and tell a story about the new bailout by using some images.

Here’s an amusing perspective on what actually happened this weekend.

I explained a few days ago that the bailouts have simultaneously enabled the delay of much-needed spending reforms while also burdening Greece with an impossible pile of debt.

But the Greek bailouts, like the TARP bailout in the United States, were beneficial to powerful insiders.

Here’s a look at how banks in various European nations have been able to reduce their exposure to Greek debt.

Sure, the banks almost surely still lost money, but they also transferred a lot of the losses to taxpayers.

To get a sense of the magnitude of handouts, here’s a chart from a Washington Post story.

And now, assuming the deal gets finalized, that pile of foolish and unsustainable debt will be even bigger.

One of the main components of the new agreement is that Greece supposedly will raise revenue by selling $50 billion of state-owned assets.

Don’t believe that number. But not because there aren’t plenty of assets to sell, but rather because the track record on privatization proceeds suggests that there is a giant gap between what Greece promises and what Greece delivers.

To understand why assets aren’t being sold, just keep in mind that most of the assets are under the control of the government in order to provide unearned benefits to different interest groups.

If you’re an overpaid unionized worker at a government-owned port, for instance, the last thing you want is to have that port sold to a private investor who presumably would want to link pay to productivity.

Here’s the best bit of humor I’ve seen about the negotiations this past weekend. It purports to show a list of demands from Germany to Greece.

While this image is funny, it’s also wrong.

Germany isn’t imposing anything on Greece. The Germans are simply stating that Greek politicians need to make some changes if they want more handouts.

Moreover, it’s quite likely that Germany will wind up being a big loser when the dust settles. Here’s some of what Gideon Rachman wrote for the U.K.-based Financial Times.

If anybody has capitulated, it is Germany. The German government has just agreed, in principle, to another multibillion-euro bailout of Greece — the third so far. In return, it has received promises of economic reform from a Greek government that makes it clear that it profoundly disagrees with everything that it has just agreed to. The Syriza government will clearly do all it can to thwart the deal it has just signed. If that is a German victory, I would hate to see a defeat.

So true.

I fear this deal will simply saddle Greece with a bigger pile of debt and set the stage for a more costly default in the future.

The title of this column is about pictures. But let’s close with some good and bad analysis about the Greek mess.

Writing for Real Clear Markets, Louis Woodhill has some of the best insight, starting with the fact that the bailout does two things.

First, this new bailout is largely just a mechanism to prevent default on past bailouts. Sort of like making a new loan to your deadbeat brother-in-law to cover what he owes you on previous loans.

…the €53.5 billion in new loans…would just be recycled to Greece’s creditors (the IMF, the EU, and the ECB) to pay the interest and principal on existing debts.

Second, it prevents the full meltdown of Greek banks.

The key point is that a bailout agreement would restore European Central Bank (ECB) “Emergency Liquidity Assistance” (ELA) to the Greek banking system. This would allow Greeks that still have deposits in Greek banks (€136.5 billion as of the end of May) to get their money out of those banks.

That’s good news if you’re a Greek depositor, but that’s about it.

In other words, those two “achievements” don’t solve the real problem of Greece trying to consume more than it produces.

Indeed, Woodhill correctly identifies a big reason to be very pessimist about the outcome of this latest agreement. Simply stated, Greek politicians (aided and abetted by the Troika) are pursuing the wrong kind of austerity.

…what is killing Greece is a lack of economic growth, and the meat of Tsipras’ bailout proposal consists of growth-killing tax hikes. The media and the economics profession have been framing the alternatives for Greece in terms of a choice between “austerity” and “stimulus.” Unfortunately for Greece, austerity has come to mean tax increases, and stimulus has come to mean using “other people’s money” (mainly that of German taxpayers) to support Greek welfare state outlays. So, if “other people” aren’t willing to fund more Greek government spending, then the only option the “experts” can imagine is to raise taxes on an economy that is already being crushed by excessive taxation.

