Greek government debt and the iron law of finance

Alex J. Pollock

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The Greek government has now added unwillingness to pay to its inability to pay as agreed. This insolvency gives us the chance to contemplate anew some timeless financial truths.  The first is the iron law of finance: Debts which cannot be paid will not be paid. As soon they cannot be paid, the economic losses to the creditors have already happened. As one observer correctly exclaimed, “Wake up, Europe—you have already lost the money!” But who exactly does “you” turn out to be?



The second truth is that all the rest of the protracted debates, agony, and negotiations, which may go on for years, are about which parties, including taxpayers, will be stuck with how much of the already-existing losses. Insolvency proceedings, whether under a national bankruptcy regime, or in free-form international negotiations, are all about this. A difficult question in this context, especially for losses on government debt, is that if banks become themselves insolvent through the losses they must take, how much should the creditors and depositors of the banks share in the losses in their turn?
The third truth is that banks, central banks, government regulators, and politicians all have a powerful interest in accounting procedures which hide or obscure the losses taken, and push them off into the future. A striking historical example of this are the orders given by then-Federal Reserve Chairman Paul Volcker in the global debt crisis beginning in 1982: that American banks were not to write down their loans to insolvent sovereign borrowers, not to classify them as nonperforming loans, and indeed were to keep lending them even more to keep the game going. The debts were finally restructured under the Brady Plan of 1989.
We can expect the debates over sharing out the losses on Greek government debt to go on for a long time