Greek Roll-Over

Includes: GREK
by: John Cochrane

The latest Greek debt "crisis" poses an interesting puzzle. (Quotes because it's hard to call something that's been going on this long a "crisis.") Greece needs to come up with $300 million euros by Friday to pay off the IMF. And the most likely source of this money is... the IMF.

What's going on here? Obviously, Greece was going to need decades to pay off loans, in the sense of running primary surpluses to actually work down debt. Why lend Greece money for a short amount of time, then institute regular "crises" about rolling over the debt?

This is part of a larger question. In "A new structure for U. S. Federal debt" I thought about the same question for the U.S. Why does the U.S. continually issue new debt to pay off the old debt? Why not just issue perpetual debt, which automatically rolls over? For the U.S., I couldn't come up with a decent reason.

For Greece, there is a good reason. Yes, in the end, the IMF will most likely lend Greece the money to pay back the IMF. Or maybe the ECB will lend Greece the money to pay back the IMF. But both sides will renegotiate the terms.

The IMF and Europe lent money to Greece with conditions that are politically painful, but that are beneficial for Greece and for the chance of the money being paid back eventually, at least in the IMF and Europe's eyes. (I don't agree with all the conditions, especially tax increases, but the point here is the negotiation not the wisdom of the terms.) By lending for a year and then renegotiating, they can enforce that Greece actually follows through on the conditions.

If you are going to lend money to a spendthrift relative you might want to do the same thing. Limit the time of help, and in a year we'll see if you're really cleaning up your act.

But this is a two-sided renegotiation. They can only impose conditions if the costs to them of allowing a default are not too large. And Greece will only take the conditions if the costs of default to them are large. So it is in Greece's interest to make its default as painful to the rest of Europe as possible.

Also by calling it a roll over, though, Greece had an interesting option -- if it didn't like "austerity," it could try other means of reviving their finances and paying off the debt. It's too late for that one.

Doug Diamond and Raghu Rajan in a series of papers have been arguing that short-term debt allows lenders to monitor and discipline the borrowers. "Short" here can mean years, any debt that has to be rolled over a few times before being eventually paid off. This situation seems like a good instance of their theory.

Back to the U.S., though, this does not strike me as a good argument that the U.S. should voluntarily issue debt that needs to be rolled over. So I'm still in favor of perpetuitites for the U.S.

The Wall Street Journal's Greek Debt Timeline is an interesting perspective on this issue. I excerpted the full set of payments, and the payments due in 2015 and 2016 below. Of course, as debt is rolled over, new payments take the place of old ones.

Except "treasury bill holders," the debt until 2020 is almost all due to governments. A small slice of "private investors" starts showing up after that. So for the next 5 years, this really is about IMF and ECB lending money (presuming nobody else wants to) to pay back loans to the IMF and ECB.

The 2015 and 2016 graphs make it even clearer. All the loans are to IMF, ECB or EIB.

But..What about these Treasury bill holders? There is this huge slice of debt that needs to be rolled over this summer. Who is going to do that? Who is holding this debt?