Let’s close with the most ridiculous bit of analysis about the Greek situation. It’s from Joe Stiglitz,

Joseph Stiglitz accused Germany on Sunday of displaying a “lack of solidarity” with debt-laden Greece that has badly undermined the vision of Europe. …”Asking even more from Greece would be unconscionable. If the ECB allows Greek banks to open up and they renegotiate whatever agreement, then wounds can heal. But if they succeed in using this as a trick to get Greece out, I think the damage is going to be very very deep.”

Needless to say, I’m not sure why it’s “solidarity” for one nation to mooch in perpetuity from another nation. I suspect Stiglitz is mostly motivated by an ideological desire to redistribute from the richer Germans to the poorer Greeks,

But I’m more interested in why he isn’t showing “solidarity” to me. I’m sure both his income and his wealth are greater than mine. So if equality of outcomes is desirable, why doesn’t he put his money where his mouth is by sending me a big check?

Needless to say, I won’t be holding my breath waiting for the money. Like most leftists, Stiglitz likes to atone for his feelings of guilt by redistributing other people’s money.

And I also won’t be holding my breath waiting for a good outcome in Greece. As I wrote five-plus years ago, Greece needs the tough-love approach of no bailouts, which would mean a default but also an immediate requirement for a balanced budget.

Last but not least, I’m going to confess a possible mistake. I always thought that Margaret Thatcher was right when she warned that the problem with socialism is that you eventually run out of other people’s money. But this latest bailout of Greece shows that maybe politicians from other nations are foolish enough to provide an endless supply of other people’s money.

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When debating and discussing the 2008 financial crisis, there are two big questions. And the answers to these questions are important because the wrong “narrative” could lead to decades of bad policy (much as a mistaken narrative about the Great Depression enabled bad policy in subsequent decades).

  1. What caused the crisis to occur?
  2. What should policy makers have done?

In a new video for Prager University, Nicole Gelinas of the Manhattan Institute succinctly and effectively provides very valuable information to help answer these questions. Particularly if you want to understand how the government promoted bad behavior by banks and created the conditions for a crisis.

Here are some further thoughts on the issues raised in the video.

Deregulation didn’t cause the financial crisis – Nicole explained that banks got in trouble because of poor incentives created by previous bailouts, not because of supposed deregulation. As she mentioned, their “risk models” were distorted by assumptions that some financial institutions were “too big to fail.”

But that’s only part of the story. It’s also important to recognize that easy-money policies last decade created too much liquidity and that corrupt subsidies and preferences for Fannie Mae and Freddie Mac steered much of that excess liquidity into the housing sector. These policies helped to create the bubble, and many financial institutions became insolvent when that bubble burst.

TARP wasn’t necessary to avert a meltdown – Because the video focused on how the “too big to fail” policy created bad incentives, there wasn’t much attention to the topic of what should have happened once big institutions became insolvent. Defenders of TARP argued that the bailout was necessary to “unfreeze” financial markets and prevent an economic meltdown.

But here’s the key thing to understand. The purpose of TARP was to bail out big financial institutions, which also meant protecting big investors who bought bonds from those institutions. And while TARP did mitigate the panic, it also rewarded bad choices by those big players. As I’ve explained before, using the “FDIC-resolution” approach also would have averted the panic. In short, instead of bailing out shareholders and bondholders, it would have been better to bail out depositors and wind down the insolvent institutions.

Bailouts encourage very bad behavior – There’s a saying that capitalism without bankruptcy is like religion without hell, which is simply a clever way of pointing out that you need both profit and loss in order for people in the economy to have the right set of incentives. Bailouts, however, screw up this incentive structure by allowing private profits while simultaneously socializing the losses. This creates what’s known as moral hazard.

I’ve often used a simple analogy when speaking about government-created moral hazard. How would you respond if I asked you to “invest” by giving me some money for a gambling trip to Las Vegas, but I explained that I would keep the money from all winning bets, while financing all losing bets from your funds? Assuming your IQ is at least room temperature, you would say no. But our federal government, when dealing with the financial sector, has said yes.

Good policy yields short-run pain but long-run gain – In my humble opinion, Nicole’s most valuable insight is when she explained the long-run negative consequences of the bailouts of Continental Illinois in 1984 and Long-Term Capital Management in 1998. There was less short-run pain (i.e., financial instability) because of these bailouts, but the avoidance of short-run pain meant much more long-run pain (i.e., the 2008 crisis).

