Why Europe can't let a reckless Greece off the hook

Other countries that use the euro want to see proof that Greece is taking painful austerity measures before they spell out what a rescue might look like. It's a return to concern about 'moral hazard' -- which got trampled in the rescue of the US financial system.

Bail out first, repair later. That’s the approach the US was forced to take during the financial crisis that erupted in 2008, and now the country is seeing how vigorously a rejuvenated Wall Street is resisting the fix, i.e., tougher regulation. 

This lesson has not been lost on Europe, which is facing its own existential financial crisis. This time, not an industry, but a country has seriously misbehaved. 

Greece has run up a government budget deficit that’s nearly 13 percent of its economy, or gross domestic product – more than four times what’s allowed for the 16 European Union countries that share the euro currency, which was introduced in 1999. Concerns about a possible Greek default on its debt have roiled the bond markets and dragged down the value of the euro. 

Leaders of the EU have said that their currency union members will in theory support Greece, but they won’t spell out the details of that support until they see proof that Greece will implement painful austerity measures to radically reduce its deficit. 

Repair first, bail out later, seems to be the EU’s sentiment.

It’s a wiser approach made possible only by the fact that Greece has an austerity plan on the table – and a bit of time to show that it’s serious about fiscal reform. It doesn’t need to refinance its debt until the spring, and indeed, the EU has given Athens a month – until March 16 – to demonstrate that it’s on the right fiscal track. By contrast, in the fall of 2008, US officials had neither a preconceived plan nor time as Wall Street giants teetered from one weekend to the next.

Demanding sacrifice from Greece upfront at least somewhat revives concern about “moral hazard” – that parties don’t consider risk when they’re insulated from it. Last year, worries about moral hazard largely evaporated when various countries rescued several financial firms (Lehman Brothers being the big exception) without asking for much in return.

The concern needs to be revived, for if a country deemed “too important to fail” gets away with continued unchecked public spending (and, in Greece’s case, bookkeeping shenanigans), so, too, will other big-debt countries that use the euro, such as Spain, Portugal, and Italy. A tougher European stance, meanwhile, will hopefully convince other countries wishing to join the eurozone that membership actually requires something of them.

Even so, there’s no guarantee that the EU’s hard-line approach will work. What’s required in Greece is a complete overhaul, not a tune up. Can Greece do that without unleashing massive social unrest? Athens plans to freeze public-sector salaries (in a spending binge, it about doubled them in the last decade); raise the retirement age for the public pension system by two years to 63; and raise taxes on fuel, tobacco, alcohol, and property – but these measures may not be enough, as other eurozone members suspect. Widespread tax evasion, for instance, is a big problem.

Another unknown: Even if Greece shows that it’s serious, will its rescuers be able to deliver? The terms of the European monetary union don’t actually allow for a bailout, so some creative solution would have to be found. And the politics are tricky indeed. Germany, the largest economy in Europe, would likely bear the biggest burden with Greece, but its population is dead set against a bailout. Why should Germans have to pay for Greece, when Greeks would get to retire at 63, while Germans have to tighten their belts and have to wait until 67? 

Beyond the issue of moral hazard lie questions about the viability of the monetary union itself. 

The euro has tremendous benefits. One currency instead of many currencies eases cross-country commerce and travel. But the currency union also has serious underlying flaws. A single interest rate and a single exchange rate have a hard time meeting the needs of highly diverse member countries. And these countries all have independent national budgets, whose profligacies have been able to hide behind the euro (until now, that is). 

The impulse toward a more unified Europe, so strong in the 1980s and ’90s but challenged in recent years, will be further slowed by this crisis. Indeed, a poll shows that 92 percent of the Dutch want Greece to leave the monetary union. (It can’t be legally kicked out, but it could leave voluntarily.) 

If Greece wants other users of the euro to help with its debt problem, it has much to prove between now and March 16. That Europe is insisting on such proof is a healthy sign.

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