Indeed, this “short termism” is a pervasive problem in government. Politicians often argue that a good policy is unfeasible because it would cause dislocation to interest groups that have become addicted to subsidies. In some cases, they’re right about short-run costs. A flat tax, for instance, might cause temporary dislocation for some sectors such as housing and employer-provide health insurance. But the long-run gains would be far greater – assuming politicians can be convinced to look past the next election cycle.

Let’s close by re-emphasizing a point I made at the beginning. Narratives matter.

For decades, the left got away with the absurd statement that the Great Depression “proved” that capitalism was unstable and destructive. Fortunately, research in recent decades has helped more and more people realize that this is an upside-down interpretation. Instead, bad government policy caused the depression and then additional bad policy during the New Deal made the depression longer and deeper.

Now we have something similar. Leftists very much want people to think that the financial crisis was a case of capitalism run amok. They’ve had some success with this false narrative. But the good news is that proponents of good policy immediately began explaining the destructive role of bad government policy. And if Nicole’s video is any indication, that effort to prevent a false narrative is continuing.

P.S. The Dodd-Frank bill was a response to the financial crisis, but it almost certainly made matters worse. Here’s what Nicole wrote about that legislation.

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There’s a big fiscal battle happening in Europe. The relatively new Greek government is demanding continued handouts from the rest of Europe, but it wants to renege on at least some of the country’s prior commitments to improve economic performance by reducing the preposterous burden of spending, regulation, and intervention.

That seems like a rather strange negotiating position. Sort of like a bank robber holding a gun to his own head and saying he’ll shoot himself if the teller doesn’t hand over money.

At first glance, it seems the Greeks are bluffing. Or being suicidally self-destructive.

And maybe they are posturing and/or being deluded, but there are two reasons why the Greeks are not totally insane.

1. The rest of Europe does not want a Greek default.

There’s a famous saying, attributed to J. Paul Getty, that applies to the Greek fiscal fight. Simply stated, there are lots of people and institutions that own Greek government bonds and they are afraid that their investments will lose value if Greece decides to fully or partially renege on its debts (which is an implicit part of Greece’s negotiating position).

So while Greece would suffer if it defaulted, there would be collateral damage for the rest of Europe. In other words, the hypothetical bank robber has a grenade rather than a gun. And while the robber won’t fare well if he pulls the pin, lots of other people may get injured by shrapnel.

And to make matters more interesting, previous bailouts of Greece have created a rather novel situation in that taxpayers are now the indirect owners of a lot of Greek government debt. As you can see from the pie chart, European taxpayers have the most exposure, but American taxpayers also are on the hook because the IMF has participated in the bailouts.

The situation is Greece is akin to a bankruptcy negotiation. The folks holding Greek government debt are trying to figure out the best strategy for minimizing their losses, much as the creditors of a faltering business will calculate the best way of extracting their funds. If they press too hard, the business may go bust and they get very little (analogous to a Greek default). But if they are too gentle, they miss out on a chance of getting a greater share of the money they’re owed.

2. Centralization is the secular religion of the European elite and they want Greece in the euro.

The bureaucrats at the European Commission and the leaders of many European nations are emotionally and ideologically invested in the notion of “ever closer union” for Europe. Their ultimate goal is for the European Union to be a single nation, like the United States. In this analogy, the euro currency is akin to the American dollar.

There’s a general perception that a default would force the Greek government to pull out of the euro and re-create its own currency. And for the European elite who are committed to “ever closer union,” this would be perceived as a major setback. As such, they are willing to bend over backwards to accommodate Greece’s new government.

Given the somewhat blurry battle lines between Greece and its creditors, what’s the best outcome for advocates of limited government and individual liberty?

That’s a frustrating question to answer, particularly since the right approach would have been to reject any bailouts back when the crisis first started.

Without access to other people’s money, the Greek government would have been forced to rein in the nation’s bloated public sector. To be sure, the Greek government may also have defaulted, but that would have taught investors a valuable lesson about lending money to profligate governments.

And it would have been better if Greece defaulted five years ago, back when its debt was much smaller than it is today.

But there’s no point in crying about spilt milk. We can’t erase the mistakes of the past, so what’s the best approach today?

Actually, the right answer hasn’t changed.

And just as there are two reasons why the Greek government is being at least somewhat clever in playing hardball, there are two reasons why the rest of the world should tell them no more bailouts.

1. Don’t throw good money after bad.

To follow up on the wisdom of J. Paul Getty, let’s now share a statement commonly attributed to either Will Rogers or Warren Buffett. I don’t know which one (if either) deserves credit, but there’s a lot of wisdom in the advice to stop digging if you find yourself in a hole. And Greece, like many other nations, has spent its way into a deep fiscal hole.

There is a solution for the Greek mess. Politicians need to cut spending over a sustained period of time while also liberalizing the economy to create growth. And, to be fair, some of that has been happening over the past five years. But the pace has been too slow, particularly for pro-growth reforms.

But this also explains why bailouts are so misguided. Politicians generally don’t do the right thing until and unless they’ve exhausted all other options. So if the Greek government thinks it has additional access to money from other nations, that will give the politicians an excuse to postpone and/or weaken necessary reforms.

2. Saying “No” to Greece will send a powerful message to other failing European welfare states.

Now let’s get to the real issue. What happens to Greece will have a big impact on the behavior of other European governments that also are drifting toward bankruptcy.

Here’s a chart showing the European nations with debt burdens in excess of 100 percent of economic output based on OECD data. Because of bad demographics and poor decisions by their politicians, every one of these nations is likely to endure a Greek-style fiscal crisis in the near future.

And keep in mind that these figures understate the magnitude of the problem. If you include unfunded liabilities, the debt levels are far higher.

So the obvious concern is how do you convince the politicians and voters in these nations that they better reform to avoid future fiscal chaos? How do you help them understand, as Mark Steyn sagely observed way back in 2010, that “The 20th-century Bismarckian welfare state has run out of people to stick it to.

Well, if you give additional bailouts to Greece, you send precisely the wrong message to the Italians, French, etc. In effect, you’re telling them that there’s a new group of taxpayers from other nations who will pick up the tab.

That means more debt, bigger government, and a deeper crisis when the house of cards collapses.

P.S. Five years ago, I created a somewhat-tongue-in-cheek 10-step prediction for the Greek crisis and stated at the time that we were at Step 5. Well, it appears my satire is slowly becoming reality. We’re now at Step 7.

P.P.S. Four years ago, I put together a bunch of predictions about Greece. You can judge for yourself, but I think I was quite accurate.

P.P.P.S. A big problem in Greece is the erosion of social capital, as personified by Olga the Moocher. At some point, as I bluntly warned in an interview, the Greeks need to learn there’s no Santa Claus.

P.P.P.P.S. The regulatory burden in Greece is a nightmare, but some examples of red tape are almost beyond belief.

P.P.P.P.P.S. The fiscal burden in Greece is a nightmare, but some examples pf wasteful spending are almost beyond belief.

P.P.P.P.P.P.S. Since we once again have examined a very depressing topic, let’s continue with our tradition of ending with a bit of humor. Click here and here for some very funny (or sad) cartoons about Obama and Greece. And here’s another cartoon about Greece that’s worth sharing. If you like funny videos, click here and here. Last but not least, here’s some very un-PC humor about Greece and the rest of Europe.

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When you support limited government and individual freedom, you don’t enjoy many victories. Particularly if you’re relying on the U.S. Senate.

But it occasionally happens.

The Senate held firm and stopped Obama from getting a fiscal cliff tax hike at the end of 2010.

The Senate overwhelmingly voted against a VAT.

The Senate unanimously rejected a Greek bailout.

To be sure, some of these votes were merely window dressing, but it’s still better to have symbolic victories rather than symbolic defeats.

Today, however, I want to report on a real victory against statism. The Senate Majority Leader, Harry Reid, has been forced to give up on his effort to ram through an expansion of IMF bailout authority as part of legislation giving money to Ukraine.

This is the second time that this White House initiative has been blocked.

Here are some blurbs from a report in Politico.

Senate Majority Leader Harry Reid will drop a provision to reform the International Monetary Fund from a bill to help Ukraine… Reid acknowledged that while the Ukraine package would likely have passed the Senate, it was “headed to nowhere” in the GOP-led House. …the administration did not hide its disappointment Tuesday afternoon over the removal of the IMF language. “We are deeply disappointed by the news that Republican opposition has forced the Senate to remove the [IMF] reforms from the Ukraine assistance package,” said Treasury Department spokeswoman Holly Shulman. …Backers of including the IMF reforms in the Ukraine deal note that it will help boost the organization’s lending capacity. …The United States is the lone holdout country that has not ratified the IMF deal, which was struck more than three years ago. But many congressional Republicans have raised concerns about potential taxpayer risk with the IMF agreement.

It goes without saying that the IMF won’t give up, and the Obama Administration is still pushing to expand the international bureaucracy’s bailout authority.

The battle will continue. Lew and ObamaIn preparation for the next skirmish, Desmond Lachmann at AEI debunks the White House’s empty talking points.

Next week, Treasury Secretary Jack Lew will make his case before the House Financial Service Committee for linking IMF reform to U.S. bilateral aid for Ukraine. If the past is any guide, he will do so by putting forward a set of disingenuous arguments in favor of his case. …The principal argument that Secretary Lew must be expected to make is that IMF quota reform is essential for large-scale IMF Ukrainian financial support. This argument glosses over the fact that under the IMF’s lending policy under “exceptional circumstances”, which has been resorted to on many occasions since the 1994 Mexican tequila crisis, the amount that the IMF can lend a country bears little relation to the size of that country’s IMF quota.  …Ukraine is reportedly currently seeking around a U.S. $15 billion IMF economic adjustment loan. If Mr. Lew were to be candid, he would inform Congress that such an amount represents only around 800 percent of Ukraine’s present IMF quota or less than half the amount of quota that the IMF recently committed to several countries in the European economic periphery. He would also inform Congress that the IMF presently has more than U.S. $400 billion in uncommitted loanable resources. This would make the IMF’s prospective loan to Ukraine but a drop in the IMF’s large bucket of available resources even without IMF reform.

Lachmann goes on to make additional points, including the fact that IMF bailouts create very real financial risks for American taxpayers.

The U.S. Treasury never tires of assuring Congress that large-scale IMF lending poses no risk to the US taxpayer. It bases its argument on the fact that the IMF enjoys preferred creditor status and that to date no major country has defaulted on its IMF loans. However, the Treasury conveniently glosses over the fact that IMF loan repayment experience with past IMF lending on a small scale might not be a good guide to what might happen on IMF loans of an unprecedentedly large scale. To understand that there now might be a real risk to the US taxpayer from IMF lending, one only need reflect on the IMF’s current Greek lending experience. Greece’s public debt is now mainly officially owned and it amounts to over 175 percent of GDP. It is far from clear that the European Central Bank will go along with the idea that the IMF enjoys senior status over the ECB in terms of Greece’s loan repayments.

His point about risks to taxpayers is right on the mark. In effect, the IMF is like Fannie Mae and Freddie Mac. For years, defenders of intervention in the housing market argued those government-created entities didn’t cost a penny. Then they suddenly cost a lot.

The same will happen with the IMF.

Lachmann closes by asking the right question, which is whether there’s any reason to expand the IMF’s authority.

I think that’s the real issue. And to answers that question, let’s go to Mark Hendrickson’s column in Forbes.

He starts by noting that the IMF has “re-invented” itself to justify its existence, even though it supposedly was created for a world – which no longer exists – of fixed exchange rates.

Bureaucracies are masters of mission creep. They constantly reinvent themselves, cleverly finding ways to expand in size, scope, power, and budget. The IMF has perfected this art, having evolved from its original purpose of trying to facilitate orderly currency exchange rates as countries recovered from World War II to morphing into a global busybody that makes loans—with significant strings attached—to bankrupt governments.

And what do we get in exchange for being the biggest backer of IMF bailouts?

What has the American taxpayer received in return for billions of dollars siphoned through the IMF to deadbeat governments? Nothing but ill will from abroad. First, the IMF’s policy of lending millions, or billions, to fiscally mismanaged governments is counterproductive: Such bailouts help to prop up inept and/or corrupt governments. Second, bailouts create moral hazard, inducing private corporations and banks to lend funds to poor credit risks, confident that IMF funds will make them whole. Third, typical IMF rescue packages demand…higher taxes in the name of balancing the budget.

It would be far better, Professor Hendrickson explains, if reckless governments had to immediately accept the market’s judgement whenever they overspent.

…it doesn’t take expert economists to figure out when a government is overspending. Markets will discipline spendthrift governments by ceasing to make funds available to them until they institute needed reforms. Without a bailout fairy like the IMF, government leaders will quickly learn that if they wish the government to remain viable, they must spend within available means. By telling governments what they “have” to do when it’s obvious they need to make those reforms anyhow, the IMF gives the recipient government a convenient scapegoat. It blames the pain of austerity on meddlesome foreigners, and since the U.S. is perceived as the real power in the IMF, we get painted as the bad guys. The bottom line: IMF use of our tax dollars buys us a ton of resentment from abroad.

He also points out that the IMF makes a habit of suggesting bad policy – even for the United States.

the IMF has waged war against American taxpayers and workers. Last October, the IMF released a paper suggesting both higher tax rates (mentioning a “revenue-maximizing” top marginal tax rate of around 60 percent) and possibly the confiscation of a sizable percentage of private assets to restore fiscal balance to the federal government. The IMF also has been one of the leading forces discouraging “tax competition” between countries. …It is using American tax dollars to lobby the American government to increase the flow of tax dollars from our Treasury to the IMF. We shouldn’t be surprised, then, that the IMF released a report on March 13 warning of the perils of “income inequality,” and suggesting tax increases and wealth redistribution as ways by which Uncle Sam might address the problem.

So what’s the bottom line?

If the IMF really wanted to improve the economic prospects of the world’s people, it would recommend reductions in government spending and taxation. Indeed, the overwhelming evidence is that vigorous economic growth is highly correlated with a country’s government shrinking as a share of GDP. What are the chances that the IMF will ever advocate such policies? Not very, as we realize that the IMF’s very existence depends on government taxes. …In a better world, there wouldn’t be an IMF. For the present, though, the best we can hope for is for enough members of Congress to understand that the IMF’s interests are opposed to those of the American people and to refuse any requests that the IMF makes for increased funding.

The Wall Street Journal is more measured in its rhetoric, but it basically comes to the same conclusion.

Republicans are reluctant to grant more leverage to European countries, which they blame for relaxing rules on Greece’s bailout in order to rescue the continent’s banks. …An internal audit last week also found that the fund’s growth forecasts were “optimistic” for countries like Greece and Ukraine that were granted larger loans under its “exceptional access” framework. Republicans fear the IMF is becoming a discount borrowing window for spendthrift governments trying to postpone reforms. IMF economic advice is often lousy—raise taxes and devalue… Congress ought to debate whether the IMF has outlived its usefulness as it evolves from a tool for Western interests into a global check-writing bureaucracy.

Amen. Which is why the United States should shut the Treasury door to the IMF. If other nations want to subsidize bad policy and promote bigger government, they can do it with their own money.

P.S. Here’s a list of other IMF transgressions against good public policy (all partially backed by American taxpayers).

Endorsing government cartels to boost tax and regulatory burdens.

Trying to undermine flat tax systems in Albania and Latvia.

Encouraging a “collective response” to over-spending in welfare states.

Pushing for higher tax burdens in Greece.

Seeking the same destructive policy in Cyprus.

Advocating for more centralization and bureaucratic rule in Europe.

Urging higher taxes in El Salvador.

Supporting “eurobonds” so that taxpayers from other nations can subsidize the profligacy of welfare states such as Greece, Italy, and Spain.

Pushing an energy tax that would mean $5,500 of added expense for the average American household.

Reflexively endorsing every possible tax increase.

Aiding and abetting Obama’s “inequality” agenda with disingenuous research.

And remember, these pampered bureaucrats get lavishly compensated and don’t have to pay tax on their bloated salaries.

P.P.S. But let’s be fair to the IMF. The bureaucrats have given us – albeit unintentionally – some very good evidence against the value-added tax.

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